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Cullen/Frost Bankers (NYSE:CFR)

Q4 FY07 Earnings Call

January 23, 2008, 11:00 AM ET

Executives

Greg Parker - EVP and Director of IR

Richard W. Evans, Jr. - Chairman and CEO

Phillip D. Green - Group EVP & CFO

Analysts

John Pancari - J.P. Morgan Securities

Brent Christ - Fox-Pitt Kelton

Andrea Jao - Lehman Brothers

Jefferson Harralson - Keefe, Bruyette & Woods

Operator

Good morning. My name is Bobby-Joe and I’ll be your conference operator today. At this time, I would like to welcome everyone to the Cullen/Frost Bankers Fourth Quarter Earnings Conference Call.

All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question-and-answer session. [Operator Instructions].

I would now like to turn the conference over to Mr. Greg Parker, Executive Vice President and Director of Investor Relations. Sir, you may begin.

Greg Parker - Executive Vice President and Director of Investor Relations

Thank you. This morning's conference call will be led by Dick Evans, Chairman and CEO and Phil Green, Group Executive Vice President and 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'll turn the call over to Dick Evans.

Richard W. Evans, Jr. - Chairman and Chief Executive Officer

Thank you, Greg. It is a pleasure to report earnings for our company of $0.93 per diluted common share, a 10.7% increase over the fourth quarter of last year. Return on average assets was 1.65%. Return on equity, 15.18%.

Annual earnings for 2007 were $212.1 million or $3.55 per diluted common share, or 9.5% increase over ’06. We are particularly pleased with these results considering Texas aggressive competition during 2007, in loan pricing and structure. Cullen/Frost worked hard to stay true to our standards. We have learned through experiences of over a 140 year history.

Today, we have the same management team we had in the 1980s. As we navigate, this current banking environment, our performance affirms the benefits of several strategic decisions that we have, have positioned us well. In 2000 we decided to exit the residential mortgage business. It was our opinion that the industry had lost its relationship focus and become a commoditized business with insufficient profitability. For the same reasons in the past we also exited the in direct lending and credit card businesses. Additionally, last quarter, we moved our company to a more interest rate neutral position, entering into a seven year, $1.2 billion interest rate swap.

One strategic focus that remains constant is our commitment to the Frost philosophy, that our outstanding staff practices and who made these strong results for 2007 possible. I thank them for their dedication to taking good care of our customers and by working as a team across all lines of businesses.

There were many positive accomplishments in 2007 and I bring your attention to the following. Average loans reached $7.5 billion, an all time high and on a linked quarter period end basis, loans increased $309 million from September of ’07 after a period of flat loan growth. Average deposits reached $10.2 billion, also an all time high. Net interest margin for the year increased to 4.69% with the Fed cutting rates a 100 basis points during the second half of the year. For the fourth quarter ’07 the net interest margin was 4.70%, up 1 basis point from the third quarter of ’07.

Non-interest income, looking at the fourth quarter of ’07 versus ’06 increased to $66.4 million or up $8 million. Trust income increased 12.5% to $18 million, service charges on deposits, $21 million, up $1.9 million. Other charges, commissions and fees, $7.9 million, up almost $2 million and investment banking fees earned during the quarter of $700,000 accounted for the single largest part of this increase.

Other non-interest income was $13.4 million, an 18.1 % increase over last year with the largest factor coming from higher income from Visa check card usage. While our insurance commissions and fees were up only slightly for the fourth quarter of last year, for the year they increased 9.3% versus ’06 to $30.8 million. Non-interest expenses increased 8.1% versus the fourth quarter of last year, a result of normal annual merit and market increases along with an increase in the number of employees as well as the acquisitions.

Asset quality metrics remained favorable and net charge offs 18 basis points or $3.5 million for the quarter and for the year, 25 basis points. Allowance for possible loan losses was 1.19% at year-end. Non-accrual loans and foreclosed assets ended the year under $30 million.

We are pleased with our asset quality and believe we're well positioned for slower economic growth in 2008. Texas job growth in ’07 was over 3% and we expect Texas will continue job growth at twice the rate of the nation, but closer to 1% in ’08. As stated earlier, we have been fortunate to avoid the major problem areas in the current banking environment. But we still look to see what other areas could be affected as we have always tried to identify problems early.

