Ladies and gentlemen, thank you for standing by and welcome to the Cullen/Frost Second Quarter Earnings Results Call. [Operator Instructions] Thank you. I would now like to hand the conference over to your first speaker today, Mr. A. B. Mendez, Cullen/Frost’s Director of Investor Relations. Sir, please go ahead..

Thanks, Joanna. 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 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 will turn the call over to Phil..

Thank you, A.B. and good afternoon everybody. Thanks for joining us. Today, I will review second quarter results for Cullen/Frost and our Chief Financial Officer, Jerry Salinas, will also provide additional comments before we open it up to you for your questions.

In the second quarter, Cullen/Frost earned $116.4 million or $1.80 a share compared with earnings of $93.1 million or $1.47 a share reported in the same quarter last year and compared with $113.9 million or $1.77 a share in the first quarter.

In the current environment, our company is in a strong position to benefit from the rebound in economic activity and we will continue our organic growth strategy while taking steps to enhance Frost’s experience for our customers and our employees. As expected, economic conditions have continued to weigh on conventional loan demand.

Overall, average loans in the second quarter were $17.2 billion, a decrease of 1.7% compared to $17.5 billion in the second quarter of last year. Excluding PPP loans, second quarter average loans of $14.6 billion represented a decline of 3% compared to second quarter of 2020.

However, we are seeing evidence of loan growth beginning to materialize as non-PPP loans trended up in the month of June and that upward trend has continued into July. Average deposits in the second quarter were $38.3 billion, an increase of more than 22% compared with $31.3 billion in the second quarter of last year.

Our return on average assets and average common equity in the second quarter were 1.02% and 11.18%, respectively. We did not report a credit loss expense for the second quarter. Our asset quality outlook is stable. And in general, problem assets are declining in number. New problems have dropped significantly and are at pre-pandemic levels.

Net charge-offs for the second quarter totaled $11.6 million compared with $1.9 million in the first quarter. Annualized net charge-offs for the second quarter were 4 basis points of average loans.

Non-accrual loans were $57.3 million at the end of the second quarter, a slight increase from $51 million at the end of the first quarter and primarily represented the addition of 3 smaller energy loans, which had previously been identified as problems. A year ago, non-accrual loans stood at $79.5 million.

Overall delinquencies for accruing loans at the end of the second quarter were $97.3 million or 59 basis points of period-end loans and were at manageable pre-pandemic levels. We’ve discussed in the past $2.2 billion in 90-day deferrals granted to borrowers earlier in the pandemic. As of the end of the second quarter, there were no active deferrals.

Total problem loans, which we define as risk grade 10 and higher, were $666 million at the end of the second quarter compared with $774 million at the end of the first quarter.

I will point out that energy loans declined as a percentage of our portfolio, falling to 6.98% of our non-PPP portfolio at the end of the second quarter as we continue to make progress toward a mid single-digit concentration level of this portfolio over time.

Our teams continue to analyze the non-energy portfolio segments that we considered most at risk from pandemic impacts. As of the second quarter, those segments are restaurants, hotels and entertainment and sports.

Those of these portfolio segments, the total, excluding PPP loans, represented $675.1 billion at the end of the second quarter, and our loan loss reserve for these segments was 8.6%. The credit quality of these individual credits in these segments is currently mostly stable or better compared to the end of the first quarter.

We also continue to add to our customer base. Through the midpoint of this year, we added 7% more new commercial relationships than we did in 2020, which included the outsized second quarter of 2020 when PPP activity was so strong.

Looking at recent trends, our new commercial relationships were 511 in the fourth quarter of 2020, 554 in the first quarter of this year and 643 in our most recent quarter. So we’re seeing good momentum in this area.

We are also seeing good momentum in the insurance business, particularly in the benefits and property and casualty segment, were up about 6% in both of those in terms of new customers.

And also, as many others, we are seeing good growth in wealth management from assets under management with these good markets, but have also seen an increase of around 3% in new customers.

In the time since we began our PPP efforts, just under 1,000 new commercial relationships identified our assistance in the PPP process as a significant reason for moving to Frost. New loan commitments booked during the second quarter, excluding PPP loans, were up by 9% compared to the second quarter last year and up by 45% on a linked quarter basis.

