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Cullen/Frost Bankers Inc  (NYSE:CFR)
Q3 2018 Earnings Conference Call
Oct. 25, 2018, 11:00 a.m. ET

Contents:

  • Prepared Remarks
  • Questions and Answers
  • Call Participants

Prepared Remarks:

Operator

Good morning. My name is Heidi, and I will be your conference operator today. At this time, I would like to welcome everyone to the Cullen/Frost Third Quarter Earnings Conference Call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question-and-answer session. (Operator Instructions) Thank you.

A.B. Mendez, Senior Vice President and Director of Investor Relations, you may begin your conference.

A.B. Mendez -- Investor Relations

Thank you, Heidi. This morning's conference call will be led by Phil Green, Chairman and CEO, and Jerry Salinas, Group Executive Vice President and CFO. Before I turn the call over to Phil and Jerry, I need to take a moment to address the Safe Harbor provisions. Some of the remarks made today will constitute forward-looking statements as defined in the Private Securities Litigation Reform Act of 1995, as amended. We intend that 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 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 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.

Phillip D. Green -- Chairman and Chief Executive Officer, Director

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.

But before we begin, I'd like to take a minute and acknowledge that in August, we lost Tom Frost, our chairman emeritus. Those of you who've followed us over the years understand the impact Tom had on our company, and most of us can recite the mission statement that we'll grow and prosper building long-term relationships based on top-quality service, high ethical standards, and safe sound assets. The reason we have those words to guide us today is because of Tom Frost, and our adherence to those principles is the basis for our success, both in the quarter that we'll discuss and over the long term.

In the third quarter, Cullen/Frost earned $115.8 million or $1.78 per diluted common share, which represents a 27% increase compared with $1.41 per diluted common share reported in the same quarter last year. Our solid third quarter earnings results from Frost Bankers executing the strategy that we've discussed over the past several quarters focusing on sustained above-average organic growth. Our return on assets reached 1.49% in the third quarter, the highest quarterly total in nine years.

Now I'd like to offer some details about the elements that go into this growth. We have continued to grow our loan portfolio while maintaining our quality standards. During the third quarter, average loans were $13.7 billion. This represents an increase of more than $1.1 billion, or almost 9%, versus the third quarter last year. Growth was broad-based across all categories.

Our provision for loan losses was $2.7 million for the quarter compared with $8.3 million in the second quarter and $11 million in the third quarter of 2017. Non-performing assets totaled $86.4 million in the third quarter. This was down 30% from the $122.8 million in the second quarter. Potential problem loans totaled $59.1 million, which matches levels before the energy downturn.

Net charge-offs in the third quarter of 2018 were $15.3 million compared with $7.9 million in the second quarter and $6.2 million in the third quarter of last year. Of the third quarter net charge-off total, approximately 75% was related to four credits, all of which have been noted as problems and had allowance dollars allocated to them in previous quarters. Third quarter annualized net charge-offs were 44 basis points of average loans.

Overall delinquencies for accruing loans at the end of the third quarter were $81.8 million or 59 basis points for the period-end loans. That's a number well within our standards and comparable to what we've experienced in the last three years.

Total problem loans, which we define as risk grade 10 and higher, decreased $122 million or 19.5% compared to the second quarter and were down about 28% from a year ago. Problem energy loans were down about 46% from a year ago. Outstanding energy loans at the end of the second quarter represented 11% of total loans. Energy industry activity has been a source of growth in markets where we do business, but the percentage of energy loans in our portfolio remains well below our peak of more than 16% in 2015.

When we visit our customers across Texas, they tell us they're optimistic about opportunities ahead of them, and because we're well positioned to serve them with a competitive product mix and strong value proposition, we're looking forward to our own opportunities.

Average total deposits in the third quarter were $26.2 billion compared with $25.8 billion in the third quarter last year, and growth was primarily in interest-bearing accounts.

In consumer banking, our value proposition and award-winning service continued to attract customers. Net new customer growth is up by 60% compared with a year ago. I must say that again because I like the way it sounds. Net new customer growth is up by 60% compared with a year ago. About 22% of our account openings came from our online channel, which includes Frost Bank mobile app. That's nearly 26% higher than last year. The consumer loan portfolio averaged $1.66 billion in the third quarter, increasing by 8.2% or $125 million compared to the third quarter of 2017.

On the commercial side, new loan opportunities are up by 8% year-to-date compared with last year. Core loan opportunities are up by 12%, and large loan opportunities are up by 5%. Our strategy of building our core loan portfolio, which we define as loan relationships under $10 million in size continues to help provide steady sustainable organic growth. For the third quarter, new commitments under $10 million accounted for 48% of commitments booked, up from 47% last year.

Looking at new loan commitments booked in the third quarter, overall, they declined from a year ago by 8% due to lower CRE commitments and energy commitments. However, the volume of non-energy C&I was up by 17% compared to the third quarter of last year. Pay-off activity was higher during the quarter. In fact, the level of payoffs was 62% above the quarterly average for the last year. With regard to our current active loan pipeline, the third quarter was up 25% from the previous year.

Finally, as we move through the last quarter of the year, we may look back on an eventful 2018. All year long, we celebrated our 150th anniversary with a series of good deeds and charitable efforts across the state. We launched an Opt for Optimism initiative, which will continue into 2019. We raised the Frost logo on the new headquarters building in downtown San Antonio, which will be completed next year. We expanded our strategic marketing partnership with the San Antonio Spurs, and signed one with the Houston Rockets of the NBA to increase our name recognition in key markets. And as you saw in the press release this morning, we plan to significantly expand our presence in the Houston region by building 25 new financial centers in growing market areas over the next 25 months.

We've operated in Houston since 1977, and we have slightly more financial centers there than any of our other regions. But the area is so big and growth has been so substantial that we really under-invested there. Our expansion plans will help us increase our deposit market share, which is currently just slightly below 2% and extend our value proposition to a greater number of customers.

Let me say that I'm extremely pleased with what our people at Frost were able to achieve this quarter and so far this year. It's not often you're able to report a 27% increase in earnings. We can do this because Frost bankers take care of our customers by offering them top quality service and excellence at a fair price. They provide a safe sound place to do business, and most of all, they provide great customer service experiences that make people's lives better. We've been doing that for 150 years, and that experience has shown us the value of having a positive optimistic attitude toward opportunities. The long-term relationships that our Frost bankers have built with customers endure through all kinds of up and downs, and I'd like to thank them for that.

