Cullen/Frost Bankers - Earnings Call - Q3 2017

Transcript

Speaker 0

Good morning. My name is Marcella, and I will be your conference operator today. I'd like to welcome everyone to the CullenFrost Third Quarter Earnings Conference Call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question and answer session.

Thank you. Mr. Greg Parker, you may begin your conference.

Speaker 1

Thank you, Marcella. This morning's conference call will be led by Phil Green, Chairman and CEO and Jerry Salinas, Group Executive Vice President and CFO. Before I turn the call over to 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 by calling the Investor Relations department at (210) 220-5632. At this time, I'll turn the call over to Phil.

Speaker 2

Thank you, Greg. Good morning, and thanks for joining us. Today, I'll review third quarter twenty seventeen results for Cullen Frost, and our Chief Financial Officer, Jerry Salinas, also provide additional comments before we open it up to your questions. In the third quarter, Cullen Frost reported $1.41 per diluted common share, and that compared to $1.24 in the same quarter last year and $1.29 in the second quarter of this year. This is a very good quarter for Frost.

Besides the excellent earnings, our return on average assets exceeded 1.19%, which is the highest level since the 2012. And we also reversed the trend of declining money market deposits and showed strong growth in loans. During the quarter, average loans were $12,600,000,000 and this represents an increase of approximately 10% over the third quarter of last year and on a linked quarter annualized basis. Our provision for loan losses was just under $11,000,000 in the third quarter, and it was up from $8,400,000 in the second quarter. Although the impact of the Gulf Coast storms to our third quarter results has been pretty nominal, we believe it's prudent to recognize the possibility of lingering impacts in the future.

Nonperforming assets totaled $150,000,000 in the third quarter. It was an increase from the total of $90,200,000 in the second quarter. And while our energy portfolio continues to improve significantly, some of these credits are still moving through the snake, as I've said before, towards their final resolution. We can talk more about them and your questions. Net charge offs in the 2017 were $6,200,000 and that compared with $11,900,000 in the previous quarter excuse me, it was $5,000,000 in the 2016.

Annualized net charge offs represent just 20 basis points of average loans for the third quarter. Overall, delinquencies for accruing loans at the end of the third quarter were only 62 basis points of period end loans. And all this is although this is a slight increase from the 58 basis points in the second quarter, it's still one of the lowest totals in more than two years. Total problem loans defined as risk grade 10 and higher, many of you know these as criticized, classified and doubtful loans, OAEM, fell to $7.00 $5,000,000 which was a decrease of 15% in the third quarter when compared to the second quarter. And this is primarily the result of favorable resolutions like upgrades and paydowns and payoffs.

Finally, outstanding energy loans at the end of the third quarter totaled $1,390,000,000 or 10.9% of total loans, and that compares with over 16% at its peak in 2015. Over the past several quarters, Frost has been building on momentum, and we've concentrated our focus on steady and sustainable growth. We have an attractive product mix. We're seeing positive responses from customers, and we're also well positioned for expected increases in interest rates. Average total deposits in the third quarter rose $25,800,000,000 and that was up by more than 4% from the $24,700,000,000 in the third quarter of last year.

Deposit growth was aided by our increase in deposit rates on high yield money market accounts and certificates of deposits. And our money market account balances are at their highest level since September 2015, and they've continued to see growth since quarter end. In consumer banking, we continue to see excellent growth in accounts, customers and balances. Same store sales growth for new account origination is up by 13.2% compared to the 2016 with strong growth in all regions. 18.8% of our account openings came from our online channel, which includes our Frost Bank mobile app.

That maintains our pace of more than double the level of the year before. In the 2017, total average consumer loans grew by 10.7% compared to the third quarter twenty sixteen. We're seeing especially good growth in consumer real estate and private banking as we continue to work hard to develop these segments further. We continue to make progress with our mobile and web based account openings, which help simplify the ways people can build a relationship with Frost. These digital account openings have helped us grow while applying the same Frost standards that are in place for traditional account openings.

On the commercial side, new loan opportunities are up by 18% compared to last year. Our strategy of building our core loan portfolio, which we define as loan relationships $10,000,000 and under in size, continues to help provide steady, sustainable organic growth. New commitments under $10,000,000 were up by 28% in the third quarter compared to last year, and they accounted for 53% of the total volume, up from 48% of the total in the second quarter. The efforts that our bankers have been putting into this area are paying off very well. At the same time, we're taking care of our larger customers as well.

