Cullen/Frost Bankers Inc (CFR) 2014 Q4 法說會逐字稿

Welcome to the fourth quarter 2014 and annual results conference call. I would now like to turn today's call over to Mr. Greg Parker, Executive Vice President and Director of Investor Relations.

Thank you, Shannon. This morning's conference call will be led by Dick Evans, Chairman and CEO, and Phil Green, President of Cullen/Frost Bankers, Inc., and Jerry Salinas, Group Executive Vice President and CFO. Before I turn the call over to Dick, Phil, and Jerry, I need to take a moment to address the Safe Harbor for 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.

Thank you, Greg. Good morning and thanks for joining us.

It's my pleasure today to review 2014 fourth quarter and annual results for Cullen/Frost. Our new Cullen/Frost President, Phil Green, and new Chief Financial Officer, Jerry Salinas, then will provide additional comments before we open it up for your questions. The separate announcement today concerning Phil, Jerry, and other expanded executive team roles is available on your website if you have not already seen that.

I'm pleased to report for 2014 that Cullen/Frost had record annual earnings with double digit increase increases in loans, deposits and net interest margin. We also maintained our strong and positive credit quality, received respected third-party recognition as one of the nation's best banks, topped $28 billion in assets for the first time in the Company history. This strong and consistent results are a credit to all our dedicated employees and strong value proposition.

During the fourth quarter 2014, our net income available to common shareholders was $70.7 million, a 16.7% increase. This was $1.11 per diluted common share compared to $0.99 for the fourth quarter of 2013.

The Company reported 2014 annual net income available to common shareholders of $269.9 million, a 16.8% increase over 2013 earnings of $231.1 million. On a per-share basis, 2014 earnings were $4.29 per diluted common share compared to $3.80 reported in 2013. For the year, return on average assets and common equity were 1.05% and 10.51% respectively compared to 1.02% and 9.93% reported in 2013.

Also in 2014, we completed our acquisition of WNB Bancshares to add the Permian Basin to strengthen our Texas franchise. WNB, like Frost, had a relationship culture with outstanding employees, so the integration process has gone even better than we expected. WNB loans of $671 million and deposits of $1.6 billion were included in our results from the closing date of the acquisition, May 30th 2014.

Deposit growth for the Company remains strong among both existing customers and new ones. Fourth quarter average deposits rose 17.9% to $23.7 billion from the $20.1 billion a year earlier. Average total deposits in 2014 rose to $22.1 billion, up $2.8 billion or 14.5% from 2013.

Turning now to net interest income, which on a taxable equivalent basis for the fourth quarter of 2014 was $212.6 million, up 15% from a year earlier. Our increase in average volume of interest-earning assets was partially offset by a decrease in the net interest margin. The net interest margin was 3.34% for the fourth quarter of 2014 compared to 3.39% for the third quarter of 2014 and 3.39% in the fourth quarter of 2013.

The decline in net interest margin primarily resulted from end, during October, of the amortization of our interest rates swap contracts. We said we would offset the loss income from the swamp and we did through our strong liquidity. I commend Phil Green and his team for their great work on this amid persistently low interest rate environment. For 2014, the net interest income on our taxable equivalent basis increased to $807.9 million, up 13.7% over 2013.

Now looking at non-interest income for the fourth quarter of 2014, it was $82.6 million, up 5.2% from a year earlier. Trust and investment management fees were $27.3 million, up $3 million or 12.5%, resulting from higher investment fees, estate fees, and oil and gas fees. For the entire year, non-interest income was $320 million, up 5.7% over 2013.

Looking now at non-interest expenses for the fourth quarter 2014, they were $169 million compared to $154.5 million in the fourth quarter of 2013. Salaries were up $5.7 million over the same period a year earlier from an increase in the number of employees and normal merit and market incentives increases. The WNB acquisition added to our employee count and we are grateful to have those new employees on our team.

Turning to loan demand, our loan growth remains strong thanks, in part, to our discipline team culling efforts. Fourth quarter 2014 average loans increased 16.7% to $10.9 billion, from the $9.3 billion reported a year earlier. For the year 2014, our average total loans were $10.3 billion, up 11.6% from the $9.2 billion in 2013.

Permian Basin loans at year end were $686 million and remained relatively flat from the closing date of May 30th, when loans were $671 million. This speaks well of the integration process.

Excluding partial year data from the Permian Basin, 2014 was our best year ever for new relationships, new loan opportunities and the best since 2007 for new loan commitments. Interestingly, energy was not a driver in 2014 commitments. New relationships added since January 2013 accounted for 56% of our loan growth in 2014 and 87% of our growth in loans less than $10 million.