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

Jerry Salinas -- Group Executive Vice President & Chief Financial Officer

Thank you, Phil. I'll make a few general comments about the Texas economy before I provide some additional information about our financial performance for the quarter and close with our guidance for full year 2018.

Regarding the economy, the Texas economy remained strong in the third quarter and unemployment continued to decrease to record lows. According to the Federal Reserve, Dallas branch, Texas employment has expanded 2.9% year-to-date and September marks the 27th month of consecutive growth. The Texas unemployment rate fell to 3.8% in September, hitting a historical low over the past four decades. The Dallas fed revised its 2018 Texas job growth estimates to 2.7%. Based on the forecast, Texas should add more than 336,000 new jobs in 2018.

Looking at individual markets, since the last quarter, the Dallas/Fort Worth economy has seen a consistent uptick in growth. According to the Dallas fed, metroplex year-to-date employment growth of 2.6% is on par with last year's pace. August unemployment hit near historical lows at 3.4%, below both the state and US rates.

Houston's economy expanded 6.4% in August, the fastest among the major metro areas, despite a slowdown in its core energy-related sectors. Year-to-date, Houston employment is up 3.6% and all of the major sectors have increased year-over-year. Houston's unemployment rate fell slightly to 4.2% in August, below its seasonally adjusted unemployment rate since February 2008.

The Austin economy grew at an accelerated pace in September. Austin's economy expanded 7.5% in September, above the long-run average of 6%. Third quarter growth was mixed across industries with a surge in construction and mining activity, professional and business services, while the financial and manufacturing sectors showed declines. Year-to-date, Austin's unemployment growth is at 3.2% and the unemployment rate held steady at 2.9% in September.

The San Antonio economy expanded at a steady, but subdued pace in September. San Antonio's economy expanded at 2.2% annualized rate in September, below its long-term average of 2.9%. San Antonio's unemployment rate was stable in September at 3.3%, below the state and US averages.

The Permian Basin economy remains robust. Employment growth has moderated in recent months, but the employment -- the unemployment rate remains at historical lows. The unemployment rate in the Permian Basin stayed flat at 2.4%, which is the lowest in the state. Month-over-month growth in oil production has slowed, but production is still 34% higher year-over-year.

Now moving to our financial performance. Looking at our net interest margin, our net interest margin percentage for the third quarter was 3.66%, up 2 basis points from the 3.64% reported last quarter. The increase was impacted by the favorable effects of higher yields on earning assets, primary loans and investment securities and higher loan volumes. These favorable variances were mostly offset by higher funding costs on both deposits and customer repos during the third quarter. The taxable equivalent loan yield for the third quarter was 5.04%, up 14 basis points from the 4.90% reported in the second quarter.

Looking at our investment portfolio, the total investment portfolio averaged $12.1 billion during the third quarter, up about $125 million from the second quarter average of $11.9 billion. The taxable-equivalent yield on the investment portfolio was 3.41% in the third quarter, up 5 basis points from the second quarter.

Our municipal portfolio averaged about $7.9 billion during the third quarter, up about $160 million from the second quarter. The municipal portfolio had a taxable equivalent yield for the third quarter of 4.15%, up 5 basis points from the previous quarter. At the end of the third quarter, about two-thirds of the municipal portfolio was pre-refunded or PSF-insured. The duration of the investment portfolio at the end of the quarter was 4.7 years, flat with the previous quarter.

Looking at our funding sources, the cost of total deposits for the third quarter was 34 basis points, up 7 basis points from the second quarter. The cost of combined Fed funds purchased and repurchase agreement -- agreements, which consist primarily of customer repos, increased to 90 basis points for the third quarter from 25 basis points in the previous quarter. We instituted a tier rate -- a tiered rate for our customer repos during the third quarter, but we are also seeing quite a bit of exception pricing in this product. Those balances averaged about $1 billion during the third quarter, flat with the previous quarter.

Regarding income taxes, our effective tax rate for the quarter was 11.4%, up slightly from the 11.1% reported last quarter, impacted by higher net income and a lower benefit from stock option settlements during the third quarter as compared to the second. On a year-to-date basis, our effective tax rate was 10.7%.

Regarding the Houston expansion, Phil mentioned in his comments our plan for expansion of our Houston presence by adding 25 new financial centers over the next 25 months. We are currently projecting that the program will reduce next year's earnings per share by approximately $0.19.

Regarding estimates for full year 2018 earnings, we currently believe that based on our third quarter results, the mean of analyst estimates for the year of $6.77 is a little low.

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

Phillip D. Green -- Chairman and Chief Executive Officer, Director

Thanks, Jerry. And I'll open up the call for questions.

Questions and Answers:

Operator

Thank you. (Operator Instructions) And your first question comes from the line of Ebrahim Poonawala with Bank of America. Please go ahead. I'm sorry, it looks like he dropped off. One moment. Your next question comes from the line of Brett Rabatin with Piper Jaffray. Please go ahead.

Brett Rabatin -- Piper Jaffray -- Analyst

Hey, guys. Good morning.

Phillip D. Green -- Chairman and Chief Executive Officer, Director

Good morning.

Brett Rabatin -- Piper Jaffray -- Analyst

Wanted to, I guess, first, ask on the Houston expansion. I'm just trying to understand, you're going to have some more locations. What's the trend of those going to look like in terms of -- are you trying to build more of a commercial platform in Houston, or is this going to be a broad base where you're trying to penetrate further with consumer as well? If you could just give us a little more color on what you want to achieve in terms of the growth in Houston, I'd appreciate that.

Phillip D. Green -- Chairman and Chief Executive Officer, Director

Okay. Great. We want to continue to do what we have been doing in Houston and really all our markets, which is growing relationships, both consumer and commercial. If you look at our overall deposit base today in our book of business, our deposit base runs around 55% commercial, 45% consumer. Historically, it's been closer to 50-50. But that's what it is these days. If you look at the asset base on the loan side, we run about 85% commercial and 15% consumer. So those are the kind of metrics we're going to continue to expect.