New commitments at or above $10,000,000 were 42% higher than last year. Overall, new loan commitments in total were up by 34% from last year. This is the kind of above average organic growth that we aim for because it helps for us succeed, but just as importantly, it makes people's lives better and helps our customers succeed. These positive customer experiences are reflected in the recognition we received from third parties like J. D.

Power and the American Banker Reputation Institute survey, which we continue to build on that success. Just this week, we learned that Frost has been named to Money Magazine's list of best banks in America, which includes the designation as the best bank in Texas. In particular, I'd like to highlight some results we received recently from Greenwich and Associates. You may recall that in the first quarter, Ross received 33 Greenwich Excellence Awards, more than any other bank nationwide for providing superior service, performance to small business and middle market banking clients. So our performance was already excellent.

Late in the third quarter, we got a kind of midterm update from Greenwich and the news was even better. Frost has significantly increased its already high scores in metrics like calls on non customers, and the results show that both large and small company prospects appreciate the way we are building relationships with them as a trusted financial adviser. It's one of our strategic priorities to increase new customer relationships through effective prospecting, and the Greenwich scores show that our hard work is paying off. Of course, none of this could happen without our Frost bankers. Besides the outstanding work they do, the long term relationships that make Frost building long term relationships that make Frost unique, During the third quarter, we faced an additional unprecedented challenge in Hurricane Harvey.

The storms ripped into the Gulf Coast, affecting not only our banks and our offices in Corpus Christi, Victoria and the Houston Galveston area, but also damaging the homes and businesses of many of our customers. And yet despite the evacuations and the damage that our employees incurred at their own homes, they all pulled together very quickly to restock ATMs, to reopen our financial centers so that we could start helping our customers with the rebuilding process. Our eight financial centers in the Corpus Christi region were all open for business after the storm passed. And in our Houston region, where we shut down all 33 of our financial centers, we were the first big bank to start reopening branches. And within days, we had 31 of the 33 opened and serving customers.

Only two of our lobbies had any serious water damage, and only one of these is still being repaired. Everything else in the Houston region has reopened, and we've even opened a thirty fourth site on the East End with our East End Financial Center. Even before they were able to return to their financial centers, Frost bankers were calling on customers to ensure they were okay, see how we could help. We waived overdraft NSF and ATM fees in the affected areas and quickly rolled out a line of commercial and consumer disaster relief loans. The spirit of Frost employees and their dedication to their communities, their customers and each other is truly inspiring.

And I'm proud of the way our company responded to this situation. I'd like to thank everyone at Frost for all their hard work and dedication as we look ahead to further growth and accomplishments. Now I'll turn the call over to our Chief Financial Officer, Jerry Salinas, for some additional comments.

Speaker 3

Thank you, Phil. I'll make a few general comments about the Texas economy before I provide some additional information about our financial performance for the quarter. Regarding the economy, despite the impact from Hurricane Harvey in the third quarter, the Texas economy continues to expand with consistent growth and historically low unemployment. The Dallas Fed estimates estimates that short term job loss in the Gulf Coast in the range of 55,000 to 75,000 jobs with a quick bounce back this quarter. Rebuilding efforts are expected to create jobs and boost infrastructure spending.

Year to date, Texas employment is up an annualized 2.2%. The Texas unemployment rate in September was 4%, the lowest in nearly seventeen years and down sharply from 5% at the end of the first quarter and 4.6% at the end of the second quarter. Texas unemployment at 4% is now below the national unemployment rate of 4.2%. Despite hurricane Harvey, the Dallas Fed still maintains its 2.6% job growth projection for Texas in 02/2017. Looking at individual markets, strengthened in September.

According to the Dallas Fed, the DFW job DFW jobs grew an annualized 4.7% last month and 2.6% in the third quarter. The Dallas Fed reports that Metroplex job growth was broad based across major sectors with construction and mining leading the way. The Metroplex labor market remains tight. September unemployment in Dallas fell to 3.5%, while the Fort Worth unemployment rate declined to 4.2%. The Austin economy expanded rapidly in September.

According to the Dallas Fed, jobs in Austin grew 3% annualized in the third quarter. Growth was broad based with construction, financial activities, health care, wholesale trade wholesale trade accelerating significantly compared to the first half of the year. Austin's unemployment rate was 2.7% in September, the lowest in nearly seventeen years and significantly lower than state and national levels. The San Antonio economy is accelerating. Jobs grew and annualized 4.5% for the third quarter.

