Greg Parker - EVP and Director, IR Phil Green - Chairman and CEO Jerry Salinas - Group EVP and CFO.

Dave Rochester - Deutsche Bank Rahul Patil - Evercore ISI Brady Gailey - KBW.

Good morning, ladies and gentlemen and welcome to Cullen/Frost Bank First Quarter Earnings Conference Call. 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. 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 or by calling the Investor Relations department at 210-220-5632. At this time, I’ll turn the call over to Phil..

Thank you, Greg. Good morning and thanks for joining us. Today, I’ll review first quarter 2017 results for Cullen/Frost, and our Chief Financial Officer, Jerry Salinas will also provide additional comments before we open it up to your questions.

In the first quarter, Cullen/Frost turned to $1.28 per diluted common share compared with the $1.07 in the same quarter last year and a $1.28 in the fourth quarter of last year. Our first quarter results represent a strong start to 2017, and we’re building on the momentum from the second half of 2016.

During the first quarter, average loans were $12.1 billion, up more than 5% from the first quarter of last year and on a linked quarter annualized basis, first quarter average loans were up over 12%. Our provision for loan losses were $8 million in the first quarter, down sharply from $28.5 million reported in the first quarter of 2016.

And non-performing assets totaled $118 million in the first quarter, which was up by $15.6 million from the fourth quarter but were down by 34% from the first quarter of 2016. The increase from year-end was primarily related to one energy related credit which was included previously potential problem loans.

Net charge-offs in the first quarter of 2017 were $7.9 million compared with $5.7 million in the previous quarter and $2.5 million in the first quarter of 2016. Annualized net charge-offs represent 27 basis points of average loans for the first quarter.

Overall delinquencies for accruing loans at the end of the first quarter were only 36 basis points of period-end loans, an extremely low number. Total problem loans, defined as risk grade 10 and higher fell by about 5% in the first quarter when compared to the fourth quarter.

This is primarily the result of favorable resolutions like upgrades, paydowns and payoffs. Energy related non-accruals increased to $78.7 million at the end of the first quarter compared to $57.6 million at the end of the fourth quarter, driven by a single energy related credit mentioned earlier.

The specific loan loss allocation for these non-accrual energy credits was $850,000, which was down from $3.75 million in the fourth quarter. The reserve for energy loans at the end of the first quarter was approximately 4.5%.

Based on all traditional measures, the number of problem energy bar was picked a year ago and we continue to manage these levels down further. Finally, outstanding energy loans at the end of the fourth quarter totaled $1.36 billion or 11.2% of total loans that compares with 11.6% at the end of 2016 and over 16% at its peak in 2015.

So, I believe we’ve moved from a period of energy-related headwinds to a period of growth and momentum and optimism. The economy is doing well in Texas and our customers are responding. Average total deposits in the first quarter rose to $25.8 billion, up by almost 8% from just under $24 billion in the first quarter of last year.

On the consumer side, we continue to see good growth in accounts, customers and balances. Same-store sales growth for new account origination is up by 22% compared to the first quarter of 2016 with growth at or near double digits in all regions. There are several reasons for this growth.

First, our value proposition is increasingly attractive versus our competitors in the market. Prospects can now open accounts and become customers using the Frost Bank mobile app wherever they are. Third, we’ve opened 10 new financial centers since the beginning of 2016, strengthening our presence in our markets.

And finally, I should say that our bankers remain committed to building relationships with customers who come to us digitally or through our locations. Regarding consumer lending, in the first quarter of 2017, total average consumer loans grew by 8.2% compared to the first quarter of 2016.

And this is an area where we’re making the conscious effort to develop this segment of our customer base. On the commercial side, the year is turning out much stronger than 2016, and new loan opportunities were up by 44% compared with last year. We’ve seen an increase in the volume of both smaller and larger commitments.

New commitments under $10 million were up by 31% in the first quarter compared to last year, while new commitments at or above $10 million were 41% higher than last year. Overall, new loan commitments are up by 36% from last year.

We’ve been focusing on delivering sustainable, above average organic growth through great customer experiences that make people’s lives better. And I believe that our financial results and the recognition that we get from third parties on J.D. Power, Greenwich and Consumer Reports demonstrate we’re making progress toward that end.

So, let me say, it’s our great staff that makes all this happen. As I’ve said before, without them, we’re nothing more than empty buildings and lease obligations. Our people are the ones who work with our customers to nurture the long-term relationships that make Frost unique.

So, I’d like to thank everyone at Frost for all their hard work and dedication through everything we’ve been through and into the opportunities to come. Now, I’ll turn the call over to our Chief Financial Officer, Jerry Salinas for some additional comments..

Thank you, Phil. I’m going to make some comments about the economy and I’ll give some additional information about our financial performance for the quarter before updating our 2017 guidance. I’ll then turn the call back over to Phil for questions. The Texas economy is accelerating across the industry sectors and metro areas.

