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Edited Transcript of CFR earnings conference call or presentation 31-Oct-19 3:00pm GMT

Q3 2019 Cullen/Frost Bankers Inc Earnings Call

SAN ANTONIO Nov 9, 2019 (Thomson StreetEvents) -- Edited Transcript of Cullen/Frost Bankers Inc earnings conference call or presentation Thursday, October 31, 2019 at 3:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* A. B. Mendez

Cullen/Frost Bankers, Inc. - Director of IR

* Jerry Salinas

Cullen/Frost Bankers, Inc. - Group Executive VP & CFO

* Phillip D. Green

Cullen/Frost Bankers, Inc. - Chairman & CEO

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Conference Call Participants

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* Brady Matthew Gailey

Keefe, Bruyette, & Woods, Inc., Research Division - MD

* Brett D. Rabatin

Piper Jaffray Companies, Research Division - Senior Research Analyst

* Ebrahim Huseini Poonawala

BofA Merrill Lynch, Research Division - Director

* Jennifer Haskew Demba

SunTrust Robinson Humphrey, Inc., Research Division - MD

* Jon Glenn Arfstrom

RBC Capital Markets, Research Division - MD of Financial Services Equity Research

* Kenneth Allen Zerbe

Morgan Stanley, Research Division - Executive Director

* Peter J. Winter

Wedbush Securities Inc., Research Division - MD of Equity Research

* Rahul Suresh Patil

Evercore ISI Institutional Equities, Research Division - Analyst

* Steven A. Alexopoulos

JP Morgan Chase & Co, Research Division - MD and Head of Mid-Cap & Small-Cap Banks

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Presentation

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Operator [1]

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Ladies and gentlemen, thank you for standing by and welcome to the Cullen/Frost third quarter earnings conference call. (Operator Instructions).

I would now like to hand the conference over to your speaker for today, Director of Investor Relations, A.B. Mendez. Thank you. Please go ahead.

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A. B. Mendez, Cullen/Frost Bankers, Inc. - Director of IR [2]

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Thanks, Stephanie. 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 minute 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 that such statements to be covered by the safe harbor provisions for the forward-looking statements contained in the Private Securities Litigation Reform Act of 1995, as amended.

Please see the last page of 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 on our website or by calling the Investor Relations department at (210) 220-5234.

At this time, I'll turn the call over to Phil.

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Phillip D. Green, Cullen/Frost Bankers, Inc. - Chairman & CEO [3]

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Thanks, A.B. Good morning, everyone, and thanks for joining us. Today, I'll review the third quarter 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 third quarter, Cullen/Frost earned $109.8 million or $1.73 per diluted common share compared with earnings of $115.8 million or $1.78 a share reported in the same quarter of last year.

Our return on average assets was 1.35% for the quarter compared to 1.49% in the third quarter last year.

Average deposits in the third quarter were up to $26.4 billion compared with $26.2 billion in the third quarter of last year.

Average loans in the third quarter were $14.5 billion, up 5.8% from the third quarter of last year.

We continue to see growth in our C&I, CRE and Consumer segments.

Our provision for loan losses was $8 million in the third quarter compared to $6.4 million in the second quarter of 2019 and $2.7 million in the third quarter of 2018.

Net charge-offs for the third quarter were $6.4 million compared with $15.3 million for the third quarter of last year.

Third quarter annualized net charge-offs were only 17 basis points of average loans.

Nonperforming assets were $105 million at the end of the third quarter compared to $76.4 million in the second quarter of 2019 and $86.4 million in the third quarter of last year. The increase in the third quarter related to a single energy credit which had been included in problem energy loans since early 2016.

Overall, delinquencies for accruing loans at the end of the third quarter were $100 million or 69 basis points of period end loans. Those numbers remain well within our standards and comparable to what we have experienced in the past several years.

Our overall credit quality remains good. Total problem loans, which we define as risk grade 10 and higher of $487 million at the end of the third quarter compared to $457 million in the second quarter of this year, and $504 million for the third quarter of last year.

Energy-related problem loans declined to $87.2 million at the end of the third quarter compared to $93.6 million at the end of the second quarter and $138.8 million in the third quarter of last year.

Energy loans in general, represented 10.5% of our portfolio at the end of the third quarter, well below our peak of more than 16% in 2015.

Our focus for commercial loans continues to be on consistent, balanced growth, including both the core component, which we define as lending relationships under $10 million in size, as well as larger relationships, while maintaining our quality standards.

New relationships increased 5% versus the third quarter a year ago. The dollar amount of new loan commitments booked during the third quarter dropped by 14% compared to the prior year, with decreases in C&I, public finance and energy, but a slight increase in CRE commitments.

Similar to what we discussed last quarter, we're looking at lots of deals but our booking ratio was down, particularly in commercial real estate.

In the current quarter, our booking ratio for CRE was 24% versus 32% in the prior year.

Overall, in the third quarter, we saw our percentage of deals lost to structure increase from 56% to 61% versus a year ago.

I was pleased to see our weighted current active loan pipeline in the third quarter was up by about 30% compared with the end of the second quarter due to higher levels of C&I opportunities. So we're seeing good activity, and I'm expecting some good growth in the fourth quarter.

In Consumer Banking, our value proposition and award-winning service and technology continued to attract customers. The fourth, fifth and sixth of the 25 new financial centers planned over the next 2 years in Houston opened in the third quarter, and we've already opened the seventh so far in the fourth quarter with more to come before the end of this year.

Overall, net new consumer customer growth for the third quarter was up by 48% compared with a year ago.

So far this year, same-store sales, as measured by account openings increased by 14% compared to a year ago.

In the third quarter, just under 30% of our account openings came from our online channel, which includes our Frost Bank mobile app. This channel continues to grow. In fact, online account openings were 56% higher during the quarter compared to the previous year.

The consumer loan portfolio averaged $1.7 billion in the third quarter, increasing by 1.9% compared to the third quarter of last year.

I continue to be extremely proud of our banking, insurance and wealth advisory staff executing our strategy of organic growth, consistent with our strong culture.

The interest rate environment presents challenges to our industry, but we continue to focus on the fundamentals and growing our lines of business in line with our quality standards.

