Cullen/Frost Bankers Inc (CFR) 2015 Q3 法說會逐字稿

Good morning. My name is Connor, and I'll be your conference operator today. At this time, I'd like to welcome everyone to the Cullen/Frost Banks third-quarter earnings conference call. After the speakers' remarks, there will be a question-and-answer session.

(Operator Instructions)

I would now like to turn today's call over to Mr. Greg Parker, Executive Vice President and Director of Investor Relations. Mr. Parker, you may begin.

Thank you, Connor. This morning's conference call will be led by Dick Evans, Chairman and CEO; and Phil Green, President of Cullen/Frost Bankers; 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 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 will turn the call over to Dick.

Thank you Gary. Good morning, and thanks for joining us. It is my pleasure today to review third quarter 2015 results for Cullen/Frost. Our President, Phil Green; and Chief Financial Officer, Jerry Salinas, then will provide additional comments before we open it up for your questions.

In the third quarter of 2015, Cullen/Frost had solid growth in average loans, average deposits and net interest income. Considering the headwinds of ongoing lower energy prices, near zero interest rates, and a sluggish economy, we are very pleased by the results. I commend our dedicated employees, who live our culture each day and help distinguish Frost in the marketplace.

During the third quarter of 2015, our net income available to common shareholders was $73.8 million, compared to $75.4 million reported in the third quarter of last year. This was $1.17 per diluted common share, versus $1.18 in the third quarter of 2014.

The third quarter of 2015 returned on average assets and average common equity were 1.04% and 10.73% respectively, compared to 1.12% and 11.29% reported in the third quarter of 2014. Third-quarter 2015 average deposits were $24.1 billion, up $1.4 billion, or 5.9%, over the $22.7 billion reported in the third quarter of 2014. Our strong deposit growth comes from new and existing customers, underscores our focus on developing relationships through this economic downturn.

Net interest income, on a tax equivalent basis, for the third quarter of 2015 was $225.6 million, up 8.3% from the $208.3 million reported last year. This increase primarily resulted from an increase in the average volume of interest-earning assets, and to a lesser extent, by the increase in our net interest margin. Our net interest margin was 3.48% in the third quarter of 2015, compared to 3.39% in the third quarter of last year, and 3.47% in the second quarter of 2015.

Non-interest income for the third quarter of 2015 was $83.4 million, up 3.1% compared to $80.9 million reported last year. Trust and investment fees were $25.6 million, down $1.2 million from last year, because of lower oil and gas fees and security lending fees. The decline was offset in part by $744,000 increase in investment fees, and insurance commissions and fees were $11.8 million in the third quarter of 2015, up 3.7% over last year.

Non-interest expense for the third quarter 2015 was $175.6 million, up 7.2%, compared to the $163.9 million in the third quarter of 2014. Salaries rose $5.8 million over the same period a year earlier, from the additions of new employees, normal annual merit and market increases, and incentive-based compensation. Net occupancy expense increased $3.3 million from higher property taxes, depreciation expense, lease expense and utility expense. These increases were impacted by our new operational and support center, and new branch locations.

Turning now to loan demand, 2015 is unlike any year I've seen. We've had the second-highest level area of loan request, and the highest level of new commitments booked since 2008. Year over year, new loan commitments are up 9%. Based upon this success, we normally would expect to see even more loan growth than what we are reporting.

For the third quarter of 2015, average loans were $11.4 billion, up 7.1% from the $10.6 billion reported for the third quarter of last year. But some of this great work I've just mentioned has been offset by higher than expected runoff and commitments. Year to date, we've had $650 million more in commitment runoff than expected, based on historical norms. There's two primary factors for this.

First, lower borrowing bases for our oil and gas credits, and second, businesses are selling assets, and in some cases, their entire company, as a result of premium prices being offered. I should note that energy loans outstanding are basically flat compared to year-end 2014.

The loan market continues to be very competitive. Our lost loan opportunities show more deals lost to structure than pricing. We remain consistent in our underwriting standards, and that credit discipline serves us well. I commend our team for its outstanding business development work, as we continue to make record number of calls on both customers and future customers.

I'm pleased to report that our credit quality remains favorable. Traditional measures of credit quality are strong, delinquencies continue to be well below 1%, at 0.64%. Nonperforming assets were $58.2 million, down 8% from the $63 million reported in the third quarter of last year, and up $5.8 million from the $52.4 million in the second quarter of 2015.