If you look at the markets that we're going into in the 25 different locations that we've -- we slotted for the next 25 months, they have deposits in those submarkets equal to the size roughly of a San Antonio. And so here you've got a market that basically gives us the opportunity to penetrate something the size of San Antonio where -- we're not there today, but we do have name and brand recognition in that market. So it's really just opportunity that we've left on the table, and we haven't -- we just haven't made the investment to grow that and we know how to do it, and I'm excited about the opportunity to do it, and I'm really confident of our ability to be successful with it.

Brett Rabatin -- Piper Jaffray -- Analyst

Okay. That's a great color. And then the deposit trends were a little better this quarter, and I know that we've talked about what does non-interest-bearing do and can that be stable or can you grow that. Was there anything that changed in 3Q? And then as you're thinking about your deposit betas, are you expecting anything to change in terms of the pace of betas?

Jerry Salinas -- Group Executive Vice President & Chief Financial Officer

I think what we said last quarter was that historically, for us, we have seen an uptick in the second part of the year. So we're really not really too surprised by what we saw. We continue to see that our demand deposits, compared to the third quarter last year, they were actually down 0.6%, but our total time -- or our interest-bearing were up 3.1% given that it's 1.6% blended. So we are seeing good growth on the interest-bearing. We're still happy with that, and continue to just see pressure on the commercial side.

And regarding our deposit betas, we're going to -- what I'm going to say is that we feel like we've done a lot of the heavy lifting. We'll continue to look at what's going on with the competition and want to be fair to the customers, obviously, but I think in a lot of ways, we feel like we're ahead of the game and feel comfortable with where we're at.

Brett Rabatin -- Piper Jaffray -- Analyst

Okay, great. And would you -- just a housekeeping. Would you guys happen to have average interest-bearing funds for the quarter, and then interest expense?

Jerry Salinas -- Group Executive Vice President & Chief Financial Officer

Sure. I can get that. Hold on a second. So you're looking for the quarter?

Brett Rabatin -- Piper Jaffray -- Analyst

Right.

Jerry Salinas -- Group Executive Vice President & Chief Financial Officer

Total interest-bearing liabilities for the quarter were $16.7 billion.

Brett Rabatin -- Piper Jaffray -- Analyst

Okay. And what was the actual interest expense?

Jerry Salinas -- Group Executive Vice President & Chief Financial Officer

The interest expense was $27,051,000. So a rate of --

Brett Rabatin -- Piper Jaffray -- Analyst

Sure. Thanks for the color.

Phillip D. Green -- Chairman and Chief Executive Officer, Director

Thank you.

Operator

And your next question comes from the line of Dave Rochester with Deutsche Bank. Please go ahead.

David Rochester -- Deutsche Bank -- Analyst

Hey, good morning, guys.

Phillip D. Green -- Chairman and Chief Executive Officer, Director

Good morning.

Jerry Salinas -- Group Executive Vice President & Chief Financial Officer

Good morning, Dave.

David Rochester -- Deutsche Bank -- Analyst

On the $0.19 impacts to earnings next year in the Houston expansion, I was just wondering what are the expected revenue and expense components of that. I would imagine you have some estimates for loan and deposit growth that you're expecting to get in the first year. I was just trying to back into that for 2019, and then the expected impact on expense dollars for next year would be great. Thanks.

Phillip D. Green -- Chairman and Chief Executive Officer, Director

Well, let me -- I don't think Jerry wants to --

Jerry Salinas -- Group Executive Vice President & Chief Financial Officer

Yes, our plan is right now not to give that sort of color at this point. I will -- go ahead.

Phillip D. Green -- Chairman and Chief Executive Officer, Director

But I think what we can do is, as we talk generally about what we've been accomplishing, we're going to let you guys build your model. The estimates that Jerry gave are based upon looking at what we've done on new locations, say, 40 new locations since early 2000, say 2006. And on average, those locations have grown to about $80 million after a five-year period of time. And after five years, they run somewhere between a 1.75% and 2% ROA on using marginal costs associated and direct costs associated with the units, and they're off about, in round numbers, about 1.5 million and -- once they've reached that five-year period of time. And there is significant growth that happens after that.

So the numbers that we've used are based on what we've done, and that's sort of the overview for it. And one thing we don't do, and Jerry would tell you this, is we don't give guidance on 2019 until the first quarter of 2019. So we're not going to give you specific expenses and revenues related to 2019, but we can give you -- we've given you the answer to the pop test and you just have to do your own writing on that.

David Rochester -- Deutsche Bank -- Analyst

Sure, sure. No, I appreciate that. I guess, bigger picture, your loan growth goal this year was high singles, up to 10%. As you're thinking about it next year, you're expecting that you could possibly exceed that, just given the openings of the branches you're talking about?

Phillip D. Green -- Chairman and Chief Executive Officer, Director

I don't think we're giving comments on next year until January next year.

David Rochester -- Deutsche Bank -- Analyst

Okay. Okay. No, that's fair. Yeah. I guess as it pertains to next quarter, perhaps, how are you guys thinking about NIM expansion with future rate hikes? We've got a little bit of expansion this quarter. Is this sort of what we should expect going forward with the December -- or the September hike?

Jerry Salinas -- Group Executive Vice President & Chief Financial Officer

I guess what I'd say is this quarter, of course, was impacted by LIBOR. LIBOR didn't move the way everybody expected. I think in the case of the three-month, it was pretty flat. So I think some of that would be dependent on that. What I said last quarter about the NIM percentage was that we kind of expected slight upward trends, and I guess, I'd continue to say that as I sit here in the third quarter looking forward.

David Rochester -- Deutsche Bank -- Analyst

Okay. And then just switching to fee income, noticed you had a little bit of a bump up in the trust fee income line this quarter. I was just wondering what drove that, and then how you're expecting that to trend from here.

Jerry Salinas -- Group Executive Vice President & Chief Financial Officer

We -- so what we did see was about $2 million of the increase was in investment fees, and obviously, we had some help from the market, but we've also had some account growth there. So that's been good. And then we saw our oil and gas fees were up $1 million, and obviously we're helped by the increase in the oil prices, but also we've gained some new customers and we've got an enhanced product offering that's helping those revenues there.