Our current weighted pipeline is 12% higher than 1 year ago, 17% higher than last quarter and 38% higher than the same time in 2019. The increases are mostly due to C&I. Our current weighted pipeline is as high as it’s ever been. So we hope this points for a good third quarter for booking new loans.

At the same time, it has to be said that competition is intense. In total, the percentage of deals lost to structure of 56% was down from the 75% we saw this time last year, but that’s really more a factor of the increase in price competition rather than more market discipline around structure.

We were extremely proud to have completed our 25 branch Houston expansion initiative in the second quarter, and we continue to be very pleased with the results. It represents a tremendous achievement for our outstanding staff. Let me update you where we stand through the second quarter and it excludes PPP loans.

Our numbers of new households were 141% of target and represents almost 11,000 new individuals and businesses. Our loan volumes were 215% of target and represented $310 million in outstandings and about 80% represented commercial credits, with about 20% consumer.

Regarding deposits, at $433 million, they represent 116% of target and they represent about two-thirds commercial and one-third consumer.

Once again, I hope that we have shown that the character of the business we are generating through the expansion is very consistent with the overall company and its profitability is weighted towards small and midsized businesses and complemented by consumer as well as other lines of business including wealth management and insurance.

Consumer banking also continues to see outstanding growth. In just the first 6 months of this year, we have already surpassed our all-time annual growth for new customer relationships. This represents about 13,500 net new checking customers. Our previous high was 12,700 for full year 2019 and it’s all organic growth.

We worked hard to lower barriers to entry for potential customers with improved product offerings and our geographic expansion. Houston accounts for about one-third of this relationship growth. Their annual growth rate for consumer customers is up over 13%. That compares to 4% in 2018 before we started the expansion.

We were excited to announce this month that we launched a new feature called Early Pay Day, which gives customers access to direct deposits up to 2 days before the money arrives in their account.

And we put this in place in time for customers to see the effect from the IRS Child Tax Credit payments, and we’ve already heard great comments from customers who’ve used Early Payday to pay bills.

This makes a difference in the lives of people who live paycheck to paycheck, and that was on top of our $100 overdraft grace feature that we rolled out in April. Also, earlier this month, we reached an ATM branding partnership with Cardtronics that will result in us having more than 1,725 ATMs in our network across Texas.

That is, by far, the largest ATM network in the state. But just as important, it gives us the largest ATM network in the Dallas-Fort Worth region as we began our expansion in Dallas early next year.

I mentioned PPP earlier and how our efforts helped thousands of small businesses and we closed out the second round of PPP with more than 13,000 loans for $1.4 billion and combined with the first round that gives us a PPP program total of more than 32,000 loans and $4.7 billion in deposits – $4.7 billion in outstandings.

The historic effort that Frost Bankers put into helping borrowers get PPP loans has now shifted to the forgiveness process. Because borrowers for the first round are approaching payment dates, if they don’t apply for forgiveness, we’ve increased our communication to them and worked on ways to make the forgiveness application process simpler.

We’ve already submitted 21,000 forgiveness applications and received approval on nearly 19,100 of them for $3 billion. That’s close to the entire first round total. We continue to be optimistic about the economy and what lies ahead.

We have the best team in the financial services industry, and thanks to them, we will continue to grow and extend our unique value proposition to more customers. 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 second quarter was 2.65%, down 7 basis points from the 2.72% reported last quarter.

The decrease was impacted by a higher proportion of earning assets being invested in lower-yielding balances at the Fed in the second quarter as compared to the first quarter, partially offset by the positive impact of the PPP loan portfolio.

Interest-bearing deposits at the Fed averaged $13.3 billion or 31% of our earning assets in the second quarter, up from $9.9 billion or 25% of earning assets in the prior quarter.

Excluding the impact of PPP loans, our net interest margin percentage would have been 2.37% in the second quarter, down from an adjusted 2.59% for the first quarter with all of the decrease resulting from the higher level of balances at the Fed in the second quarter.

The taxable equivalent loan yield for the second quarter was 4.28%, up 41 basis points from the previous quarter and was impacted by an acceleration of PPP forgiveness during the quarter which accelerated the recognition of the associated deferred fees.

Excluding the impact of PPP loans, the taxable equivalent loan yield would have been 3.80%, up 3 basis points from the prior quarter. To add some additional color on our PPP loans, forgiveness payments received accelerated during the quarter, totaling $1.3 billion compared to the $580 million received in the prior quarter.