In 2014, we grew our combined revolving lines and construction commitment loans by 13.2%, while balances under these commitments increased 19.1%. As you know from previous quarterly discussions, outstandings growing faster than commitments is what we've been waiting for.

The ratio of lost opportunities, due to pricing versus structure, shifted from pricing in 2013 to structure in 2014. We're pleased by that, because that means we're competitive on pricing without sacrificing credit quality.

Our credit quality is strong. All traditional measures of credit quality are positive. Non-performing assets at the end of 2014 represented 0.59% of total loans, at a lowest level since September 2008. Delinquencies ended the fourth quarter at 0.58% of period end loans. Net charge-offs during the fourth quarter were $3.2 million, and for the year represented nine basis points of average loans.

Well now for the 800 pound gorilla. We obviously are focused on the recent decline in energy prices and are in close communication with our energy-related customers. It's still too early to know where prices will go, how long they will stay at the lower levels. Nevertheless, we believe that our conservative underwriting and strong credit discipline positions us well for the challenging environment.

Only two energy related loans have been noted as problem loans. The first is a home equity loan to a borrower who is in the industry. The second was noted as a problem loan at WNB and was properly recognized and discounted when the acquisition was closed. In total, these two loans represent less than one-half of 1% of our energy portfolio.

No energy loans are currently on non-accrual. One additional loan is on the watch list, but that credit has been noted for several periods as we have visited quarterly.

The allowance methodology, by its construct, has increased the general reserve for energy industry primarily through environmental components of the model and as a result of some credit migration within the past components. As the year end 2014, more than 10% of the allowance total is associated with the energy portfolio.

We recently contacted and visited with more than 90% of our energy-related customers based on committed dollars. The result is, no energy additions were made to our problem loans since the third quarter.

Customers were preparing for decreased revenue and margins and have developed formal operating plans to deal with these declines. Specifically, borrowers have contingency plans in place and are prepared to reduce overhead and employees when needed. Additionally, they are reaching out to their customers and suppliers to adjust their cost structure.

Outstanding energy loans represent approximately 16% of our total loans. Energy credits total $1.8 billion at year-end.

The largest segment of our portfolio are as follows: $1.1 billion in production; $319 million in service; $85.5 million in transportation; $76.7 million in manufacturing. In regard to our production base borrowers, it is important to note that our current price-deck projection has oil at $50 a barrel for 2015 with some escalation through 2019 topping out at $70.

Our borrowing base is 65% of the discounted cash flow stream that results from the price deck. The price deck for most of 2014 was higher than the current one. However, given our 65% discount to determine the borrowing base, the 2015 price of oil that we use to establish commitments was $52.

Many of our customers have hedges in place. In 2015, 41% are hedged with an average hedge price of $89.50 for oil and $4.09 for gas. In addition, 15% of our customer production is hedged in 2016 at $87.25 for oil and $4.01 for gas.

Some customers are liquidating their hedge positions and are paying down debt. Others are evaluating the merits of such action. A vast majority of the hedge counterparties for our borrowers are money center banks, big regionals and some large Canadian banks.

We recently conducted a pricing stress test on certain of our customers. In the test, we reduced the price of oil to $37 in 2015 and maintained a sub-fifty number through 2018. We recognized the benefit from hedges in place, but did not adjusted the borrowers cost structure. This exercise covered approximately 90% of our year-end outstanding production-based credits which are a little over $1 billion. The result reveal potential exposure of approximately 7%. When you consider each borrowers financial capacity, such as liquidity and other assets beyond the actual production, that potential exposure is less than 1%.

There are many variables and lots of unknowns. But this is what we know today based on the analysis I just described.

Now, regarding nine production base customers and service manufacturing and transportation. The majority of these borrowers expect revenues to decrease 30% to 50%. Our borrowers leverage is not excessive, less than three times, and most cases we are the customers only bank.

No significant concentrations were noted in regard to our customers' customer. They have plans in place to adjust overhead and personnel.

It's important to remember the location of services can impact revenues and expenses. The Permian Basin, and Eagle Ford Shale and Texas, in general, are considered to be the most favorable areas to operate. Low cost structure, developed infrastructure, help offset the cost of lower commodity prices. Operating in multiple regions creates diversity. By definition, that creates flexibility.

Based on location of our operations, more than 80% of our customers operate in an environment that are best positioned to sustain volatile commodity prices. 43% of our energy-service customers operate in the Permian Basin and our Eagle Ford Shale, 10% operate in other areas in Texas, 28% operate in multiple regions in America.

You've heard me say before, we don't loan on oil and gas. We loan to people who happen to be in the oil and gas industry, principally, people who are established and experienced in the industry and have been through multiple downturns.