Our focus is on two areas. Home construction primarily, even though 2008 is projected to be in the top five best years we have ever experienced in home construction in Texas. And we're watching retail strip centers.

Some facts about Cullen/Frost home construction portfolio. We have $510 million committed, approximately 50% outstanding. 75% are to homebuilders and 25% to individuals constructing their homes. 39% is in our Fort Worth market, 27% Houston, 11% Dallas, 9% San Antonio. We have no financing outside of Texas and no homebuilders shared national credits. Price points over our builders is balanced across the spectrum, with no concentration in starter homes or higher end.

Secondly, we're also closely watching retail strip centers and feel our exposure is very manageable at $185 million in commitments and a $115 million outstanding. Re-leasing and guarantees are required on these loans. Overall, our asset quality metrics are favorable today, and even with some softening primarily in the home building, we feel builder’s inventories will be adjusted to the slower growth.

The Texas economy should perform better than the U.S. with positives coming from continued job growth, high energy prices and high-tech doing well.

Our six strategic priorities are clearly defined and understood across our company. First, we will quickly address and improve any underperforming markets.

Secondly, is to expand our financial center network. We added a new office in Austin in the fourth quarter, and we moved into a new building in the NASA area of Houston.

Third, is to provide and communicate attractive value propositions to our customers and prospects. For example, five years ago we simplified our checking account products, introduced free checking, lowered the prices on other checking accounts. Again last year, we improved the features and lowered fees again. We address our value proposition across all lines of businesses.

Fourth, is a focus on growing new customer relationships by effective prospecting. I reported to you before that we began a process of identifying high quality business prospects for our Relationship Managers and they are working through a list of 25,000 plus prospects that are more likely to appreciate Frost relationship style banking.

Fifth, team selling across product lines gives us the ability to broaden and deepen the relationships with our customers. We are approaching the customers by bringing together combined capabilities of our team to study our customer first. Only then do we bring these resources to improvements for our customers, focusing our products and services that make a difference to the customer’s future. I have asked my entire management team to participate in this process.

Finally, we are always working to improve our ability to attract, develop, and retain the right people. I believe Cullen/Frost is well positioned for these uncertain times that we are experiencing in our industry, and we look forward to 2008.

Now I will ask Phil Green, our CFO to make some comments.

Phillip D. Green - Group Executive Vice President & Chief Financial Officer

Thanks, Dick. I will comment on some additional aspects of our operations and talk some about our earnings outlook for the year and then open it up for questions.

It was definitely good to post another record earnings year in this challenging environment. I’d say, admittedly, it was not exactly what we hoped for in that loans outstanding held flat for most of the year, but we did finally see some loan balance follow through to the growth we saw in the period-end numbers last quarter. As Dick mentioned, fourth quarter loans on a period-end basis increased an annualized 16.5%.

In addition since the end of the year through January 21, loans have increased another $87 million to $7,856 million. Dick also mentioned the net interest margin which increased 1 basis point during the quarter to 4.70%. One basis point may not sound like a lot, but given the fact that the Fed cut interest rate to 100 basis points the last four months of the year, we were very pleased with the stability of the margin. We were able to offset the decline in rates through a combination of things, including $300 million in securities purchased at the end of the last quarter, the emergence of loan growth that we just talked about and then the implementation of $1.2 billion seven year interest rate swap we implemented in October of last year.

Related specifically to the swap position, it paid us positive cash flow of $241,000 in the fourth quarter, and it added about 1 basis point to margin. However at current rates, and taking into account Fed cuts of yesterday, the position is currently paying at a rate of about $3.2 million per quarter. So it’s now doing a lot more heavy lifting to help us offset the impact of lower rates on our margin. It’s obviously a very valuable tool for us, in our management of net interest income and providing stability. It was valued this morning at a quoted value of about $100 million.

A few comments were related to non-interest income and expenses. We did see a reduction in non-interest income due largely to the seasonality of insurance commissions, which declined $1.8 million from the third quarter. The fourth quarter is our slowest quarter during the year for insurance commissions on a seasonal basis. And also, we saw a drop in charges and fees, other charges and fees that were down $2.8 million from the third quarter due to a $3 million reduction in investment banking fees from our very strong third quarter performance. As you are aware, those revenues are fairly lumpy.

