Greetings and welcome to the Cullen/Frost Bankers First Quarter 2022 Earnings Conference Call. [Operator Instructions] As a reminder, this conference is being recorded. I would now like to turn the call over to A.B. Mendez, Senior Vice President and Director of Investor Relations. Thank you. You may begin..

Thanks, Daryl. Our conference call today 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 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 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 Investor Relations at 210-220-5234. At this time, I will turn the call over to Phil..

Thanks, A.B. and good afternoon, everybody. Thanks for joining us today. I will review the first quarter results for Cullen/Frost and our CFO, Jerry Salinas, will provide additional comments and then we are going to open it up for your questions as a normal practice.

In the first quarter, Cullen/Frost earned $97.4 million or $1.50 per share compared with earnings of $113.9 million or $1.77 a share reported in the same quarter last year and $99.4 million or $1.54 a share in the fourth quarter of 2021.

Our return on average assets and average common equity in the first quarter were 79 basis points and 9.58% respectively.

And I am happy with these results to start the year and I am optimistic about the prospects for our sustainable organic growth strategy as business activity continues to return to normal and we move further into a rising interest rate environment. Average deposits in the first quarter were $43 billion.

That was an increase of more than 21% compared with $35.4 billion in the first quarter of last year.

This is outstanding growth and Jerry will talk more about this growth in his comments, but I believe at its core, it reflects our commitment to strong value propositions centered around world class customer service, investments into our business for both physical expansion and employee compensation and account features and also a commitment to a square deal with our customers, which is the basis of any healthy long-term relationship.

Loan growth was also outstanding. Average loans, excluding PPP in the first quarter, were $16.1 billion or 8.3% ahead of the same time last year.

On a linked quarter basis, we saw average loans, excluding PPP, increase over the fourth quarter and unannualized 4.5% helping support our expectations for full year average loan growth in the high single-digits. I am very pleased with the success of our Commercial Lending segment.

We booked $1.73 billion in new commitments in the first quarter, up 51% from new loan commitments in the first quarter of last year. The gains were strong in all segments.

New commitments booked in the first quarter tend to be seasonally lower than the fourth quarter and that was true this first quarter as well as we saw first quarter commitments down 29% from our record monster fourth quarter level.

However, our gross new loan opportunities at the end of the first quarter were up by 29% compared to the fourth quarter and our weighted pipeline at the end of the first quarter increased by 9% from the fourth quarter. And all this is to say that the outlook for loan growth continues to be good.

A few other things I found interesting about our lending activity. In the first quarter compared to a year ago, we looked at 19% more deals, but we booked 42% more deals. That improvement was driven by the C&I component, which went from a 29% booking rate last year to a 41% in the first quarter. So we are having more success.

We are seeing more activity from customers as they begin expanding their businesses. So, we of course would expect a higher success rate there. Our advance rate on commercial working capital lines increased from 32.5% at year end to 34.8% at the end of the first quarter, still below a more normalized 38% to 40% level.

New customer acquisition continues to be key. Our numbers show that 40% of our linked quarter growth and outstanding loan balances came from customers added over the last 12 months. Our expansion efforts are becoming more accretive to growth. As an example, our year-over-year loan growth of 8.3% and would have been 6.8% without the expansion volume.

Our consumer business continues to be strong. In the first quarter, total consumer checking households grew over 7.2% compared to last year, which aligns with the record growth we saw in 2021. Same-store sales for checking accounts increased 17%.

Consumer deposits grew nearly $1 billion in the quarter, giving us a 20% year-over-year increase and loan demand has picked up on the consumer side helping us grow loan balances by a little over 7% year-over-year and helping to set the stage for the launch of our mortgage product later this year.

We believe our value proposition is resonating and we can continue to grow this business, especially in our expansion markets. In Houston, we see the momentum continuing to build as the newly opened branches there mature. At the end of the first quarter, we stood at 110% of our deposit goal, 125% of our new household goal, and 181% of our loan goal.

And we have had a very successful start to our Dallas region expansion as well. For the two locations that opened so far this year along with the Redbird Financial Center that opened in 2021, our numbers are early, but they do represent 130% of deposit goal, 183% of loan goal and 245% of our household goal.

Despite the macroeconomic challenges, we continue to be optimistic about growth in this economy. The third new location in our 28 branch Dallas expansion project is scheduled to open in the second quarter. Additionally, we will continue to expand in Houston adding another 8 locations over the course of ‘22 and ‘23. Credit continues to be good.

Total problem loans, which we define as risk grade 10 and higher, totaled $447 million at the end of the first quarter, down from $540 million at the end of the previous quarter. During the first quarter, newly identified outstanding problem loans totaled $14 million. During 2021, the average addition of problem loans was about $54 million.

The increase during the first quarter was one of the smallest in several years. The resolution of problems via payoffs, payments and upgrades in the first quarter totaled $104 million. The short story here is that the favorable rate of resolutions continued through the first quarter of 2022.

The March 31 total for delinquency was the lowest in several years. Once again, we did not report a credit loss expense in the first quarter and our net charge-offs for the first quarter, were $6.3 million and those compared with $2.8 million in the fourth quarter.

Annualized net charge-offs for the first quarter, were 16 basis points of average loans and below our typical long-term level. Non-accrual loans were only $49 million at the end of the first quarter, a decrease from $53.7 million at the end of the fourth quarter last year.