Expansion was strongest in leisure and hospitality, manufacturing, mining, health care and government. San Antonio's September unemployment rate declined to 3.9%. The economic report for Houston is in flux as the area recovers from Hurricane Harvey. Damaged homes, general wealth destruction and family disruptions led to an initial surge in jobless claims. The Dallas Fed reports that Houston payrolls contracted at an annualized 8.9% rate in September following the hurricane.

Sector showed mixed results. Energy sector jobs grew an annualized 24.9% in the month, while leisure and hospitality jobs declined 15.2%. From December 2016 through August 2017, prior to the storm, Houston employment grew by 2.1%. Growth was strongest in education and health services, leisure and hospitality, and manufacturing. Houston's unemployment rate fell to 4.8% in September.

While the economic impact of Harvey was significant, the local economy is expected to rebound fairly quickly. As a result, the Dallas Fed reaffirmed its 2.6% job growth projection for Texas in 2017. Now moving to our financial performance. Included in our quarterly results are a couple of unusual items that I wanted to point out. First, during the quarter, the company corrected an over accrual of income taxes that resulted from incorrectly classifying certain tax exempt loans as taxable for federal income tax purposes since 2013.

As a result, we've recognized a tax benefit totaling $3,700,000 in the quarter, which resulted from reclassifying the related interest income from taxable to tax exempt. Also late in the third quarter, we sold $750,000,000 in available for sale treasury securities with a rate of 1.3% and recognized a loss of $4,900,000 or $3,200,000 after tax. The proceeds from the sale of those securities were included in our balances at the Fed at the end of the quarter and provide us with additional investment flexibility in a projected higher rate environment. Looking at our net interest margin. Our net interest margin for the third quarter was 3.73, up three basis points from the 3.7% reported last quarter.

Adjusting out the impact from correction of the tax exempt, income issue I just mentioned, the net interest margin would have been flat with last quarter at 3.7%. Higher yields on both our loan portfolio and balances kept at the Fed contributed to about a six basis point improvement, which was offset by the impact of higher deposit rates compared to last quarter. The taxable equivalent loan yield for the quarter was 4.46%, up 14 basis points from the second quarter. Adjusting out the impact from the correction of the tax exempt, income issue, the adjusted loan yield would be 4.42%, up 10 basis points from last quarter. Looking at our investment portfolio.

The total investment portfolio averaged 12,300,000,000 during the third quarter, down about $59,000,000 from the second quarter average of $12,400,000,000 The taxable equivalent yield on the investment portfolio was 3.94%, up one basis point from 3.93% for the previous quarter and was impacted by a higher proportion of higher yielding municipal securities. The taxable equivalent yield on our muni portfolio was 5.34%, down four basis points from the prior quarter. During the quarter, we purchased about $250,000,000 in municipal securities with a TE yield of about 4.46% with a twenty one year average maturity. These purchases offset the $212,000,000 in municipal securities that were called as expected during the third quarter contributing to the drop in the TE yield from the prior quarter. Our municipal portfolio averaged about 7,400,000,000.0 during the third quarter, up about 76,000,000 from the previous quarter.

At the end of the second at the end of the third quarter, about 68% of the municipal portfolio was pre refunded or PSF insured. The duration of the investment portfolio at the end of the quarter was four point eight years, down slightly from four point nine years for the previous quarter. Regarding income taxes, the effective tax rate for the quarter was 9.6%. Excluding the tax benefit relating to misclassifying certain tax exempt interest income that I've mentioned previously, the effective tax rate for the quarter would have been about 13.2%. Regarding capital, our capital levels remain strong with our common equity tier one ratio at 12.38% at the September.

During the third quarter, we started and completed our 100,000,000 stock buyback program, which was authorized last year. We bought back about 1,100,000.0 shares at an average price of $88.11 In addition, yesterday, our board authorized a new 150,000,000 stock buyback program. Regarding full year 2017 earnings, we currently believe that the current full year mean of analyst estimates of $5.2.23 is too low. With that, I'll now turn the call back over to Phil for questions.

Speaker 2

Thank you, Jerry. We'll now open up the call for questions.

Speaker 0

Your first question comes from the line of Michael Rose. Your line is open.

Speaker 4

Hey, good morning. Thanks for taking my questions. At the outset, you mentioned that the momentum in deposits had continued. Can you talk about specifically maybe where some of that growth is coming from? And are you starting to see some inflows in deposits in the hurricane impacted markets?

Speaker 2

I'll let Gerry speak to some of the deposit flows. I can tell you that we really haven't seen the Hurricane Harvey any Hurricane Harvey deposit money coming at this point.