In the area of non-interest expense we saw a reduction in benefits expense in the fourth quarter due mainly to lower cost resulting from better medical and workmen’s compensation experienced through the year.

Concerning our deposit mix, there was a reduction in average demand deposits in the fourth quarter of about $84 million which is somewhat atypical for us. However during the quarter we implemented a redesign of some of our consumer checking accounts that Dick just mentioned. And as a part of that, we migrated an estimated $250 million in non-interest bearing consumer account types, into interest on checking account types. While this ostensibly lowered demand deposits and increased time deposits, the rate paid on the interest on checking account is currently only 5 basis points. So that part of restructuring is not really a significant amount.

And now to comment on a few issues that have been impacting banks recently and describe our situation with regard to these issues.

First, we are not in the residential mortgage business. As Dick mentioned, we stopped making residential mortgages eight years ago.

Secondly, it relates to… or I wanted to relate, costs associated with the VISA settlement that you have seen. Our fourth quarter did contain some costs associated with those settlements. It contained about $550,000 in costs representing our portion of recently announced VISA settlements. This is admittedly a fairly small number and represents our VISA interest of only 0.02%. We have that small a percentage because as Dick mentioned earlier, we sold our credit card portfolio in the mid-1980s and only reinstated a direct VISA relationship when we offered a VISA check card a few years ago.

Thirdly, the bank does not utilize credit default swaps on any its loans.

Fourth, the bank just does employ BOLI investments the vast majority of which is a $100 million position purchased by Frost Bank seven years ago. That BOLI is separate account structure with the investment criteria consistent with investments made in the bank’s own investment portfolio which includes no sub-prime paper. Our most recent review of that separate account portfolio showed no sub prime investments and a portfolio consistent with bank holdings. Regarding our investment portfolio, it includes no sub-prime investments, no CMOs or I should say, I think we had about $92,000 in CMOs. No CDOs, no IOs, no POs. Of the $3.415 billion portfolio, 83% represents mortgage backed securities issued by Fannie Mae, Ginny Mae and Freddie Mac. 15% represents municipal securities, 1% represents short-term discount notes, notes of federal agencies with terms of approximately six months and 1% represents stock held in the Federal Reserve and federal home loan bank.

I want to focus for a moment on our $526 million municipal portfolio because of the recent problems of certain private bond insurance companies. First, none of our municipals were purchased strictly because of the presence of any private insurance rating. Bank’s municipal portfolio consists of general obligation bonds with unlimited taxing authority. We do have bonds which happen to carry private insurance in the amount of $62 million or about 12% of the investment portfolio, or municipal portfolio. But looking at the underlying ratings of these bonds, 43% are AA, 55% are A, and 2% are BBB. Finally, 75% of our municipal portfolio is backed by the Permanent School Fund in Texas, known as PSF, which has $1 of investment assets for every $1.50 insured. Obviously, vastly different from the structure of the private insurers.

To sum up, we feel extremely good about our investment portfolio.

Before I turn it back over to Dick for questions, let me just add, as we look at the range of earning estimates for our company, we currently see ourselves as most likely toward the middle section of that range.

With that, I’ll turn it back over to Dick.

Richard W. Evans, Jr. - Chairman and Chief Executive Officer

Thank you, Phil. We're now happy to entertain any questions you may have.

Question and Answer

Operator

[Operator Instructions].

And your first question comes from the line of John Pancari.

Richard W. Evans, Jr. - Chairman and Chief Executive Officer

Hello John. John, we can't hear you, maybe you don’t have your button on or something. Operator, are you there?

Operator

Sir, your line is open.

John Pancari - J.P. Morgan Securities

Hi, can you hear me now?

Richard W. Evans, Jr. - Chairman and Chief Executive Officer

I can hear you now.

John Pancari - J.P. Morgan Securities

Okay. Great. Wanted to see if you can give us a little bit more color on loan growth, specifically by products. Certainly we're seeing this rebound, this quarter off of the sluggishness over the past couple of quarters. So, just give us an idea of where you saw that growth and then how your pipeline looks?