In the first quarter, we continued making progress toward our goal of a mid single-digit concentration level in the energy portfolio over time, with energy loans representing 6.27% of loans at the end of the quarter. And over the last 12 months, energy loans are down by 16%.

After 2 years of working with business customers on PPP loans, we are almost across the finish line, with forgiveness complete for 97% of our borrowers. Putting in the extra effort to help PPP borrowers wasn’t easy, but it was the right thing to do. And the same goes for our decision late last year to raise our minimum pay to $20 an hour.

Then in the first quarter, after the Federal Reserve increased interest rates, we made the decision to pass some of that increase along to our depositors. Again, it wasn’t easy and it wasn’t inexpensive, but it was the right thing to do for our customers.

Steps like these show our commitment to our communities and being a force for good in people’s everyday lives and that’s reflected in the third-party recognition that Frost receives.

We learned in the first quarter that once again for the sixth year in a row, we received the highest number of Greenwich Excellence and best brand awards of any bank in the nation. The Greenwich awards are given for providing superior service, advice and performance to small business and middle-market banking clients.

Also earlier this month, we learned it once again, at this time it was the 13th year in a row, we received the highest ranking in customer satisfaction for J.D. Power U.S. Retail Banking Satisfaction Study for Texas.

Over the past few years, we have talked to you about all the steps we have taken to enhance our value proposition and our competitive advantage, things like organic expansion projects, overdraft grades, early payday, the state’s biggest ATM network.

Keep in mind, this growth is taking place during the pandemic when many of our employees were working remotely and while our financial centers were taking extraordinary measures to keep people safe. I say this a lot, but I can’t say it often enough. I am so proud of our company and our employees and everything we have accomplished together.

I know in what our team can do is what makes me so optimistic about Frost’s success in the future. Now, I will turn the call over to our Chief Financial Officer, Jerry Salinas, for some additional comments..

Thank you, Phil. Looking first at our net interest margin. Our net interest margin percentage for the first quarter was 2.33%, up 2 basis points from the 2.31% reported last quarter.

Excluding the impact of PPP loans, our net interest margin percentage would have been 2.32% in the first quarter, up 7 basis points from an adjusted 2.25% for the fourth quarter. The increase was a result of some positive items partially offset by some items with a negative impact.

A lower relative percentage of earning assets held at the Fed, down from 34% in the fourth quarter to 29% in the first quarter as we deployed some liquidity into our investment portfolio had the largest positive impact.

Higher volumes of securities and loans also had a positive impact on the net interest margin percentage, while lower yields on securities and loans had a negative impact.

The taxable equivalent loan yield for the first quarter was 3.74%, down 15 basis points from the previous quarter, excluding the impact of PPP loans, the taxable equivalent loan yield would have been 3.73%, down 6 basis points from the prior quarter.

And just to finish up on PPP, as Phil talked about, our total PPP loans at the end of March were only $208 million, down $221 million from $429 million at the end of December. As such, we don’t expect PPP to have any material impact on our 2022 results.

Looking at our investment portfolio, the total investment portfolio averaged $17.2 billion during the first quarter, up about $2.7 billion from the fourth quarter average as we continue to deploy some of our excess liquidity during the first quarter.

We made investment purchases during the quarter of approximately $3.4 billion, which included about $1.8 billion in agency MBS securities, with a yield of about 2.58% and about $1.5 billion in treasuries yielding about 1.25%.

Included in the $1.5 billion in treasury securities purchased in the first quarter is a $1 billion purchase of 2-year treasuries that we purchased in late January with a yield of 1.02%.

We purchased those short duration treasuries as a defensive measure given the uncertainty in the market resulting from the potential invasion at that time of Ukraine by Russia and its potential market implications.

In addition to the $3.4 billion in purchases we made in the investment portfolio in the first quarter, our current expectation is that we would invest an additional $5 billion of our excess liquidity and into the – into investment purchases through the remainder of the year.

The taxable equivalent yield on the total investment portfolio was 2.88% in the first quarter, down 20 basis points from the fourth quarter. The yield on the taxable portfolio, which averaged $9 billion and was up $2.9 billion from the prior quarter, was 1.90%, up 4 basis points from the fourth quarter.

Our tax exempt municipal portfolio averaged about $8.2 billion during the first quarter, down about $200 million from the fourth quarter, with a taxable equivalent yield of 4.03%, up 2 basis points from the prior quarter. At the end of the first quarter, 78% of the municipal portfolio was pre-refunded or PSF insured.

The duration of the investment portfolio at the end of the first quarter was 5.2 years, up from 4.4 years at the end of the fourth quarter, primarily related to the extended duration on lower coupon mortgage-backed securities. Average deposits for the quarter were $43 billion, up $7.6 billion or 21% from the first quarter last year.

The growth in non-interest-bearing deposits was up $2.7 billion or 17%, while interest-bearing deposits grew $4.9 billion or 24%. Looking at a 12-month look back of deposit growth, about 32% of our growth over the past year has come from new relationships. On a linked quarter basis, deposits were up $1.9 billion or 4.7% on a non-annualized basis.

In the linked quarter comparison, the growth has come primarily from growth in interest-bearing deposits. The cost of interest-bearing deposits in the first quarter was 8 basis points, up 1 basis point from the previous quarter.

Looking at a couple of linked quarter income statement comparisons, in non-interest income regarding insurance commissions and fees, I will point out the strong linked quarter growth of $4.9 million or 42%.

