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Cullen/Frost Bankers, Inc (NYSE:CFR)

Q3 2008 Earnings Call

October 22, 2008 11:00 am ET

Executives

Greg Parker - Investor Relations

Dick Evans - Chairman and CEO

Phil Green - Group Executive Vice President, CFO

Analysts

Andrea Jao - Barclays Capital

John Pancari - JPMorgan

Charlie Ernst - Sandler O'Neill

Jennifer Demba - SunTrust

Susan McGilly - Benham Investments

Operator

Good morning. At this time, I would like to welcome everyone to the Cullen/Frost Third Quarter Earnings 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. (Operator Instructions). Thank you.

Mr. Parker, you may begin your conference.

Greg Parker

Thank you. This morning's conference call will be led by Dick Evans, Chairman and CEO and Phil Green, Group Executive Vice President, CFO. Before I turn the call over to Dick and Phil, I need to take a moment to address the Safe Harbor provisions.

Some of the remarks made today will constitute forward-looking statements as defined in the Private Securities Litigation Reform Act of 1995, as amended. We intend such statements to be covered by the Safe Harbor Provisions, for forward-looking statements contained in the Private Securities Litigation Reform Act of 1995 as amended. Please see the last page of the text in this morning's earnings release for additional information about the risk factors associated with these forward-looking statements. If needed, a copy of the release is available at our website or by calling the Investor Relations department at 210-220-5632.

At this time, I will turn the call over to Dick Evans.

Dick Evans

Good morning and thank you for joining our call. I'm very pleased to share some outstanding results with you today. Let me provide a little context for the strong numbers I'm about to review with you. After that, our CFO Phil Green, will provide some additional comments behind the results, and then we'll be happy to handle any questions.

I would characterize our third quarter as a tale of two storms. Investors everywhere know all about the first storm, the turmoil that is tearing through the financial sector in the US and around the world. It's the same storm that has disrupted markets and taken with it banks and financial institutions of all sizes. Many banks would be very relieved to announce that they are weathering the storm, but Cullen/Frost is not just weathering the financial crisis. We are, in fact, prospering.

Our deposits were up. Our loans were up. Our net interest margin was up. Our non-interest income was up. We opened new financial centers in Houston and San Antonio, and we will open additional locations in coming months to capture the opportunities before us.

But the storm that impaired our results is the one that most people have forgotten. I'm talking about Hurricane Ike, one of the most devastating storms in our history. Ike was a Texas-sized disaster, decimating Galveston and shut down the city of Houston, where 30% of all Texas jobs are located. Risk Management Assessment Inc., estimates Ike's impact will exceed $6 billion of insured losses.

Investors, media, and others moved on around from Hurricane Ike relatively quickly for several reasons. The global financial crisis was dominating the news, and the historic presidential election demands a great deal of attention, and because the relief effort was managed well, and on that note, I would like to thank all of our employees who worked so hard to get our locations back up running in face of such hardships. Our employees remain the best asset we have.

Still, if something is bad for the Texas economy, it's bad for Cullen /Frost. Job growth in Texas for example, is fundamental to Cullen/Frost's economic vitality. But some estimate that Hurricane Ike may reduce job growth by 1.5% or 1%, in the fourth quarter and into January on annualized basis.

As a result, we have made a special provision of approximately $10 million to cover potential loan losses related to the impact of Hurricane Ike. This is the greatest mitigating factor to what otherwise would have been sterling results.

Primarily because of Ike, our earnings for the third quarter of 2008 were $49 million compared to $56.5 million in the third quarter of '07. On a per share basis, net income for the quarter was $0.82 per diluted common share, compared to $0.95 per diluted common share reported a year earlier.

Again, the provision related to Hurricane Ike cost $0.11 on an after-tax per share basis.

Average loans for the third quarter increased 13.4% from last year to $8.4 billion. Average deposits were up 2%, to 10.4 billion. In the first few weeks of the fourth quarter, we continue to see increases in deposits from both consumers and businesses looking for a safe financial haven and excellent customer service.