Richard W. Evans, Jr. - Chairman and Chief Executive Officer

That’s a great question. Let me give you just some feel for it. About $50 million was to municipal utilities. There was, just to give you a whole random, $7 million to a leasing company; there was $2 million… $10 million to an old grocery operation that we have been financing for years; $10 million to a blood bank; $6 million to a hospital; we had about $10 million increased to insurance companies which we have a specialty in financing. We had another couple of about $15 million into municipalities. The municipalities are in our public finance area. We had about $8 million to a fuel additive company. We also had $91 million to permanent mortgage increase, which we are pleased with. Again, remember this is an owner-occupied part of the portfolio. We had about $11 million to a 100-year old company in the agricultural business and $6 million to a technology company. And we did have, those tech companies and that Ag were in shared national credits. They did increase $50 million. And the balance, the majority of it is in the energy, oil and gas, production credits. Our shared national credits did go up to $411 million. We still are running, about 63% of those credits are in energy credits. We have found, as you would expect with these high energy prices, it takes a lot more dollars to just finance the same kind of borrowers.

John Pancari - J.P. Morgan Securities

And what was the shared national credit balance last quarter?

Richard W. Evans, Jr. - Chairman and Chief Executive Officer

We are up about… let’s see here.

Phillip D. Green - Group Executive Vice President & Chief Financial Officer

Last quarter it was period-end, $363 million.

John Pancari - J.P. Morgan Securities

Okay. So it’s increased $363 million to $411 million?

Phillip D. Green - Group Executive Vice President & Chief Financial Officer

Yes.

John Pancari - J.P. Morgan Securities

Okay.

Richard W. Evans, Jr. - Chairman and Chief Executive Officer

And let me just make one other comment and let Phil comment on that, for the year I think one of the things that our construction loans, this for the year, decreased $89 million. We did see a good increase of a little over $200 million in permanent mortgages which has been a focus of our company. Again, we think that is the best place to be, is to finance the working capital for our company as well as the building. And we have worked diligently on land loans throughout the year, and in fact had about $10 million decrease in that overall portfolio. Phil, you have something--?

Phillip D. Green - Group Executive Vice President & Chief Financial Officer

Yes, John I’ll just give a little bit of a summary and then maybe a little more granularity in terms of the location of the loans. On a linked quarter basis period-end, commercial and industrial loans were up $221 million. So that’s where the lion’s share of it came. Real estate loans were up by $86 million, but included in that commercial real estate mortgages were up by $91 million. So I think you can get a feel for where the growth was in the portfolio. Construction loans were actually down $32 million in the quarter.

If you look at where the growth came from by market, we had a couple of markets that were flat for the quarter. Our Valley region was flat, Fort Worth market was flat. But if you look at the other markets, Austin was up 5%, Corpus Christi up 6%, Dallas up 7.5%, Houston was up 8%, San Antonio up 7%. I think you can see we had pretty good growth across the board in terms of our markets loan portfolio.

Richard W. Evans, Jr. - Chairman and Chief Executive Officer

John, just to add one other comment on shared national credits, of the $49 million increase, $37 million was energy and $5 million was in the spirits business which is typical that that increases at year end, around the holiday season. So that will come back down.

John Pancari - J.P. Morgan Securities

Okay. Alright, great. And just a little bit on your pipeline?

Richard W. Evans, Jr. - Chairman and Chief Executive Officer

Overall our pipeline, really looks good. For a year, our calls were up 14%, our pipeline is up 22% for the year. We booked new loan commitments, they were up 29% or $814 million compared to the previous year. And in the fourth quarter, our new commitments were over $1 billion, it’s a new record for us in that regard. And that is in this competitive market. As I have shared with you before, for the year, we lost $661 million due to pricing, we lost $477 million due to structure. That’s over $1 billion. But we stayed strong about keeping our standards related to pricing and structure.

And I would you that it’s harder to take prospects away from competition. For those companies that we were trying to take, we lost… $332 million stayed with the incumbent [ph]. And so, while we’re out hustling, it’s still harder. That’s one of the reasons why I think it’s so important that the processes that I talked about in the 25,000 plus prospects, are focusing on customers that again appreciate Frost relationship style banking. That is the way that we have addressed this very competitive market and again stand by our standards at keeping quality strong in the structure of loans.

John Pancari - J.P. Morgan Securities

And then just around the loan growth, just given that you compete directly with some of the larger money center players that have exposure outside of the States, are you seeing an opportunity to add to your lending share as some of these larger players kind of turn off the spigot as credit begins to really hit their income statements across the US?