To sum up, Frost has received the highest ranking in customer satisfaction in Texas in J.D. Power's U.S. Retail Banking Satisfaction Study for 10 years in a row.

We have received more Greenwich excellence and best brand awards for small business and middle-market banking than any other bank nationwide for 3 consecutive years, and we've once again been named the best Bank in Texas by Money magazine.

You don't do that without great people, dedicated to providing the kind of service that makes people's lives better.

Now I'll turn the call over to our Chief Financial Officer, Jerry Salinas, for some additional comments.

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Jerry Salinas, Cullen/Frost Bankers, Inc. - Group Executive VP & CFO [4]

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Thank you, Phil. I'll make a few comments about the Texas economy before providing some additional information about our financial performance for the quarter, and I'll close with our guidance for full year 2019.

Regarding the economy, Texas unemployment remained at the historically low level of 3.4% for the fifth month in a row in September. Texas job growth continued at a healthy pace but decelerated during the third quarter, coming in at 3% in July, 1.8% in August and 0.9% in September compared to the 2.3% growth seen in the first 6 months of the year.

The Dallas Fed currently estimates Texas job growth at 2.1% for full year 2019.

In terms of employment growth by industry, construction has been especially strong, growing at 6% year-to-date, followed by manufacturing job growth of 2.7%.

Energy industry job growth has weakened and now stands at 1.6% year-to-date, however, energy job growth was negative in the third quarter.

Looking at individual markets. Houston economic growth was slightly ahead of historical trends in the third quarter. The Fed's Houston business Cycle Index slowed to a 3.9% growth rate in September, but remains above its historical average of 3.5%.

Year-to-date, Houston employment is up 2%, with third quarter growth slightly better at 2.2%. The construction sector saw 7.3% job growth in the 9 months through September. The strongest growth of any sector in the Houston economy. Houston's unemployment rate fell slightly to 3.6% in September.

The Dallas business cycle index expanded at a 4.4% annual rate in the third quarter while the Fort Worth business cycle index expanded at a 3.5% annual rate.

In September, the unemployment rate fell to 3.1% in Dallas and 3.2% in Fort Worth.

The Austin economy also remained healthy in August. The Austin business cycle index grew at a 7.8% annualized rate. Austin's unemployment rate stood at 2.7%. The information sector saw by far the fastest job creation in Austin in the year-to-date period, with job growth of 23% over the prior year period.

Growth in the San Antonio economy accelerated in September. The San Antonio business cycle index expanded its fastest pace since 2016, growing at a 3.8% rate in September, well above its long-term trend of 2.9%.

San Antonio's unemployment rate decreased slightly to 3% as of September. The Permian Basin economy showed year-to-date job growth of 0.2% through September, with unemployment of 2.3%, remaining well below the state's overall 3.4%.

Looking at our net interest margin. Our net interest margin percentage for the third quarter was 3.76%, down 9 basis points from the 385 -- 3.85% reported last quarter. The decrease primarily resulted from lower yields on loans and balances at the Fed, partially offset by lower funding costs.

The taxable equivalent loan yield for the third quarter was 5.16%, down 18 basis points from the second quarter.

Looking at our investment portfolio, the total investment portfolio averaged $13.4 billion during the third quarter, up about $122 million from the second quarter average of $13.3 billion. The taxable equivalent yield on the investment portfolio was 3.43% in the third quarter, up 1 basis point from the second quarter.

Our municipal portfolio averaged about $8.2 billion during the third quarter, flat with the second quarter.

During the third quarter, we purchased about $100 million in agency mortgage-backed securities yielding 2.63% and about $260 million in municipal securities with a TE yield of 3.31%. The municipal portfolio had a taxable equivalent yield for the third quarter of 4.08%, up 2 basis points from the previous quarter.

At the end of the third quarter, about 2/3 of the municipal portfolio was PSF insured. The duration of the investment portfolio at the end of the quarter was 4.3 years, flat with the previous quarter.

Looking at our funding sources. The cost of total deposits for the third quarter was 39 basis points, down 2 basis points from the second quarter.

The cost of combined Fed funds purchased and repurchase agreements, which consists primarily of customer repos, decreased 16 basis points to 1.53% for the third quarter from 1.69% in the previous quarter.

Those balances averaged about $1.29 billion during the third quarter, up about $49 million from the previous quarter.

Moving to noninterest expenses. Total noninterest expense for the quarter increased approximately $15.2 million or 7.8% compared to the third quarter last year.

Excluding the impact of the Houston expansion and the increased operating costs associated with our headquarter's move in downtown San Antonio, noninterest expense growth would have been approximately 4.3%.

Regarding the assets for full year 2019 reported earnings, we currently believe that the mean of analyst estimates of $6.81 is reasonable.

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

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Phillip D. Green, Cullen/Frost Bankers, Inc. - Chairman & CEO [5]

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Thanks, Jerry. Now I'll open up the call to questions.

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Questions and Answers

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Operator [1]

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(Operator Instructions). Our first question comes from the line of Brady Gailey with KBW.

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Brady Matthew Gailey, Keefe, Bruyette, & Woods, Inc., Research Division - MD [2]

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Maybe we can just start with loan growth. You're losing more CRE deals to feels like to structure, where are these deals going? Are they going to some of your peer banks? Or are they going to non bank lenders?

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Phillip D. Green, Cullen/Frost Bankers, Inc. - Chairman & CEO [3]

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I think there's a combination of all those, it will depend on the deal, it could be -- I think I mentioned this last time, it was -- we've seen it go small banks, in smaller communities, we've seen to go to large banks, we've seen it go to private equity, just a lot of competition for CRE.

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Brady Matthew Gailey, Keefe, Bruyette, & Woods, Inc., Research Division - MD [4]

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Okay. And it's great to hear you a little more upbeat on loan growth in the fourth quarter, Phil. What is driving that optimism? I think I heard you say something about C&I. What's driving the more positive tone there?