Just as a reminder, the first quarter is always our strongest quarter for insurance commissions and fees due to our natural business cycle of higher renewals in that quarter and also the impact of contingent commissions that are typically received in the first quarter.

I will also note that typically the second quarter is our weakest quarter for insurance commissions. Looking at linked quarter total non-interest expenses, I will note that the first quarter total expenses were right in line with our projections from one quarter ago.

However, given the continued increase in salary pressures in this current environment, I am increasing our expectation for non-interest expense growth for the full year. Last quarter, I stated that we expected total non-interest expense for 2022 to grow at a high single-digit growth rate over 2021 reported non-interest expense.

Given recent activity, primarily related to higher than previously projected increases in salary levels, given the competition for talent in this environment, we now expect total non-interest expenses for the full year to increase at a percentage rate in the low double-digits over 2021 reported levels.

In addition to continued market salary pressures, our projected growth in non-interest expenses is also impacted by our expansion efforts.

The impact of our Houston and Dallas expansions is responsible for about 2% of the growth, cost associated with reintroducing our residential mortgage product adds about 1%, and increasing our minimum wage from $15 per hour to $20 per hour in December as a result of salary pressures across the state is responsible for about 2% of the projected growth in non-interest expenses in 2022.

Looking at our effective tax rate, the effective tax rate for the first quarter was 11.3%. And our current expectation is that our full year effective tax rate should be in the range of 11% to 12%, but that can be affected by discrete items during the year.

Regarding the estimates for full year 2022 earnings, our current projections assume 50 basis point Fed rate increases in both May and June, followed by 25 basis point Fed rate increases in September and December.

With those rate assumptions and the expected ‘22 expense growth that I previously mentioned, we currently believe that the current mean of analyst estimates of $7.29 for 2022 is low. With that, I will now turn the call back over to Phil for questions..

Alright. Thank you, Jerry. Okay. We will open it up for questions now..

Thank you. We will now be conducting a question-and-answer session. [Operator Instructions] Our first question is come from the line of Michael Rose with Raymond James. Please proceed with your questions..

Hi, good afternoon, guys.

How are you?.

Great. Thank you..

Good. So it looks like the amount of securities that you’re going to repurchase is clearly higher than I think the $7 billion that you talked about last quarter, obviously, the rate hikes appear to becoming a little bit more intense and a little faster than expected.

Can you just talk about maybe what outside of that maybe is driving that decision? Or is that kind of just higher rates quicker and things like that?.

Well, I guess one of the things that I did point out was the $1 billion in short-term or the 2-year treasuries that we purchased in January. That was really something that we did more as a defensive measure. It really wasn’t part of our original plan. Given that short duration, it will be back investable in a couple of years here.

And so I kind of took that $7 billion, I’d say the $8 billion was just an addition, again, given what was going on in the current environment at that time. And really, deposits have been a little bit stronger than we expected. I think I mentioned in the last quarter’s call that given some of the past history that we had.

I thought the first quarter deposits might be a little bit softer, but they have continued to perform well. I know that when we had the call, a quarter ago, our balances at the Fed were $14 billion. I looked this morning and we’re at $13.5 billion.

So that gives you a good feel that we spent quite a bit already, and yet we still have a significant amount of liquidity. So that’s a long-winded way of answering your question. I hope I gave you what you needed..

Yes. Yes, exactly. Perfect. Thank you so much. And then the loan growth this quarter, obviously, very strong. It looks like you guys are really hitting our stride here, but you reiterated the outlook for growth for the year. To me, it seems a little conservative.

Can you just kind of walk through kind of the puts and takes? I know probably broadly speaking, there is some concern on the economy as we move into the back half of the year. But clearly, Texas, if you look at the Moody’s expectations for growth over the next couple of years for Texas looks very strong.

So if you can just talk about the puts and takes to that outlook? Thanks..

Michael, first of all, you’re right. We do expect it to be – and we do see the outlook is really good. We’ve got a good pipeline, as I mentioned, just the opportunity is up 29% from the quarter end at the end of the year.

We are seeing some paydowns or hearing about possibilities paydowns in the commercial real estate side as people are concerned about higher cap rates. I don’t think we’ve seen much movement in cap rates yet, but there is concern there. Obviously, you’ve seen some higher interest rates. So I think there could be some of that.

But that’s probably the biggest headwind. And then also, we have been continuing to watch our energy portfolio, and we’re almost down of where that mid-single-digit number is. I really want to get a five handle on that. And I think probably we have a good chance sometime during next – this quarter, I guess, the second quarter to get there.

But we’re still being real careful with that. So that’s a bit of a headwind. And that’s what I would say would be the things that would make it more conservative, but I feel more and more confident about the high single digits number that we had talked about earlier this year..

Great. Thanks for taking all my questions..

You are welcome..

Thank you. Our next questions come from the line of Brady Gailey with KBW. Please proceed with your questions..

Hi, thanks. Good afternoon, guys..

Hi, Brady..

But I heard the comments in your prepared remarks about how you guys have already passed along some of the Fed increase to your depositors. I remember you guys doing this the last Fed tightening cycle as well.

But how much of the initial 25 basis points did you pass along? And then how are you thinking about that as we head into the Fed continuing to aggressively hike rates from here?.

Yes, Brady. So the first hike, I think that we were about, if you look at interest-bearing, I’d say in the 28% beta in that first hike. I think as we look through the rest of the year and again, I guess I should start by saying we – you’ve always heard us talking about the fact that we’re going to do what we need to do from a market standpoint.