Richard W. Evans, Jr. - Chairman and Chief Executive Officer

I hope that will happen in 2008. As of recently, it’s still competitive but certainly logically, we should have some opportunities, which is typical. As you properly said, the larger banks have a tendency to open the spigot wide open or shut it off whereas our focus is always on quality relationships and is built around the people rather than the particular area.

John Pancari - J.P. Morgan Securities

Okay. All right, thank you very much.

Greg Parker - Executive Vice President and Director of Investor Relations

Thanks John.

Operator

Your next question comes from the line of Brent Christ.

Brent Christ - Fox-Pitt Kelton

Good morning, guys.

Phillip D. Green - Group Executive Vice President & Chief Financial Officer

Good morning.

Brent Christ - Fox-Pitt Kelton

A couple of questions. I appreciate the color on the home construction and retail strip center portfolios. Could you give us a little bit of a sense of kind of some of the underlying trends you are seeing, whether it be vacancy or rental rates in the strip center portfolio or just on new home starts or absorption rates in the construction portfolio, in terms of kind of, early indicators from a credit prospective?

Richard W. Evans, Jr. - Chairman and Chief Executive Officer

Let me take the last part. I think the key word in regarding strip centers is what I said about watching. We really haven’t seen the deterioration there. We are focused to be sure they have anchored tenants. And as you drive around the country, and as I drive around the state and look, it’s the centers that don’t have a big anchor that we have stayed away from, and that’s where I think the biggest risk is going to be. As far as any specifics, we haven’t seen, thank goodness, any problems in that regard, and as I told you, we do require pre-leasing and guarantee. So I just think it’s an area that you’ve got to watch.

Now moving to home builders, we have really scrubbed our portfolio from one end to the other. And just to give some specifics, our total non-performers were up from $26.3 million in the third quarter to $29.8 million in the fourth quarter. $4.4 million of that was to home builders, was an increase, non-performers were home builders, that’s less than 1% of our exposure. So we are sliced in the cheese pretty thin. But I think it’s important to watch that. And as we look at our potential problems, they increased from $14 million to $30 million. And there were $7 million to builders in that group, and $1.4 million to developers. But over 50%, 51% was to CAN.

So, I think we're early in the cycle to start trying to identify a trend, but we want to be early in the cycle of identifying these problems and working them early. We did foreclose on, I think it’s about $2 million of a builder on January the 1. That happened to be the first Tuesday and we sold a couple of lots on the courthouse steps that day. And so, I think when you look at these numbers, you're talking about very, very small percentage of our exposure and we've scrubbed them all. And to this date I’ve told you all the facts I know. So, I feel good about where we are. And as I mentioned, the job growth is still happening in Texas, and we still have a good growth and it’s… we've been fortunate in Texas that we also have not seen increases in pricing. As of the third quarter we had not seen pricing… decreases, I’m sorry…. we had not seen decreases in the prices of housing and we're coming off a period of time where, because as I've said in other conference calls, this state is a flat state. There’s lots of land, very different than where we're seeing some of the problems.

So, I think we're in a, certainly the best market and… but I also just by our nature we're going to really focus on it. We… our builders are builders that have built in Texas. They know the market, they typically have experience of over seven years. So, it’s not new to them. And there’s some pockets, the foreclosure that I mentioned that we did on the first day of the year, was really a small pocket, so don’t come to any conclusion of big trends.

And I think the key to it, that I’m most pleased, when you look at the total market, is that the builders are focusing just like I am. And as we go into the spring, I think you’ll see less building. We're already seeing permits coming down. And so they’ll be able to absorb this inventory. The latest numbers that I saw, I think the nation is running about 10 months in inventories and Texas is about eight months. And so I think we are in a pretty good shape in that regard.

Brent Christ - Fox-Pitt Kelton

Got you. And kind of, in light of that backdrop, I mean it certainly sounds better than what we are hearing from banks and other markets, you guys have been matching your provision with charge-offs over the past couple of quarters, I think excluding the student lending relationship last quarter and have seen your…

Richard W. Evans, Jr. - Chairman and Chief Executive Officer

Don’t worry, that isn’t there.

Brent Christ - Fox-Pitt Kelton

Right.