Our net interest margin was 4.74% for the third quarter of '08, an increase of five basis points over year ago quarter, and 6 basis points over last quarter. Net interest income on a taxable equivalent basis rose 3.7% to $139.7 million, compared to $134.7 million, reported in the third quarter of last year.

In the third quarter of 2008, the provision for possible loan losses was $18.9 million, compared to charge-offs of 6.4 million. As I've said earlier, approximately $10 million of the provision for possible loan losses was related to the projected impact of Hurricane Ike.

We ended the quarter very well-capitalized. Tier I and Total Risk-Based Capital Ratios were 10.3% and 12.7% respectively for the corporation. And for Frost Bank, the ratios were 10.4% and 11.9% respectively. Both sets of ratios are well in excess of the levels that are considered well capitalized.

Non-interest income, $77.3 million, up 9.3% from the third quarter of last year. Looking at the components, trust income increased 11.3% to 19.7 million. This was due to higher levels of oil and gas management fees, as well as investment fees.

Service charges on deposits were $22.6 million, up 9.4%. Insurance commissions and fees were $8.3 million, compared to $7.7 million, reported in the same quarter a year ago. And non-interest income increased 14.6%, to $15.9 million.

On the expense side, non-interest expenses for the quarter were up 8.3% to $123 million from the third quarter of last year. The major component of this increase was salaries and wages and related employee benefits, which increased 7.5% to $68.5 million. This increase was primarily due to normal merit increases and increases in the number of employees.

Let's turn to credit quality for a moment. Overall credit quality remains favorable. Some elevation in credit issues has occurred; however, the rate of increases is very manageable, and issues are not appearing from unexpected sources. Management has been able to work with the borrowers, shore up positions, and manage through the issues, which generally result in fewer non-performers, charge-offs and expenses.

With respect to our special provision for Hurricane Ike, the Houston region has credit commitments of approximately $1.9 billion. Commitments in the mandatory evacuation zones are approximately $300 million. We have performed a high level overview of these credits by reviewing historical payment performance, our collateral position, the borrowers' credit scores and geographic locations of the borrower. More complete reviews, inclusive of direct discussions, are occurring with borrowers to more fully understand their current needs and the abilities.

Some traditional metrics have experienced some elevation, while others have remained relatively flat. Non-performers at the quarter end aggregated $55.2 million. At the end of the second quarter, they stood at $49.6 million, and at year end non-performers totaled $29.8 million. Remember that the '07 total was at or near historical lows when compared to total assets and total loans. Approximately 50% of the increase has occurred during '08 came and can be tied to the home building industry, another 25% related to the insurance industry, and the balance is spread over general commercial lending, with no one industry segment standing out.

While non-performers have increased, they represent only 0.39% and 0.64% of period-end assets and period-end loans respectively. Both numbers are very respectable and comparable to prior reporting periods and well below current industry levels. Additional increases in non-performers are possible; however, we do not foresee any significant increase.

Charge-offs for the quarter were $8.1 million, and recoveries totaled $1.7 million for a net position of $6.4 million. The $6.4 million when annualized represents 30 basis points of average loans. The year-to-date net charge-off figure of 14.5 million is 0.24 basis points of average loans.

While net charge-offs did increase during the third quarter, they were driven by two specific credits, neither related to home building or commercial real estate, but rather the driver of the losses were poor management and administration of those businesses. There's no systemic or industry downturns that drove current charge-offs. The outlook for charge-offs is to remain consistent.

Past due loans at quarter end totaled $74.2 million, or 0.86% of period end loans. Both of these figures are comparable to prior reporting periods. The 90 day and over subset of delinquencies stood at 7.8 million, the lowest level in several quarters. It is this subset that frequently forecasts increases in charge-offs and non-performers.

Potential problems were 42.4 million on September 30th, up from 33.4 million as of June 30. One primary borrower contributed to this increase, a home builder for $13.1 million. Progress is being made, the borrower is cooperative, the collateral protections afforded the bank, the loan is current.