Our energy line of business officers, cumulative, possess nearly 400 years of experience, and several member of our executive team have worked through other volatile times in the energy industry. Even so, we recognize that a prolonged duration of lower oil prices could increase the number of problem loans and charge-offs. But because we have maintained our strong underwriting standards and credit disciplines, we believe any resulting problem loans can be addressed in a rational and proper manner. While surprises can always happen, we believe we are about as well positioned as we could be to withstand turbulence-falling energy prices.

Let's look at our capital levels, because they are strong. Tier 1 and total risk-based capital ratios for Cullen/Frost are 13.68% and 14.55% respectively at the end of the fourth quarter 2014 and are in excess of Basel III fully phased-in capital requirements. The ratio of tangible common equity to tangible asset remains strong at 7.39% at the end of the fourth quarter 2014.

2014 was another good year for Cullen/Frost. As the national economy was recovering, we were reaping the benefits of our consistent and focused efforts to grow the Company through the downturn. We also delivered our commitment to outstanding technology service and convenience.

We added new functionality to our top rated mobile apps for iPhone and Android and introduced industry-leading debit card fraud alerts. We expanded our ATM network through branding partnerships and Frost has one of the largest ATM networks in the region we serve. We opened new financial centers in Dallas and Houston, relocated and renovated several older locations and expanded into Midland and Odessa through the WNB acquisition.

For the fifth consecutive year, JD Powers and Associates ranked Frost highest in Texas in retail banking customer satisfaction. Frost also was named JD Power customer champion as a one of 50 US brands cited for service excellence. Greenwich Associates awarded Frost with 21 Greenwich Excellence Awards for superior performance and overall client satisfaction and other relationship and service categories in small business and low market banking. And in late December, Forbes ranked Cullen/Frost among the top 10 best publicly traded banks in the country.

In 2014, we expanded our customer base and brought value to our shareholders, paying an increase in the shareholder dividend for 20th consecutive year. The dedicated employees at Frost deliver on our value proposition and live our culture each and every day. I thank them for their commitment, which makes our success possible.

I continue to be optimistic about our Company's future. Consumer confidence is up in part because of lower gasoline prices. This is a positive, especially for middle-income and low-income individuals.

There's been a lot of talk about how the lower oil prices will affect Texas, but this is not the Texas of the 1980s, which was overly reliant on the energy industry. Texas is extraordinarily diverse and a dynamic state with GDP higher than the entire country of Australia.

In 2014, Texas added more than 350,000 new jobs and only 2.6% of them were in the oil and gas extraction and support business. Texas employment growth is broad-based across income groups and industries such as manufacturing, professional and business services, exports and trade, transportation and utilities. Since the beginning of the recession, Texas labor force has grown at a rate 10 times higher than that of the US labor force.

Texas continues to be the top migration destination for other states. Even with lower projected energy prices in 2015, the Dallas Fed estimates Texas job growth will still be between 2% and 2.5% this year, at least on par with US average. We are pleased to see that energy companies are adjusting quickly to the lower energy prices. Market forces are working as they should.

At Cullen/Frost, we continue to focus on basics. We're reaching out to new and existing customers to expand our customer base. Our credit quality is strong because we stay true to our principles and lending disciplines in all markets cycles.

Our capital levels are excellent. We have money to lend. We remain focused on our value proposition, outstanding culture and excellent customer service. And we continue to deliver steady and superior financial performance for our shareholders.

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

Think you, Dick.

With all the folks on energy prices and the challenges that might be presented because of it, it is easy to lose sight of that the fact that, not long ago, a lot of discussion centered around how we planned on recovering from the loss of $36 million a year in net interest income when the gain amortization from our prime interest-rate swap was completed. Well as scheduled, that income went away in the fourth quarter, beginning in November.

Also, as we've outlined in the past, our plans have been to utilize excess liquidity built up in our balance sheet to invest in municipal securities with our investment strategy in order to continue to replace this income. In effect using actual liquidity reinvestment to replace unnotional maturity. Our investment division did a great job acquiring $717 million in municipal securities during the quarter which made up the lion's share of the investments needed.

Also during the quarter, we invested $1.4 billion in additional liquidity into US treasury securities, about two thirds of which were five year maturities in a third and seven year maturities. These purchases were prompted by continued strong liquidity fueled by strong deposit growth and our view of value at that point of the yield curve in the current economic environment. They have proved to be advantageous to this point and we think they are likely to be as they roll down the yield curve over time. At the end of the day, after our investment activity, we continue to maintain strong liquidity, including about $3 billion at the Fed, and investment portfolio representing half munis and have treasuries and agencies in a balance sheet with overall asset sensitivity.

Just a couple of comments that our balance sheet volumes. Our loan volume was solid for the fourth quarter. On a period end basis, our loans for the link-quarter were up an annualized 9% with all the growth coming in the C&I component. San Antonio, Houston, Dallas and the Permian Basin were all up in excess of 10% annualized. Other markets reflect a slightly down, due mainly to strong pay downs during the quarter. Average deposits were also very strong on both a year-over-year and link-quarter basis, up 17.9% and 16.6% respectively.