In the third quarter of 2015, we had net charge-offs of $3 million, compared to $2 million last quarter. Through September 2015, our charge-offs for the year totaled $7 million, and represented 6 basis points of loans. Annualized, charge-off percentage was 8 basis points of loans.

Given the low oil prices, we know that many of you are interested in our energy portfolio. Before we get into the numbers, here's a few key headlines that I think are very important. They show why we are performing well in this significant decrease in oil prices.

We remain in close and continual contact with our energy customers. Current conditions align with what customers expected when we visited with them late last year and early this year. Customers are executing their plans and strategies, and are adjusting their business plans and cost structures in a prudent and practical manner.

While increase in problem loans are expected, the overall impact should be very manageable. And most importantly, we still have not had any surprises, which underscores that our customers are communicating and implementing their business plans well.

Outstanding energy loans at the end of September 30 were $1.789 billion. That's $8 million less than the end of the second quarter of this year. Classified energy loans at the end of the third quarter of 2015 totaled $85 million, or about 4.8% of our energy loans. There's another $56 million were graded special mention. Our credit of consequence is on non-accrual, a production credit that totals $12.8 million.

We currently do not believe the results of the fall borrowing base re-determinations will have a material negative impact on asset quality within the oil and gas production portfolio. For our oil-weighted borrowers, we would expect possible borrowing base declines in the 10% to 15% range. For our gas-weighted borrowers, we would anticipate possible borrowing base declines in the 3% to 5% range.

We may have some further deterioration from past classification, but we do not foresee a material increase in non-accruals or charge-offs. We base this belief on the following. First, most of our borrowers are not fully funded under the borrowing base, and will be able to absorb any decrease that may or may not occur. On average -- and I know you have to be careful with averages -- but on average, commitments represent 59% of the engineering's reports value.

Second, as early as January or February of this year, we have identified borrowers who have been more fully funded under their borrowing base, that is greater than 75%, or who operate with higher amounts of leverage. We also continually reevaluate our borrowers, using analysis other than borrowing base re-determinations, to identify the appropriate amount of leverage.

Our management team and the lending staff work closely with these companies throughout the year. They have evaluated strategic alternatives to reduce senior debt amounts to levels supported by the current commodity price environment, given their asset base, strategy, liquidity and capital structure.

These strategic alternatives include equity and debt issuance injections, or sale of non-core assets. Many companies have already completed their strategic strategies, while others are in the process of executing their strategies. We anticipate that these strategies to be completed by late 2015 or the first half of 2016.

We evaluated the hedge positions of our borrowers, and we believe that any impact from hedge expiration should be manageable, and will not be a reason to cause classifications. The vast majority of our borrowers have elastic expense structure that can react as prices move, especially downward.

Regarding our production base borrowers, which is 72% of our portfolio, it is important note that our current price deck has oil at $50 a barrel for 2016, with some escalation through 2019, topping out at $70 a barrel. Our borrowing base is 65% of discounted 9% cash flow stream that results from the price deck. Sensitivity price are 75% of our price deck. For 2016, that translates into a sensitized oil price of $37.50.

Non-production customers -- that is service, manufacturing and transportation -- are feeling the impact of lower prices, also. Some have experienced revenue decreases of 10% to 15%. Many are expecting total decreases of 30% to 40% for 2015. Fortunately, they know what needs to be done. They are adjusting their expenses, lowering CapEx for the year, reducing inventories and intensifying their accounts receivable and administration.

Our energy team is doing an outstanding job working with our customers to identify the facts, potential problem areas and various solutions where needed. Even so, we believe the impact will be manageable, and we will be able to resolve problems in a rational and proper manner, because we know and communicate regularly with our customers. We have maintained our strong underwriting standards and credit disciplines, and have chosen to bank with experienced individuals who have been through multiple downturns.

Most of our energy officers have worked through other volatile times in this industry. Surprises can always happen, of course, but we have had no surprises since the beginning of late last year, and we are grateful for that.

Now moving to capital ratios. Our capital levels remain strong. In fact, all regulatory capital ratios significantly exceed the well-capitalized levels. We are grateful for another good quarter, with solid growth in average loans, average deposits and net interest income, amid economic uncertainty, lower energy prices and a low interest rate environment.