Now let's turn to our consumer banking. Our consumer banking business remains strong by any measure. Looking at customer growth, same-store sales growth and de novo accounts acquisition are both strong. On consumer loans, looking at month-end balances of the third quarter '08 versus '07, consumer loans experienced a 14% growth rate.

Home equity and home improvement products have resulted in the largest growth contributor. I want to remind you again, Texas law is very conservative on these products, compared to other states, and home values have remained relatively stable in Texas.

Now, let's move to our business side. We've seen a change in the pipeline, as evidenced in looking at borrowing requests of customers. For the full year of '07, we had 12% more borrowing requests from customers than the prior year. However, through September 2008, our customers have requested 14% less in borrowing needs than the same period last year.

However, our increased prospecting efforts have offset this reduction. This coincides with our accelerated prospecting effort which is yielding good results. To date, we have made 33% more in person calls on prospects than last year. More importantly, we have increased the number of new relationships by 23% compared to last year.

To summarize, let me repeat how pleased we are with the company's performance, especially in light of the twin storm environment we faced this quarter. Our company continues to grow and this quarter was no exception, validating our business model of relationship banking, extraordinary customer service, and fair pricing.

That was further validated by the research firm of Greenwich and Associates, which last month rated for us as a national winner in overall customer satisfaction, online service, and relationship management performance than Middle Market Banks.

I'm very pleased with that kind of recognition because it speaks so highly of the commitment to excellence that our employees bring to work everyday. And of course, the other piece of good news for us is that the Atlantic hurricane season officially ends next month, and that can't come soon enough.

Now I would like to turn over to Phil Green.

Phil Green

Thanks Dick. I'll make a few additional comments to Dick's comprehensive overview and then update our outlook and then open it up to questions. We were pleased that our margins continued to grow during the quarter. As Dick said, it increased six basis points for the second quarter to 4.74. Of that increase, about half was related to volumes, primarily loans. The remainder related to various improved asset yields.

Dick pointed out the strong growth in our loan portfolio and through the 20th of this month they have continued to increase our growth through that date, and has increased another $72 million to 8.668 billion. And it remains to be seen how volumes will do if the economy continues to slow, but if our calling efforts that Dick pointed out are any indication, then we have some reason to hope for continued success.

Regarding pricing, we have definitely seen an increase in deposit pricing relative to general market rates as competition in our markets has increased. And I will give you an example, we've seen our top tier personal money market account rate go from a 125 basis points below fed funds a year ago, to 25 basis points above fed funds today, as we have deliberately improved our value proposition in this area.

However, at the same time, we've seen even more dramatic changes from some larger banks in our market. We've also implemented similar efforts to improve our rates on CDs and at the same time, we are also looking to improve spreads in our loan portfolio to more rational pricing that gives effect to the current environment. Through all this, our interest rate prime swap continues to serve us well and contribute $7.7 million during the quarter, and it helps us to neutralize our margin against rate moves.

At current prime levels, the swap contributes $9.1 million per quarter. Just a few comments about some non-interest items; we are very pleased with the growth in our trust fees versus last year. Oil and gas fees are up 72% from last year to $3.1 million reflecting both prices and drilling activity.

A few things to keep in mind as we've seen energy prices decline; about 90% of our revenue is related to royalties, about 80% of our production is gas, which is down about 30% from the peak versus oil's 50% drop. And other things equal, we're going to see some pressure on these revenues in live lower prices. However, there is a great deal of drilling activity going on that is leading to new wells, and remember, also, there is a three-month lag from production to payment. So the October royalties that we're seeing are based on July's peak prices currently.

Looking at growth in trust fees on a linked quarter basis, they were driven by a few things; one, an $838,000 increase in oil and gas fees, a $386,000 increase in investment fees in a tough market, $356,000 increase in the state fees, and these were somewhat offset by a $752,000 quarterly decline related to seasonal reductions in tax preparation fees which happens each year. So we continue to be pleased with our performance in this area.