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Phillip D. Green, Cullen/Frost Bankers, Inc. - Chairman & CEO [5]

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It's hard to say. We were a little disappointed with the C&I growth that we had in the third quarter in terms of book commitments. As I talked to our folks around, it seemed like there was a little bit of a pause with -- on the C&I side, on customer side, on the prospect side, and maybe that was just an anomaly in timing. It looks like it's picked up more strongly in the fourth quarter. So as we look at our weighted pipeline, it's increased. And I'm not sure there's anything I can really specifically relate it to. But it is -- it's definitely better than it was in the third quarter.

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Brady Matthew Gailey, Keefe, Bruyette, & Woods, Inc., Research Division - MD [6]

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All right. And then finally, for me, 1 for Jerry. I know last quarter, you talked about a full year net interest margin of $375 million for this year. It seems like you're running about $380 million on average for the first 3 quarters. Now that we just got the last rate cut, what's your updated thoughts on kind of how the NIM reacts from here?

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Jerry Salinas, Cullen/Frost Bankers, Inc. - Group Executive VP & CFO [7]

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Brady, I think the guidance I gave you, right? It was a $375 million for the full year. And in our assumption last quarter did include rate cuts in July and October. And at this point, we're still comfortable with that $375 million kind of a full year NIM is kind of what we're thinking.

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Operator [8]

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Your next question comes from the line of Rahul Patil with Evercore ISI.

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Rahul Suresh Patil, Evercore ISI Institutional Equities, Research Division - Analyst [9]

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Just going back to the NIM question. Just wondering, looking beyond the fourth quarter, assuming no additional cuts, following yesterday's cut. Do you expect pressure on asset yields given competitive pressures to more than offset any benefit that you're seeing on the downward pricing of deposits? Or do you anticipate the NIM to kind of inflect at some point in 2020 as you see the benefit from deposit pricing actions?

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Jerry Salinas, Cullen/Frost Bankers, Inc. - Group Executive VP & CFO [10]

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I think our -- obviously, there's going to be pressure on the NIM. And a lot of it will be dependent on what happens to any further rate cuts, right? So at this point, I think what we're projecting it is continued pressure on the NIM. From an investment portfolio standpoint, yields aren't what they used to be. So we're struggling a little bit there. We're talking about potentially adding some duration there, which will help the portfolio. But from a deposit standpoint, we kind of raised deposits as we were going up, and we've kind of done the same thing coming down. We're still very competitive on our deposit pricing, but for our deposit betas, I think we've been, let me see here, on total deposits, our beta was about 25% in related to the October cut. So there's definitely going to be pressure on the NIM. I can't sit here and say that given what's happening with rates. And given what's happening in the loan portfolio. I think Phil has said before, that we're going to be more competitive on pricing there's no reason for us to lose a deal with a long-term relationship over 5 or 10 basis points. So we're going to be more competitive with pricing even in this lower rate environment. So at this point, what I'm seeing if I look forward, is still continued pressure and kind of a downward trend on that NIM in 2020.

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Rahul Suresh Patil, Evercore ISI Institutional Equities, Research Division - Analyst [11]

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Got it. And then the deposit growth was pretty strong this quarter, particularly on -- in a period basis. Was there anything seasonal that was sort of unique to this quarter that you expect to flow out in fourth quarter?

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Jerry Salinas, Cullen/Frost Bankers, Inc. - Group Executive VP & CFO [12]

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Historically, for us, the third and the fourth quarter are the strongest quarters. It was good to see the sort of growth that we had. Even on average basis, I think linked quarter, we were up annualized 5.5%. We had seen some pressures we talked about on the DDA, especially early part of the year, after the Fed raised rates in December, there was quite a move out, it is, I think, CFOs and treasurers, that the interest rates at that point were so high that it was an opportunity cost basis to just keep it in their checking accounts. And so we started seeing some outflows in those commercial demand deposit accounts. We started to see some settling in there. We're doing some things on our end to be more competitive. And yes, so I think that it was good to see. I don't think there's anything unusual that caught our attention. We've had good growth in the CD categories and the MMA, obviously, but it was good to see the demand deposits growing also.

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Rahul Suresh Patil, Evercore ISI Institutional Equities, Research Division - Analyst [13]

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Got it. And just one last. Could you quantify the distressed energy loan exposure, which is sort of the residual from the previous energy downturn in 2016, that you are still kind of working through right now versus any new distressed energy credit that just kind of materialized over the recent weeks?

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Phillip D. Green, Cullen/Frost Bankers, Inc. - Chairman & CEO [14]

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Okay. Well, on the -- let me see what I can do for you. Hang on a second. The -- as we mentioned, an increase in nonperformers was related to an energy credit that had been a part of problem loans for a good while. The -- our -- let's see. You look at energy loans that we classify as problems. At the end of the third quarter, it was about $87 million in round numbers. And the big majority, vast majority of that's 2 credits that are nonperformers. One is a $34 million credit, one's $33 million. We've been living with those. As we said, moving through the SNC for a long time, and they're just trying to generate liquidity. And it's a tougher environment, as you all know, with less capital moving in those markets for people who want to sell anything and need to sell anything. You've got discount rates on the reserves, used to be PV9s to be 15%, 20%, something 25%. So that's reduced collateral values and liquidation values. So I mean, that's really what's happening there. As far as our outlook there. I feel good about the portfolio. It doesn't mean we don't have any risk. The -- if you've got somebody who is intending to sell assets, that's what I worry about. We've got -- we got a credit that's $50 million to us. It's not a problem loan, but I know they're looking to sell assets, and I'm not very optimistic about the environment to do that. So we'll just have to see how that works out. But that's -- other than that one. As far as what we've got. We I think feel good about it. We've got about $1.5 billion outstanding in energy. The weighted average risk rate of that portfolio is at 6.13% compared to the overall portfolio of 6.44%. So aside from a few larger credits that we're either been working through it in SNC or that I've got my eye on out of the SNC. I think I feel really good about the portfolio.

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Operator [15]

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Your next question is from the line of Jennifer Demba with SunTrust.

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Jennifer Haskew Demba, SunTrust Robinson Humphrey, Inc., Research Division - MD [16]

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On the 2 energy credits you just mentioned, Phil, $34 million, $33 million on NPL. What kind of reserve is on those loans? And what kind of loss are you thinking could happen?