I thank our dedicated employees and leadership team, as they implement a seamless and transparent leadership transition that we announced last quarter. It's been business as usual, just the way it should be. At Cullen/Frost, we continue to focus on the basics. We're delivering innovation and providing outstanding customer service whenever and however customers want to communicate with us.

We are reaching out to new and existing customers. Our credit quality remains favorable, as we stay true to our principles and lending disciplines. Our capital levels are strong. We have money to lend. We continue to deliver steady and superior financial performance for our shareholders, and we have a steadfast focus on our unique culture and value proposition.

And with that, I'll turn the call over to Phil and Jerry.

Thanks, Dick. I'll just make a few comments about the Texas economy, and then turn it over to Jerry for some additional comments.

Looking at the Texas economy, while Texas economic growth has slowed in 2015, it is still projected to produce positive growth for the year, along with an unemployment rate almost 1% lower than the nation. In fact, the Dallas Fed currently projects 2015 job growth for the state of roughly 1% overall, even as lower oil prices have caused a 15% drop in oil and gas employment, and manufacturing employment is down almost 5%, due to weakening in energy and the stronger US dollar.

The diversity of the state's economy has helped offset these weaker areas through strong growth in service sectors such as: healthcare, and leisure and hospitality. And while construction employment is about flat statewide due to slowing in Houston, San Antonio, Austin and Metroplex areas continue to show growth. In addition, residential construction statewide is healthy, and housing stock continues to be tight, at 3.4 months, which is down from last year's 3.5 months.

I'd also point out that looking at the 2015 Texas job growth versus other energy-dominant states, Texas has performed significantly better. And one way to demonstrate the improved diversity of the Texas economy is to compare its industry mix to that of the US over time. With an index factor of 1 being a perfect match, Texas has improved its index from 0.92 in the early 1980s to more than 0.96 in 2015. Overall, the state's unemployment rate is 4.2% at the end of the third quarter.

A comment we still hear consistently from businesses we call on, is the problem finding enough skilled labor to support their business growth. Houston is slowing, but it still showed 0.4% job growth in the third quarter. And currently, the Houston unemployment rate sits at 4.4%, less than the national average. The fact that Houston is still growing despite the downturn in the energy sector underscores the strength and diversity of the Texas economy.

And with that, I'll turn it over to Jerry for a few additional comments.

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

The net interest margin for the third quarter was 3.48%, up 1 basis point from the 3.47% for the previous quarter. We had some items that had a positive impact on the margin, and some items that had a negative effect. But basically, higher average balances at the Fed, up $159 million this quarter, earnings 25 basis points, had about a 2 basis point negative impact on our net interest margin. While loan purchase discounts associated with our WNB acquisition had about a 3 basis point favorable impact on our net interest margin.

Regarding investment securities, during the third quarter, we purchased approximately $348 million in municipal securities, with an average maturity of 19 years, callable in 10 years, with a tax equivalent yield of 4.76%. These purchases offset the $204 million in pay-downs, maturities and calls in the investment portfolio during the quarter.

For the third quarter, the investment portfolio averaged $11.57 billion, up $109 million from the $11.46 billion average balance during the second quarter this year. The tax equivalent yield on the investment portfolio during the third quarter was 3.99%, up 2 basis points from the link quarter. The duration of the investment portfolio at September 30 was 4.5 years, flat with the previous quarter.

Regarding taxes, our effective tax rate on a year-to-date basis was 14.3%, down from 17.2% for the same period last year, and was impacted by our higher level of municipal securities. Our capital ratios remain strong. Our common equity Tier 1 ratio was 11.57%, compared to 11.70% last quarter.

During the quarter, we bought back approximately 955,000 shares of our stock, as part of our approved buyback program. That leaves us about $25 million in stock buybacks still available for repurchase during -- under that program.

Finally, regarding full-year 2015 earnings, we currently believe that, given earnings in the third quarter, the full-year mean of analyst estimates of $4.48, as reported by Capital IQ, is low, and that estimates a little over the current mean would be more reasonable.

With that, I'll turn the call back over to Dick for questions.

Thank you, Phil and Jerry. And now we will be happy to have our questions.