Taking a look at insurance fees for the quarter, they were up 7% from a year ago, which is good in light of a tough market. And if you look at the year-to-date performance, we have experienced a 7.5% drop in property and casualty fees due to the soft market. But, we've had 53% increase in benefit commissions, half of that from acquisition, but half of it’s from organic growth, and all that together produces a 7.5% growth in insurance fees overall for the year-to-date.

On other charges and fees, they were flat, but we had $1 million less in investment banking advisory fees related to the natural variability in the timing of these revenues. Also, other income included a $1.7 million recovery of previously charged off interest on a particular credit in the third quarter, which we were very pleased to see.

Also of note are other expenses, which included $1.6 million in higher FDI fee premiums, and $1 million in expenses related to Hurricane Ike, not included in the $10 million provision impact that Dick noted. The FDIC has proposed increasing premiums, which we understand would essentially double our current expense before adding any additional impact of the new expanded FDIC coverage for transaction accounts in senior debt recently announced.

Finally about half the increase in expenses for net occupancy and furniture and equipment relate to new and relocated branches as the company continues to expand to take advantage of growth opportunities in our major markets.

I will conclude by saying that based on what we are currently seeing today, we believe the current consensus of analyst estimates for 2008 is reasonable. With that I will turn it back over Dick for questions.

Dick Evans

Thank you Phil. Now we would be happy to entertain your questions.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from the line of Andrea Jao of Barclays Capital.

Andrea Jao - Barclays Capital

Good morning everyone.

Dick Evans

Good morning

Andrea Jao - Barclays Capital

I was hoping you’d share with us your interest rate outlook or the assumptions that you have for the remainder of the year and perhaps the first half of '09. Then given those assumptions, how will the drivers that you already spoke about regarding the margin change, i.e. do you think you can still get improving loan spreads? How will funding pricing be?

Phil Green

Andrea, in our outlook we did not have another prime cut factored in. For example, we have the Fed standing pad-on rates through the end of this year. But I believe we have a prime cut near the very end of the year or very early next year.

As far as the impact on our outlook, I don't think it really affects us that much, particularly another say, 50 basis point cut, if that's what the Fed chose to do because the prime swap that we have in place has really rendered us to be more neutral in our position, as opposed to so highly asset sensitive that we used to be.

So I think our comfort with the guidance we gave is agnostic with regard to what the Fed does within a reasonable, I guess, no telling what they could possibly do, let us say within 50 basis points, we are sure we would feel pretty good about.

Andrea Jao - Barclays Capital

What are your thoughts regarding participation with TAR? And if everyone participates, what kind of exit plan would you have in place?

Dick Evans

Well, first of all, we are just studying exactly what it is. As you know, to my knowledge they want a final document early this week. And so we are still in the analysis stages to see exactly what would be good for us. As I've stated, you heard how strong our capital is and we are pleased to be going into this with a good capital position, but we will look for the right answer for our shareholders.

Andrea Jao - Barclays Capital

Thank you so much.

Operator

Your next question comes from the line of John Pancari of JPMorgan.

John Pancari - JPMorgan

Good morning.

Dick Evans

Good morning.

John Pancari - JPMorgan

Can you talk a little bit about the expected impact or the impact you may already be seeing of the pullback in oil and energy prices on the local economies? And what that could mean in terms of loan demand and ultimately credit? I know you did talk about this a little bit, but you kind of indicated more detail around your direct business with the energy companies. I just want to get an idea of what your view is in terms of an economic pullback?

Dick Evans

I think, as we look at next year, the rest of it, we think this year will end up with job growth in Texas of about 1.5%. It could be a little higher in '09, being 1%. So it's going to drop a little bit. Energy could be an effect of that, but I think when you look at prices of energy, we've got to remember a couple of things. As I look at the price of oil and gas, you really see that natural gas at around $6 or $7, quite frankly, that's pretty much where it's been since '04.

You have these peaks, sometimes the peaks are pretty steady, around six or seven, and oil dropping down, and I don't look today, I don’t know where it is but lets say at 70. We were little higher than that in '06 and about there in '05. So we have got to remember that we had good growth for several years at lower prices. All of these prices are higher.