As a result of the accelerated forgiveness, interest income, including fees on PPP loans totaled about $45 million in the second quarter, up significantly from the approximately $30 million recorded in the first quarter.

Given our current projections on the speed of forgiveness of the remainder of our PPP loans, we currently expect that the interest income on PPP loans recognized in the third quarter would be less than one-half of the $45 million recorded in the second quarter. Total forgiveness payments through the second quarter were approximately $2.7 billion.

And total PPP loans at the end of June were $1.9 billion, down from the $3.1 billion at the end of March. At the end of the second quarter, we had approximately $38 million in net deferred fees remaining to be recognized, and we currently expect a little over 70% of that to be recognized this year.

Looking at our investment portfolio, the total investment portfolio averaged $12.3 billion during the second quarter, up about $46 million from the first quarter. The taxable equivalent yield on the investment portfolio was 3.36% in the second quarter, down 5 basis points from the first quarter.

The yield on the taxable portfolio, which averaged $4.2 billion, was 2.01%, down 5 basis points from the first quarter as a result of higher premium amortization associated with our agency MBS securities, given faster prepayments.

Our municipal portfolio averaged about $8.1 billion during the second quarter, down $104 million from the first quarter, with a taxable equivalent yield of 4.09%, flat with the prior quarter. At the end of the second quarter, 78% of the municipal portfolio was pre-refunded or PSF-insured.

The duration of the investment portfolio at the end of the second quarter was 4.4 years, in line with the first quarter.

Investment purchases during the quarter were approximately $680 million and consisted of about $400 million in municipal securities with a TE yield of about 2.30% and about $190 million in 20-year treasuries with the remainder in MBS securities.

Regarding non-interest expense, looking at the full year 2021, we currently expect an annual expense growth rate of around 3% from our 2020 total reported non-interest expenses.

And regarding income tax expense, the effective tax rate for the quarter was 11.3%, up from the 6.4% reported in the first quarter as a result of higher earnings, but also impacted by lower tax benefits realized from employee stock option activity in the second quarter as compared to the first.

We currently are projecting a full year 2021 effective tax rate in the range of 9% to 9.5%. Regarding the estimates for full year 2021 earnings, given our second quarter results and recognition of lower PPP fee accretion for the remainder of the year, we currently believe the current mean of analyst estimates of $6.33 is reasonable.

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

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

Thank you. [Operator Instructions] Your first question comes from the line of Jennifer Demba from Truist Securities. Your line is open..

Thank you. Good afternoon..

Hey, Jennifer..

Just wondering if you could talk about the branch expansion and kind of the deposits and loan balances in the new offices at this point in Houston and how many offices you expect to open in Dallas and over what timeframe?.

Okay. Well, the – as I mentioned, the character of the business that we are generating the branches looks pretty close to what we do in the overall company. It is about two-thirds commercial at this point on deposits, about a third consumer. That’s a little bit higher than our bank totals on commercial consumer mix.

We are probably somewhere between 55% and 60% on the commercial, if you look at the total company, but I think that’s pretty close. And if you look at loans 80% commercial and 20% consumer. If you look at the 80% commercial number, I think the biggest component of that is going to be traditional C&I loans.

Second largest would be owner-occupied real estate, that type of thing. I can tell you, Jennifer, that we have been seeing the size of loan that we are doing in the expansion branches has been increasing, but it’s still deeply core. I think the latest numbers I saw is – we only had like three relationships that had loans of $10 million and more.

So, this is really a good core business for us. And I think the last number I saw is the average loan size of about $1.2 million. And if you go back several months, that would have been probably more like $0.75 million and really round numbers.

So we are seeing those numbers get a little bit larger, but not – we are not elephant hunting, and I think that’s good for us. And I think that it really shows that – two things. One, I think the economy is improving.

So you are getting a little bit more demand, but I also think that the new bankers are becoming accustomed to our systems and our underwriting and our offerings and also being more successful prospecting. So, that’s what we are seeing on the loan side there.

I will tell you that in Dallas, I really believe it’s going to be very consistent with what we see in Houston market. You can argue that Dallas might have even a little bit more diversified economy than Houston, because of the impact of energy on the Houston market.