Looking a little deeper at our annual growth, and not including the WNB acquisition, almost half of our growth, 47%, was from new deposit customers. We think that's a good number, but it was a little bit lower than recent quarters where it spent 50/50, or a little over half, from new customers. We've continued to do a good job bringing in new deposit relationships but we've seen an increase in deposit growth from existing customers. And while, yes, we do operate in Texas where energy is an important industry, that deposit growth has been very diversified.

For example, of all the augmentation for existing commercial accounts over the last year, only 5% of the total growth came from the mining sector, which is basically oil and gas. Also, of the 25 relationships that had augmentation in excess of $10 million versus a year ago, only three were from the oil and gas sector. I think this helps demonstrate Dick's point about the diversity of the state and our approach to doing business in Texas.

I'm going to turn it over now to our CFO, Jerry Salinas for some additional comments.

Thank you, Phil. I'm going to make a few additional comments about the quarter, and then I'll discuss our guidance for 2015 before turning it back over to Dick for questions

Summarizing the quarter compared to a year ago, we did see net interest income on a TE basis grow 15%. Provision for loan losses was down $1.5 million and it exceeded our net charge-offs by $1.2 million. Non-interest income grew 5.2%, and if you take out the $1.2 million in securities gains that we recognized in the fourth quarter last year, non-interest income growth was over 6.8%.

Non-interest expense growth was affected not only by our acquisition of Western National in the second quarter last year, but also by a $1.4 million increase in fraud losses, some of which was associated with high visibility breaches that have been reported in the media. We also saw an increase in sundry losses of $1.1 million during the quarter. In addition, we continue to focus on expanding our business as we saw an increase in advertising and marketing costs of $2.2 million.

Our effective tax rate for the quarter was 17.6%, down from 19.1% recorded in last year's fourth quarter, and continues to be favorably impacted by our purchases of municipal securities. Net income grew a solid 16.7% compared to a year ago. As Phil mentioned, our net interest income was up on link-quarter basis, as we were able to offset the loss of the deferred gain amortization with investment purchases. The loss of the income for net deferred gain did have an impact on our net interest margin for the quarter, which was 3.34%, down five basis points on a link-quarter basis.

That five basis point decrease is affected by some positive factors and some negative factors. On the negative side, we did see a drop in our loan yield during the quarter. The lower loan yield negatively impacted our net interest margin by about 14 basis points. The lower loan yield was mostly due to the swap gain, which ended in October. Also affecting our loan yield in the quarter were lower purchase discounts related to the WNB acquisition and interest write-offs combined with some pricing pressure.

On the positive side, as Phil mentioned, we deployed some of our excess liquidity into investments, which resulted in average investment securities increasing almost $1.1 billion on a link-quarter basis. In addition, we saw good growth in loans, on a link-quarter basis, with average loans up $298 million or 11.2% on an annualized basis.

Average deposits increased $946 million and, combined with the redeployment of liquidity into investments and loans, allowed us to reduce our excess liquidity about $440 million on a link-quarter basis. This repositioning of our liquidity into higher-yielding assets had a favorable impact of about nine basis points on our net interest margin compared to link-quarter partially offsetting the negative impact of losing the swap gain amortization.

In conclusion, given our current view of the economy and our expectation that interest rates will rise modestly in the second half of the year, we currently believe that the 2015 mean of analyst estimates of $4.56 is reasonable. With that, I'll turn it over to Dick for questions.

Thank you, Jerry and Phil. We'll be happy to entertain your questions now.

(Operator Instructions) John Pancari, Evercore ISI

Of course, don't want to start on energy here. So did you say, Dick, that there was a shift in the loan loss reserve allocation this quarter from unallocated to energy?

No, I didn't say that. What I'm saying is that the normal-- what I'm pleased about, just the normal methodology allowed us for it to build on energy because of-- in the unallocated. And what I said is, it built up to about 10% of the total reserves, and basically it doubled from about 5% to 10%.

I'm trying to understand, what would you say, as part of reserve right now, is the portion that is specifically allocated to energy?

Because -- you heard the discussion I went through on the specific loans, it would be very nominal. If any. This is all in the general. Are you with me?

Yes.

We've looked and talk to these customers, you heard me say there's no energy additions to the problem loans. What you've got is the methodology and allowances working the way it ought to work. If you have an industry that starts to get weak, it should pull more of the reserve.

That's all that's happened. There are no specific problems that we've identified, even though we have gone through in a detailed discussion and stressed the customer. Are we together?