But I feel certainly Houston could show some slowing, although we've a good, diversified economy in Texas. It is near what it used to be as I look at our portfolio, and I just will remind you, when we look at the sensitivity and taking out the hedges because that's even a greater protection of our portfolio. We're over the life of the loans; we can get out of the loans at $45 oil and $4.78 gas.

So that’s the really the figures that we watched. There's no question, you have read that there has been a cutback in the drilling activity, particularly in Barnett Shale. Chesapeake has announced that they are one of the players here, and certainly the leasing activity has slowed, although most of that land is all leased and as I fly in and out of DFW, you will see drilling rigs all around you.

So let's don't discuss a price drop, and I think it would come to a wrong conclusion that everything is shutting down. In fact, the economics of Houston were what, nearly 50%. If you look at the three month job growth, you've got Texas at about 1.5% and you've got Houston at about 2.3%.

So it's still growing very well. The hurricane will slow it down, but also with hurricanes, you get a dead cat bounce when you get the construction activity that's so strong for six to nine months after hurricane.

John Pancari - JPMorgan

Okay. So is that $45, is that your price tag you are using on the oil?

Dick Evans

No, that's the sensitivity, what it gets down to. Price index, we are $65 for the rest of '08, $60 and for the next two years and $55 and then we take the discount and then we take 75% and that is how we look at our portfolio. So that's kind of the scars of the '80s, something I learned. I want to see where the bottom is for our company.

John Pancari - JPMorgan

All right and then separately, in terms of your provision you took for Ike, can you talk to us about the recoverability of that provision and if you do expect any proceeds from insurance, etc., to help offset that impact that you had to take or the hit you have to take in terms of the provision for the storm?

Dick Evans

Yeah, those are all good questions, and I wish I had the answers. What we do know is what I said to you, is that we used a methodology, which was a high level of reviewing the payment records and looking at credit scores and collateral positions and geographic locations and obviously focusing on the mandatory evacuation zones where we have $300 million.

And that analysis, I think, was done extremely well and that's how we came up with the 10 million. And every day we're talking to customers and learning more. As you look at Houston, while it was really tough, Houston was really shut down for a week and then took about three weeks to get all the electricity back up, but it's up and running.

And if you go to Houston today, things are moving forward and people are doing all the things that you see, except for some trees and other things that are still being done. I will say, I was in Galveston last weekend, and we’ve got to remember that in Galveston 75% of all the homes had water in them. While it was a Category 2 storm, it was really a Category 4 from the water surge. It came back up out of the bay and covered the island, as I said. So that damage we got to deal with.

Downtown, the stores are all being redone, and I met with the Mayor, and they are really doing everything they can to rebuild it, but that island was, if you go out on the island where the homes are and you saw some of the pictures on television, it looks like a bomb hit it.

John Pancari - JPMorgan

Then one last question; in terms of credit again, where are you seeing weakness in your portfolio particularly? If you could just talk about that, and then related to that are you seeing any pressure in terms of your loan participations, if you could just talk about that book as well?

Phil Green

As I mentioned, the good news, as I said, we've already talked a lot about home builders and we have identified that very specifically and I'm particularly pleased, when we started realizing the difficulty for home builders, we had $550 million in outstanding commitments, today we have $380 million. And back then, we had $250 million in outstandings, and today we have 227.

Obviously the outstandings have slowed somewhat as a result. It's slowing; houses are selling slower, but it's in an orderly fashion. So, I was also particularly pleased to see that the non-performers of home builders represent about 28% of our total non-performers. And I say pleased; I'm not pleased with any of that, but I would have guessed, had I not looked at it, it would have been higher than that figure.

And so as I pointed out last time, and it continues to be true today, that there's really no particular area. As I talked about the two loans that we had losses on, really, its just poor management and administration of the businesses, and in fact, it probably would have happened in any kind of economic climate.