Speaker 3

Yeah. Michael, just looking at if we look at a linked quarter basis on a period end, we've you know, deposits increased 3.1% or 12.3% annualized. A lot of that growth is coming from, the high yield MMAs where we talked about increasing those rates, but we're also seeing good increase in our checking account in DDA and IOC.

Speaker 4

Okay, that's helpful. And then just wanted to talk about loan growth. Was that impacted at all by the hurricane? And you mentioned that the commitments were up pretty substantially year over year. And you previously guided to kind of a high single digit growth rate.

Is that still hold? And then kind of where are you seeing maybe by geography the strongest growth?

Speaker 2

We really haven't seen anything that's significant regarding the hurricane. I think there were $3,300,000 of sort of disaster loans through a disaster loan program that we put in place that we have positioned at this point. So that's very minimal. No, I think don't the hurricane is impacting our loan volumes at all. And we're seeing good growth really throughout all the regions, a little bit of weakness in the Far South Texas markets, but those aren't large markets for us.

So loan growth just continues to be positive. It continues to be diversified, and it's across a broad base. We'll have to see how what impact the hurricane might have on specific markets like the ones in the affected areas. We're not seeing a tremendous increase right now, but you could see some slowing there. So we're going to keep an eye on our pipeline.

I think really what we've seen in the pipeline this quarter, which is it's down a little bit on a linked quarter basis. But in talking with all our people, I think that's more us just being successful in a number of deals and just in the process of reloading there.

Speaker 4

Okay. And then finally, good to see the new stock buybacks. Given where the stock is trading now relative to where it was last quarter, I mean, how aggressive would you expect to be? I mean, capital levels are still pretty strong here. Thanks.

Speaker 2

Thank you. Well, the program that we put in place that the Board approved yesterday isn't really to be aggressive per se. It's really just good corporate housekeeping. I mean you need a program like that in our view for whenever opportunities arise, either you can't use the capital or you think that there's a as I really believe was the case in this last quarter, there's sort of a dislocation between what management believed about our situation was and what some of the market believed about what our situation was. And we say in Texas, that's what makes horse races.

And so we decided to bet on the company about $100,000,000 And So that was more aggressive than we would typically be. But the program that we put in place now, as Jerry said, is a two year program. And as we see opportunity to use it, if it's prudent to use it, we'll use it.

Speaker 4

That's great color. Thanks for taking my questions.

Speaker 2

Your

Speaker 0

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

Speaker 5

Hey, good morning guys.

Speaker 2

Good morning.

Speaker 5

You mentioned the sale of treasuries at quarter end. Have you guys used the proceeds to purchase other securities in 4Q? I know you mentioned the muni purchases in 3Q, but any additional ones that we should think about and what were the yields on those?

Speaker 3

So Dave, our plan is to invest about $400,000,000 of that amount. So our plan will be to try to purchase those as quickly as we can. A lot of it's going to be, of course, determined by what's available in the market. But that's the current plan.

Speaker 5

And the $400,000,000 will that primarily go into munis as well or other things?

Speaker 3

Yes. Right now, it's primarily we're thinking that the $400,000,000 would go into munis. The $350,000,000 we're talking about keeping in balances at the Fed gives us more flexibility in this rising rate environment and helps us from an asset sensitivity standpoint. So that's the current thoughts.

Speaker 5

Yes. Okay. And then can you just talk about the increase in the nonaccrual loans this quarter, maybe just some details around product types impacted, reserve coverage, that kind of thing?

Speaker 2

Yes. The increase in the nonperformers really is not indicative of the overall portfolio's continued improvement. If you look in the quarter, resolutions exceeded downgrades in the portfolio by more than two:one. If you look at the quarterly additions that we had, say, last year to problem loans, which are, again, these risk grade 10 and higher, just our term for, they averaged $380,000,000 This year, it's averaged $153,000,000 and third quarter is only $100,000,000 So things are going very well there, and it's going well in the energy portfolio as well. As I've said for the last several quarters, we still have some credits that, as I say, are moving through the snake.

And these are credits that had property sets that weren't in favor, like you've seen some of the activity in the Permian Basin, for example, that maybe have high cost structures, things like that. And they're just going have to work their way through. They didn't have the opportunity to deleverage like some of our other customers did. The biggest one of these was a $43,000,000 credit, which was a potential problem before it had been servicing its debt. It let the bank group know in the last quarter that it would stop doing that and that it needed a plan to move forward.