(Operator Instructions)

Steven Alexopoulos with JPMorgan.

Good morning, everybody.

Good morning.

I wanted to ask first, Dick, you mentioned the $1.8 billion energy portfolio this quarter again. Could you give us the breakout of that into its subcomponents?

Yes. 72% is production -- 72% production, 15% in service, private client 3.4% -- that means rich people -- manufacturing 4%, transportation 3.7%, refining 0.4%, traders 1.02%.

Okay, that's helpful. And Dick, do you have the specific energy reserve, where that stood?

The energy reserve related to that, we've got everything here. Hold on here. The total reserve is $110 million, energy is $24.8 million. So -?

About 22%.

Yes, about 22%.

Okay, that's helpful. And I wanted to follow-up on the commentary around hedges. Could you guys talk about what percent of the E&P loans you have in the portfolios current --?

6% would be affected by it, in our portfolio.

Is that related to the hedge question I'm asking? Or is that something else?

Yes.

So 6% are covered by hedges currently?

6% of total revenue. So it's almost insignificant here. That's the reason I said what I did.

Okay, got you. And then maybe just a final one. Sorry to beat a dead horse on energy here.

But can you comment on the pressure you're seeing, specifically on the services segment? And in your view, do you think that segment can withstand another, call it, 20% CapEx reduction -- we will see where oil is next year -- coming from E&P companies?

So tell me what your assumption is? You think what is going to happen? You think (multiple speakers) --

If oil stays where it is, what we've heard from larger E&P companies is that they are talking about another at least 20% reduction in CapEx spending for 2016. And my question to you is, when you look at the services segment of your portfolio, do you think that segment can withstand another step-down in CapEx in 2016?

Here's what I think. As I mentioned to you, we are about 10% or 15% down now, and it could be as much as 30% to 40%. And this stuff moves around, depending on how close you are to the drill bit, how much service work you've got.

But I would say to you that in my opinion, you squeezed that lemon about as much as you can. And there's just so much you can get out of it.

I think the service industry has been very aggressive. I think they've done a great job of cutting cost. But you can't get blood out of a turnip.

So I would say to you, I think the total decrease is going to be in the 30% to 40% range, and that's about where it's going to be. Does that answer your question?

Yes, I appreciate all the color. Thanks

Jennifer Demba, SunTrust.

Thank you, good morning. Following up on the oil field service question, I know you don't have a big exposure there, Dick. But how much of your oil field service exposure is closer to the drill bit?

Yes, it's pretty -- thank goodness it's pretty small, but that's all relative. Hold on, I've got a piece of paper here. You've got nine customers, totaling about $30 million, or 7% out of the total service of --

$272 million.

$272 million.

That's helpful, thank you. And could you tell us what you're seeing on the M&A front, Dick? Are you seeing any opportunities? Or have the potential sellers pulled back while oil is low?

You're talking about the energy?

I'm sorry, the bank M&A market.

Bank M&A. There continues to be a lot of dating in the little banks under $1 billion, because you know regulation has made it to where they can't survive, which is a shame. But I don't see much activity. And you know my position. I'm an aggressive looker and conservative buyer, so --

I think you're going to see the little guys get together to try to get over $1 billion. I don't blame them. They're survivors, and work hard. But it's a shame what Dodd-Frank and all the stuff did to the industry in America.

Thanks, Dick.

You're welcome.

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

Good morning, guys.

Good morning.

On capital, what's your appetite for more repurchases, going forward? And how do you think about the Tier 1 leverage ratio, back below 8% today? Do you think you have some room to take that lower?

We still have got about $25 million left in the current plan, as Jerry mentioned. So I think that it's going to -- it's like anything else, it depends. It's going to depend on what our growth prospects are, and how the economy is doing. So I would say, right now, we're just focused on completing the current plan, and we will see what happens in the future.

Buy-backs have always been a part of what we've done, whenever we didn't see opportunity to do acquisitions in Houston. Or when we didn't see organic growth that was significant enough to use it. So it's always going to be something that's on our radar screen, but it would be premature for me to say what it would be at this point, when we still have $25 million left.

And you mentioned growth there as being a factor? What are your thoughts on loan growth over the next couple of quarters, given the environment, and the potential for some drag on energy? I know you said those balances sounded like they were stable this quarter.