Dallas, I think is known for – in general business, I think it’s got over 10,000 corporate headquarters there, from an old number that I remember hearing. And I think that our kind of business banking is going to resonate very well there and it has already. I think Dallas is going to have a pretty good year.

So, I think we will see pretty much the same kind of impact. I was really glad for us to be able to get the opportunity to create that number one ATM network in the DFW market. That has been – as good as our network has been in the state, I think we might have been number three before, 2 or 3.

We were probably 4 or so, maybe 5ish in terms of ATM network in DFW, particularly Dallas. And this really takes that barrier to entry off the table and I think puts us in a really strong position as we move forward in that market beginning in January..

Phil, what are you seeing in terms of wage pressure right now? And what are you seeing in terms of – there seems to be a war for talent out there. So I am just wondering what you guys are experiencing..

We are experiencing it. I keep going back to this conversation I had with our Director of HR and this has been at least a month ago now, but she came in, we were talking about telephone customer service operators. I think she said we got about 50 applications a week typically for that position. And I think she said that as of the last week, we got 3.

It just shows you how much competition there is, not just from other businesses, but at that point in time, there was the government benefits, which are also frankly a competitive factor. So we’re seeing from our customers, everyone we talk to talks about wage pressure, they talk about the inability to hire people.

And that’s on top of the supply chain issues that are out there. So we’re experiencing it. It’s a little bit worse in some markets, but it’s bad in all of them, maybe a little bit worse in Dallas and Austin, but again, it’s bad in all of them. So it’s tough..

Thank you..

You’re welcome..

Your next question is from the line of Steven Alexopoulos of JPMorgan. Your line is open. Steven, if you are on mute, please unmute. Your line is now open. I think we have to move on. [Operator Instructions] Your next question is from the line of Brady Gailey of KBW. Your line is open..

Hey, thanks. Good afternoon, guys..

Hey, Brady..

Hey, Brady..

So cash as a percentage of average earning assets just keeps going up for you guys and it’s now 31%. I know earlier this year, we had talked about Frost potentially using some of that cash to deploy into the bond book. But as we have seen the long end of the curve has gone down here.

So, maybe just updated thoughts on when you feel is the right time to start putting some of that cash to work in a higher earning asset?.

Brady, I think we have been pretty consistent. What we said last quarter was that our plan wasn’t to make any major purchases until late in the third quarter or early in the fourth quarter. That’s still currently our expectations. Obviously, we will keep an eye on the market and we do everyday. It’s something we are talking about all the time.

But we did some purchases of municipals, as I mentioned during the quarter. We were somewhat opportunistic. Those yields had been coming down and we saw the ability to get in there early. So we did accelerate a couple of hundred million of purchases there.

But at this point, we are just – we are more focused on late into the third and I am really thinking early in the fourth as we begin to see the deferred fees associated with PPP start coming off the books. As we said, they are accelerated in there. We saw a big chunk of them this quarter and they will continue to payoff through the rest of this year.

So, that’s our current thought process. Obviously, we will keep an eye on the market if something comes up. If we have an opportunity, we will jump in. Did we like the market 45 – the yields 45 days ago better than we do today? Most certainly. But I think given what we see in our expectations, we still believe that inflation is out there.

It’s not this temporary sort of conversation that’s going on, as Phil mentioned, even on the salary side that we talk about. So, we are being consistent at this point. I haven’t seen anything that’s made us change our thought process too much, but again, we will be conscious of when it’s time to pull the trigger as to what it makes sense to do..

Alright. And then what do you think about the magnitude of these purchases? I mean, as you mentioned, your bond book is around $12 billion.

How much growth could we see beginning this year and into next year? Is it going to be significant or is it just going to be modest?.

Well, you mentioned the kind of looking at cash as a percent of our earning assets and even cash as a percentage of total assets. And obviously, we are way above any level that we’ve been here within the recent past. So we will – you know us and you have followed us for a long time.

We are pretty conservative and have been on the amount of balances that we typically have at the Fed. But given the fact that I think this morning, we had $14 billion in balances there. We are looking to make significant purchases.

It’s not going to be all at once obviously, but the thought process today is that we would utilize a significant amount of that liquidity in ‘21 and into ‘22 as well..