Yes. Now we have seen other banks significantly increase the qualitative component of their reserves given the decline in oil prices.

I don't worry about other banks. I'm telling you what we've done, and have other banks gone and talked to each of their customers in detail, seen their plans, and I am telling you the results of that.

Got it. Now regarding what you have stressed, you stressed 90% of the portfolio you indicated. Are you currently stressing the remaining 10%? And how does that 10% different than the initial 90 that you did?

Don't get into that. It doesn't make any difference.

The 90%-- my whole point is, like any stress test is to-- The point you should have heard, because it's a point I hear from the stress, is because it says: do we have any problems at those kinds of prices? You may remember that for years I've been telling you that in addition to the base cases on energy that we've done, and as a result of our experience in the 1980s of surviving, we added another component of sensitivity. And the 65% loan base, and all those kinds of things, we then took 75% sensitivity.

The prices you heard me talk about, of a stress test, we just said: let's see what the values are at the sensitivity of 75%. That's where you start with 37% and you don't go over 50%. And basically when you went down in commitments, to $5 million commitments, you get 90%.

So I'm not trying-- the whole point that I'm trying to make is, I think this is a very good analogy. This is just a stress test, and I'll be honest with you, I'm surprised it was as good as it was. Do you understand what I'm saying?

Yes. On the loan side, are you seeing any impact on energy loan demand or any change in borrower behavior amid the pullback in oil prices?

Not yet, not really. I would tell you that things are going to slow, particularly in the first 90 days to six months of this year. Because what's going to happen, I told you that our service companies expect their revenues to be down 30% to 50%. That's a pretty good drop.

So what's going to happen, people that were running four rigs are going to two or one. You've seen the rig counts, they're coming off pretty fast. Quite frankly that's healthy. I am surprised that unlike the 1980s, where people stayed in denial much longer, that is not happening today. I will tell you they're cutting costs fast. And that is healthy to get that cost cut out of there. I think we're in a healthy process of where it's going.

Brady Gailey, KBW

When you look at the loan growth that you all had in the fourth quarter, it looks like most of it was energy related. I think energy went from 14% of loans to 16% of loans. So it's, I hear your, longer-term, it's going to be a negative for energy lending, but it sure doesn't seem it was a negative in 4Q. Was most of that growth driven by a heavier utilization of existing lines? Or new energy customers?

In fact, the growth is very little. I understand where you're getting your numbers, because I'm the one that told you we had a round number of around 15% and 16%.

Be careful with that conclusion, because the facts are that energy did not grow, except there was a greater usage of the lines under those commitments. Which is to be expected as they started to come down and to finish the drilling programs before they shut the rig down. That is in the normal. So to say that it's growth because we have got a lot of new customers is incorrect.

When you look at the $1.8 billion that's on the books at year-end, was a lot of that SNIC balances, and if so, what percentage? How much of that book is snicks where Frost is not the lead?

The total shared national credits were $470 million at the end of the year for energy. The big majority of those were not the lead.

Lastly, with the bond purchases you all put on in the quarter, did that change the duration of the bond book much?

It changed some. The portfolio duration went from the end of the third quarter's four years they went to 4.4%.

Steven Alexopoulos, JPMorgan

Dick, the outcome from the stress test that you discussed, the 7% exposure you referred to, what exactly was that number? That's not a charge-off rate. Is that the percentage of loans that moved into nonaccrual. I just want to understand what that number was.

Remember, this is just a test to see a proxy of what you get. What that is-- we just took those numbers: $37 oil in 2015 and below $50 oil out to 2018. So remember we are talking about four years.

Over that for your period of time, at $37 and below $50, and with nothing else taken into consideration, yes, you would have an exposure of 7% of about $1 billion. But when you consider the other responsibility of the borrowers, which is how we make our credit decision because we don't just loan on the energy. We together?

Let me give you an example, in those dollars of that potential exposure, here is a customer that owes us a $65 million. It had its stress test exposure as a part of that 7% of $7 million. That borrower has $50 million to $75 million in cash in the bank. You with me?

You've got another one that part of that exposure, the borrower has begun selling non-core assets to reduce the debt and has a guarantee of another part of his Company. And so when you go through the total assets, that's a reason we loan to people and there are other things. You get that exposure down to 1%. Now did I answer your question?

Yes, that example is actually very helpful. Maybe -- it's interesting because, you said you were in close contact with your customers, and what we are hearing from peer banks, I know you don't like to hear about peer banks. But what we're hearing from peer banks is that they have to wait until March and April until we get financial statements and they're just guessing what the impact would be.

When you talk to your customers, are they actually cutting expenses and going to that contingency plan now? Or are they waiting to eventually see where oil prices stabilize?