So these are current assumptions based on what we saw back in the – I’m going to say, the time period of the 2000 – I’m going ‘18 to ‘19 what we were doing there. And if you recall, we were a little slow.

I think as an industry we waited – in our end, we waited until rates had gone up 100 basis points before we move materially, and we said we didn’t want to do that so this time. So for that first hike, we’re at about 28%.

I’m going to say, looking at kind of where we’re going from here is that we’d probably be talking something closer to a 20% Beta on – and let me grab my notes here just to make sure that I’m giving you the right information.

But again, I think what we want to do is we want to make sure that we are were consistent with where the market is going to be at that point, hold on here. Alright. So really, we’re looking at on the interest-bearing side, we’re looking at something pretty consistent with that, what we did in the first quarter.

So all in, I’m looking through the rest, most of the hikes that we have for this year, we’d be at about a 30% beta on interest-bearing 20% overall. When I go back and looked at what we did between 2016 and 2018, it’s pretty comparable to that. So again, we will see what the market does, but that’s what we’ve got in our current expectations right now..

Okay. Alright. And then this is, I think, your fifth or sixth consecutive quarter of having a zero provision. The reserve is still roughly 150 basis points. Could it be years until we see a number in that provision line.

I mean like you still have new reserves, it seems like you could bleed down that percentage as you book loan growth just done there to be much provision need for a ways out.

Is that the right to think about it?.

What I would say is that if you look at our disclosures in the 10-K and the 10-Q that we’ve been pretty descriptive of what we’re doing. And what we’re finding is that from our standpoint, the models really truly aren’t reflective of what we see out there.

And so from our analysis, you’ll see that a significant part of the reserve need is based on overlays to those models. This quarter, given some of the considerations and concerns about a potential recession, even that sort of a discussion was really what was changing what was going on in our minds as we finalized our allowance calculation.

I guess what I’d say is, when I look at our projected loan growth that Phil kind of quoted there. I look at the credit quality that we’ve got and knock on wood, it’s Bill Parati, our Chief Credit Officer, Keith saying it can’t be any better, but it continues to be really good.

So as I look at projected loan growth, if there is not a whole lot of changes in the environment that we’re operating in, I think that having a provision at no provision or minimal provision is kind of probably where I’d be thinking for the full year, but there is a lot of it out there. But again, everything looks so good.

Loan growth is it’s at a high single digits, in my mind, isn’t unreasonable. Phil was talking about 20% loan growth or something like that, I’d be answering that question differently.

But basically looking at where our projections are, the sort of asset quality we have what we’re seeing in the outlook from a projection standpoint, again, it’s going to all come down to what the model say and what our analysis says at the end of each quarter.

But where I sit right now, it’s hard, as you said, looking back for the last few quarters and not seeing a whole lot of provision. Yes, it’s kind of hard to figure that there’d be much of a provision going forward through the next couple of quarters, all things being equal..

Okay. Great. Thanks for the color..

Thank you. Our next questions come from the line of Ebrahim Poonawala with Bank of America. Please proceed with your questions..

Hey, good afternoon. I guess just wanted to follow-up on loan growth and just in terms of the outlook, maybe Phil I guess when we think about the back half of the year, the concern obviously is Fed hikes and what that implications it carries for customers, both businesses and consumers in their ability to absorb that.

Just talk to us as you deal with your customers and what you’re hearing from them in terms of what of fed funds at 3% means is it enough to really hurt demand and potentially push the economy into a recession? Would love to hear your thoughts?.

Ebrahim, we’re not seeing a lot of impact at this point. We are doing a lot with our officers to really sensitize them about the impact that inflation can have on businesses. Some of us older guys, we know what is like back when Volcker was doing his thing, shutting things down.

But most people, I’d say most lenders in the financial services industry haven’t been through a period of any meaningful inflation. And so we’re doing our job to help our people understand how to contact and ask questions and understand the impact that inflation could have on a business and for us to understand that.

That said, we haven’t seen that impact to this point I think that the most direct impact would probably be in the commercial real estate just in terms of viability of projects. We haven’t seen a big impact on that at this point. But if you look at actual real rates, I think, are still pretty negative.

So Fed’s got a way to go, given inflation and other things to tighten things up and slow things down. So right now, not seeing too much of it, except as it relates to worry in the commercial real estate area..

Got it. And I guess one question for you, Jerry. I’m sorry if I missed it, but remind us in terms of the outlook for deposit growth from your – just do you expect any outflows as rates move higher? I know you talked about the – just the deposit betas and your thought process there.

But what do you think about deposit growth? And any perspective you can share in what you think spread revenue growth could look like given the rate assumptions that you outlined earlier?.

Sure. Yes. We did – if you look at our numbers, you can – we can see that commercial DDA is softer. It’s still growing, but it’s not growing at the pace that we’ve seen. To me, I think that’s still a positive. I’ll say back in the previous cycle we really didn’t see a whole lot of movement for the first 100 basis points.

I’m going to say that we’re much more aware and much more sensitive to what’s going on and certainly try to be as reactive as we can. I think that deposits I think we’re still projecting growth. I don’t think we are – we’d be foolish to project a 20% growth year-over-year, although I probably said that last year, and we still had 20%.

But I do think that our current projections, based on what we’re seeing with the growth that we’re getting from new customers and the success that we’ve had with our expansion, I still expect that we will see some upside this year.