Okay. And then my last question, just on the deposit side, deposit growth has been amazing, 27% last year, first half of this year, you’re still at over a 20% annualized pace.

Do you think that eventually some of these deposits will move back out of the bank or how do you think about sustaining all of this notable deposit growth we’ve seen over the last year or so?.

Yes. It was – I have to admit, I was amazed, looking even at the linked quarter growth. If you look at it annualized, was even stronger than the year ago growth. I think Phil talked a lot about our focus on new relationships, and we continue to do well when we look at our 12-month rolling average of what’s going on with our deposit base.

We still see, obviously, that augmentation of our existing customers is, I think, something north of 70%, say, 72%. But we’re still getting growth from new customers, which is about 28%, which is still a good chunk.

But what we’ve also seen is we’re seeing a lot of our larger commercial accounts increasing their deposit balances as well and have been at some of the higher levels.

I think that given the rate environment that we’re in right now, given what you’re seeing out there as far as investment is concerned, I think it’s really hard to gauge when we might see those deposits leave.

At this point, we continue to feel like the deposit level that we saw through the end of the second quarter, it was pretty consistent in July, that sort of level of growth. So we haven’t really seen any sort of runoff. And our projections right now don’t really have us growing a lot more from here.

And a lot of it is really more due to the uncertainty as you said. So I think we’ve been really impressed with where we’re at and the growth that we’ve seen both from existing customers and from our new relationships. But you’re right, there is still a lot of uncertainty out there, a lot of liquidity out there.

And hopefully, as some of the economy starts to take off, you’d expect that some of those dollars, both on the consumer side and on the commercial side will probably be spent and probably would be a good sign for the economy and for what’s going on.

But at this point, we’re not projecting it to go much from here, but I haven’t seen any indication as of today that would indicate they are moving..

Got it. Thanks guys..

Your next question is from the line of Steven Alexopoulos of JPMorgan. Your line is open..

Take two.

Can you guys hear me?.

Yes..

Okay. I don’t know what happened before. First, I just want to drill down a little further into the commentary around deposits.

If you guys look at the non-PPP loans that you said trended nice up in June and up so far in July, for those customers that are starting to draw on their lines on the commercial side, are they working their deposits down at all first? Or are they just concurrently bring deposits to you and then also drawing on their lines further?.

Steven, that’s a good question. And it just depends. I see so many anecdotal stories. I’ve talked to customers who’ve just had game-changing experiences with PPP or with grants. I mean complete reduction of debt on balance sheets. We just thought we’ve all got stories that we see there.

So there – I think 1 thing that we’re seeing is we’ve got probably – we’ve got C&I opportunities, but we’ve got a fair amount of CRE opportunities. The CRE is probably a different deal than the scenario you described. I think what you’re talking about is mainly see C&I, regular C&I lending.

So – and it’s just hard to pinpoint a dramatic trend either way. I just think it depends on the business. A lot of businesses just didn’t get any PPP loans. So they are – they have really been dependent upon what they are seeing in the economy and are seeing activity and are they willing to expand. So I think that’s probably driving most of that.

At the same time, as I said, there have been some really game-changing balance sheet changes that have happened for some companies with regard to their liquidity and debt loads and all. So I wish I had a good answer for you. I just don’t know..

It’s a bit perplexing, but okay..

Yes. Steven, the one thing I will say is, early on, and you’re probably aware of this, a lot of us were saying that when PPP first started last year, the deposits – the loans would be made and the deposits would stay, right? The money wasn’t spent immediately.

And so a lot of the conversation was around the inflation, and the deposits, if you will, were just the fact that customers got a PPP loan and then just parked the money. We’re not really seeing that being the case. We’ve seen movement of most of those.

And again, you can’t tag that specific PPP loan to a deposit and then just be able to follow it completely. But when we looked at the activity within those accounts, it really looks like those dollars were spent. So it doesn’t look like we’re in that same situation that we were, say, 9 to 12 months ago..

Got it. Okay. And then I wanted to drill down on the 13,500 new net checking accounts you opened in the quarter.

What’s the base? In other words, what’s the growth rate?.

Yes. So if you look at our customer growth overall, that’s about a 6.2% growth, annualized growth. And thinking round number is $400,000 to $500,000, but we could divide that. But I mean, that’s – I mean, that to me is amazing, honestly. I mean we’ve had – we have had goals to grow that number.