Do you think the runoff in commitments continues? And are you thinking that maybe loan growth, or maybe balances, remain flat nearer-term? What are your thoughts there?

I would say, from the industry standpoint, as you already heard, energy loans are flat. Which quite frankly, in this environment, I'm extremely pleased with our staff. We've -- quality is amazingly good, under the circumstances of this kind of drop.

And so we've gone after the good opportunities that -- I know everybody talks about how bad everything is, and the world ending. Quite frankly, that's when a lot of people make a lot of money. And there's a lot of Texans down here that have made a lot of money the last years. And they look for this as a great opportunity, and we like financing them.

As far as the overall portfolio goes, you heard what I said about, it's just about as different a time as I've ever seen. And that number one, I couldn't be prouder of our people, because they are out making calls and asking for the business.

We can't control stupid structuring by competition, and you have got a lot of that going on. And we are not going to bend down and take that. So we just got to keep working hard, which we're doing, make the calls, and keep the quality of the portfolio up.

The gap between the commitments and the outstandings is discouraging. And I tell you, we work hard, and go get the commitment, but it wouldn't take off. But it's just, with this zero interest rate environment, the Fed not having the ability to make a decision for years, it just puts us in this unusual environment.

In the meantime, we are going to keep calling on customers, work hard to build the commitments. And over time, it will grow, and should grow faster.

Okay. And then just back on energy, how far along are you guys on the re-determination process through 3Q?

Just starting. But from our standpoint, I gave you some color, which we believe what the results will be already. Because we spent -- we're close to our customers, we have got a pretty good understanding. So we'll know more, by year-end, exactly what's going on.

Okay. And then just one last one, on the securities book. Do you guys have any details on any upcoming lumpy calls in the muni book?

And then, it sounds like you're continuing to see a lot of opportunities there. Do you expect those purchases, at that level, to continue?

I would say, with regard to what we are anticipating in the investments, we expect to continue to make it. We'll make it along with treasuries, as well, as we move forward through the next 12 months, I'd say.

Our balance sheet continues to grow, in light of our great deposit growth. And I don't think we plan on seeing a significant change in the mix of the categories of our investment portfolio that is between treasuries and munis primarily. So I think what you'll see, over the next 12 months, a balance in purchases that maintains the current structure and proportions in structure. So I'd say that.

I'd say with regard to calls, really, the program that we have been on in investments for muni's is for, now, several years back to at least 2008. As, remember, we've been buying the high-coupon structures, usually about 100 basis points above the on-the-run coupon. And so it's really built in that we anticipate the call to occur, absent some kind of huge dislocation in the rates.

And so even though we're buying, as Jerry mentioned, say 19 or 20 muni's, they've got 10-year calls and high coupons. We're really expecting them to be called. And in fact, today, about 11.5% of our muni portfolio is already pre-refunded.

So what we are expecting to see, with regard to the calls on the 10 years time period, is happening. So I'd say -- so as far as there is lumpiness of the calls, it is not because some are being called and some are not. It's really based upon what blocks of securities we bought, and when, in the line with maturity.

So I think you could go back and look at what our reported purchases were over time. And at least at this time, add 10 years to that, and that's what we expect to see in calls.

Okay. Great, thanks guys

Steve Moss, Evercore ISI.

Good morning. I was wondering if you could just discuss the overall loan growth outlook over the next 12 months, given you mentioned the pay-downs in the energy headwinds, going forward?

We just talked about it a little bit.

Yes, I think we're probably -- our expectations are, first of all, we are not -- even though energy is a little bit soft, we're not really seeing declines there. It's been more flat, and we think there may be some opportunities, as we move through the year, as people do some deals, and some of the money gets employed.

I think, really, that we are still, though -- we don't expect that growth to be robust, and that's a pretty good segment of the portfolio. So I would say, from our point of view, somewhere still in the single digits, somewhere between the mid and high single digits loan growth, over the next 12 months.

Okay. And I was also wondering if you could quantify your Houston commercial real estate exposure?

Yes, let's see. We have got a little something here for you.

Commercial real estate and commitments is about 21%. It's about $1.3 billion in commitments. About the same.

If you'd like it -- San Antonio, Houston and Fort Worth are all in about the same neighborhood. Is that what you're looking for?