Richard W. Evans, Jr. - Chairman and Chief Executive Officer

We have already provided, it was a dormitory [ph]…

Brent Christ - Fox-Pitt Kelton

And then seeing the reserve come down a little bit, how are you guys kind of thinking about the provisioning relative to charge-offs going forward with still kind of a relatively positive outlook for credit quality?

Richard W. Evans, Jr. - Chairman and Chief Executive Officer

Well, as you know that’s driven by formula, and we forget about where our reserve is today, our allowance and as you have watched our history of providing… if we got a problem, we are going to address it. And so I think you have got to just look at it each quarter and see where you are.

Let me make one correction on the inventories of existing home sales. Texas has 6 months, not 8 months and the US is a little over 10 months. This is the latest statistics I have.

Brent Christ - Fox-Pitt Kelton

Well, thanks a lot. I will let some others hop on.

Richard W. Evans, Jr. - Chairman and Chief Executive Officer

Thank you.

Operator

Your next question comes from the line of Andrea Jao.

Andrea Jao – Lehman Brothers

Good morning, everyone.

Richard W. Evans, Jr. - Chairman and Chief Executive Officer

Good morning, Andrea.

Andrea Jao – Lehman Brothers

I was hoping to talk a bit more of the margin drivers. So I imagine the portion in your loan book that isn’t hedged, the yields are coming down. And are they coming down faster than that same market funding. What does it imply for 2008? I imagine low cost deposits are still migrating to higher cost deposits. Do you see that growing into 2008, and again what does it imply? And do you have the ability to reinvest cash flows from your securities book at higher yield?

Phillip D. Green - Group Executive Vice President & Chief Financial Officer

Well, Andrea, this is Phil, you kind of laid a relative broad spectrum out there. I would just say that… well how do I do this… I think that you asked in one part of your question about other things equal not considering the interest rate swap position. And yes, without that swap, we would be in the same position we would be in, which would be, we’ll fight reductions in interest rates really with four different weapons. And those weapons are… would loan continue to be there or would it not be there in the economy, because higher loan growth can help your margin? Two, is there any pricing power in your deposit portfolio? Are you such compared to the different competitors in the marketplace that you will be more able to recognize reductions that happened in the general market through the fed in your deposit pricing portfolio? The third thing is, are you able to add duration to your balance sheet because of any liquidity that you’ve got built up in there and dry powder that you have? And then the fourth thing would be sort of a non-interest related item which is, what kind of service charge revenue growth you might have that’s above the norm because the earnings credit rate is now less and the commercial depositors have got to pay more because your balances don’t pay for as much services?

I think all those things are in place for us still today. As you heard me say, we did invest at the end of last quarter, $300 million in Ginny Mae portfolio. So I feel like we did take and used a lot of that dry powder. So I don’t… it will be a little while before that builds up, I’d say, probably another six months at least, before we see the liquidity position building up to that level again. And as you’re seeing, the loan growth is there. So that’s a good thing, that’s an alternate use of that liquidity. The… so loan growth in fact has been there even though rates are declining. So that’s a positive for us as we look at the margin mix.

I’d say on the pricing power issue, that is a tougher one. I would say we have definitely less pricing power than we had in the past. And that’s partly because other banks I think are, in fact, to be honest, probably more concerned about funding given their balance sheet positioning and given what’s been going on in the marketplace. And so we’ve seen some of those rates be particularly sticky with some competitors whereas with others we’ve see them go down. So we’re not so much on the highest rate in the market for the largest bank, as we had been a lot of the time over the last few years. I’d say I’d put us more in the middle of the pack now. And so I would say we have we got somewhat less pricing power than we used to have.

I would say with regard to the interest rates that have recently come down, we certainly have not been able to recognize all of the reduction in general market rates in our deposit portfolio. I’d say probably, we were able to cut about, in round numbers 70% of the general market declining rates, we are able to bring that to our investment portfolio, excuse me, deposit portfolio, at least in many of the broad categories of deposits. So, that would be, that would tend to imply a squeeze other things equal. And then I think you're going to see some good deposit service charge growth, because earnings credit rate is going down.

I know that’s a little bit rambling, but that’s kind of where we stand on all those four weapons that we use. We were employing all of them. We've employed them at various degrees already and we're just very pleased to have in place the interest rates swap position because it does give us a fair amount of stability in our margin, and we're expecting stability in the margin in this year.