No. It started in January, and you're going to see this continue to be hard and fast. That's what I mean by people not being in denial. That drop is going to be-- is today happening as we talked and started before.

And it'll be hard and fast, and that's good. You're going to get the weak players out of the market, they're going to go broke. You're going to get the cost down. You're going to adjust real quick to reality.

There's a couple things let's not forget. It wasn't many years ago that oil and gas was at $40, $45. And you know what, the people made a lot of money. And so this is going through the construction-- just adjusting down. We've also got a lot of equipment out there that ought to junked, and it will be junked at these lower prices.

And the other thing I've talked about, quarter after quarter, is we couldn't get any skilled labor. Let me tell you, this is good news. Because, I tell you, if you could do the job, you are going to have a job. Those that were not that good are going to be out of work, which is good. So this industry needed cleaning up.

And last but not least, I can't tell you how many calls I get of funds and individuals wanting to buy some problems. I don't have any problems to sell them. That's the good news. But there is tremendous money and capital on the sideline waiting to take advantage of these.

Maybe to follow up on that, all of these disclosures you are providing illustrate why Frost is so differentiated, right? And why you perform so well in other periods of price shocks. Now in your opinion, do you see that other banks have learned lessons from the past? Do you just think the industry is better positioned today to deal with this price shock?

Let me tell you, I have spent 100% of my time worrying about Frost and I haven't been worrying about those others. I'm sorry I can't help you there.

Just a final one, are any of the changes being made to credit or risk management, does it have anything to do with pressure on the energy portfolio at all?

Absolutely not. This started at the beginning of last year. I've been working, and it is just a continuation of what this Company's done for over 100 years to be sure that we continue to expand and grow responsibility. But it has nothing to do with this oil and gas.

Ken Zerbe, Morgan Stanley

First question, just in terms of expenses, it looks like they ticked up a fair amount this quarter. I think I heard you mention something about $1.5 million of fraud losses. When you think about going, aside from first quarter seasonality going into 2015, is $169 million roughly a good rate or was there other unusual items in there that may bring it lower?

Brady, this is Jerry. We don't give a lot of granular guidance, but I can talk to little bit about what's happening with expenses and let you get a feel for it.

We will have higher compliance costs in 2015 as we work towards meeting our agreement with the Federal Reserve in conjunction with their approval of Western. We saw lower rates at the end of the year, which resulted in us using a lower discount rate on our pension plan. And as a result, we actually had income in that plan this year, in 2014. We'll actually be recording expense in 2015.

Last quarter, Phil also mentioned that we were opening an Operations Center here in San Antonio, which is going to bring together quite a bit of our back-office staff. And then, we're just a growing business, it's going to continue to grow our franchise and our value proposition. That's about all I could tell you about expenses going forward.

That is still very helpful. Quick question on the deferred accumulated gain on the swaps, I'm assuming that most of that's one time. What is the residual impact that we might see on margin in first quarter?

I'm not sure what you mean on the one-time, let me just say what it was. It had been like $9 million a quarter, in round numbers it was $3 million a quarter, in the fourth quarter because we only had one month of amortization. So there is one month of amortization more than you'll see in the first quarter of 2015, so that would be the residual impact I would say.

Yes, Brady. We think that is about 4 basis points, just given one month.

It's Ken. But okay. Understood. I will take out the $3 million. Thank you.

Dave Rochester, Deutsche Bank

If you could give some more detail on those muni and treasuries purchases. I've got the amounts, but if you have the rates and terms on those. And then if you could just talk about your Outlook on muni purchases for the year going forward that you've got baked into your guidance, that would be great.

On the seven years, we bought, as I mentioned, it was about a third of it, $500 million for seven years. The yield on that, [2.05] in December, and then of the remainder, which had been $900 million, which is in the five year point of the curve, it averaged about a [165], both of which looked pretty good given the current market.

Again, we feel like they'll do well for us given our view of what's likely to happen to the yield curve. And then don't forget, as those things run down the yield curve, roll down the yield curve, we expect them to be advantageous for us, as well.

And then on the muni side?

On the muni side, we bought the $717 million that we did in the quarter at an average tax equivalent yield of 4.65%, average term of 23 years. But remember the way we buy these things, they were all 10-year callables, are virtually all of them were 10-year callables. They are high coupons, higher than on the run coupons, so we got fairly high certainty of call for these.

I appreciate all the color on the energy portfolio and your credit process there. I was just wondering, do you have any concerns about the Texas muni portfolio at this point? As you just talked about your exposure there to certain regions of Texas that might be harder hit by the drop in energy prices. I know you've got some insurance on a good chunk of that, so just any additional color there would be great.