Yes, so $1.3 billion in commitments and --

Outstandings are about $862 million in commercial real estate, in the Houston region.

Okay. And then I guess lastly, as you look at borrower stresses, you mentioned a fairly low criticize ratio. You indicated modest migration, going forward.

Just wondering if you could put a little more quantification as to how you're thinking about the migration? And what kind of reserve levels you're applying to criticizing classified loans?

We're following the formula on our allowance, and it is working well, and that's the reason you've seen the energy percentage go up to where it is. Quite frankly, I don't -- you have got to do these models and stuff, and I realize you've got a model you're trying to fill in.

But the best thing is to know your customers, and that's what I've emphasized about what's really going to happen to you. And the -- I don't know where you're trying to go, except maybe to fill in a number into your model, but I feel pretty good about where we are.

I know the formula is working. It's consistent, and we do what we are supposed to do, and it's all legal.

But the most important thing is what I said. And the reason I started off with energy, and talked about staying close to customers, and knowing what's going on, is where we get our comfort. You're not going to get it from running a bunch of statistics. Does that answer your question?

That's helpful. Thank you very much, I appreciate it.

You're welcome.

Brett Rabatin, Piper Jaffray.

Hi guys, good morning. Wanted to -- just wanted to ask a question on expenses, and just thinking about how you guys view the world, with interest rates continuing to look like they might stay low.

Was curious if you were thinking about, as we go into maybe 2016, any new expense savings initiatives to improve profitability? I know you guys have a high service touch to your client base. But any thoughts on driving the expense line [flat]? Or I don't know how you think about it, going forward, but was just hoping for a little color.

Yes, it's a good question. It's -- think you said the key thing is, we've got a high service model. As we focus on -- actually, if you think about our Company, we are careful with expenses on an everyday basis, okay?

To get a person hired, or to have a capital expenditure over $10,000, you've got to get the Chairman and the CFO's signature on that. So there's an accountability that exists for that. So we're not -- we are careful about what we're spending.

I would say, also, we are looking at utilizing technology better, and we're doing a good job on that, and there are a number of things that we are doing. And we've got initiatives that are in place that are really not to be disrupted to our business model, but to just be smarter and better about things. And we're having some success, as far as that goes.

But the thing we're focused on primarily is that, there are two things that really unlock the operating leverage in the Company. And one of them is interest rates, because we're solidly asset-sensitive, and we don't know when that's going to happen.

The other is, taken alone, the deposit ratio that is, say, 46%, 47%, and moving that to a level that's more in line with what it was five or six years ago, which -- when it was around 80%. And that really is what creates great operating leverage for us. In the in the meantime, when we are spending money, we are spending it on our value proposition. Taking care of customers, delivery methods and technology.

And we're doing that throughout this cycle, because we think that's the opportunity that creates opportunities to grow market share. And I think if you've seen our deposit growth, and how much is growing from new customers, as we've reported and Jerry's reported over the quarters, that we are being successful with that. So that's really our focus at this time.

Okay. And would you maybe consider -- and just thinking about technology, and the branch network. Would you guys ever consider a branch rationalization process? Or any sort of program where you're going to try and -- specifically trying and cut expenses at a part of the Company?

First of all, the -- we have before. We'll rationalize branches in markets and situations where we have got too much capacity. We did that, maybe it's two or three years ago by now, time flies. But we probably reduced our number of branches by about 4% that year.

And because in one particular market, we had, as a result of some acquisitions that we had not rationalized, we have too much capacity. And we cut it back, and -- which ended up being, I think it was 3% or 4% of our total branches.

But keep in mind that we are not an over-branched Company in the state of Texas. In the state, we've got about 5% market share in total. We only have like 9% -- we're number nine, in terms of numbers of branches.

So our locations tend to be larger, they tend to be more commercial and consumer related. And so I think a branch adjustment strategy would not be part of a -- some kind of a means to an end.

It would really be, what does it take to run the business effectively, in light of our volumes and activity? And continue to do that, as I say, we've done it in the past. We will continue in the future, if necessary

Okay.

One thing I would also point out branches, though, is that the character of the branches is changing. Whereas in the past, locations would have been more transaction-centric, more drive-through lanes, more freeway-centric locations, to get people on and off, and process transactions.