Richard W. Evans, Jr. - Chairman and Chief Executive Officer

Andrea, I’ll just add one intangible. Through our history, we have been fortunate to be a flight to quality. And people that understand the weakness in the financial organizations and understand why they have to pay a higher price, appreciate the quality of our organization and that is a benefit to us. Obviously, an intangible and hard to measure.

Andrea Jao – Lehman Brothers

Great. And then, if I may just follow-up with questions on seasonality in terms of fee income and expenses. So insurance should be seasonally strong in the first quarter and service charges pull in. Is that something that we can expect?

Phillip D. Green - Group Executive Vice President & Chief Financial Officer

I would say service… definitely insurance should be seasonally strong. That is our strongest quarter, as I recall. And the… on the service charges, I think you should see some growth there as earnings credit rates go down. If there was a negative in there, I think you typically see overdrafts reduce a little bit after the end of the year. So, that might be a little bit of a… out a little pressure on it, but that’s a seasonal factor.

Andrea Jao – Lehman Brothers

Okay. And how much of a seasonal do you expect on the expense side?

Phillip D. Green - Group Executive Vice President & Chief Financial Officer

I would say that the thing that you typically see is a big jump up in the benefits costs area for us because we've got to meet that FICO level for payroll taxes and those typically bump up. We had such great experience this year with the medical costs and workmen’s compensation, it’s hard to predict that would still be there at the same level next year. And so I think you’ll see some increase there as well, maybe over and above what you typically might see, I’m just talking off the top of my head here but I think you could probably see that trend.

I think another thing to keep in mind next year is that, is the FDIC assessment is kicking in for banks, and our credit will last through the first two quarters of next year, I think we estimate. And then we’ll see that cost on FDIC kick in. So that is not going to be transparent in the third or fourth quarter. So that would be a factor that you would need to be aware of.

Andrea Jao – Lehman Brothers

Okay. But that’s not until the first half of ’09?

Phillip D. Green - Group Executive Vice President & Chief Financial Officer

No, that’s in the second half of ’08.

Andrea Jao – Lehman Brothers

’08. Okay. Perfect. Thank you so much.

Phillip D. Green - Group Executive Vice President & Chief Financial Officer

Welcome.

Operator

[Operator Instructions].

Your next question comes from the line of Martin J. Martin, your line is open.

Unidentified Analyst

Hello.

Phillip D. Green - Group Executive Vice President & Chief Financial Officer

Hello, hello.

Unidentified Analyst

Hi. Sorry about that. My question is on the swap. I just wonder… we have this cut 75 basis points coming up, maybe a little bit more, a little bit less. I just wonder what the swap structure where the structure… I mean, the swap itself will commanded this type of a shock in terms of the movement of the rate?

Phillip D. Green - Group Executive Vice President & Chief Financial Officer

Okay. Well it’s a fairly straightforward math really. Under the swap structure we pay… we pay floating rate prime and we receive 7.559%. And so that’s the fixed side of it. So anytime the rates go down… and the swap is $1.2 billion.

Unidentified Analyst

Right.

Phillip D. Green - Group Executive Vice President & Chief Financial Officer

So, anytime you see prime go down, you could look at the difference, you can basically compute that difference on $1.2 billion position.

Unidentified Analyst

I see. So, the size of each cut doesn’t really matter?

Phillip D. Green - Group Executive Vice President & Chief Financial Officer

No. I mean it is very linear.

Unidentified Analyst

I see. Okay. Thanks.

Operator

And your next question comes from the line of Jefferson Harralson.

Jefferson Harralson - Keefe, Bruyette & Woods

Hi. Thanks guys. When does the swap expire?

Greg Parker - Executive Vice President and Director of Investor Relations

It’s a seven year position. It started on October 23rd. So I think it is three months old today.

Jefferson Harralson - Keefe, Bruyette & Woods

All right. Thanks a lot.

Operator

[Operator Instructions].

And at this time there are no further questions.

Richard W. Evans, Jr. - Chairman and Chief Executive Officer

Okay. Thank you for your continued support and we will continue to work hard to produce good results and continue to grow this company. We stand adjourned.

Operator

That does conclude today’s Cullen/Frost Bankers fourth quarter earnings call. You may now disconnect.

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Source: Cullen Frost Bankers, Inc. Q4 2007 Earnings Call Transcript
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