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Jerry Salinas, Cullen/Frost Bankers, Inc. - Group Executive VP & CFO [17]

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Yes. I think that reserve, specific reserve wise, we have $10 million roughly associated with each of those credits. So $20 million total between the 2.

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Phillip D. Green, Cullen/Frost Bankers, Inc. - Chairman & CEO [18]

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It just depends on how things work out until, as far as what it will ultimately be, we don't know. It's kind of a fluid situation, I think, in the markets with regard to what the value of these assets are, particularly if it's -- if it's gas-related or if it's outside of the Permian, it's still that same situation.

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Jennifer Haskew Demba, SunTrust Robinson Humphrey, Inc., Research Division - MD [19]

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On expenses, you just moved into the new headquarters a few months ago, still going through the Houston expansion. I mean, should we expect a bit more expense growth next year in 2020 than we're seeing this year? This year, it's been around 6% year-to-date?

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Jerry Salinas, Cullen/Frost Bankers, Inc. - Group Executive VP & CFO [20]

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Yes, I think that's -- yes, logical question. I think that if I was putting together a model what I would say is, yes, we've only been in this building since June of this year. So those additional costs are -- it's only going to be a partial year this year, and it will be a full impact for next year. So that obviously it will have an impact on 2020 growth. And then as far as the Houston expansion is concerned, we talked about what our plan was originally, which we said was about 1 a month for 25 months. We're running a little bit behind schedule this year. I think we've opened 6 through the end of September, the seventh just got opened in October. So running a little bit behind schedule on the opening of those locations. I think from the hiring standpoint, everything I hear is that we're doing pretty well. And so hiring has been better than expected. And so those are probably going, just maybe just a little bit slower on the hiring, but I think still really keeping pace. The last numbers I looked at versus pro forma, we were slightly better on expenses, but not a whole lot. I mean, the numbers just aren't from the first couple of quarters weren't that significant. But if you remember, we talked about a $0.19 impact on 2019. And we talked a little bit about the profitability model of those branches. Just as a reminder, what we have done is we went back and looked at, on average, how our new branches had performed, I think, over a 10-year period, I think we look like a 40 branches, if I remember correctly. And what we said on average was if those locations tended to breakeven about month 27. And so really, for the $0.19 guidance, a big chunk of that was really expense related, right? Because those locations have to open, you've got to get the deposit, you've got to get the loans, but the costs start really pretty quickly. And so the way I would look at it is we were planning to open 12, it was going to cost us $0.19, and they don't break-even until the month 27. And if 2020 has kind of that same sort of concept, my starting point would be kind of like a $0.19 impact from the new locations opened in 2020 plus still a drag from the locations that we opened in '19. So yes, your thought process there is correct, that there is going to be a bigger drag on '20 than there was on '19.

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Operator [21]

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Your next question is from the line of Brett Rabatin with Piper Jaffray.

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Brett D. Rabatin, Piper Jaffray Companies, Research Division - Senior Research Analyst [22]

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Two housekeeping issues or items. One, do you -- would you happen to have interest expense for the quarter and the ending period securities portfolio?

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Phillip D. Green, Cullen/Frost Bankers, Inc. - Chairman & CEO [23]

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Sure, here. What was your first question? I'm sorry.

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Jerry Salinas, Cullen/Frost Bankers, Inc. - Group Executive VP & CFO [24]

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Interest expense.

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Brett D. Rabatin, Piper Jaffray Companies, Research Division - Senior Research Analyst [25]

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Interest expense. You guys have the total net interest income, but you don't break out the interest expense?

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Phillip D. Green, Cullen/Frost Bankers, Inc. - Chairman & CEO [26]

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Sure. Yes, just real quick here for you, you wanted it for the quarter?

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Brett D. Rabatin, Piper Jaffray Companies, Research Division - Senior Research Analyst [27]

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Right.

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Phillip D. Green, Cullen/Frost Bankers, Inc. - Chairman & CEO [28]

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$33.3 million.

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Brett D. Rabatin, Piper Jaffray Companies, Research Division - Senior Research Analyst [29]

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Okay. And then the ending period securities portfolio size?

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Jerry Salinas, Cullen/Frost Bankers, Inc. - Group Executive VP & CFO [30]

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Let me grab my 10-Q, that's probably the best place for me to go. And we'll be filing that later today. So ending securities, we had a $1.021 billion and -- held-to-maturity and $12.420 billion in the available for sale. So roughly $13.440 billion.

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Brett D. Rabatin, Piper Jaffray Companies, Research Division - Senior Research Analyst [31]

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Okay, great. And then just wanted to go back to expenses. And how -- I guess, one was how much was the incentive comp related to the third quarter increase in personnel?

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Jerry Salinas, Cullen/Frost Bankers, Inc. - Group Executive VP & CFO [32]

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Take a look there. The -- really, the incentive comp year-over-year, I'm not seeing a real big impact. Obviously, there's some from -- could be some from higher commissions on the insurance agency side as their commissions were up compared to the third as -- yes, their insurance commissions were up. There might be some additional commission income that the brokers might earn. But other than that, really, the increases have to do primarily with our typical merit and market increases, promotions that we give, but also the increase in headcount, it's also impacted by the Houston expansion.

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Brett D. Rabatin, Piper Jaffray Companies, Research Division - Senior Research Analyst [33]

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Okay. And then just thinking about going back to expenses, just thinking about the bigger picture, you got the branch build-out, is there any reason to think that core expense growth in '20 would be different than the kind of the 4%, 4.5% range now?

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Phillip D. Green, Cullen/Frost Bankers, Inc. - Chairman & CEO [34]

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I think it might be just because -- and I haven't seen detailed numbers but my gut tells me with what we're spending on additional cost and technology particularly cyber security. And then also, we've got some technical debt we've been dealing with. And some -- I mentioned last quarter, I think it was -- we had a number of positions that we needed to be filling in the IT and operations side. So we're making some headway on that, and we need to. So technology is always something that's going to be a big expense category to every business. It is to ours, too. And so I think that's going to be a little bit outsized for a while. I don't know that in and of itself is going to drive the number materially, but it will drive it some. And then I just think also, my gut is telling me that just cost for labor is getting tougher, not just for us, but for everyone. And just what you have to pay to bring in good people, keep good people is you just have to stay up on top of that, stay on top of the benefits you're providing. So just as we run the business, those are things I know we've got to be dealing with. And we can't be asleep with the switch on it. So that's why I tend to think it may be a little bit higher.