I think our goal was to maybe get to 4% one day because you’re talking about a large base there. And for us to be at over 6% now on the entire base, I mean, I’m just – I’m really excited about that. And that’s not an accident. That can’t be an accident..

What portion of those are coming through digital channels versus the traditional branch? And does it vary much in Houston just given you’re opening new branches there?.

Yes. I’m thinking that 35%ish comes through digital. But I saw that number 2 hours ago and I just don’t have it here handy, but a significant amount. Hang on, maybe I’ve got it here. I would say about 30%ish in round numbers, looks like not a bad number..

Okay. Yes, very impressive. Okay, thanks for taking my questions..

You bet..

Your next question is from the line of Ebrahim Poonawala of Bank of America. Your line is open..

Hey, good afternoon. I guess just wanted to clarify, Jerry, around your PPP numbers. You mentioned about $45 million, I think, in the second quarter; $30 million in 1Q. That implies an NII of about $235 million quarterly for the first half. Just wondering, it sounds like you’re managing the securities book with an eye on the NII outlook.

Is that core NII ex PPP around $235 million the right way to think about where you might be in the back half of the year and where you would look to grow from as you look to redeploy cash into securities?.

I do think that it looks like the NIM percentage might have hit the floor there. But again, a lot of it’s going to be dependent on if and when we pull the trigger on the investment portfolio purchases as you said. So that’s obviously a big driver of it. So – and again, the level of deposits, we really don’t know what’s happened.

The level of growth that we’ve had has really been a lot more, obviously, than we expected and keeping that liquidity at the Fed has really had a downward pressure on that NIM percentage. So it’s going to be dependent on those things, you’re right.

But I think at this point, I think you’re thinking about it right, we kind of feel like we are at the bottom of that. It was nice to see the loan yields up a little bit even on a linked quarter basis, even ex PPP. But I’m going to tell you that there is a lot of pricing pressure, a lot of competition there.

And obviously, we’ve said and we continue to say, we’re a relationship bank and we don’t want to lose relationships for a few basis points. So we’re really saying that we want to be competitive there. So we could feel a little bit of pressure there. We will continue to feel pressure there.

I shouldn’t say that we won’t because we will, and it’s going to continue from everything that I hear. So we will feel some pressure on that loan yield. But I think, knock-on wood given all things being equal, I think we may have hit bottom there..

The cash deployment into securities is that more a function of where the interest rates go or is it a function of how quickly PPP runs off, like what’s the bigger driver of your thought process in the cash?.

No, it’s not really related to the PPP runoff. I mean obviously, we’re aware of it. So it’s not like we can look in our financials and not realize it. But no, that’s not really not going to be the thing that pulls the trigger.

I mean we’d already been talking about before, the acceleration of the forgiveness that we were talking – I think Phil mentioned in the call last quarter that we were talking about late third, most likely early fourth. So again, we don’t like the market.

We have the right to not pull the trigger if we don’t think it’s where we want to be, but you know where we’re headed. I mean that’s just our process at this point..

That’s helpful. And I guess just a separate question. Phil, we have talked about this in the past, you introduced the Early Pay Day, the $100 grace period on deposits. Just talk to us in terms of the retail side of the bank. You shared some of that.

What are you seeing in terms of customer behavior changing about acquiring clients? And of the 13,000 checking accounts that you talked about, what percentage are truly translating into customers where you see them as being [Technical Difficulty] down the road? Just talk to us in terms of how many of these 13,500 accounts [indiscernible] in term of relationship for Frost?.

Okay, Ebrahim, you were breaking up. I apologize a bit, but let me answer what I think I heard your question. Of the 13,500, I think you asked about accounts, how many are relationships with Frost. Just one point of clarification, those are not accounts. Those are new relationships.

So – and we don’t count it a relationship unless we get a checking account, okay? So these are not – we could go on and advertise higher rates on CDs or higher rates on money market deposit accounts and bring in a bunch of rate shoppers or whatever. These are relationships.

The account number is consistent, but – so I really believe that all these represent solid relationships from us. Another thing we keep an eye on, and you have to keep an eye on is what does attrition look like. And our attrition year-over-year has been really good.