The branches that we are putting on now, and which I think -- and some examples of really fast growth in out locations, are really more community-focused. They are in locations where people go anyway. They really, in many cases, don't even have a drive-in.

And the idea is to get people into the location, because it is a place for us to project our brand, to put people face-to-face with Frost bankers, which is really the key and secret of our Company. And to offer things that are more than just transaction processing -- but wealth management, commercial lending, insurance, in many cases. So it's -- while the numbers may not be changing dramatically, I think the role is changing.

Okay, that's great color. I appreciate it. Was just thinking about some drivers, given that rates are tough right now, and continue to look to be so. Appreciate the color, thank you.

You bet.

Ebrahim Poonawala, Bank of America Merrill Lynch.

Good morning, guys.

Good morning.

I just had one remaining question, and sorry if I missed it. But could you just comment, in terms of your outlook on the Houston CRE market, as you look out into next year? Because there's been a sense that 2016 might be worse, not just for you, but the overall market, given if oil stays where it does. And just would appreciate any color that you could share, Dick.

A lot of theories going on. There's no doubt that Houston has more energy than any other.

Also, you see a little bit of slowing, but not too much. And Houston will see, if you look at the office buildings, there's some new ones that have been put on hold. The occupancy is pretty strong, if you look at it. And so how much is going to slow down?

I think the other thing you have got to remember, healthcare is tremendous in Houston. The port is, even with the strong dollar and export slowing down little bit, it is still tremendous. And don't forget petro-chemicals, which have taken advantage of their low cost in natural gas. So that business continues to expand.

So yes, we have a little slowing, probably. Already seeing some beginnings of it. But it's a pretty darn dynamic market that I'm sure glad we operate in.

Thanks for taking my question.

You're welcome.

John Moran, Macquarie.

Hi guys.

Hi.

Just a quick follow-up on, operating expenses ticked up a little bit this quarter versus where we have been running, first half of the year, and a pickup on comp. Was that new hiring activity?

And then, do you feel like this is a good run rate, going into 4Q? Or should we see the normal seasonal noise in the fourth?

Yes, I would expect that you'll see some of that seasonal noise in the fourth quarter. We do have some incentives that vest immediately. So you should see that, in our typical trend, third to fourth quarter increase.

A lot of the incentive that we recorded in the third quarter was related to higher revenues. So some of that will be impacted, if we don't see that sort of revenue growth in the fourth quarter. You may see that -- the growth not be as significant, third to fourth.

Okay, got it. And then the other ticky-tack kind of modeling question, the tax rate ran low this quarter, 14.3% on the year. Obviously, you guys redeployed into a bunch of municipal -- in the muni book.

Thoughts on that, going forward? Is this quarter's sub-14% the right way to be thinking about that, going forward? Or is it, year-to-date, the better kind of run rate?

Yes, the year-to-date would be a better one to focus on.

Okay. And then the last one I have, bigger picture.

Dick, you mentioned a couple times competition structure, and some competitive pressure. Is that broad-based across the footprint? What -- is the source of it, is it still the big uglies? Or the smaller banks getting more competitive?

And is there any kind of product that's more competitive. Obviously, CNI has been something that people talk about a lot. But any structure weakness that you're seeing in some of the other product types?

No, it is just stupid bankers, and there are both big and little ones. They just -- you get all this pressure; that's one of the benefits of the Feds getting out of keeping interest rates low forever is, they're creating some other bubbles. You know where they are, and hedge funds, and all kinds of private equity investments.

And so what happens, the math is pretty simple. You're sitting there, and want to grow loans, because they yield better. And so you start doing stupid things, and lowering your standards down.

And I think we're pretty good at our discipline, and I'm proud of our people. It's just harder. You have got to keep running hard, and finding the good ones.

And when a customer understands it, or a future customer, they realize they ought to be doing business with somebody that's got some sense. Because over the long term, they're going to be a lot better off.

Got it. Thanks very much for taking the question, guys.

Thank you.

Emlen Harmon, Jefferies.

Good morning. Just one other modeling question for me, as well. The other fee line was strong. I know you called out the year-over-year improvement in OREO valuation.

But on a quarter-over-quarter basis, could you help us understand what helped there? And just what the total OREO valuation improvement was?