David Rochester -- Deutsche Bank -- Analyst

Is this a good level to grow from here, or do you think that some of those fees were a little elevated this quarter?

Jerry Salinas -- Group Executive Vice President & Chief Financial Officer

I'm not aware of anything that was unusual this quarter in that line item.

David Rochester -- Deutsche Bank -- Analyst

And then just one last one, just on other income. It looked like that was maybe a couple of million above the core line from last quarter. Anything in that, or is that a good run rate going forward?

Jerry Salinas -- Group Executive Vice President & Chief Financial Officer

I think that's pretty choppy. Looking at the detail, I -- there's really not a whole lot there. I think we had an insurance settlement, probably was the biggest piece of it, which was maybe $700,000, something like that. But everything else, there is just a lot of choppiness in there, but nothing else popped out.

David Rochester -- Deutsche Bank -- Analyst

Okay. Great. Thanks for the all the detail guys. Appreciate it.

Jerry Salinas -- Group Executive Vice President & Chief Financial Officer

You're welcome.

Operator

And your next question comes from the line of Ebrahim Poonawala with Bank of America. Please go ahead.

Ebrahim Poonawala -- Bank of America Merrill Lynch -- Analyst

Good morning, guys.

Phillip D. Green -- Chairman and Chief Executive Officer, Director

Good morning.

Jerry Salinas -- Group Executive Vice President & Chief Financial Officer

Good morning.

Ebrahim Poonawala -- Bank of America Merrill Lynch -- Analyst

So I guess, just the first question, Phil, you mentioned the new customer growth, and I think you mentioned 60% year-over-year of customer growth. What does that mean? Like if you can help us sort of think through around -- obviously, you're investing in the franchise, but what does that mean in terms of fee income growth, deposit growth, as we think about Frost 12 months from now, over the next few years? Like if you could help put up a framework around that, that would be helpful.

Phillip D. Green -- Chairman and Chief Executive Officer, Director

First of all, Ebrahim, let me just -- let me give you the raw number. So first, let me get to customers. Okay. So customer growth in this quarter was up 60% higher than the customer growth of the third quarter last year. In raw numbers, it was -- we grew new customers, on consumer side, a little over 2,000 customers in the third quarter of the last year. We grew 3,300 customers in the third quarter of this year, and we did that by increasing new customers and expanding that number by 6% percent from where it was, and we reduced the number on attrition by 6%. So we are doing well on both sides. We're increasing growth on a gross basis and we're reducing the amount of attrition that we're having.

And we're doing -- what it tells me is how healthy is your value proposition, and are you getting your name out in the marketplace, and are you becoming a viable alternative for people who are deciding to switch banks. And I really believe that we're getting some traction there. Just some examples of things we're doing to help develop that. We've got a number of things going on. For the first -- few quarters ago, we were really developing our marketing message, and we were reducing the amount. We really hadn't had that much marketing spend. So we've increased that. We've built that around, something we call, Opt For Optimism. And whether or not you like our stock or company, I encourage you to go -- all of you to go to the Opt For Optimism website with Frost, that's opt4optimism. And just look at what the content there, and what it is we're trying to do. We're trying to build community. We're trying to inspire generosity. Take the 30-day optimism challenge. It'll make you a better person.

And so those kinds of things have actually begun getting some, I'll call it, a little bit of a viral movement with it as we enlist partners on the web. And so I think our awareness is better. You might have noticed, as I mentioned, we're the jersey partner for the San Antonio Spurs. We are getting -- ultimately on that deal, we'll get hundreds of millions of brand impressions that we wouldn't have gotten before. So it's a really unique opportunity there. A more limited, but still significant arrangement with the Houston Rockets. So there are things we're doing there to get our brand impression out there.

And I think we're doing a better job digitally of just improving our spending and messaging and targeting on people that we represent a good fit for, and letting them know of our capabilities and other things. So -- and it's also interesting, I think, that we've done all that and really just opened up one location this year, and it was a small one in Fort Worth and two last year. So it's not like we're -- we've been expanding our footprint and developing those numbers. We know that expanded locations help with that, but we've been doing this, I think, just by doing a better job. And I think to your question, it will result -- not -- you can't tie it to the one quarter, but directionally, it's going to result in more fee income, more deposits, just through more relationships.

And one thing I'll say with regard to the digital side, we do a really nice job on the digital side. You can open an account--you can download our app on your phone and open up an account. So we -- and we've done that development ourselves. We do that work and do that development at Frost. And when you look at the digital accounts we've opened in Houston, 60% of the digital accounts that we've opened in Houston are within a five mile driving distance of a Frost Bank branch. So I think even though digital is important, physical locations are as well. And what we're doing is we're giving both alternatives to the customer.

And whenever I see numbers like that -- and that was customers, if you look at account growth, new accounts are actually up 120% during that same period of time. So I'm really energized about that, and I think all these positives along with the operating leverage that we've been developing, I think earnings were up about 20% last year, they've been up 27%, 28% this year, I mean, we're deciding to invest that increased operating leverage in expanding in these great markets at a time when our recognition and our capabilities and really our performance on customer development is improving.

Ebrahim Poonawala -- Bank of America Merrill Lynch -- Analyst

Got it. That was very thorough and helpful. Thank you very much. And just going back to the Houston expansion, so a lot of what you said applies in terms of, I guess, how you think about growing in Houston. But would love to get your thoughts around why Houston versus Dallas/Fort Worth. I mean, obviously, you have presence in both markets. Just wondering were there any specific attributes to Houston that causes you to want to expand there versus Dallas, or --

Phillip D. Green -- Chairman and Chief Executive Officer, Director

Well, we're going to expand in both. I heard a -- and so the 25 we're talking about over the next two years really is in addition to normal expansion we do in the market anyway, and we're -- our plan is to continue to grow our loan growth, as we've said many times, has been high single digits. We assume if it continued to do that, I mean, you might want to consider growing your branches something similarly. And so we will continue to expand in other markets. And we've got a number of locations on the board right now for Dallas. And I think that we'll want to do that.