So what we did, we and they're a great group of people, so don't get the wrong idea. But we took a specific allocation, which would move this credit down to its liquidation value if we chose to do that. And so that's in place right now. So it's neutralized as far as any meaningful financial effect where we are right now. But I think the good news about that particular credit is that the nature of that their business is enhancing existing production.

And so if they're provided with additional capital, they can pretty efficiently increase the amount of production associated with investing that capital in terms of what they do. And what they do is, again, it's enhancing existing production. So they could pretty efficiently increase their production against the loan balance that would be outstanding. It's just a question of do they and how they go about getting that additional capital to do that. So even though it's a big number, I feel we've neutralized the impact in terms of where it is right now versus market value.

And we still they still got an opportunity to make this work.

Speaker 5

So was most of this migration related to energy or credits in energy heavy areas?

Speaker 2

Say that one more time.

Speaker 5

Was most of the migration you saw to NPA either energy credits or credits that are located within energy dominated areas? Yes,

Speaker 2

they were. I mean, there was another credit that was it's about a $13,000,000 credit that went non performer. But it's actually recently is demonstrating positive cash flow, and I feel good about the prospects for that one. So and then the other one was in, as you say, in an area that was that's dependent or heavily related to energy, but it's more in the maritime business and it has some issues with regard to the competition overcapacity. That's really just a banking business issue.

Those things come up every now and then. They're just having to work through some issues and we'll see how that goes. That one wasn't really one of these credits moving to the snake that I talked about.

Speaker 5

Right. Okay. I appreciate the color there. And then just one quick one on expenses. The other expense line was down a lot this quarter.

Can you just talk about the drivers there and then your outlook overall on expenses for 4Q?

Speaker 3

They were low. I think what I'd say is typically the third quarter is lighter on some things like advertising, for example. So we'll see some pickup there in the fourth quarter. Also, fourth quarter will be higher a lot of times on the incentive pay areas. We'll kind of finalize those in Q4.

So typically, salaries are higher there. So yes, I think the way I'd look at it is that the third quarter would need to be adjusted up on a more fourth quarter on a normalized basis. I'd go back and look at our historical trends. You can kind of see an uptick there.

Speaker 0

Your next question comes from the line of Steven Exfolios from JPMorgan. Your line is open.

Speaker 6

Hi, everybody.

Speaker 1

Good morning.

Speaker 3

Good morning.

Speaker 6

I wanted to start on the $43,000,000 non performer that you saw this quarter, I assume that was E and P. Is that correct?

Speaker 2

Yes.

Speaker 6

Was that a Shared National Credit also?

Speaker 2

Yes.

Speaker 6

Okay. And I just want to understand, I would think there would be less pressure on E and P at this stage given oil is over 50. What would cause a loan that size to trip into nonperformer at this stage?

Speaker 2

Well, the fact that they informed the group that they were not going to be making interest payments.

Speaker 6

Okay. Got then what were the thoughts? I know you sold a pretty significant chunk of treasury securities in the quarter at $750,000,000 and you took that $3,000,000 loss. What was the thought behind that? I to fully understand that.

Speaker 3

Well, sure. If you think about it, we were only only earning one one point three, you know, just five basis points of what we would earn at the Fed. They just thought there was an opportunity to to utilize some of those proceeds, in this higher rate environment.

Speaker 2

And also, as Jerry, think, mentioned before too, we're only reinvesting a part of it.

Speaker 3

Right.

Speaker 7

400

Speaker 2

Yes. We're letting some of that ride in liquidity. I mean that will help our asset sensitivity, and that's just sort of our orientation in terms of what we see, we believe, is happening with rates. And so, we will keep some dry powder in that.

Speaker 6

Got you. And then I appreciate the commentary on the expenses and the pickup. If we look, you had some movement too in the fee revenue this quarter, looked a little bit high. How do you think about a run rate of fee revenue from where we came out in the third quarter?

Speaker 3

Give me just a second. Yes, I think that looking at the fees, I think that I would expect that it's a fairly good run rate typically in the fourth quarter. If you go back and look at some of our historical performance, insurance revenues are typically up in that fourth quarter. So I expect we probably see that sort of trend. Other than that, I think it's a fairly good trend, course, the loss on the securities transactions.

Speaker 6

Got you. Okay. And then just one final one. With all the deposit growth you guys are seeing in the money market account now that you've raised rates there, how do we think about margin here in the fourth quarter? Is that going to continue to pressure margin?