And so, you know, home builders, retail centers which I talked about for two quarters is where we are looking, and starting to see maybe some very slight trends in not-for-profits, churches. And research shows us that basically what happens, people honor their pledges but they just spread them out over a longer period of time. But to answer your question, there's no specific area except what I pointed out to you.

John Pancari - JPMorgan

Okay, thank you.

Operator

Your next question comes from the line of Charlie Ernst of Sandler O'Neill.

Charlie Ernst - Sandler O'Neill

Good morning guys.

Dick Evans

Good morning.

Phil Green

Good morning.

Charlie Ernst - Sandler O'Neill

In the press release you mentioned that you are seeing pretty good deposit flows since the end of the quarter. Can you elaborate on that a little bit?

Phil Green

Charlie, the thing I thought was most exciting, if you look at the average of time deposits and see, for October, it's about just under $200 million higher than the period end for the third quarter. So that's just pretty strong time deposit growth for us.

Charlie Ernst - Sandler O'Neill

Okay. And then, given that you had a number of days shut down, was there any discernible revenue loss that happened because of this storm?

Dick Evans

You're talking about for our customers or for us?

Charlie Ernst - Sandler O'Neill

Yes, in your income statement this quarter.

Phil Green

No, as I pointed out there was another $1 million of expenses and other expenses that represents our opportunity to recognize the uninsured part of all this, but that's the only other thing that we saw. I'm not aware of any revenue loss or any specific customer we know at this point that has specific problems with their credit as a result of the storm.

Dick Evans

Charlie, our staff did an incredible job of bringing our offices back up. We were able to get one of our guys into Galveston at very early stages, which was almost impossible, and we have had our units working on a couple of branches. We had a roof totally fall in in our Pearland, which is a office building we had to do totally redo, and then our Galveston locations both at Downtown and one on Stewart Road had to be rebuilt, and as I was over there, I can't tell you how impressed the customers were.

Going into a trailer, which wasn’t perfect but it was from their perspective and how much they appreciated us, coming up early, so our staff did a great job.

Charlie Ernst - Sandler O'Neill

Okay. Great, and then Phil, on the balance sheet, average earnings assets were pretty flat in the quarter, so I'm assuming, you're re-mixing out of either bonds or short-term assets. Can you add a little bit of color as to what was happening there?

Phil Green

Really, if you look at the averages, you are exactly right. We did see security is down somewhat on an average basis. We went from 3.370 billion or 3.380 billion in the second quarter down to 3.206 billion in the third. Although, it is interesting that our yields improved slightly, one from the 539 in the second quarter to 543 in the third, and as I pointed out, that's one of those benefits that endured to our margins somewhat.

And then we also saw fed funds decline. The fed funds sold average, we were 144 million in the second quarter and that dropped down to 66 million in the third quarter.

Charlie Ernst - Sandler O'Neill

And do you expect that to continue, that you will use your bond portfolio to fund loans or will we start to see, maybe a little bit better loan-balance sheet growth?

Phil Green

I think that we are hoping to see better deposit and a balance sheet growth. There's a natural amortization that occurs in that mortgage-backed portfolio, although that slows, I think, we were around 50 million a month for a while there, that's moved down to 25. As you'd expect those are you've seen a slower speed for mortgages today. So that's going to provide some. But we are also expecting to see deposit growth be more important driver than it was before.

Charlie Ernst - Sandler O'Neill

And your capital historically is at higher levels. Is the bias to sit back and let that bill given the uncertainties in the world or are you guys thinking more about how you can use that?

Phil Green

We've been really husbanding capital for the last several quarters, we had our buy back run out and then I guess the first quarter of this year we finish that up and we didn't reinstate one so we have been building capital up and that just because I think it's the prudent thing to do in this economy.

Charlie Ernst - Sandler O'Neill

Okay, great. Thanks a lot, you guys.

Phil Green

Okay.

Operator

(Operator Instructions). Your next question comes from the line of Jennifer Demba, of SunTrust.

Jennifer Demba - SunTrust

Hi.

Dick Evans

Hi Jennifer.