Texas employment expanded at an annualized 2.4% in the first quarter of 2017. The Dallas Fed notes more hiring optimism in Texas than in recent years. Although Texas rig counts are rising, employment growth in the energy sector is a bit slower due to both increased efficiency and automation.

For the first time in many years, the Texas unemployment rate is higher than the national average due to a sharp increase in the state’s workforce. The March unemployment rate in Texas is now 5% compared to the national average of 4.5%. Looking at individual markets, Dallas/Fort Worth remains strong with 2017 employment growth above 4%.

The increase is mostly broad-based across sectors. The professional and business services sector is adding jobs rapidly from ongoing relocations and expansions in the Metroplex. The March unemployment rate was 4.1% in Dallas and 4.8% in Fort Worth. Austin continues to expand but at a slower pace.

Austin jobs grew at a 2.6% annualized base from the previous three months. Austin job expansion is diversified across most industries, especially construction and manufacturing. Austin’s employment rate in March was 3.6%.

San Antonio employment increased only 0.7% during the first quarter, indicating slower than expected growth in the first half of 2017. Health services jobs rose sharply over the past three months while jobs in scientific and technical services declined. San Antonio’s unemployment rate was 4% in March.

With the oil and gas sector improving, the outlook for Greater Huston is modestly positive. February nonfarm employment grew at an annualized 2.5% or nearly 19,000 jobs. The largest gains in Huston came from manufacturing and professional and business services. Huston’s unemployment rate in March was 5.6%.

For Texas overall, the Dallas Fed projects 2.4% job growth in 2017. Looking at our financial performance. Our net interest margin for the first quarter was 3.64%, up 9 basis points from the 3.55% reported last quarter. We had some positives and negatives affecting the net interest margin percentage this quarter as compared to the fourth quarter.

On the positive side, we’d higher rates that affected our yields on loans and balances kept at the Fed. Our lower proportion of earning assets being held in balances at the Fed as compared to the fourth quarter also have positive impact on our net interest margin percentage.

Partially offsetting these favorable variances was the lower yields on our investment portfolio as compared to last quarter. The taxable equivalent loan yield for the quarter was 4.15%, up 11 basis points from the fourth quarter.

Average loans for the first quarter were $12.09 billion, up $364 million or 12.4% on an annualized basis from the $11.73 billion last quarter. The taxable equivalent yield on the investment portfolio was 3.99%, down 5 basis points from 4.40% for the previous quarter and was impacted primarily by a lower yield on our municipal portfolio.

The taxable equivalent yields on our municipal portfolio was 5.44%, down 8 basis points from the fourth quarter last year. The duration of the investment portfolio at the end of the fourth quarter was 5.0 years -- excuse me, at the end of the first quarter was 5.0 years, up slightly from 4.8 years for the previous quarter.

The total investment portfolio averaged $12.55 billion during the first quarter, up about $39 million from the fourth quarter average of $12.51 billion. Our municipal portfolio at the end of first quarter was down approximately $100 million from December to $7.25 billion.

During the first quarter, we purchased approximately $291 million in municipal securities, yielding 4.76% with an average life of 20 years. As we expected, during the first quarter, about $400 million in municipal securities were called.

These securities came off our books at a taxable equivalent yield of over 7%, which had a negative impact on the municipal portfolio yield for the quarter, as mentioned previously. At the end of the fourth quarter, about 67% of the municipal portfolio was pre-refunded or PSF insured.

Regarding income taxes, the exercise of stock options during the first quarter had a favorable impact on income tax expense for the quarter of approximately $3.5 million. Under the new accounting standard, which we adopted in the third quarter of last year, the tax effect of settlement of share based payment goes to income tax expense.

Our effective tax rate for the first quarter was 11.83%. Without the tax benefit from the stock option exercises, our effective tax rate for the quarter would have been about 15.5%. Our capital levels remain strong with our common equity Tier 1 ratio at 12.71% at the end of March.

Regarding full year 2017 earnings, we currently believe that the current full year mean of analyst estimates up to $5.13 is low, an estimate closer to the average of the low estimate of $5 and the high estimate of $5.45 would be more reasonable. I’ll now turn the call back over to Phil for questions..

Thanks, Jerry. We’ll now turn the call over for questions..

[Operator Instructions] Your first question comes from the line of Dave Rochester of Deutsche Bank. Your line is open..

Just real quickly a housekeeping on the tax rate. You mentioned that 15% core rate ex the tax benefit.

How do you think that trends going forward?.

For the -- a lot of it would be dependent on the stock option exercises but of course it can be dependent on stock prices and people exercising a stock option.

So, I guess when I tell that you 15.5% all things being equal would be our core rate and would be adjusted accordingly for any changes in projected earnings or early exercises that had a tax benefit.

Does that make sense?.

Yes. That’s great. Thank you. And switching to the fee income side.

I was just wondering what the driver was for the weaker insurance income year-over-year and how you’re thinking about growth in that line item going forward?.