Speaker 3

The way I tend to look at it is kind of flattish with what the adjusted 3.7 that I mentioned for the we took this 3.73 for the actual adjust out the adjustment we're at 3.7. And so I tend to look at it as staying pretty flattish. The challenge there of course is going to be the timing of the purchases of the municipal securities that we talked about, the 400,000,000 as you mentioned, of course, also the deposit level. So there may be some a little bit of pressure on the percentage itself that may be more optics than anything else. Where you'd see, you know, with with we're in favor of getting it.

We we love to get more deposits. And so we could potentially see a a little bit of pressure on the percentage, but an increase in net interest income dollars.

Speaker 6

Terrific. Thanks for taking my questions.

Speaker 2

Sure. Thank you.

Speaker 0

Your next question comes from the line of John Pecari from Evercore ISI. Your line is open.

Speaker 8

Good morning.

Speaker 3

Good morning.

Speaker 8

So regarding the ad energy book again with that credit, can you just remind me the size of the reserve still around 4.5% of the energy book?

Speaker 2

No. Time that has gone down is it has improved.

Speaker 3

Yes, we're down. We were last quarter, we were at 3.85%, and we're down to 3.74% this quarter.

Speaker 8

Okay. All right. And at that 3.74% level, still comfortable that it's adequate to absorb the remaining items that can move through the snake here? I mean, these are somewhat lumpy in terms of the size of these credits. So if we've got a few more, you're going to be hitting that reserve by a fair amount.

So just curious how it stands. Well,

Speaker 2

first of all, the answer to your question is yes. And the this is for what hits the reserves going to depend upon, obviously, whatever happens, what they're able to do. But I want to keep in mind that just the overall portfolio in the energy sector has really been improving. So you've

Speaker 3

got

Speaker 2

a dichotomy here of these firms that weren't able to deleverage, if you will. And so I'd say another thing is that we haven't identified any new credits in the energy side this year. So again, like I said, that makes horse races, right? That's what makes it. But we feel like we're doing a good job of recognizing where we are with these credits.

And when we see issues or see something get worse, we're aggressive in marketing it to where it needs to be is. So I'm not worried about the remaining credits in the snake. It will be what they are, but I frankly moved on from that.

Speaker 8

Okay. All right. And then back to the margin. On the deposit side, could you just talk to us about the remind us of the beta, the deposit beta that you assume in terms of this cycle and where you stand currently?

Speaker 3

Our assumption as far as, we do have an assumption for a Fed hike in December, but it's not having a material impact, of course, on our numbers. Our betas, I guess, the way we'd look at them is that you know, we kinda set up when we made those deposit increases, in July. You know, we kinda looked back over the you know, the Fed had raised by that point, raised by a 100 basis points. And so we probably took a beta at that point of, say, about 30%. We would expect, you know, as rates go up, you know, we'll we'll just need to, well, to look at the competition.

You know, we kinda feel like we're in a good place, to be quite honest with you, compared to to, some of the competitors out there who haven't raised rates. So our betas may not need to be as aggressive going forward, but we'll just have to see how it plays out.

Speaker 8

Okay. So it may not be as high. The incremental beta may not be as high as F30?

Speaker 3

Correct. But we'll to see what's happening in the market.

Speaker 2

Yes, John. I think we did the heavy lifting last quarter. So now what we're doing is we're just going to keep an eye on the market. We're going to we want deposits to grow. We want to make sure our value proposition is good enough to attract customers.

And so it's going to be more I think it will be a little bit more fine tuning than it was with the heavy lifting we had to do last quarter.

Speaker 8

Okay. And then lastly, back to the capital discussion regarding the buyback. Just trying to gauge your how you're thinking about the magnitude. I mean is there what's the likelihood that you remain somewhat aggressive with this program and potentially follow it up with another one? I mean, your capital levels are still relatively solid.

I know that this was already asked about your appetite from here. But is there a rationale when you look at your growth outlook right now? Is there any type of rationale where you can stay somewhat aggressive in terms of of buying back here and, just given how solid your capital levels are?

Speaker 2

John, I'd say that the it's going depend on growth prospects, right? We're a highly rated company. We sort of manage now to increase our loans in a sustainable way. And a lot of that is related to, again, this focus on the core part of the portfolio. So it's really well diversified.

I'd like to use capital in that regard and I'd like to have a strong capital position. That said, we'll use the buyback if in an opportunistic way if we feel it's warranted. And when you look at the buybacks historically, I think the €100,000,000 that we've sort of authorized has been fairly close to what I'll call the leakage is in terms of the stock that goes out based upon stock plans that the company has and that kind of thing. So this one really represents sort of that level plus a little extra. So it's a little bit bigger than what we had before.