Jennifer Demba - SunTrust

I jumped on a few minutes late, so you may have discussed it, but can you give us some color on your loan growth during the quarter and also Phil, you mentioned there was a nonrecurring item in other income, if you could repeat that.

Phil Green

The nonrecurring item, it's unusual. We have these occasionally, so it's hard to say it is nonrecurring, there is pretty large one. With $1.7 million related to previously charged off interest recovery for a particular credit relates to prior years and when that comes in, that's booked in other income. And so that was a nice feel for us to receive.

As far as the loan growth, I did I point out, Jennifer, that we had increased another, just let me refer to for a second. We saw loan growth increase $72 million after the end of the quarter to $8.668 billion as of yesterday or the day before. So we have seen that continue to grow. And Dick pointed out the average increase was around 13% year-over-year.

Dick Evans

It's interesting, what's happened and then I talked a little bit about changes. What we are really seeing is slower pay downs and greater advances year-over-year. When I say slower pay downs, that's not a negative, its just the customers are using their money a little bit longer, good customers. And so you've got advances on the lines of credit are stronger.

When people do have a new commitment and the new growth, the advances on those lines is greater at the beginning than we've seen in the past and then we've had a good growth of just brand new credits in total.

Probably one of the most interesting things, and I feel good about talking a little bit about is mix, is as we all know 70% of your growth usually comes from existing customers. And we still have good growth from that. But what we've started to see those lines cross in the third quarter of '08, to where we are starting to see that the growth from prospects is, in fact, greater than just existing customers.

So existing customers are using their lines and using the money and not as much pay down activity as they have seen in the past, but we are building on a lot of new customers. That is good diverse group and so it really speaks to the opportunity.

Now, had we not started over five years ago with a very disciplined, very detailed, very accountable calling program. I don't think we would be where we are today, and so it's those tools that you put into place many years before that really make the difference. So I'm very pleased to see that and see the opportunity.

Jennifer Demba - SunTrust

Thank you. Phil, one more question. You said you had $1 million in costs related to Ike. Will you have any more costs in the fourth quarter?

Phil Green

We tried hard to recognize all those in the quarter, because they happen then. The only thing I can think of right now is if there's any, and this is just the way it works, is if there's any insurance dispute or that type of thing, I guess you might get to see some cost associated with that. I'm not aware of any right now, but I've had a few things insured in my life and seen how that works. And so I think that would be the only thing. I think we’ve tried hard to recognize pretty much everything.

And I just want to echo what Dick said. Our people did a fantastic job of being the first full service branch open in Galveston after the disaster there, which was really devastating, and just literally rebuilding two branches in Houston in six weeks. Just fantastic.

Jennifer Demba - SunTrust

Thanks so much. Nice quarter.

Phil Green

Thank you.

Operator

We do have a follow-up question from the line of Andrea Jao of Barclay Capital.

Andrea Jao - Barclays Capital

Hello again.

Phil Green

Hello.

Andrea Jao - Barclays Capital

Earlier you gave the number for securities, also if could share the number for borrowed funds; I believe it was 958.3 million last quarter. And then, given everything that's been going on in the past quarter, just an update if you’ve had to do certain things differently?

Phil Green

Andrea, our borrowed funds were pretty consistent. They were $949 million in the third quarter. You know, the thing that I think we are doing differently is really just kind of more on the margins. We are just being more aggressive with our value proposition on rates than trying to be on our deposits. And I think that's definitely helping us. And I think the safety and soundness, the safe haven is also a big deal to us also.

We have seen some really pretty interesting movements of money in, some very large, as people are just concerned about places to go and they felt good about this place. So I think so, on the deposit side that we we’re going to try and be more aggressive, because it's long term and we are talking really long-term.

I think the banking industry has got to re-intermediate funds back from the money market funds because everyone is going to have to fund their own asset expansion. I mean that's what we've done for our entire history, and I think more and more people are going to do it. So I think it could mean more competitiveness with regard to deposit pricing over time.