No, not worried about that at all. The 65% of our portfolio, or as you said, insured, which is the Texas PSF: Permanent School Fund, which continues to have a better credit rating then US Treasuries literally. Most of the rest of it, we've got some State of Texas exposure which we feel extremely good about the State of Texas. Only 2.5%, roughly, is outside of Texas and those are states that you'd know to have very conservative fiscal situations and are state up names.

We really don't buy-- The thing you might be referring to is, let's say you have a revenue bond -- and I don't know anything specific about these examples. Let's say you had a revenue blank in Cotulla, for a hospital or something, to take care, and that they were counting on energy-related revenues. That might be the kind of thing you're talking about, we don't buy those kinds of things.

We don't buy revenue bonds, first of all. The only very specific example, like maybe University of Texas dormitories, Texas A&M dormitories, that kind of thing. We're really not in that part of the market. There could be some issues in some of the smaller markets but we're not there.

Thanks, just one more on the loan pipeline and your guidance for 2015. How are you thinking about loan growth for the year? You pointed to some slow incoming. Do expect to see any run-off at all in the energy portfolio this year? Is that baked into your guidance?

I mean, there will be some runoff. Although, I tell you what's amazing on the acquisition, the strong players are going to buy the weak players, and we've already seen some activity in that regard. And so it's hard to call. Some of the production loans, by their nature if it stays down low, the loans are going to just liquidate out. But there's a lot of other things happening.

We've had, just yesterday, two customers see an advantage of the lower prices and acquired additional acreage. I've had, if you look at the dollars, you'll find that the strong players know that they can acquire, or believe they'll have opportunities to acquire properties and by runs cheaper then they can drill. There's two sides to this thing.

Everybody's talking about one price of oil, hadn't talked about gas, it's not moving much, and even with the cold winter there's a lot in storage. There are just a lot of moving parts.

I would say we don't have a significant, dramatic drop-off in energy lending at this point, baked into these numbers. There could be some pressure in what people decide to do, as Dick says, but remember, our portfolio is very diversified. Our people are working extremely hard in some great markets to grow overall.

Sorry, just back on that muni question. Are you anticipating any more purchases there, or do you feel like you've pretty much offset the lost income from the swap amortization going away?

The stuff that you'll see from this point on will be sort of normal course of business, just as the Company grows and we've had great growth in terms of deposits, et cetera, on our balance sheets, so there'll be some normal-- But nothing like the kind of quarterly activity that we saw in the fourth quarter.

Ibrahim Poonawala, BOA

First, follow-up question, in terms of if you can provide us what was the royalty fees tied to the ONG business in the trust income this quarter?

Well just overall, we think that the oil and gas income and our wealth advisory business will be pretty much flat with last year. But I'm sure some of my cohorts have better--

Now for the quarter you're looking for the oil and gas fees? In our wealth advisors that was $2.6 million in the quarter.

Thanks for that, and I think this bigger picture-- thanks a lot for the color on your stress test. As you think about where could we be going in terms of, I mean I appreciate you being far conservative than the industry historically. But where could we be wrong in terms of why losses could be worse than we expect?

Why losses could be worse for us, is that what you're asking me?

That's correct, and is there any room-- when you look at sort of your full-year 2015 EPS guidance, what is the downside risk there? Are energy prices need to fall just absolutely much lower, or what needs to happen for the risk to get worse?

Well, there's so many factors on this thing. I've said over and over, what we don't know, you don't know and nobody knows, where the prices going to go to and how long it's going to stay there. Quite frankly, I feel comfortable with the sensitivity test that we did at 75% of the deck and where we are.

I also said, and let me make it very clear: all of us can be surprised. That's what a surprise is, it's something you do not know. But I feel, number one, we have communicated and our staff is very knowledgeable and we're staying very close to the industry of what's happening day by day. And at this point, I have shared with you everything that I know to date and what understanding of risk that I see going forward. And from that standpoint, I'm very comfortable.

Yes, there can be a surprise, and there could be a surprise to your analysis, but that's what a surprise is. It's something we don't know. I've been amazed. You can see projections that we will go to 30 in the first six months of this year and be over 100 by year end. It's all over the board.

The other thing that I think is really-- two things. One, what's the environmental going to do to this thing? And of course I'm in Texas where we believe in letting free enterprise work, that doesn't seem to be a consensus nationally. This is no time to hit the industry again.

At the end of the day, when you read these studies in regard to the supply and demand, and I'm not an expert in that, but just looking at the US Energy Information Administration, and you look at where we started this, year they were starting to widen. They'll widen in the first quarter between the world production and the world consumption. Quite frankly, it's pretty close, and it will get a little worse as this increase in production is going to continue to increase.

We've all got to understand it takes four to six months to turn this thing down. You don't just go out there and turn that drilling rig over. You let it finish drilling the hole, and complete it, and all the kind of stuff you've got to do. When you want to stop on a dime, which I see the industry adjusting very quickly, it takes four to six months.