I wouldn't read too much into strategy with that program. It's really just to give management the ability to take advantage of situations in favor of shareholders as we see it. Look, again, I hope growth is what uses this capital up. We are committed to sustainable organic growth. But if it doesn't and we have excess capital just like we've done over time, we'll continue to use a buyback and the Board meets every quarter.

Speaker 8

Got it. All right. Thanks, Phil.

Speaker 0

Your next question comes from the line of Ebrahim Poonawala from Bank of America. Your line is open.

Speaker 1

Good morning, guys.

Speaker 2

Good morning.

Speaker 7

I'm sorry if I missed this. Did you say what the money market rate was this quarter and whether that reflected the full impact of the upward pricing on those deposits?

Speaker 3

Maybe the best way that I could answer that is looking at our deposit cost on interest bearing deposits. So they went up from six basis points in the second quarter to 15 basis in the third quarter. And if you recall, that rate hike went in, I guess, about the July 24. So we'll still have a little bit of an impact, in the fourth quarter.

Speaker 7

And is that at a point I know you mentioned that the money market high yield growth was strong. Is it at a point where you believe it's okay that even if we get a December rate hike, you don't need to further increase that rate? Or how do you sort of look at the competitive pressures in the market? And do you expect that we might be in a situation where you need to raise that again if the Fed moves in December?

Speaker 2

Abraham, we'll just look at it at the time. Like I said, I think we'll fine tune it. I think we'll increase. If the Fed increases, I think we'll increase. I don't think we'll increase the same level.

Think we went to I think our high yield rates were 35 basis points on the high end, which is a great rate. CDs were 5%. Yes, 7580%. It was probably less. CDs really aren't that big a deal, I mean, in terms of their dollar impact on our balance sheet and the marginal effect.

I think but just since you asked, I think probably the pressure on if I can use that word on betas for CDs is less than MMA. I think you're going to have to make sure that your MMA continues to be a relevant rate. So I think we'll see increase. I don't think we'll see anywhere near the 35 basis points or move into the 35 basis points that you saw last time. Jerry has got that in his projections that he just talked about, too.

Speaker 7

Understood. And I'm sorry if I missed it. You mentioned there was a spread between the three seventy three and the three seventy margin. What was the three basis points?

Speaker 3

We I mentioned it in my comments that we did have a correction on some loans that were misclassified as taxable rather than tax exempt. So we tried to take that that impact out of the that was related to twenty seventeen out of the margin just to give a more normalized rate, which would have been that three seventy.

Speaker 7

Understood. And just one last question, Phil. In terms of when you think about balance sheet growth, think it was earlier asked, did you see any dampening impact in this quarter from the hurricanes? And if not, do you expect that the kind of quarter we saw about 1.5 to 2% sequential loan growth, that's sustainable as we think about 2018?

Speaker 2

Yes. I'd like to see similar loan growth. I mean, we said high single digits is what we'd like to shoot for, and we're going to have a goal to do that. We really haven't seen much impact from the hurricane with regard to deposits or loans. But we're going to have to keep an eye on it, right, because you you just don't know we hadn't been through it.

And so we're going to have to see the impact it might be in the fourth quarter, early first. But I'm optimistic about it. We want to be careful and prudent about it, but I'm optimistic about how we're able to grow and what our people really have been able to do.

Speaker 1

Understood. That's all I had. Thank you.

Speaker 2

Your

Speaker 0

next question comes from the line of Jennifer Demba from SunTrust. Your line is open. Thank you. Is there any way to quantify the fees you lost during the quarter from the waivers related to the storms?

Speaker 2

I'll say yes, there is. Mainly it has been done. It's mainly about remembering it. Seems to recall it was around $0.02 $5,000,000 Yes.

Speaker 3

I think at the high end, Phil. I really don't remember. It wasn't a I thought it was $200,000

Speaker 2

Okay. So something in that range, Jennifer.

Speaker 0

Okay. Thank you very much.

Speaker 3

Thank you.

Speaker 0

Your next question comes from the line of Brandi Gailey from KBW. Your line is open.

Speaker 9

Hey guys, it's Brady. Good morning.

Speaker 2

Hey Brady. How are doing? I'm doing Brady. Yes,

Speaker 9

not Brandi. So one more question on fee income. If you look at one of the big drivers for increased fee income on a linked quarter basis, it was also in that other category, went from about $7,000,000 to roughly $11,000,000 a little under $11,000,000 What were some of the components that pushed up other fees?