You're talking about the other income line item that got mentioned?

Yes.

Are you looking at link or year-ago quarter?

So I'm looking at link, and that was up about $3 million, quarter-over-quarter.

Right. The big part there, I think you saw it in the release, and Dick mentioned it, we did have a gain on the sale of some stock that we'd acquired in a previous -- in our acquisitions, that helped us about $2 million. So that's probably the big increase. It was a one-time deal that won't be repeated.

But we also had -- I think that was probably the biggest piece of it going, to be honest, on a link quarter basis.

Got it, perfect, thanks. That was it, just a quick one.

Sure.

Peter Winter, Sterne Agee.

Good morning. You guys have given good color on the overall Texas economy. I was just wondering, when we drill down into West Texas, the Midland Odessa area, what you're seeing there?

Yes, it's -- I'll make a comment, and look to Phil. It's surprising, with oil down from $100 to -- pick a number, $45, $43, wherever it is today, one of the things that, if you're out there, what people will observe is how much traffic. And there's still a lot of traffic.

I think it's going to slow down a lot. It's got to.

But what you can't forget is that the Permian Basin is one of the best honey holes that you've got for oil in the world. And so you're going to continue to have some activity.

And secondly, I'd point out to you, because it was so ridiculously tight, that you couldn't hire a waiter or anybody, it is getting back in balance.

Thanks, Dick. And I might also point out that the basin's slow, and it's one of the -- it's got the highest percentage of energy of its economy in the states. Probably I'd say, in round numbers, about 20%.

Our people out there tell us that historically, when they go through a down cycle there, it usually takes 18 months to get through it. And you can pick your starting point of this down cycle, but we're certainly in that, I'd figure, probably in the first three or four innings of that cycle.

If you look at some detailed things, retail sales are down about 15%. I think auto sales are down, as well. You're seeing apartment rates decline. They were running, say, $1,250 to $1,000. So you've seen that go down.

Interestingly, school districts are up. There's an increase of 1,000 kids in school districts. So people continue to move in.

I would say if you looked at some of the job growth numbers, the latest numbers that I've got from the Dallas Fed, show job growth for the last three months at 2% in Midland, 3.6% in Odessa. So that's hasn't totally caved.

And if you look at unemployment rates, the Midland unemployment rate is 3.2%, and the Odessa rate is 4.2%. So where it's slowing, you're seeing reductions in retail sales, auto sales, apartment rates dropping.

I know hotel availability is better than it was. Again, as Dick said, it was insane before. You are seeing it move through a normal adjustment to the cycle, like it's been having, when this has occurred in the past.

Got it. Thanks very much

Stephen Austin, IceCap.

Hello? Stephen, are you there?

Stephen Austin, your line is open.

Connor, let's move to the next question.

Brady Gailey with KBW.

Good morning, guys. I wanted to expand on the comment you made about the expiration of hedges not being an impact for you.

I think you said something about 6% of revenue is hedged. Is that 6% of your energy customers' revenue is hedged? I would've thought that number would've been a lot higher.

No, you got it right. You heard right. It's energy customers.

Okay, so only 6% is hedged. Okay. And then on the buybacks, the 955,000 shares that were repurchased in the third quarter, what was the average price that stock was repurchased?

It was a little over $67.

All right. And then lastly, the purchased shared national credit portfolio, I think it was 793 million at the end of 2Q. I was just wondering if that shrank a decent amount? And that's what caused the flat period in loan growth?

Not really. It was up a little bit. It was 824 million on September 20.

The other thing is, only 26% of our energy loans come from shared national credits. We had some other growth in there. That was a growth -- some other good credits that you get. And of these things, it's an opportunity to share -- just good, prudent sharing of risk.

The -- we had some good opportunities in all the markets. I mentioned the port of Houston earlier, and stuff like that, just that you want to be a participant in. And so it's holding in there about right.

You remember -- don't be confused, Brady, that we do not invest in shared national credits. We build relationships and diversify risk through shared national credits.

Understood.

You're not confused on that, are you?

No, sir. (laughter) Thank you.

There are no further questions at this time. I will turn the call back over to Mr. Evans.

Thank you for joining us today, and this concludes our third-quarter 2015 conference call. We appreciate your confidence in Cullen/Frost. We stand adjourned.

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