I think our closed accounts were up only 0.5% year-over-year quarter in the second quarter. So we’re doing a good job there. I mean – and when you look at the value proposition, I mean, we’ve got a really great comparison with our new overdraft grace and with our – the Early Pay Day.

And another thing to keep in mind is about 70% of our customers are – we’re the primary relationship where we have their direct deposits. So I think that also speaks well of what our – how sticky and how deep these relationships are. But I apologize again there was some breakup when you were asking the question.

If I’ve missed something, please guide me to where I should be going..

No, I think that covers it, yes and sorry about that..

Thank you very much. Your next question is from Ken Zerbe of Morgan Stanley. Your line is open..

Great, thank you.

Just want to clarify really quick, in terms of the 3% expense growth, is the base that you’re looking at the full $849 million from last year? I know there is some one-time items in results late last year, so just that one?.

Yes, I’m just going off the reported number, that $849 million, you’re right..

Got it. Okay, perfect. And then in terms of provision expense, obviously, a couple of quarters in a row is zero.

Is it fair to assume that you’re going to try to stay at zero on a go-forward basis or – I know other banks have obviously been releasing a lot more reserves based on the CECL model, but there is also some subjectivity to CECL modeling? Thanks..

Right. Yes. I think you’re right. At this point, we haven’t recorded any provision for the year. And a big part of us, of our allowance calculation need, if you will, is associated with the overlays, right? Because the models themselves – and we will release our 10-Q this afternoon, and we gave quite a bit of detail on how the – how that CECL worked.

The models did actually calculate, if you will, a lower reserve requirement.

But what we’ve said is given all the uncertainty that we continue to see associated with the pandemic and the effects it has on certain parts of the economy, and again, given all the uncertainty that we’ve seen here recently with the variant, we feel that it really was not the time to release any reserves.

We obviously feel real comfortable about our reserve coverage but thought there was too much uncertainty in the market for us to release reserves. At the end of the day, we’ve got to look at it every quarter and see where we’re at.

I know there are some thoughts that the September, October time frame will be interesting given that you’ve got a lot of employers requiring or requesting employees to get back to work after Labor Day. You’ll have the kids back in school.

Obviously, the variant conversation that’s going on currently is starting to highlight other issues with the mask again. So we think that come September, October, I think it will be interesting to see where we’re at. I don’t expect – and then maybe this is a given. I don’t expect us to have provisions for the rest of the year, given where we’re at.

But as far as any discussion about would we be releasing reserves that will really be dependent on what we’re seeing at the end of the third quarter and at the end of the fourth quarter. Right now, I think there was just too much uncertainty given what we were saying to release reserves..

Got it. That makes sense. And I certainly understand the variability around the Delta variant.

But just, I guess if the economy does get better, let’s say, the Moody’s models get better in 3Q, but there is still that concern, I mean, do you have enough flexibility that you can continue to add to the qualitative reserves like for the next couple of quarters? I’m just wondering if there is a limit to where you’re unable just to keep adding qualitative, if that makes sense..

Yes. No, it does. And obviously, the thought process there is – I think, my take on it would be the more – the bigger percentage of your allowance that is related to overlays or qualitative factors, the more quantitative those qualitative factors will have to be, if that makes sense.

It’s not – it’s – I’m not going to be at a point where I can say it would never be the case, but I can’t have an extreme where the models would say I needed $10 million, let’s say, and I had a $90 million overlay to get you to $100 million reserve. That’s never going to be the case.

And so again, I think given where we’re at, I think our overlay, you’ll see was significant compared to the models this quarter. We feel comfortable with that.

But I think to answer that question, could we not or could we grow our qualitative reserves as a percentage of the total allowance for the rest of the quarters? I think that’s a difficult question to answer.

If we did, let’s say, we got to that point, I think what you’d find is that the support for that would be a lot more quantitative in nature, even if it’s a qualitative adjustment if that makes sense..

It does. Alright. Thank you very much..

Sure..

Your next question is from the line of Dave Rochester from Compass Point. Your line is open..

Hey, good afternoon guys..

Hey, Dave..

Back on your expense guide, it seems like that would imply a pretty decent step-up in the expense run rate in the back half of the year, maybe to that 225 level quarterly just to hit that 3% just roughly.

Any color as to what lines you’re expecting will drive that?.