I don’t expect that it will be in the double digits, but I think that we’ve got a good opportunity to be at least high single-digit deposit growth as we move forward. And we’re going to be competitive on rates, as you’ve heard us say..

Got it.

And any sense on what spread revenue growth could look like?.

Yes, I think we talked a little bit about in the quarter – last year’s quarter that on a TE basis, full year growth I think it’d be in the high – higher than the mid-teens but not 20% sort of range is kind of what I’m thinking, given on our current assumptions with the rate hikes, obviously, the December hike doesn’t do much for us at all.

But I think that’s kind of what we’re seeing right now. Obviously, we don’t have – let me – the only thing I guess I want to be sensitive to is that let me make sure that PPP was such a big piece of our financials. We did such a – our team did such a great job in getting those PPP loans booked and now forgiven.

But no, I think I think I’m pretty comfortable with that number. It would be something – at least based on our current projections and our current betas, it’d be something north of the mid-teens.

Does that help?.

No, that’s very helpful. And thanks for taking my questions..

Sure..

Thank you. Our next questions come from the line of Jennifer Demba with Truist Securities. Please proceed with your question. Jennifer, you have to check if you are on mute..

Yes. Good afternoon. Hi, just wondering if you could talk to us about what you’re thinking in terms of future branch expansion after ‘23.

Do you think you could go back and do more in Houston and Dallas or proceed on to Austin, any thoughts there?.

Jennifer, I think we will be we will probably have a little bit left to do in Dallas on follow on ‘24, so we will do some of that.

And we could – just like we had Houston 2.0 where we came back with about another third of the new locations for new branches there, we could see some expansion in Dallas Three years from now, I really believe this is going to be an ongoing activity for us as we develop these markets like Houston and Dallas, and I keep saying the thing that is so amazing about those two markets is each one of them 50% larger in deposits than either the state of Arizona or the state of Colorado.

So these are massive markets. Just another thing that I think is interesting. If you look at our further Northwest location, Houston to our farther east Southeast, I think it’s the same distances between San Antonio and Austin. So that’s a big city. Obviously, Austin has got some opportunity there. And I think that we will be looking at that over time.

But Jennifer, one thing that it might seem like a little deal to you, but this is something I saw just yesterday that I am really excited about. And this is a branch location that we opened in San Antonio now it’s in a good growth market that we really hadn’t been in for various reasons.

So on the west side of San Antonio, it’s called Alamo Ranch, and that branch opened around Thanksgiving, okay? So it’s – and it’s been open about 4 months. A lot of those months really bad months for banking in terms of opening up accounts, but looking at those numbers in 4 months, we’ve got $17 million in deposits, and we have 603 new relationships.

In 4 months, this is a market we’ve got 25%, 27% market share. Let me put that in perspective. I said, well, tell me what was the best branch we had in Houston? And we said, well, it’s got to be Cinco Ranch and Katy in terms of speed of growth, so I’ll compare that to Cinco Ranch and Cinco Ranch after 4 months had $3.5 million in deposits.

That compares to $17 million of San Antonio location. It had 180 households compared to 603 in San Antonio. I mean what that tells me is that – and you pick the right markets with the right brand recognition with our value proposition and our ways of engaging that market, we’re going to be successful. And look, it’s not because we hired Mr.

Alamo Ranch in terms of knew the market, brought all the business. As I recall, the person we hired to run it is from Kansas City. So Man, this was really encouraging. And I think it’s instructive for us about the value of putting properly placed properly managed new locations around the state.

So I really believe this, Jennifer, that the best two words, I can say about our organic growth strategy. is that it is durable and it’s scalable. I really believe that we’re going to be doing this for a long time.

Thank you, Phil. That’s helpful..

Welcome..

Thank you. Our next question is come from the line of Steven Alexopoulos with JPMorgan. Please proceed with your questions..

Hi, everyone..

Hi, Steve..

Hi, Steve..

Jerry, I was hoping you could help out with this.

So if we look at the yields that you called out on the taxable and tax-exempt securities, as interest rates rise, can you help us think about a securities beta, if you will, or how responsive should those be? I’m assuming it’s probably a 3 to 5-year part of the curve we should be looking at for both of those probably longer and for the munis.

But how responsive if you look at cash flows coming off, do reinvestment rates, how should we think about those resetting as interest rates move higher?.

Well, let me help you a little bit with kind of what we’re thinking about with the $5 billion that I said we still have to purchase. And you’re right. I mean right now, what we’re thinking is that about 70% of that is going to be in treasuries. And we’re probably – we’re thinking that it would be 5 years and shorter is what we’re doing.

And so that really only leaves another 15% in mortgage backs and another 15% in munis. I guess if you look at the 5-year today, we’re at 2.88%. I think we were this morning. I mean, I’m trying to look here what we’ve got rolling off.

I think that the kind of comparison I would make is more the fact that because we’re really increasing the portfolio from the standpoint of using our excess liquidity 2022 is really not a significant year for projected muni calls or maturities.

And so I don’t – I think mostly to what we will be doing is we will be reinvesting primarily out of our excess liquidity. So in a lot of ways, that whatever assumption you make on what we’re investing is going to be a pretty significant pickup.

Now if I look at kind of some of the calls, I’m trying to see if I got some of that information here with me. For the first quarter, we really didn’t have a whole lot of coming off I think we had just $300 million. And most of those tended to be munis.

And I think the blended rate there was $35 million as I look at kind of what we’re going to see through the rest of the year, I don’t see any really significant maturities that I would feel that we would want to call out. I mean I think our current projections, for example, August and February are the big calls on our muni portfolio.