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Jerry Salinas, Cullen/Frost Bankers, Inc. - Group Executive VP & CFO [35]

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Yes, I think that's right, Phil. And you mentioned during the previous call, the open positions that we had in the technology area and what our focus was. So as we hire those people in the third and fourth quarter they will only be in our run rate for a part of the year. So yes, that's going to full impact on '20.

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Brett D. Rabatin, Piper Jaffray Companies, Research Division - Senior Research Analyst [36]

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Okay. And then maybe just one last one. Any thoughts on CECL and have you guys -- can you give us maybe your range if you're not ready to give a more definitive number?

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Jerry Salinas, Cullen/Frost Bankers, Inc. - Group Executive VP & CFO [37]

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Yes, we're going to be disclosing in our 10-Q that based on our September parallel run, we currently expect that the combined impact on the -- related to loans and unfunded commitments is about 15% to 25% higher than our allowance at the end of September.

Yes. And of course, all of the impact on CECL, we need to say a lot it is going to be dependent on what sort of economic forecast we have at the end of the year. What our loan portfolio looks like and any refinements we have made to the credit models by then. But we do have a disclosure in there. I think the team has done a really good job moving us forward.

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Operator [38]

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Your next question comes from the line of Peter Winter with Wedbush Securities.

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Peter J. Winter, Wedbush Securities Inc., Research Division - MD of Equity Research [39]

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Jerry, I heard your comments on the margin, initially in 2020, that there will be some pressure, I guess, as you guys compete on loan pricing. But just looking out longer-term for the margin, assuming the Fed is on hold. Just directionally, what do you think the margin does because I know there's a lot of puts and takes. I'm not looking for specific guidance.

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Jerry Salinas, Cullen/Frost Bankers, Inc. - Group Executive VP & CFO [40]

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I think that certainly, the positives, if you will, are going to be loan growth. If we've got loan growth kind of consistent with where we've been. And Phil mentioned, he felt better about our outlook for the fourth quarter. So obviously, loan growth is going to have a-- will have a positive impact there as far as our net interest income is concerned, I talked a little bit about on the investment portfolio. Unfortunately, today, there's just not a lot of opportunities. And so what we're talking about now is potentially looking at adding duration. So decisions that we make there could potentially have a positive impact on our net interest margin percentage. From a deposit sort of standpoint, I think I told you the betas that we've used, I think we've been pretty aggressive on our deposit pricing. We were aggressive going up and we're aggressive coming down. But we're going to continue to keep our eye on what our competitors are doing even though we have a low loan-to-deposit ratio, from a deposit standpoint, you know us well enough to know that we're concerned about the relationships. So we want to make sure that we're treating our customers fairly. If we see any weaknesses there, we'll react accordingly. So I think that to say right now that there'd be upward -- that I could push you with an upward guidance, I think that's tough right now. I think that where we are right now is we can't make -- we can't make miracles happen. So right now, at best, I think we could do is kind of stay flattish. But that's really a challenge that we have moving forward.

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Peter J. Winter, Wedbush Securities Inc., Research Division - MD of Equity Research [41]

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Okay. And then you confirmed the full year guidance at $681 million, and you beat guidance a little bit in the third quarter. So it does imply a pretty significant drop in earnings from 3Q to 4Q. I'm just wondering where the pressure points are coming? I mean, you reconfirm margin and you're looking for a little bit better loan growth.

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Jerry Salinas, Cullen/Frost Bankers, Inc. - Group Executive VP & CFO [42]

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Right. I think the thing that I would talk about is the guidance that we gave on full year -- that I gave on full year expenses during the last call, I think we said net of the Houston expansion, and net of the additional operating costs associated with our move downtown, we said would be in the 4%, 4.5% range. And we still -- I still feel comfortable there. So obviously, what that infers is that there is a ramp-up in expenses in the fourth quarter. And if you go back and just look historically, we do have higher salaries expense in the fourth quarter, typically, a lot of the incentive plans are kind of trued up there based on performance. And if I'm looking here just at third quarter to fourth quarter of last year, I'm seeing that salaries by themselves went up from, gosh, a little north of $3 million. So we'll expect that there. And then now we're also adding the people related to the Houston expansion. Phil mentioned also that we're doing hirings in the technology area. And so those people that came in the third quarter would have come in either late in the third quarter or starting in the fourth quarter. So we'll see some additional pressures there. I think that, that's probably the thing that kind of moves the needle, if you will, will be expenses in that fourth quarter that are -- like I said, that were impacted by the -- on a reported basis impacted by the Houston expansion and also the (inaudible).

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Peter J. Winter, Wedbush Securities Inc., Research Division - MD of Equity Research [43]

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And then just my last question. Just going back to Jennifer's question about the expense growth for next year. I mean, and the comments that core expense growth could move up a little bit. I mean, is it unreasonable to assume like 8% type growth, expense growth next year?

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Jerry Salinas, Cullen/Frost Bankers, Inc. - Group Executive VP & CFO [44]

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Is that -- help me -- are you talking about core, reported?

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Peter J. Winter, Wedbush Securities Inc., Research Division - MD of Equity Research [45]

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Reported.

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Jerry Salinas, Cullen/Frost Bankers, Inc. - Group Executive VP & CFO [46]

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Yes, I think it could be north of that.

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Peter J. Winter, Wedbush Securities Inc., Research Division - MD of Equity Research [47]

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Got it. Could you give a range?

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Jerry Salinas, Cullen/Frost Bankers, Inc. - Group Executive VP & CFO [48]

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We wouldn't give any. So we typically don't give any guidance really about ranges. And if we did that, anyway, that conversation wouldn't happen until our fourth quarter call. But I will say, as far as the fourth quarter expenses, the third quarter was also light on advertising costs. So those can really swing the needle and they have during other quarters. And some of the projections that I've seen have us increasing those advertising dollars pretty significant -- advertising and promotions pretty significantly in the fourth quarter compared to the third.