The thing is that our base in Houston is just bigger than Dallas right now, and Dallas/Fort Worth is -- I know they don't like to be lumped together, but the government does it when they do the MSA. And so if you add all our locations there together, we're very well represented in Fort Worth. We're underrepresented in Dallas, but the absolute size of the market in Houston is geographically about the size of Dallas/Fort Worth when you look at going from Katy to the eastern markets that we're going in. And so it's just a -- we've just got more opportunity, I believe, to leverage what we are in Houston, where we've been for Dallas, 40 years or so -- 40-plus years. And Dallas is a good opportunity for us. We're going to grow in Dallas, and we're going to grow significantly there. But right now we felt like the best place for us to allocate our energy and capital and resources and to make the biggest impact was in the Houston market.

Ebrahim Poonawala -- Bank of America Merrill Lynch -- Analyst

Got it. And just one last one. I appreciate that you don't want to give a lot of moving pieces around your expansion, but just from an efficiency and ROA, ROE perspective, we're about a mid-50 -- around 55% efficiency ratio this year. Do you see that improving over the next few years, given all the things that you talked about?

Jerry Salinas -- Group Executive Vice President & Chief Financial Officer

I think -- I guess, we continue to say that we really don't give guidance going forward. I think that -- what you really -- if I was modeling it, the way you need to think through this is, Phil mentioned that we're talking about targeting one a month for opening, and you've got a certainly basically grow the business from there, if you will. So that's kind of the thought process I would use if you're talking about the mix between revenue and expenses as you do your model.

Phillip D. Green -- Chairman and Chief Executive Officer, Director

And I'll just also comment there, just conceptually, a couple of things. One is that remember, we're doing this in a period of time when we've been expanding and increasing operating leverage. So we've seen our ROAs and profitability increase significantly is really because of two things; just one is higher interest rates, and second thing is, what I call, a bit more efficient balance sheet by a more consistent loan growth, and we've been able to do that. We've still got runway on interest rates. We've still got runway, I think -- we've got runway on the loan growth as well. So those two things will sort of, notwithstanding Houston, right, I think will continue to help with regard to our operating leverage on the company. And then the second thing I'll say is that our efficiency ratio runs in the, I think, you said like mid-50s or so.

Jerry Salinas -- Group Executive Vice President & Chief Financial Officer

58. Yeah.

Phillip D. Green -- Chairman and Chief Executive Officer, Director

58 or so. If you look at the various segments of our business, really the traditional intermediation part of the business is a lower efficiency ratio than our total company because we've got a number of businesses like wealth management and others, which are great return on equities, but fairly high efficiency ratios by the nature of those businesses. And while we have some of that growth with the Houston expansion, it's going to be primarily a traditional intermediation business with loans and deposits, and I think the nature of that over the long term is going to be a lower efficiency ratio for that part of the business. So I think that -- let's just say, I don't expect it to hurt our efficiency ratio as this investment matures.

Ebrahim Poonawala -- Bank of America Merrill Lynch -- Analyst

Understood. Thanks for taking my questions.

Phillip D. Green -- Chairman and Chief Executive Officer, Director

You're welcome.

Operator

Your next question comes from the line of Jennifer Demba with SunTrust. Please go ahead.

Jennifer Demba -- SunTrust Robinson Humphrey -- Analyst

Thank you. Good morning.

Phillip D. Green -- Chairman and Chief Executive Officer, Director

Good morning, Jennifer.

Jennifer Demba -- SunTrust Robinson Humphrey -- Analyst

Any thoughts or interest on share repurchases with the bank stocks now significantly lower over the last several weeks?

Jerry Salinas -- Group Executive Vice President & Chief Financial Officer

Jennifer, we've got -- I think you know, we've got $150 million in buyback program authorized, and we've said we're going to be opportunistic. And we have not utilized any of that. So I'll just leave it at that. How about that?

Jennifer Demba -- SunTrust Robinson Humphrey -- Analyst

Thank you very much.

Operator

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

Rahul Patil -- Evercore ISI -- Analyst

Thanks for taking my question. Just -- could you discuss your thoughts on funding loan growth using cash flow in the securities book and accordingly allowing that -- the low loan-to-deposit ratio, which is around 52%, to kind of drift higher going forward? I understand that you look at it in terms of loans and munis together as a percentage of your total base. But just curious about how you're thinking about funding loan growth going forward.

Phillip D. Green -- Chairman and Chief Executive Officer, Director

I think that the main thing we want to do, as you talk about going forward, we were long term -- we've got long-term views. We'd like to fund it with deposit growth, but we also will use the securities portfolio on liquidity as well. And so the thing I think you'd see us use -- so let's kind of -- let's sort of rank order how you'd use it. I'd like to use deposit growth to fund loans, which is going to continue to give us runway and a loan-to-deposit ratio below peer but growing. And secondly, we've got -- Jerry, how much do we have the Fed now?

Jerry Salinas -- Group Executive Vice President & Chief Financial Officer

Just about $2.8 billion.

Phillip D. Green -- Chairman and Chief Executive Officer, Director

$2.8 billion. So just under $3 billion there. So there's lots of liquidity there to be used. And then there's the -- not municipals per se, but we've got treasury portfolio that we also have available, which is a fairly significant part, and that's a lower yielding piece.

Rahul Patil -- Evercore ISI -- Analyst

Got it, got it. And then could you talk about the drivers of the paydown activity that you saw this quarter in terms of products and markets? And then just wondering, with the long-term rates up since at least quarter-end, has that paydown activity kind of abated in recent weeks?

Phillip D. Green -- Chairman and Chief Executive Officer, Director

The paydowns really were, I think a lot of them, in commercial real estate as people move projects to permanent. It was pretty widespread. If I had to pick up one market where it was probably a little bit heavier, I recall, just in talking with our folks at Fort Worth, it's fairly high. But I think that's sort of abated some. So I don't -- it's just the nature of the business, right? I mean, we do -- we've got great core loan activity, and we worked on that. You all know about that. But half our loans are large loans, and you're just going to see -- you're going to see things happen and things -- people take advantage of different things. So I wouldn't read anything more into it other than just the way the business works.