Sure. Well, I’ll just talk about a couple of things there. We’ve really – I think I said this last time, and we were having a meeting with the head of our marketing group. We’ve really been light for the first half of the year on marketing expenses.

So we are projecting a pretty big increase in marketing-related expenses, especially in the fourth quarter. So that’s going to take a big bite out of that increase. In addition to that, we’re going to have additional expenses with that Houston expansion in the second half because as we’ve got more and more settled there, you’ll see that rise.

And as we’ve talked about, we’re going to do future expansion there and also the Dallas expansion. We will see a little bit of that. You won’t see a lot, but it’s going to run through our numbers here. We also have incentives that get paid in the fourth quarter that are one-time hits and are discrete to that quarter.

So that’s also going to affect the line items there. Phil mentioned some salary pressures. We continue to have that. And then also, really, we’ve got open positions that we’re trying to fill. There is a lot of requests for – a lot of desire for some talent that’s not that easy to find.

And so we’re projecting that we can fill those positions, but it’s taking us longer to do that than we had expected. And so – and then generally, I think just in the other expense category, it’s been a little bit slower starting out the year.

I think now that we’ve started cranking up and people are in the office and we’re starting to visit with customers again, you’ll see just an increase, if you will, in this general sort of meals and entertainment sort of category of items than we’ve had in the first half of the year. I will say that we continue to focus on expenses.

I’m going to tell you, if we are able to beat that 3% growth, I’m going to be happy about it. But at this point, given what I’m seeing, that’s what it looks like right now. And there are some specific things like I mentioned that I can put my finger on that are going to drive that increase..

Okay, great. I appreciate all the color there. Maybe just switching to the margin, you mentioned loan pricing pressure a bit on the call.

I was just curious what the front – both back books’ differential is now on new loan yields versus the roll-off rate at this point?.

What I saw was 28 basis points on the weighted commercial portfolio decrease on the new business in the quarter versus the back book..

Okay. And then you guys mentioned still feeling comfortable about making the securities purchases a few months from now.

I was just wondering if the curve at that point looks like it does today, are you still okay with that? And would you still plan to accelerate those purchases?.

It’s hard to say. Just I think everybody hates this market and few people understand what the tenure is doing when inflation is growing like gangbusters and then it continues to go down. So I mean, we will do what we have to do.

I mean we said for a long time, really all year long that we looked at the late third, fourth quarter to be when we thought we’d be pulling trigger on this stuff. Obviously, we thought rates would be higher that point in time and inflation would have reared its head and the market would have responded well. Half of that happened.

Inflation has reared more than its head and the market hasn’t really responded on it. We also said during that time that we might miss the peak and we have, at least at this point, but that were still going from 10 or 15 basis points to 125 or so 175 basis points.

So there is still a lot of operating leverage that we will bring to the party when we decide to do it. But I would love to see – there is – clearly, there is been volatility in the market as it relates to yields. We’ve got some time based on our time frame to see that play out in the marketplace.

I’d love to see some variability happen and be able to take advantage of some of it on the high side. We will see. I know that’s not definitive, but no one’s got the answer to that question right now..

Yes, great. And then maybe one last one on capital, those ratios continue to grow. Just in general, CET1 ratio is inching up to 14%.

How do you think about that? Do you expect those to continue to grow from here? Are you thinking about buying back some shares to stabilize that? Any thoughts there would be great?.

We’ve said repeatedly, and you saw us increase our dividend this quarter. Our focus is really on ensuring we can pay that dividend. That’s what our primary focus is on. I’m sure you saw on our balance sheet that – and we talked about earlier in the call, I mean, assets are going like crazy given all the deposit growth that we’re seeing.

And if you look at our leverage ratio, we’re probably a little low compared to peers. And we’ve been coming down there. So we keep an eye on that. But – so really, David, right now, I’d say that we’re more focused on ensuring that we pay the dividend more than we are on the stock buyback..

Yes. Okay, great. Thanks guys..

Thank you..

[Operator Instructions] I am no longer seeing any questions. I would like to turn the call back to Phil for closing remarks..

Well, thank you. We appreciate everybody’s interest and for being on the call today. And with that, we will be adjourned..

Thank you so much. Ladies and gentlemen, this concludes today’s conference call. Thank you all for joining. You may now disconnect..