And both of those are less than – they are in the $200 million to $300 million in each of those time periods. So from a maturity if you include repayments in there, again, I mean, we’re just not – I’m looking at a 12-month forward, so I got a little bit of ‘22 and a little bit of ‘23 included here.

But it’s only $1.7 billion that’s combined both maturities and prepayments. So in a lot of ways, I think a lot of it is going to be a good upside that we’re picking up, investing out of balances that are at the Fed.

Now I think if we put anything on, it’s going to be – especially in the near-term, it’s probably going to be, if you are replacing the security, it’s going to be at a lower yield in today’s environment against what we’ve got on the books..

Yes.

And then – so if we look at all the liquidity you’re sitting on today, do rates – do they get to a certain point and you’re like, okay, like we can go back to where we used to be in terms of cash to assets ratio, which was, I guess, about third were now? Or is there some reason that from a structurally you need to hold more liquidity than in the past?.

No, I don’t think so. There is – in some ways, I would argue that we have more access to funding if we needed it, that we’ve – than we’ve had in the past. So no, I don’t see any sort of structural reason that we would want to invest.

We are not – what you will see us doing as we go through the rest of ‘22 and what I would expect through the ‘23 is a much more averaging sort of dollar cost averaging, if you will purchases. We are going to try to avoid making any significant purchases.

Now, if for some reason we saw something really unusual happen in the market, might we jump in and do something, we might. But I think right now, what we are projecting is we are projecting that it’s going to be a – we are expecting rates are going to go up.

And so we are just going to continue to over the next – for the rest of the year, let’s say, for the next nine months, we are just going to make some ratable purchases each month, expecting that we are never going to be able to time the market exactly.

But if we kind of make purchases during the remaining months, we are going to catch some good balances there. And we may miss one like we did in the case of the 2 years that we bought at 1%. So, we are just going to average it and I would expect that’s what we would do as we get into 2023.

A lot of it is going to be dependent on what happens with deposits, right. We have been really fortunate, like I said when we look at the balances at the Fed, we are making a lot of investment purchases, but at the same time, that balance doesn’t really seem to move a lot. So, we have been fortunate there.

And obviously, if that continues we might find ourselves in a position where we would be willing to invest more. But we are not looking to invest all our dry powder in ‘22..

Okay. And then final one, going back to Ebrahim’s question on deposit growth. Loan-to-deposit ratio is fairly low, but you have always new markets and initiatives really driving nice deposit growth.

Should we think the loan-to-deposit ratio could stay fairly stable at these levels, or should we be thinking that loan growth is faster than deposit growth? So that trends lower, say, through 2022, 2023? Thanks..

I think that and I will let Phil give his thoughts on it. The challenge is that we have got such a big base of deposits and we have been so fortunate to be able to grow that base with the top quality service that our employees are providing the fair pricing that we are giving.

And so when deposits are more than twice the size of our loan book, if they are growing at that – even if they grew at 6% and the loans grew at the high-single digits, it’s going to be a while before we make a significant dent on that ratio. And where we certainly love deposits, we love the relationships that come with them.

We think that a lot of our success is based on our core funding. So, that’s my thoughts. So, I will turn it to Phil..

Yes. I think that the math of it is going to be we are going to have a low loan-to-deposit ratio for some time. But I would also say that, that’s a high-class problem. And I think the more important thing is the company growing, right. And so I think it will take a while to eat into that ratio.

The other thing I will say about growing deposits is we have such a high level of transaction accounts because of our relational business model. In fact, I think that we are probably, I don’t know, 60%, maybe almost two-thirds or transaction accounts, if you look at consumer checking accounts and commercial checking accounts.

At any kind of normalization of interest rates, let’s say, a 2% Fed funds rate, for example. I mean the spread that you make on those deposits being in liquidity is what you might make on some old LIBOR-based loans. I mean it’s – there is nothing to sneeze at, at some point when you are – when your interest rates are moving.

So, I am feeling very comfortable about the fact that, yes, we are probably going to have a fairly low loan-to-deposit ratio certainly lower than peer for a pretty good period of time..

Okay. Thanks for taking my questions..

You bet..

Thank you. Our next questions come from the line of Jon Arfstrom with RBC Capital Markets. Please proceed with your question..

Thanks. Good afternoon..

Hi Jon..

Steve Alexopoulos is a smart guy. That was the question I had for you, but I do have a couple of others. Just Phil, you usually give us some color on the competitive environment in terms of loans that you passed on due to structure and pricing.

Can you just give us a 30,000-foot view on what the environment is like?.

I think the environment is – gets a little bit worse every quarter.

I think that it’s – it continues to show up in commercial real estate where people are struggling to underwrite in a market where prices are increasing so fast and where most of us have these sensitized analyses that, okay, well, will your project cash flow x percent based upon an x percent interest rate.

Those are harder to justify they are harder to underwrite. It’s hard to underwrite. Well, how much rent growth are you willing to underwrite into deals, okay. That’s an important factor when prices are going up like they are. I think people are asking for longer terms.

And at the front end, and they are looking for ways to extend it really was really not much required of them. And that’s – I mean I am not telling anything you don’t know. I mean all this stuff is just what’s out there in the marketplace.

I think some people are we are seeing maybe a little bit of a trend to people’s underwriting to a debt yield and whereas you might have underwritten to a 10% debt yield maybe they are backing off that number and maybe you would see an 8% number.