So these reserves, this production is going to build up. But quite frankly by the third quarter, you're getting close to being back in balance. Certainly the fourth quarter between world production and consumption. And like any projection, whoever this is from the US Energy Information Administration, they're not perfect either.

But I think we've got to realize that the gap between production and consumption is pretty close. You are talking about 91 million barrels to 93 million, a couple of million barrels a day difference. I know about storage, and I know their storage is building. And I know that it's going -- the wells are going to be become completed and more will come online in the next month.

But at the end of the day, this thing's adjusting. I don't know whether it's in the third quarter or when.

Emlen Harmon, Jefferies

At this point, how much higher do you let the liquidity build, just given where rates are. Obviously a little bit of weight on capital there, and obviously lower profitability. Just going to be curious as to-- how you are thinking about that.

The way we think about it, the liquidity is really a derivative of our relationship-based strategy. We don't have any wholesale funding really at all in the Company. So all of our balance sheets on the liability side is a result of a relationship with somebody.

So we don't really have the option or desire to reduce it based upon slowing the inflow, because what we are really doing is building long-term relationships. What we are trying to do is utilize the markets to the extent that we can, make good loans to the best we can in a quality way. We're going to the markets and extract value where we think is, either on the curve or in various segments. And then we'll let the liquidity build because we believe that there's tremendous value long-term in those relationships.

And we haven't talked about in well, given the discussion of energy, et cetera. But having a 46%, 47% loan-deposit ratio, and getting to a normalized environment, creates tremendous operating leverage for us. And that's going to be where we'll take advantage of those relationships. We'll fade the pressure on margin, if you will, or some of the capital leverage that it creates, waiting for the time when that value is realized.

On the loan yields, how much of the decline there this quarter was the completion of the swap amortization versus actual core loan yields coming down a bit?

I'd say about, round numbers probably two thirds of it was from the swap, and a third was from the other factors that Jerry mentioned.

Brett Rabatin, Sterne Agee

Wanted to ask a question on the guidance. Was just curious, thinking about 2015, does that make any assumption for interest rates staying flat, going up? What's your underlying thought on interest rates in 2015?

We do have it embedded in our assumptions, modest rate increases in the second half of the year.

They are really small for the second half.

And then balances for deposits, obviously strong deposit flows in 4Q. Was any of that-- year-end liquidity build or can you give us any color on-- you obviously continue to have strong deposit flows, but was any of that a bit of noise in the fourth quarter?

I don't think there was anything special we know of. It tends to be seasonally a really high point for us and that's what we saw. We've seen deposits tail off a little bit in the first quarter, again, which is a seasonal factor. But nothing that I would say was anything large that we know of that moved the needle.

And then just going back to think about maybe the margin in 2015. Would it seem likely at the margin, might continue to have a little bit of pressure in the first half. But it sounds like you're saying it might start to move back higher in the back half of the year. Would that be a fair assumption?

I don't think we typically could give that kind of granularity in the movement of margin. I think what we would typically say though is, as Jerry mentioned earlier, there's some good things and some bad things that are always at work there.

The bad things are, that we are maturing assets that we can't replace in the current yield environment. That's going to create some pressure. On the good side, we think are able to make loans and in some cases make investments like we did in the fourth quarter, that's going to be a positive.

We tend to see-- I would say that those things we tend to somewhat offset our view of the margin, and when we talked on these calls historically have been, sort of more of a flat range. Those things we tend to offset each other, and while the ducks moving across the pond, it looks like it's pretty smooth. There's a lot going on underneath it.

And then one last cleanup. WNB took a lot longer than expected, I know you always say you're aggressive lookers and conservative buyers. But any thoughts, Dick or Phil, on the M&A environment as you see it in Texas today.

Nothing's changed from what you already know our position is.

Jennifer Demba, SunTrust, Robinson and Humphrey

My question was covered. Thank you very much.

(Operator Instructions)

Jon Arstrom, RBC

I think everything's pretty much been covered here. But Dick, just one of them, if you could talk about the management announcements that you made this morning? What changes at the bank, and is there any messaging here in terms of your long-term plans?

The messaging is just what I said it was. This isn't unusual for a Company's that's been around 146 years to spread responsibility, continue to develop people. And that's what we're doing.

So you're not going anywhere in the near-term.

I'm right here working hard. I've worked hard to understand all this energy stuff.

We heard you, I think the transcript is going to be in all caps, but we heard you. (laughter)

I can explain stuff to people but I can't understand it for them. So I think I was trying to work on the understanding.

Thank you.

You have no further questions at this time. I will turn the call back over to you.

Thank you very much. We appreciate your support of our Company. This concludes our fourth-quarter and year-end 2014 conference call.