I have said though, that I believe that if there will be some rationalization of loan pricing, which really banks weren't being paid for the risk over the last few years, there's more than enough money there to pay for the deposit pricing that we'll need to experience as a company and as an industry. So that's the thing I see doing a little bit different, but I believe that we can hold our own there.

Andrea Jao - Barclays Capital

Fantastic. Thank you again.

Phil Green

Welcome.

Operator

Your next question comes from the line of Susan McGilly of Benham Investments.

Susan McGilly - Benham Investments

Hi. You just touched on it a little bit, but I was wondering if you could talk a little bit more about what you are currently seeing from your competitors on the loan side. Have things rationalized a bit?

Dick Evans

Well, they are certainly beginning to, and of course, I mean compared to the past, what borrowers have had the last five to almost 10 years is the greatest time they will probably ever experience. It's been where the financial industry really didn't charge the right rate for risk. And we are, as Phil just discussed with you, what we believe going forward over the long term of deposit pricing, moving up, and certainly you've got to move loan pricing up, we are in the midst of talking to our borrowers about that, and that's a long, gradual process.

It's intellectually very easy to understand; it's emotionally very difficult for the customers, but we are moving through that. And so by the very nature of that, and able to increase pricing somewhat as we go forward, I would say it is beginning to be rational. We feel strongly about it and so we have been forging ahead. We are in the early stages of it, but I am encouraged by it and I see that it will work well.

Susan McGilly - Benham Investments

In terms of the growth from prospects, are you seeing any patterns in those prospects? For instance taking prospects, winning them versus larger players or smaller players? Just curious about that.

Dick Evans

I don't have any numbers specifically, but I think one of our greatest opportunity as this industry continues to consolidate, the larger players will have a difficult time of really having a good borrower/bank relationship. And if you look at the problems that existed, the trillion dollars or whatever you want to call it, that to me is fundamentally what happened to the industry and that's why it's difficult.

The lender doesn't know who the borrower is and the borrower can't find the lender. That is something we don’t believe in and haven't done for 140 years. We call that relationship banking, that is our model, where we take both deposits and lend to people that we know, and I see that as a real advantage. Out of the top 30 banks in the country, we are the number one retention organization and that is a result of good customer service and good relationships.

Operator

You have a follow-up question from the line of Charlie Ernst of Sandler O'Neill.

Charlie Ernst - Sandler O'Neill

Dick, can you just give us some observations when you look at your energy customers about, how their balance sheets are situated right now? My recollection is that a lot of these guys were paying down loans and not really drawing down big lines of credit while the prices were so high. So, how do they stand from just an ability to persevere in a period of potentially lower prices?

Phil Green

Charlie, I feel good about it. They've hedged a lot of their positions. Last time I looked, I think our customer is about 60% hedged and that runs all over the board, some are not hedged and some are hedged 100%. So you get everything in between. But they are strong on cash.

The main thing is when you look at the pay downs or look at their ability to pay their loans down, which is, when you look at balance sheets of an energy company or production kind of companies, they don't mean a lot. When you look at the value and the amount of production they have and the price, and that's the reason I always focus and had the discussion on price, is that's what really that cash flow is, what really gives them the ability to service their debt.

You can call it a down turn and $80 is less than $140, but it's a lot more than what it's been in the past. Gas has a little bit one narrow squeeze, but it always moves with demand. They remember the pain that they've had with the customers, most of our customers that we deal with, and so they position themselves pretty well with where they are.

So, you go to somebody like Chesapeake and you certainly read what's happened and they have cut back. But this is not first time they have made big cutbacks in their drilling expenses over a period of time. And, this was, I think it was $3 billion, a giant number, that's a giant company and a lot going on.

So I think we are going through, they are pretty good about pulling back because they have been through these times, let the market settle, see where it's going to be and then see where they go from there.

Charlie Ernst - Sandler O'Neill

Great. Thanks a lot.

Operator

(Operator Instructions). And there are no further questions at this time.

Dick Evans

We appreciate your continued support and this concludes our conference call. Thank you very much.

Operator

Thank you. You may now disconnect.

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