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Operator [49]

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Your next question comes from the line of Ken Zerbe with Morgan Stanley.

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Kenneth Allen Zerbe, Morgan Stanley, Research Division - Executive Director [50]

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I guess, just -- I had a question. You were talking about losing deals to or deals lost to structure. Just to clarify, I believe that is only related to CRE, but correct me if I'm wrong, but the question is also, like, do you envision that continuing? Are you still seeing that in October? And is it having a material impact? Is that -- could have been one of the reasons for the slower loan growth in Q3.

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Phillip D. Green, Cullen/Frost Bankers, Inc. - Chairman & CEO [51]

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Well, the lost to structure comment relates to the entire portfolio. I don't have in front of me what the real estate number is broken out, but I can just tell you, it'd be higher on real estate, because if you look at the amount -- this is a year-to-date number, for example, which is what I'm mainly focused on in this what we call the look-to-book area. But real estate loans, we looked at 34% more deals so we look at a little over $6 billion. It was up 34% from the quarter or the full year a year ago year-to-date third quarter, and we booked $13 million more, only 1% more, $1.458 billion. So I mean, I think that's where you really see it. And when I said earlier, I think I mentioned it was a quarterly number on that success rate going from 20% -- from 32% to 24%, that's a year-to-date number, but that's really what -- where you see that. Actually, our C&I, I do have a year-to-date number on success rate for that, that's only down 1%. So C&I, our look-to-book ratio was 41% last year, year-to-date, and then it's 40% this year. So you don't see it as badly in the C&I, it's more relationship based. Based on other factors, you increase in there some, but I think it's really mainly related to commercial real estate, has a lot to do with guarantees, has a lot to do with advance rates, burndowns, just everything.

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Kenneth Allen Zerbe, Morgan Stanley, Research Division - Executive Director [52]

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Got it. But do you see that trend slowing in fourth quarter? Because it sounds like you were a little more optimistic around loan growth in fourth.

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Phillip D. Green, Cullen/Frost Bankers, Inc. - Chairman & CEO [53]

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Yes, I'm optimistic there because we've seen our pipeline increase -- our weighted pipeline and the C&I piece is one that's driving a lot of that weighted pipeline there. So that's really cause for most of my optimism. Do I expect it to get better or worse? Probably worse. It's pretty bad now, but if things slowed, you might see people rein in a little bit and be less aggressive. But right now, I don't expect it to be any better. I think as the yield curve gets, there's less and less opportunity there. People are looking for spread.

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Operator [54]

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

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Jon Glenn Arfstrom, RBC Capital Markets, Research Division - MD of Financial Services Equity Research [55]

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Just a couple of follow-ups, maybe just economic health, we can follow-up on what Ken was asking about. But the job growth numbers that you guys talked about, maybe it's just obvious, maybe it's energy. But can you maybe put a finger on or give us an idea of what you think is driving that slower job growth?

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Phillip D. Green, Cullen/Frost Bankers, Inc. - Chairman & CEO [56]

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I think some of it -- some of it's energy. But I think one thing that the people that we've talked to have pointed out to us consistently is the tighter it gets as far as the lower the unemployment rate gets, the bigger impact it's got on the ability to grow jobs. And so I think that's also a factor. But, but you are seeing some reduction related to energy employment. So I think those two things are the things that I would put my finger on.

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Jon Glenn Arfstrom, RBC Capital Markets, Research Division - MD of Financial Services Equity Research [57]

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Okay. Bigger picture, you set aside energy, you're just -- you don't feel like you're seeing slowing in Texas at all?

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Phillip D. Green, Cullen/Frost Bankers, Inc. - Chairman & CEO [58]

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No, not really. I mean, the energy business is slowing a bit and it's not bad, but it's slowing. I mean, it's still strong in the Permian, the numbers, if you look at the hotel rates out there have gone down, which is something to look at. I think they had the highest rates of the state, but still year-over-year, both in employment year-over-year growth, and the economic number, sales tax and all those kinds of things are still positive. So -- but it is slower than it was. And it was white hot before, maybe it's only red hot now, but that's what we're seeing.

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Jon Glenn Arfstrom, RBC Capital Markets, Research Division - MD of Financial Services Equity Research [59]

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Okay. Net new customer growth of 48% year-over-year, that's one of the -- and I'm assuming that's consumer, that's just -- it's a big number.

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Phillip D. Green, Cullen/Frost Bankers, Inc. - Chairman & CEO [60]

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It is. It is.

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Jon Glenn Arfstrom, RBC Capital Markets, Research Division - MD of Financial Services Equity Research [61]

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And then consumer loans up about 2% year-over-year. Curious on the 48% and what's driving that? And do you think at some point, that leads to faster consumer growth for the company overall?

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Phillip D. Green, Cullen/Frost Bankers, Inc. - Chairman & CEO [62]

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Consumer loan growth? Is that what you're relating to?

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Jon Glenn Arfstrom, RBC Capital Markets, Research Division - MD of Financial Services Equity Research [63]

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Yes.

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Phillip D. Green, Cullen/Frost Bankers, Inc. - Chairman & CEO [64]

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We're measuring this on consumer deposit relationships. So yes, I think it's reasonable to assume that. I think one of the things you're seeing on the consumer side is, if you look at the unsecured PLC part of the business, it's been slowing. We've been more careful there over the last few quarters. And so that's sort of our downward pressure. But we're still seeing good growth in commercial -- excuse me, consumer real estate and other kinds of real estate products. So I think once we get some rationalization of the, the growth rate on the PLCs, you'll see some increase in the growth rate on the consumer loan side. The -- as far as what's driving it, it's just -- I mean, it sounds corny, but we've got a great value proposition, a tremendous brand. I mean, we've been spending money to get that out and to make that more well known. Our technology is good. I mean, I think you can look at some of these awards that we get and they are composite of different things, and I can't mention, I'm not sure I can mention which ones so I won't, but it's not unusual for us on our mobile app to end up #1 in the categories. So -- and we're getting better, and we're pretty good and getting better at how we are interacting, engaging the prospects. If you look at broadcast advertising, it's probably, I don't know, maybe I'm going to guess, it's less than 15% of what we do. It's really more engaging the prospect at the proper time on the web. And that's helping us. And then people are doing their research online. And of course, you can look at the awards and stuff that we get, we look pretty good in that regard. So -- and then the service level that you get is great here. It's just great. And that comes out in word of mouth, seeing a lot of people that are willing to refer you. So I mean, I think it's a really important number to look at it. We had, like I say, the third quarter last year, we had net new customers, that's new and net close. We had net new customers, not accounts but customers 2,756. This quarter, we had 4,065. So we went over the 4,000 number. It's the first time I remember that. But anyway, I'm just really feel good about it. And it's not any one thing. It's a result of a lot of hard work over a long time.