Sure. In the first quarter what we typically received is our bonus payment, the contingent payment that we’ve received on our policies. And the payment that we received are based on how those policies -- how the business grows from the prior year and how those policies perform individually.

And so, for the quarter, we were actually down compared to the first quarter last year. Those contingent fees were down $2.6 million.

So, I think it was bulk of the reason for the decrease offsetting some of that was about $1.3 million and favorable commission which were the ongoing sort of type fees, resulting in the unfavorable variance of $1.6 million. So, the contingents, we would have liked to have them but they’re not part of the core business.

So, we feel good about the growth that we’re seeing in the commission business..

Okay.

So, year-over-year you’re thinking that you could actually still be up on this, on the insurance line versus last year for the full year of 2017?.

Yes.

Are you talking about including those contingents or are you pulling them out or are you including those?.

Just keeping them in, I’m just wondering if this line item for 2017 do you think is going to be down or that could be up?.

It’s going to be relatively flat which what we’re hoping as it will see increases in commissions offsetting those reduced contingent commissions -- contingents excuse me. So pretty flat for us. .

Sounds good. And then just real quick on expenses. Those came in a bit below expectation this quarter.

How you’re thinking about the trend there going into 2Q, and then your thoughts for the full year? I know you mentioned growing financial centers, a decent amount over the last year, maybe if you could just comment on your plans for the next year as a part of that that would be great?.

I would say that looking at expenses, what I would say is that the first quarter had a pretty number run-rate associated with it. I think that we’d expect some bumps, some small bumps throughout the year, but with a fairly stable running rate down. I don’t think there was anything unusual there.

And you’re right, we will continue opening financial centers into 2017, maybe at a little bit slower pace than the 10 Phil mentioned for 2016, but we’ll continue to open some..

And your next question comes from the line of John Pancari of Evercore ISI. Your line is open. .

Yes. This is Rahul Patil on behalf of John. Just question on loan growth which came in better this quarter, better than what you were expecting, better than it looks like overall industry trend.

Could you provide some color on where you’re getting incremental loan growth, the main drivers of loan growth in coming quarters?.

Yes. I think the growth is good overall. As I said, consumer’s up 8. We’re seeing strong commercial real estate growth. There is a lot of activity there. We’re being little careful and selective as far as that goes. And we’re seeing good C&I growth. I would say, it’s a very broad-based growth in the portfolio overall.

So, it’s just indicative of better activity..

Okay. And then just shifting to deposits.

Could you talk about trends in deposit flows, especially post recent fed hikes, do you see any notable shift in behavior? And then, just as a follow-up, what sort of deposit betas are you seeing on your commercial deposits?.

Well, on the deposit side, yes, we’ve seen a really good growth in the quarter. It’s been pretty broad-based, leaning a little bit more on the commercial side than on the consumer side. We do a look back where we look at deposit growth over the last 12 months rolling.

And we’re really seeing about half of our growth is coming from existing customers and half is coming from new customers. And we just see a good nice increase in energy deposits also. So, overall, feeling pretty good about where deposits are and the growth potential there..

Okay. Just lastly, just one small question.

Do you have the portion of the demand deposits that are related to commercial clients?.

I think the number that we have is not associated with the balances where they’re used to paying services were about $3.6 billion, I think was the last number I heard, something in that range. .

[Operator Instructions] Your next question comes from the line of Brady Gailey of KBW. Your line is open..

So, it sounds like cash balances went down a little bit linked quarter. Can you just update us on as we’re seeing higher loan rates, you guys still have a lot of cash on the balance sheet.

What’s your interest in pulling that cash to work in the bond book longer term?.

As we’ve kind of said it before, our goal is to really create the sustainability of inorganic growth and to do that we got to grow the loan portfolio consistently in all our regions. And that’s what we’ve been doing and plan on doing and have really been pleased with the results that we’ve been seeing.

Brady, we’re going to try and not to buy many more securities. If you look at say the second half of this year, we’ll do a limited amount and I mean less than $100 million would be my guess in municipals, just to fill out some of what our plans were and to recognize some pay-offs that we’re having in that portfolio.

But we’re not really expecting much in a way of securities purchases in the second half of this year and not very much in the second quarter. And that’s a good thing..

Yes. Okay, great. And then, I don’t think you’ll have much healthcare exposure, but we’re seeing increased focus on that this quarter.

Can you quantify how much healthcare exposure you have, if any?.

It’s in the top five categories of our C&I portfolio. Hang on just a second..

And are you all seeing any weakness in healthcare right now?.

No. Yes, it’s probably -- Brady, look for it, just a second. We’ll get back to you..

[Operator Instructions] There are no further questions in the queue. At this time, I’d like to turn the call back to Mr. Phil Green for his closing remarks..

Okay. Well, first of all before we leave, Brady, we were able to locate the medical services number. In 2016, it was 4.6% of our portfolio. So, it’s a good sector and has performed very well. Okay. Well, if we have no more questions, then we’ll bring the call to an end. And thank you for your participation today..

And this concludes today’s conference call. You may now disconnect..