I think they are just – creativity being utilized by underwriters in the market to justify and to bring deals across the line. I am sure that’s not exhausted, but it’s just an example of some of the things we are seeing..

Okay. Got it. Question on your mortgage expectations, just – I know a couple of quarters ago, you talked about it, and it just seemed like more of a rifle shot approach.

But I was just thinking of your Alamo Ranch example and some of the consumer checking account growth that you are seeing, any change in the expectations there? And kind of what are your expectations for the mortgage contribution?.

I think you make an excellent point, Jon. I mean it’s one of the things we were talking about. I mean just take that example.

I think our loans there like, I don’t know, $1.5 million, which is not bad in four months, but – and you look at what is in this case, it is a more consumer-oriented more of a house top location, whereas we typically tend to go to a more where you have got a lot more concentration of businesses since that’s more wheelhouse.

But I think that the addition of the mortgage product into our product mix, into some of these markets like this one here and there are tons of these, I think around the state. It makes it more viable from generation of assets. And so I think it helps us net-net in terms of the viability of locations that we can go into.

And remember, we are not approaching this as a refinance strategy on mortgages. We are looking to do deals where you are – their purchase money mortgages and where we can provide great service and help customers with a significant financial transaction in their lives. So, I think we are going to have to see.

We are not going to be offering our first one until later this year, like I would say, fourth quarter sometime. But I am really optimistic on the quality experience we are going to give and how successful we are going to be with that asset class over time.

And I just can’t wait to get after this market in a prudent way, of course, but get after this market with that customer experience, I think it’s going to be great..

Yes. Okay. Yes. I just – I think through that as it’s maybe one solution to your loan-to-deposit question and if you portfolio some of this, and you have seen some peer banks do that as well. But I think it’s clearly – yes..

That’s a fair point, fair point..

And that is our plan currently that we would portfolio those mortgages..

Okay. Just last one, non-quantitative, but how do you think the Frost brand resonates with new residents? Is this market share you are taking from other banks in Texas from existing people, or do you feel like the brand resonates with somebody we hear about people moving from California to Texas, is that part of this growth as well? Thanks..

Yes. I can’t tell you that I have definitive information on what our penetration is for Californians or people from Illinois or into Texas. Here is what I think though, our growth numbers have been so good say, on the consumer side that I think that – I think that it is pretty – we are having good success.

I mean the way most people shop, our research says you are going to go into a market and if I just stay with your own old bank, but you are going to still look to see where the nearest branch location is. That – our research shows that’s still the number one factor someone considers.

And then you are going to look online at what kind of reputation and those kind of things, you are going to look at – you can do your research. And if you do that, I mean our numbers are – we are just going to be in the game. In fact, obviously, with our customer service numbers, I think that we will be ahead of the pack for most of the time.

So – and there is so much in-migration into these cities and our growth is good, it just tells me that I think we are – what we are doing resonates with a fair number of people that are moving in. And the thing is we are of a size. We don’t have to get everyone. We just got to get our share plus on that, and we will do really well..

Yes. Okay. Thanks guys. I appreciate it..

Alright Jon..

[Operator Instructions] Our next questions come from the line of Bill Carcache with Wolfe Research. Please proceed with your question..

Thank you. Good afternoon Phil and Jerry. I just wanted to follow-up on some of your comments around the deposit franchise and the strength of the deposit base. And in particular, some have raised the concept of surge deposits and the possibility that there could be some outflow as the Fed starts to drain liquidity from the system.

It sounds like you think your deposits are sticky.

And that’s not something that you are worried about, but perhaps if you could just frame how you think about that? And lastly, if I could squeeze in, you mentioned that consensus EPS looks low, but I was hoping you could perhaps share your thoughts on what you think about consensus net interest income, growth expectations.

Does that also look like it’s perhaps a bit late? I would appreciate your thoughts. Thank you..

Thank you. I will just say that with regard to deposits and what the levels are, I mean I think what you are hearing us and what you are hearing Jerry say is that we are careful and conservative. We expect these growth rates are going to slow, right. We have been growing at 20% for gosh, I think the last 2 years, and we think they will slow.

Do we still see augmentation in our deposit balances as opposed to new customers, yes, probably, what is it Jerry about augmentation?.

68%..

Yes, 68%. So, call it two-thirds of our growth is augmentation right now, at least the last quarter, third from new customers. We could see some drop. And if we see diminishment of account balances, we could see some drop on that. But my gut tells me, and we saw this back in ‘99 whenever the Fed reacted to the tech bubble and push rates down too low.

You could see deposits flatten. But I think once they do, they probably reach what I will call it, dynamic equilibrium where you have got maybe deposit balance for current customers diminishing, but you are still bringing on that account growth that we are showing and what we are reporting on. We have got these expansions.

So, I tend to think it would be more of a flattening than an absolute reduction of surge deposits, as you call them. But hope is not a plan. And I will tell you that one part of the reason we have that $13 billion liquidity there because you provide for those kinds of eventualities. So, we are prepared regardless of which way it goes.

I will let Jerry speak to the margin..

Yes. I think the number that I see out there that AB is sharing with me is $1.149 billion something like that is kind of where it looks like consensus is that. And I will go back to – and what I don’t know is whether that’s a TE number or not.