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Jon Glenn Arfstrom, RBC Capital Markets, Research Division - MD of Financial Services Equity Research [65]

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Okay, good. And then just one more last follow-up on the energy credit. The new NPL, any guess on a resolution time line on that? And then the other two that you identified. I think you're saying they're in there and you're sizing them for us, but there isn't anything new on those two, because they've been around for a while. Is that fair?

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Phillip D. Green, Cullen/Frost Bankers, Inc. - Chairman & CEO [66]

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Well, the two nonperformers, one of them has been a non performer for a long time. I don't really know of anything specific going on there. I mean they're still trying to work some liquidity, but that's a tough game right now. The one that came in new is the borrower just changed their strategy in terms of providing capital, that type of thing. There were some changes there, and that really caused that one to go nonperformer. That's in the early stages of working that out. I'm not looking for a quick resolution there. You never know, but I don't look for one. I think one thing we've learned about the large energy credits in this cycle is just if you're not in a Permian Basin with oil. It's hard to get -- it's hard to work out of a large problem, just takes time. The other one that I mentioned, it's not a problem, but it's just a credit that I'm aware of, it wants to create some liquidity and I know that's hard to do. And so they're good operators. They've got -- they support the credit with a certain amount of guarantees. They've got other assets. I mean, it's all that. But I mean it is -- I'm just being realistic. It's a tough market, and it's about a $50 million deal to us. So -- but my point I guess, there is then other than that, I'm really not aware of anything that concerns me at all. And I think we showed that the problem energy loans were actually down so I'd now love to get rid of these nonperformers, but just going to take some time.

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Operator [67]

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Your next question comes from the line of Steven Alexopoulos with JPMorgan.

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Steven A. Alexopoulos, JP Morgan Chase & Co, Research Division - MD and Head of Mid-Cap & Small-Cap Banks [68]

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I wanted to follow-up on the commentary regarding the pace of branch openings in Houston coming in at a slower pace than at least originally outlined. How many branches do you now think you'll have opened by the end of this year? And how many will -- do you think you'd have opened by the end of 2020?

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Jerry Salinas, Cullen/Frost Bankers, Inc. - Group Executive VP & CFO [69]

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I think that our current projection is 10 in '19. And I think we're still shooting try to get all 25 open through 2020.

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Steven A. Alexopoulos, JP Morgan Chase & Co, Research Division - MD and Head of Mid-Cap & Small-Cap Banks [70]

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Okay. So you plan to accelerate the pace a bit in 2020?.

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Jerry Salinas, Cullen/Frost Bankers, Inc. - Group Executive VP & CFO [71]

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Exactly. And some of it, those openings are somewhat not completely under our control, if we are working on a leased location. We've got to work with landlords and such and lease documents go back and forth. And then also getting building permits in Houston could also affect timing of that. So a little bit slower this year, but really are working to catch up by the end of next year is the current thought.

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Steven A. Alexopoulos, JP Morgan Chase & Co, Research Division - MD and Head of Mid-Cap & Small-Cap Banks [72]

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Do you think it will be relatively even through the year? Or should we expect most of these to come on pretty late in 2020?

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Jerry Salinas, Cullen/Frost Bankers, Inc. - Group Executive VP & CFO [73]

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I think that my rec -- I don't have any information in front of me. My recollection was that it was more skewed towards the latter part of the year. But again, I think a lot of it is just dependent on what we can accomplish. I think the people, like I said, are being hired. I think we feel good about that. In some places, we're booking, we're able to book loans even before the location to open, right? If those -- if the lenders that we hire, the relationship managers that we hire have relationships but I think right now, it's kind of lumpy and really hard to predict. And -- but our overall goal is to try to get [10] -- and the last number that I saw, that's obviously a little bit easier to gauge, '19 is. 20's a little bit more difficult for us, given some of what we've mentioned.

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Steven A. Alexopoulos, JP Morgan Chase & Co, Research Division - MD and Head of Mid-Cap & Small-Cap Banks [74]

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Yes. And then looking at the branches that you've opened already, is the $1.5 million cumulative loss per branch, still a good assumption that you guys originally outlined until breakeven?

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Phillip D. Green, Cullen/Frost Bankers, Inc. - Chairman & CEO [75]

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I'd say probably. I mean, I don't really know. I don't have that in front of me now, but I mean, that was a fairly representative number for 40 branches that we had done. I don't think anything we've done is such that it's dramatically different from that. So I really should probably say, I don't know. But I don't know it's worse either.

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Steven A. Alexopoulos, JP Morgan Chase & Co, Research Division - MD and Head of Mid-Cap & Small-Cap Banks [76]

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And then finally, just looking at some of the expense details. Why are the benefits cost running up so much, I think, we're like 14% year-over-year? And do you see those continuing at a double digit pace? Any color would be helpful.