Rahul Patil -- Evercore ISI -- Analyst

Okay. And then just one last question about the Houston expansion. In the press release, I think you highlighted that the deposit market share is still -- is low, is only 2% in that market. How much of your focus is deposit generation with this expansion in Houston? And given that deposit competition is particularly intense in this market, how will that influence deposit costs, at least to what degree going forward?

Phillip D. Green -- Chairman and Chief Executive Officer, Director

Well, the deposits are a big part of it, right? If you look at -- just say, look historically at -- say -- take a branch breakeven analysis, OK? Everyone's got their own analysis. I'd say it probably runs around, let's say, $35 million, and you loan out a third of that, all right? So deposits are important for that analysis. And then that's -- you probably reach breakeven in about -- somewhere between two and three years, probably, maybe 27 months on average, I guess. And so from that point on, if you continue to grow loans and deposits, that's really where you add to that top growth that I talked about by year five. So they're both important, but our growth in deposits is really checking account driven. Do you want to talk about the deposit base a little bit, Jerry?

Jerry Salinas -- Group Executive Vice President & Chief Financial Officer

Yes. So I think if you know anything about our deposit franchise, about 60% of it is in checking accounts. And I think we performed pretty well there. A big part of who we are is relationship-driven, and so in a lot of cases, we may get the deposit first before we get the loan relationship even on the commercial side. So I think that we've been able to be competitive with deposits. I think that our rates, our deposit rates, currently are very competitive. I think also if you look at J.D. Power Awards that we've won for customer service over the last eight years, we've performed better than most or than all really in the state of Texas. So I think that really from that standpoint, at this point, we think that our rates are competitive. We don't think at this point that we'll have to do anything special there. But again, we're -- we've got a lot of visibility and exposure and deposits are important to us, and we'll continue to focus on doing what we need to do to grow them.

Rahul Patil -- Evercore ISI -- Analyst

Great. Thank you.

Phillip D. Green -- Chairman and Chief Executive Officer, Director

Yes. If what you're asking is because of this strategy, do we plan on really increasing deposit betas to bring in high-cost money, that's not our plan. Our plan is a very relational plan. It's -- which means it's a very first a checking account-driven plan and then build from there. It's going to be core type accounts.

Jerry Salinas -- Group Executive Vice President & Chief Financial Officer

Yeah. And we historically are very competitive. I think Phil talked about marketing dollars. So certainly, we'll spend some marketing dollars there to make sure that we're competitive on those -- to the deposit customers there. So we'll be doing some new things there in Houston to make sure that we're able to grow the franchise.

Rahul Patil -- Evercore ISI -- Analyst

Got it. Thank you.

Operator

Your next question comes from the line of Jon Arfstrom with RBC Capital Markets. Please go ahead.

Jon Arfstrom -- RBC Capital Markets -- Analyst

Thanks. Good morning.

Phillip D. Green -- Chairman and Chief Executive Officer, Director

Good morning.

Jon Arfstrom -- RBC Capital Markets -- Analyst

Question for you on the commitment comments that you made. You talked about commitments being down about 8%, but if you exclude CRE and energy, it's actually up quite a bit in C&I. Can you just talk a little bit about CRE and energy and what's going on there? Is that the market or is that your caution that's driving that?

Phillip D. Green -- Chairman and Chief Executive Officer, Director

With energy, as we discussed before, we're just being really careful in that segment because we've -- we're reducing the concentration down and -- but we're still growing. We're up a little -- I guess, we're up a little bit below our average growth rate, but somewhere between 5% and 7% year-over-year for energy, as I recall. So yeah, I talked to our folks about it. We're probably saying yes for every four nos. And we're just being careful. We're building great relationships, some that we haven't been -- had the opportunity to build before and we're curating some others. So that's what going on with energy, and I'm not concerned about that at all. By the way, our people are doing a great job and building good business there, and I'm really proud of what they're doing. We've got a great brand in that space.

With regards to CRE, I think a lot of it -- we had a huge year last year in CRE, particularly early on, and then it -- and so the nature of that business is it's a little bit choppy. With regard to our view on it, competition we're seeing is price probably first, but that's everywhere. And then you see it on guarantees and term loan projects. We're very -- we're relational-driven, right? We bank customers in that area. We don't just bank projects. And so I feel really good about what we're doing, and I think that we are -- we've got good opportunity.

We -- probably in Dallas, as I talk to our folks, probably Dallas we're being a little bit more careful, but because you're seeing supply, which is really strong because you got to see a good 2019 to absorb it. But I was asking and I was saying, kind of, what's the view? Because we bank a certain way. We bank people. We've got a great reputation going. So what's the view? Well, they really respect us, but they go to the easy money, OK? And so we're losing some deals, but I think we're still seeing opportunities to get the kind of projects that we want. But it was just a little bit lumpy, but the fact that we're down from last year, I think, has to do more with last year. I wouldn't read it as we are just totally pulling back on CRE. We've always been careful. And as you know, and we said for years, we don't swing one way or the other in these things. We are a consistent source and player because we deal with relationships in these markets. I think that helps us really. But we're not really -- it's not a sign that we're afraid of it and we're moving out of things.

Jon Arfstrom -- RBC Capital Markets -- Analyst

Okay. Two more things I want to touch on. Just, I know you don't give the forward guidance on the margin, but I think what you're saying is, you don't feel any unusual pressure on deposits, and you still have an upward bias on the earning asset yields. Is that fair? Is that big picture enough?

Jerry Salinas -- Group Executive Vice President & Chief Financial Officer

Yeah. I would be OK with that.

Jon Arfstrom -- RBC Capital Markets -- Analyst

Okay. Good. And then I guess back to Houston, the hiring plan. I know 200 people is not a lot in terms of the grand scheme of things in Houston, but I think culturally, you have to get it right with that kind of expansion. Can you talk a little bit about the hiring plan and how you plan to approach it?

Phillip D. Green -- Chairman and Chief Executive Officer, Director

Absolutely. First of all, you're dead right. I'm so proud of you, Jon, for talking about culture as it relates to this because that's who we are, and that's a piece that we've got to get right. We're going to do the hiring plan two ways; one is, it really gives our people there an opportunity. I think people like to be part of a company that's growing and is developing its business. So I think we've been -- we're going to have and we already have some buzz internally about growing these positions. And in a city that's tough to get around, there will be some opportunity for people who work closer to home, frankly, and -- which I think would be good. I think that will help employee satisfaction and retention.