I will say that if it’s a TE number, the guidance I gave would infer a higher number than that one is concerned. If I look at trying to see if I have got the non-TE number. Yes, if it’s a non-TE number, I would say that, yes, I mean it’s in the ballpark, a little – what I would say, maybe a little shy of where we are at.

But again, just – that’s I’m going off $1.149 billion number. Our projections both on a TE basis, obviously, on a TE basis much higher than that, on a non-TE basis, still higher, but certainly within the range..

That’s very helpful. Thank you for taking my question..

Sure..

Thank you. Our next question comes from the line of Dave Rochester with Compass Point. Please proceed with your question..

Hey, good afternoon guys. Just back on the NII discussion, appreciated the update there and your thoughts that you just talked about in terms of what you are seeing versus consensus. I guess when I take a step back and you talk about maybe things should be a little bit stronger than your prior guide, which is mid-teens.

Back in January, you guys were only factoring in a 25 basis point hike in May, July and December. And now we are talking 50 and 50 in 2Q alone. It just seems like the updated guide is still conservative, especially just given the message on deposit betas as well, which I think improved in your prior thoughts in January as well.

So, it just seems like – is this a case of maybe you are factoring in a little conservatism in here, or it feels like 20% plus might be more in the ballpark of what you are looking at.

Any updated thoughts there?.

Yes. I think that part of the discussion is going to be the betas that come in, especially on the hikes after this hopefully, this may hike. I think that’s some of it.

I think also the assumption, what gets assumed on investment purchases going forward, right, in the timing of those, I think a lot of it is just going to be dependent on timing and what assumptions you make on the rates that we will be purchasing at on the investment securities because that’s going to be a big part of the driver here.

We are probably a little conservative on deposit betas as well. We want to ensure that we do what we say we are going to do, which is make sure that we are competitive in the marketplace against all the peers not just too big to fail. So, I think there is probably some of that as well.

There is going to be – there will be some pressure on loan pricing as well. We did see a drop on a linked quarter as well. So, we will feel some of that as well. But I mean I think I give you about all the color that I can give you, and I think a lot of it is just going to be dependent on your assumptions..

Okay. I appreciate that. And the $5 billion in securities purchases you were talking about that purchase is not growth, right? So, you are expecting maybe another $3 billion or $4 billion in securities growth for the rest of the year.

Is that fair?.

Yes, that would be fair. That $5 billion is just purchases..

Got it. Alright. Maybe I can just sneak in one more. I was just curious to you guys gave some pretty positive color on the percentage of your goals that you are achieving in Houston and Dallas. I was just curious since you – since I have been around for a while now.

If you could just update us on what the loan-to-deposit balances look like in terms of dollars, that would be great? Thanks guys..

One thing I will say about Dallas that even though it’s early, it’s running about two-thirds of commercial on the deposit side, one-third consumer. So, I think it’s uncanny how the character of the business that we are generating in the Dallas market is consistent with Houston..

Yes. And so looking at the loan-to-deposit ratio, you were asking for the expansion. That’s running about a 71% right now..

In terms of the dollar amounts of loans and deposits you have in Houston?.

Right. Just the expansion branches is all I am sharing with you kind of what we have been able to accomplish there.

Is that what you are asking?.

Well, I was just curious how much in the way of loans and deposits you have in Houston?.

Sure. Yes. So, we had deposits of $725 million, call it and loans of a little bit shy of 5.15..

Alright. Great. Thanks guys..

Sure..

Thank you. Our next question comes from the line of Peter Winter with Wedbush Securities. Please proceed with your question..

Thanks. I hate to beat this to a dead horse this net interest income. If I could try it one more time.

Jerry, the guidance that you gave north of mid-teens, is that on a reported basis of 2020, or does that exclude PPP income?.

No, that’s – so the guidance I am giving is TE net interest income, full year ‘22 just reported over full year ‘21. And you are right, ‘21 does include PPP, quite a bit more PPP than we have got. So, I am saying that we would have a little bit north of mid-teen growth is what we are projecting currently over the reported 2021..

On a reported basis. Got it..

Yes..

Okay. That’s helpful. And then overdraft and NSF fees have become a hot topic for the banks and you have seen a number of banks reduce their fees.

I am just curious what your thoughts are on overdraft NSF fees and how much that is on a quarterly basis for you guys?.

Sure. The things that we are talking about now is we implemented, I think Phil may have mentioned in his comments, overdraft grace in April, I think it was of last year, which basically allows customers that have at least $500 in a direct deposit to be able to incur $100 overdraft with no fee.

The current conversation that we are having is that we would expand that to include all customers, all consumer customers. So, even if you didn’t have a direct deposit. And that probably cost us about $2 million a year when we pull that trigger, which will be some time later this year..

Okay. Thanks Jerry..

I think the other thing, Peter, is we continue to monitor that program and adjust it. We have been doing it for years. I think the other thing that’s becoming mainstream is elimination of what’s called NSF fees. And we are in the middle of working towards that. It’s just a systems programming issue that you are got to put in place.

And I expect us to have that done in the next few months.

And Jerry, do you have to give an idea on that one?.

Yes, that’s probably somewhere around $350,000 to $400,000 a quarter..

Okay. Thank you..

But all those are considered in my guidance..

Thank you. There are no further questions at this time. I would like to turn the call back over to management for any closing comments..

Alright. Well, we thank you for the questions today and for everybody’s interest and we will be adjourned now. Thank you..

Thank you. This does conclude today’s teleconference. We appreciate your participation. You may disconnect your lines at this time. Enjoy the rest of your day..