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Jerry Salinas, Cullen/Frost Bankers, Inc. - Group Executive VP & CFO [77]

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Sure. On the benefit side, yes, there's obviously some benefits that are going to get impacted just by the numbers of employees. In the case of the third quarter, we really saw an increase -- had been seeing an increase through the -- through really most of 2019 related to our medical claims. So we're self-insured. So there was a pretty good increase in medical reserve contributions, if you will, in the third quarter. So hopefully, we're doing some things here to manage that. But it can tend to be lumpy. We obviously, like I said, are self insured, we do have a stop-loss limit. But we can swing quite a bit depending on what's happening there. We also -- one of the negatives, I guess here is related to our retirement plan. I think if you compare the third quarter this year to the third quarter last year, we're up about $600,000. And so that's really just based on what happened last year as it relates to return on plan assets. And even though, I think those have performed pretty well. The discount rate, if I remember correctly, went down. And so our assumptions related to returns and what the actual discount rate is affecting that. So some of the numbers I've seen kind of don't see that as having a big impact, '20 versus '19 related to the pension plans, but '18 versus '19, they did. The other things are really primarily, as you would expect, it's going to be things like payroll taxes, 401(k) contributions, those are going to be more normalized with employee count. So I think there are some unusual things. The medical, I think, is lumpier in the third quarter than it would otherwise be. And then compared to the third quarter last year, the benefit -- the retirement plan expense is higher this year than last. We really won't know what that expense is for '20 until the discount rate gets determined at the end of the year. But from what I've seen, we should be in pretty good shape from keeping them relatively flat.

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Operator [78]

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And your next question comes from Ebrahim Poonawala with Bank of America.

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Ebrahim Huseini Poonawala, BofA Merrill Lynch, Research Division - Director [79]

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So Jerry, just following up on sort of -- there have been a bunch of questions around expense and expense growth. To make sure -- is there anything in your reported numbers from the first 3 quarters that we should be excluding? Or are the reported numbers a good base in terms of how we think about expense growth next year?

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Jerry Salinas, Cullen/Frost Bankers, Inc. - Group Executive VP & CFO [80]

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Gosh, the first 3 quarters, yes, I think that -- that's a tough one. I don't think that off the top of my head, as I think about it, I don't really recall anything significant that we had. We may have had some move costs that were associated with our move here in downtown San Antonio. And then we also had a move in our Corpus location. Those costs are in this number -- in this year's numbers, but they're not what I would consider material to the run rate, if you will. Ebrahim, nothing comes to mind that I could point out to you that was unusual during the quarters.

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Ebrahim Huseini Poonawala, BofA Merrill Lynch, Research Division - Director [81]

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That's helpful. And just, I think if you take a step back more, I guess, philosophically or strategically, how -- if you can talk about just -- I appreciate that you're making investments with a longer-term view. But Phillip, you can talk about just outlook for operating leverage? How do you think about that in terms of where you want to manage the bank from an efficiency standpoint? And -- because it seems like we should see that drift higher over the course of the next year, given your investment plans. So would love to get thoughts around that. In terms of how you and the management team thinks about it?

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Phillip D. Green, Cullen/Frost Bankers, Inc. - Chairman & CEO [82]

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Well, we -- we think about it a lot. We recognize -- and I'm going back 2 years when we were in -- the Senate bill that changed the cut line on going to that significant financial institution from $50 million to I think it went from that to $250 million or so. I mean, there are a lot of discussion about will that be a lot of acquisition activity that happens. And we -- you heard us talk about it. And our position was that while we didn't want to do a roll-up strategy in that case. We really -- instead of investing with our balance sheet to make expensive roll up acquisitions, we were going to invest operating leverage that was improving at that time because of higher interest rates and more consistent loan growth. And so we were pretty clear that was our view and our plan and that's what we've been doing. I realize that it is costing us money. And we could all ostensibly be making more money today if we were not investing in Houston like we are in 2019. And like we are going to do in 2020. We know what the impact of that is. We've been pretty open about what it was this year, $0.19. I think I heard Jerry say it's going to be more like twice that next year. Or in that range in terms of just the math I heard him go through. So we know it's increasing. And there's nothing I can do about it. Because that's what it takes to execute a strategy like that. I'm absolutely confident it's going to be positive for the long term. And that's the view we have, and I wish it was different. What I wish that we had higher interest rates instead of rates going down because so I would be able to access -- I would be able to invest some excess operating leverage, but we just don't have that right now. But I don't think that change in that strategy just because of some movements in short-term rates is really the thing to do. I've said before, we're not planting corn, we're planting trees and those trees are going to grow, and they're going to really be a benefit to us in the long term. And I'm also really proud of how we're doing in the Houston market. If you look at some of our better volumes we're -- they are in the Houston market. And it's not just related to branches because those things are pretty new, but a lot of it is around, I think the recognition and buzz that we're creating in that market doing what we're doing. So that's what we're thinking about. I don't have a decimal point oriented number on what we will go to on efficiency ratio or that kind of thing. It's more of a strategic overall view of how we want the company to move forward. In the meantime, we're doing the best we can on expenses that we do incur today. We've always been careful on expenses. And I think we've shown over time that that's -- that we have been, you got to recognize, I know you do, that we have a high service model. So we're not going to have the lowest efficiency ratio on the block. We are going to be very profitable. And we are going to have good growth over time. And that's really what we're focused on doing. So I'm sorry that it's costing us money to expand, but I really believe it's the right thing for us to do. And we think we're paving the way for good returns going forward.

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Ebrahim Huseini Poonawala, BofA Merrill Lynch, Research Division - Director [83]

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I guess, no reason to be sorry, it all makes complete sense. So -- but thanks for going through that. And just one follow-up, Jerry, in terms of the margin guidance so it sounds like and I'm not sure if you actually gave that number, but it sounds like we'll get another 10 basis points drop in the fourth quarter. Is that reasonable?

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Jerry Salinas, Cullen/Frost Bankers, Inc. - Group Executive VP & CFO [84]

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I think that we're going to stick with our guidance, Ebrahim. We think full year will be $375 million. I think that, obviously, we'll see a drop there. You're right. We saw a 9 basis point drop between second and third. Again, it will be dependent on what happens on some of the loan pricing, but I wouldn't be surprised if that drop was somewhat higher than that on the net interest mark -- on the percentage

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Operator [85]

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There are no additional questions at this time. I'll turn it back over to management for closing remarks.

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Phillip D. Green, Cullen/Frost Bankers, Inc. - Chairman & CEO [86]

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Well, that will be the end of our call. We appreciate your support. Thanks for joining us, we're adjourned.

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Operator [87]

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