But we're also going to be onboarding new people and new leaders in new markets that we're going into. And I think that the early indications of our efforts there have been really positive, in my view. I'm really excited about what we're seeing. And I think a lot of it is -- sure we're competitive in terms of pay and all those things, everyone has to be, but I think people are excited about joining a company with a reputation like ours that is investing for the future. And so -- but a specific part of our efforts in hiring these new people is onboarding of new employees in cultural indoctrination, if I can use the word. We don't want to -- what we want to do is expand the brand and expand the culture. We don't want to have it diluted, and what we're looking for is people who want to buy into that, which is what we've always done. So it's -- we're dead focused on it and we are not going to let that get away from us. We are just not.

Jon Arfstrom -- RBC Capital Markets -- Analyst

Perfect. Okay. All right. Thank you.

Phillip D. Green -- Chairman and Chief Executive Officer, Director

You're welcome.

Operator

Your next question comes the line of Michael Rose with Raymond James. Please go ahead.

Michael Rose -- Raymond James -- Analyst

Hey, guys. Thanks for taking my question. Sorry if I missed this earlier, but you guys had a nice a drop in non-performers. Just wanted to get some color there. And then as I look at the reserve ratio, it's about 1%. I know you've been below that before. Credit looks pretty good at this point. Just any sort of commentary on how comfortable you are with just generally credit at this point. Thanks.

Phillip D. Green -- Chairman and Chief Executive Officer, Director

I'm extremely comfortable, but you always have to knock on a little bit of credit, right? When we have Frost Bankers, we wouldn't worry about credit, but the trends are just great. The third quarter inflow problems was only $83 million. It's averaged $112 million for the year. Last year, it was $166 million per quarter. If you look at 2018 resolutions of problems, we have $469 million of favorable events, which include upgrades, payments and payoffs, and the unfavorable events, which are really charge-offs, of $34 million. So we're just seeing good movement there.

And as you look our level of non-performers, which today is $82 million, it's still heavily weighted toward a couple of energy, and particularly one energy credit that continues to move through the snake. And at some point, we're going to get that resolved, and so I really look forward to our non-performing levels being lower.

The charge-offs were elevated this quarter. They were really, as I said, four credits. They were -- one of them came on in '16 as a problem; some in '17; one of them was at the end of the -- end of last year as a potential problem; about half of those were energy-related, and the other two were just general business. We -- and that just happens. You had a company that had lost a major company -- lost a major customer to another company. We've talked about them before had problems sourcing the inventory and lost some relationships. And it really, really hurt their business (inaudible) of liquidating. And that stuff happens. I'm not proud of it, but that's banking, and we're going to have to try to get better from all of those. But I feel really good about credit.

Michael Rose -- Raymond James -- Analyst

Okay. Thanks for the color, and maybe one follow-up question. I think last quarter you guys talked about savings of $8 million to $9 million pre-tax from the FDIC surcharge roll-offs. So I just wanted to get a sense if that's still the right estimate, and then if that played into the investment decision in Houston as it relates to the number of centers and the size, which will take some of those savings when they eventually do hit and roll it into the expansion.

Jerry Salinas -- Group Executive Vice President & Chief Financial Officer

The number -- yeah, the number that you quoted, the $8 million to $9 million, I think, is still where we're at. And really I think the Houston decision -- you're right, there may be some offset there, but really the Houston decision was really just the right decision to make for us. So even regardless of whether that we were aware of that savings or not, this was just something that we needed to do and wanted to do to continue to grow our business.

Michael Rose -- Raymond James -- Analyst

Understood. Thanks for taking my questions.

Operator

Your next question comes from the line of Peter Winter with Wedbush. Please go ahead.

Peter Winter -- Wedbush Securities -- Analyst

Thanks. Good morning. The -- I was just wondering, with the 2018 expense guidance of 4.5% and I guess it's off the base of $747 million, it seems like you could come in below that level unless you are expecting a big step-up in 4Q expenses.

Jerry Salinas -- Group Executive Vice President & Chief Financial Officer

We're going to stick with our guidance. I think that there was some concern that maybe the guidance was too high given the low second quarter, and we did mention that we expected that some costs would be higher. We talked about the advertising programs and such. And so at this point, I think the guidance, yeah, is -- we're going to stick to that.

Peter Winter -- Wedbush Securities -- Analyst

Okay. And then just unfortunately one more question on that Houston expansion. As I think about 2020, when you're going to continue to open up another 12 branches and the hiring, should we expect a similar type of earnings impact in 2020, or will you get some of the -- start to see some earnings accretion from what you do in 2019 and it should be less?

Phillip D. Green -- Chairman and Chief Executive Officer, Director

Well, the arithmetic of it is if you continue to open up branches and the others haven't reached profitability, it'll be more. It's just the math of it, right? And then you reach a -- it's like with any other investment, right? You reach a burn rate and then you -- it becomes less and it becomes accretive to what it was the previous year and then it becomes accretive to where you were before you started. So it's just the nature of it, right? I mean, I think we said earlier things -- historically, these things have averaged about $1.5 million burn, and -- but when you look at what it throws off after a five-year point, what that does for our company on any reasonable PE , I'm very excited about what it's doing and about what it does.

The only question about this -- because the math is simple, OK, the only question is can we do it, right? That's the only, to me, relevant question. And I am confident of our ability to do it because this is what we do. If we can't do this, why are we in banking right now? Right? I mean, this is what we do. And so I feel very confident about our ability to achieve it, and I'm really excited about what it does for our growth trajectory over the next five to seven years in Houston.

Peter Winter -- Wedbush Securities -- Analyst

And if I could just ask one more question, Phil, how did you come to the decision to do it de novo versus buying something, or buying another bank?

Phillip D. Green -- Chairman and Chief Executive Officer, Director

The reason is -- and look, Peter, Jerry and I've bought, I don't know how many banks and how many brokerage -- insurance brokers. We've probably bought 40 companies. So we've done it a lot. We've normally done it to build out markets, and -- but we're in markets now where we have mature viable platforms. And so the question that we've been asking is do we take and spend shareholder money to just increase mass in a market, or do we spend operating leverage, right? Do we spend our balance sheet or do we spend our operating -- our income statement in developing these markets.