Speaker 3

Sure. One of the things there in that other income category was we did get, 1,200,000.0, related to a recovery. This was an asset that Western National Bank had our acquisition that we did in 02/2014. They'd written it off, and so on our books, it had a zero value. We got a million 2, related to that in the third quarter.

We also had a real strong quarter on derivatives activity. They were up about 900,000 compared to the third quarter last year. And then you'll recall, you know, we sold this, Frost Bank Tower in Downtown San Antonio and recognized a gain, and, we're we deferred a portion of that gain because we're still in the building. And so that gets amortized, into income about 700,000 a quarter, and and we didn't have that in the third quarter last year. That building sale occurred late in the fourth quarter last year.

Speaker 9

And how that $700,000 a quarter, how long will that last?

Speaker 3

That should go on until mid-twenty nineteen.

Speaker 9

All right. And then just to be clear, back to Harvey, it sounds like you all did not take a Harvey specific provision. Is that the right way to think about it?

Speaker 2

Yes, it is. I mean, just the way the reserve works and how it's calculated and improvements in other parts of the portfolio and just our ability to look on a macro basis. There was no specific allocation or specific provision for Harvey, but we really feel good about the general allocations that we have, which would recognize that along with lots of other things that are out there in the environment. So feel good about our where we stand with regards to having a reserve against what might happen there.

Speaker 9

All right. And then lastly for me, if you look over the last three years or so, I think you might have even said it in your comments, Phil, that energy has gone from over 16% of loans to a little under 11% of loans. Now since we've seen some stability with oil over 50, do you think now is the time right to think about starting to increase that percentage? And could that be additive to loan growth for you guys over the next couple of years?

Speaker 2

Brady, I wouldn't increase the percentage just strictly to add to loan growth. What I expect from the business is for it to continue to grow and to grow in line with what the rest of our loan portfolio and our loan business does. If you look at what's going on in the markets today, based upon what we're hearing from our people, it's slowed a little bit on energy. And it may be because CapEx budgets near the end of the year fill up. There's been a little bit of slowing on these big acreage deals that have been pretty public out there.

I think on a long term basis, the independent producer is an important customer to us. And they may not be coming back until oil gets to 60 in any great degree. So I don't think it's really a robust market right now. Energy is steady, but with a little bit of slowing in the pipeline. So I would not look for that part of the portfolio to sort of make our dreams come true in any way.

I mean it will be a part of that. But I look to it more being in line with what our growth. So we may be more in line with sort of where we are right now as percentage could move up a little bit on a quarter or go down occasionally. In the Permian, even though the independents may take, say, 60 to work, 52 works well in the Permian and in the SCOOP. But beyond that, it can be problematic.

Speaker 3

Thanks for the color, Phil. Your

Speaker 0

next question comes from the line of Ebrahim Poonawala from Bank of America. Your line is open.

Speaker 2

Hello?

Speaker 0

Ebrahim Pourremanal, your line is open.

Speaker 7

Hey guys, can you hear me?

Speaker 2

We can.

Speaker 1

Sorry about that.

Speaker 7

Just a quick question. Did you say what you expect the effective tax rate to be going forward and into 2018?

Speaker 3

We don't give any guidance yet on 2018. If I was looking at the fourth quarter, I'd probably say we're going to our expectations would be that we'd be somewhere in that 13% to 14% range.

Speaker 7

And appreciate that you don't want to give the 2018 guidance. Would the delta from the 13% to 14% versus into 2018 would be just the level of muni purchases? Or are there other things that would impact the tax rate?

Speaker 3

Of course, the strength of earnings because from that marginal level, that corporate rate is still 35%. So yes, it could be affected by a lot of issues associated with that.

Speaker 1

Got it. That's all I had. Thank you.

Speaker 3

Thank you.

Speaker 0

Your next question comes from the line of Matt Olney from Stephens Inc. Your line is open.

Speaker 10

Hey, good morning guys. Thanks for taking my question. Just want to ask on the update for the Shared National Credit portfolio. Do you guys have the updated balance of that portfolio? And were there any grade changes from the recent national exam for the SNCs recently?

Yes.

Speaker 2

The size of portfolio, just give me a second, period end was $795,000,000 and there was no change as a result of that last exam.

Speaker 10

Thank you.

Speaker 0

There are no further questions at this time. I turn the call over to Phil Green.

Speaker 2

Okay, everyone. We thank you for your participation in the call. We'll be adjourned.

Speaker 0

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