I'm convinced that we build greater shareholder value if we can grow it organically, but you have to have the opportunity and ability to do it. I'm convinced everything we bring to the table -- and I hope that the things we've been talking about and people who know us see that we are a viable candidate to develop these markets. Heck, we've got the second-largest free ATM market -- network in Houston. That means we're bigger than two other too big to fails.

And so we've got the chops, in my view, to get this done and so do I want to pay -- because look, everything I've got is tied up in this company. And I always say, if my family is going to have anything, it's because this company is going to do well. And am I just going to take a 150-year company with the kind of valuation quality we have and just give X percent of it to someone because they put a few branches and hired a few lenders just so I can get bigger in a market I'm already in? I don't want to do that. I think that we can reward our shareholders better as long as we have the opportunity to grow organically.

Now, all that said, I want you to think that well, we'll never do an acquisition ever. We may not in my tenure, but we might. But if we ever did, my view is that the best use of something like that -- and if we do them rarely, but the best use we've had of those is when it put us in a market where we weren't that gave us the ability then to grow organically. I'll give you an example of that. 20 years ago, we did Overton, and we wouldn't be in the North Texas market today. I don't think. Well, we wouldn't be, if we hadn't done that acquisition, OK?

Another example would be the Permian Basin that we did four years ago, and that market is -- yes, it had its lumps for a couple of years, but I was talking to our regional president out there, and it is harder than it's ever been, and the best report I've ever had for that market -- and he made an interesting comment that has stuck with me. He said, we used to be a niche bank in a niche market, but now we're broadening our base. And that's really what we do. We go into a market, we grow long-term relationships, and we broaden them. So I don't want to say -- give the impression that I hold acquisitions in contempt. It's just to me and to our team when you've got the ability to grow organically, and you're in fantastic markets and we are in Texas, let's leverage to that. That's the way to create value. That's my stream of consciousness thinking on acquisitions right now.

Peter Winter -- Wedbush Securities -- Analyst

That's really helpful. Thanks, Phil.

Operator

And your final question comes from the line of Brady Gailey. Please go ahead.

Brady Gailey -- Keefe Bruyette & Woods, Inc. -- Analyst

Yeah. Hey, good morning, guys.

Jerry Salinas -- Group Executive Vice President & Chief Financial Officer

Hey, Brady.

Phillip D. Green -- Chairman and Chief Executive Officer, Director

Good morning.

Brady Gailey -- Keefe Bruyette & Woods, Inc. -- Analyst

So Phil, just to clarify, you talked about the $1.5 million burn per branch. That -- you're saying that each branch, once it's up and running, it has an expense base of roughly $1.5 million pre-tax annually. Is that what you're saying?

Phillip D. Green -- Chairman and Chief Executive Officer, Director

No. I'm saying that the net income of the branch would be a net loss of $1.5 million for the -- as it burns its way through profitability. And Brady, these are averages. We've had some branches that reached profitability slower, some sooner. Some we do great; others, we don't do as well. But this is the average of what we've done for a long period of time on the locations. And so it's kind of like a burn for a business. You'll lose money for X period of time between two to three years, and it's -- and the burn has been on average about $1.5 million.

Brady Gailey -- Keefe Bruyette & Woods, Inc. -- Analyst

Okay. And then just so we can sense the magnitude, what's your current branch count at Frost?

Phillip D. Green -- Chairman and Chief Executive Officer, Director

133. Hope I got that right. Within one or two.

Brady Gailey -- Keefe Bruyette & Woods, Inc. -- Analyst

Okay. And then lastly for me, your -- it looks like you all -- you charged off some allocated reserves with the four credits. Your loan loss reserve ratio is now right at 1%. I know when you look back, I don't know, three or four years ago before the energy think popped up, you all were below a 1% reserve. Is there any reason to think you all wouldn't head back below 1% going forward?

Jerry Salinas -- Group Executive Vice President & Chief Financial Officer

Brady, if I would have answered the question just kind of the way you asked it, to be quite honest with you, we have been below 1% before, and of course, it's all formulated based on our allowance calculation. So as long as credit quality is where it is, yeah, I would not necessarily be surprised that we're below 1%.

Brady Gailey -- Keefe Bruyette & Woods, Inc. -- Analyst

All right. And then actually on the reserve, CECL, we're still over a year away, but any comments on the impact that CECL could have on your reserve?

Jerry Salinas -- Group Executive Vice President & Chief Financial Officer

Well, I guess I have to say we don't like CECL obviously, but it's too early to tell. Obviously, what ends up happening is that you'll have to look at kind of your loan makeup at 2020 and what your economic forecast is at that time. But I think right now we're in good shape where we're at, where we need to be from a planning standpoint, but no, we wouldn't be anywhere near of ready to give any sort of impact at this point.

Brady Gailey -- Keefe Bruyette & Woods, Inc. -- Analyst

Got it. Thanks, guys.

Jerry Salinas -- Group Executive Vice President & Chief Financial Officer

Thank you.

Operator

There are no further questions in the queue.

Phillip D. Green -- Chairman and Chief Executive Officer, Director

All right. Well, thanks, everyone, for your interest, and we are adjourned.

Operator

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

Duration: 65 minutes

Call participants:

A.B. Mendez -- Investor Relations

Phillip D. Green -- Chairman and Chief Executive Officer, Director

Jerry Salinas -- Group Executive Vice President & Chief Financial Officer

Brett Rabatin -- Piper Jaffray -- Analyst

David Rochester -- Deutsche Bank -- Analyst

Ebrahim Poonawala -- Bank of America Merrill Lynch -- Analyst

Jennifer Demba -- SunTrust Robinson Humphrey -- Analyst

Rahul Patil -- Evercore ISI -- Analyst

Jon Arfstrom -- RBC Capital Markets -- Analyst

Michael Rose -- Raymond James -- Analyst

Peter Winter -- Wedbush Securities -- Analyst

Brady Gailey -- Keefe Bruyette & Woods, Inc. -- Analyst

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