Cullen/Frost Bankers, Inc.

Ladies and gentlemen, thank you for standing by and welcome to Call-In Plus Q3 Earnings Results. At this time, all participants are in a listen-only mode. After this speaker's presentation, there will be a question and answer session. To ask a question, you will need to press star one on your telephone. If you require any further assistance, please press star zero. I would now like to hand the conference over to your speaker for today. We call in Trust Director, Investor Relations, Mr. A.B. Mendez. Please go ahead, sir.

Thanks, Jerome. This afternoon'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 210-5234. At this time, I'll turn the call over to Phil.

Thank you, A.B. Good afternoon, everyone, and thanks for joining us. Today, I'll review third quarter results for Cullen Frost, and our Chief Financial Officer, Jerry Salinas, will also provide additional comments before we open it up to your questions. In the third quarter, Cullen Frost earned $95.1 million, or $1.50 per share, compared with earnings of $109.8 million, or $1.73 per share, reported in the same quarter of last year, and $93.1 million, or $1.47 per share, in the second quarter of this year. Overall, average loans in the third quarter were $18.1 billion, up by 25% from $14.5 billion in the third quarter of last year, which included the impact from PPP loans. However, even excluding this impact, loans managed a 3.3% increase from a year earlier. Average deposits in the third quarter were $32.9 billion, also up by 25% from the $26.4 billion in the third quarter of last year and the highest quarterly average deposits in our history. We understand that the banking industry has seen broad increases in deposit levels as authorities implemented comprehensive fiscal and monetary responses to the pandemic. However, it's also been our experience that Frost has historically been a safe place in times of uncertainty, and I believe this will always be a part of our growth in challenging times. For the first time, our total assets have surpassed $40 billion, up 41% in the last five years, and all of that representing organic growth. And speaking of organic growth, I'll discuss our Houston expansion in more detail later in the call, but I'd like to point out that we were pleased to see our deposit market share in Houston has now moved up to number six, up from 10th place a year ago. Even with the challenging environment, We and others in our industry have seen pressure on profitability. Our return on assets in the third quarter was just below 1% at 0.96, and we were pleased to announce yesterday the action of our board to increase our dividend for the 26th consecutive year. We saw a reduction in credit cost expense to $20.3 million in the third quarter, down from $32 million in the second quarter of 2020. This compared with $8 million in the third quarter of last year. Net charge-offs for the third quarter were $10.2 million, down sharply from the $41 million in the second quarter, and included no energy charge-offs. Annualized net charge-offs for the third quarter were 22 basis points of average loans. Non-performing assets were $96.4 million at the end of the third quarter, compared to $85.2 million at the end of the second quarter, and $105 million at the end of the third quarter last year. The third quarter increase resulted primarily from the addition of an energy service company. Overall delinquencies for accruing loans at the end of the third quarter were $133 million, or 73 basis points of period-end loans. Those numbers remain within our standards and comparable to what we've experienced in the past several years. Regarding payment deferrals, in total, we granted 90-day deferrals to more than 2,500 borrowers for loans totaling $2.2 billion. At the end of the third quarter, there were around 300 loans totaling $157 million in deferment, or about 1%. Total problem loans, which we define as risk grade 10 and higher, were $803 million at the end of the third quarter, compared to $674 million at the end of the second quarter. Energy-related problem loans were $203.5 million at the end of the third quarter, compared to $176.8 million for the previous quarter and $87.2 million for the third quarter last year. To put that in perspective, the year-end 2016 total problem energy loans totaled nearly $600 million. Energy loans continue to decline as a percentage of our portfolio, falling to 9.1% of our non-PPP portfolio at the end of the third quarter. As a reminder, the peak was 16% back in 2015. All prices have stabilized from volatile levels that we saw earlier in the year, and we continue to moderate our company's exposure to the energy segment. Through the first nine months of this year, the pandemic's economic impacts on our portfolio have been negative but manageable. During our last two conference calls, we discussed the non-energy portfolio segments that have had an increased impact from the economic dislocations brought on by the pandemic, namely restaurants, hotels, entertainment and sports, and retail. The total of these portfolio segments, excluding PPP loans, represented $1.54 billion at the end of the third quarter. And our loan loss reserve for these segments was 3.37%. New relationships are up by 38% compared with this time last year, largely because of our strong efforts and reputation for success in helping small businesses get PPP loans. The dollar amount of new loan commitments booked through September is up by about 2% compared to the prior year. Regarding new loan commitments booked, the balance between these relationships has stayed steady at 53% large and 47% core so far in 2020. The market remains competitive and in fact seems to be getting more so. For instance, the percentage of deals lost to structure increased from 61% this time last year to 70% this year. It was good to see that in this environment, our weighted current active loan pipeline in the third quarter was up 11% compared with the second quarter of this year. Consumer banking continues to see growth, although it slowed somewhat by the effect of the pandemic. Overall, net new customer growth The third quarter was down 13% compared with the third quarter of 2019 for consumers. Same-store sales, as measured by account openings, were down by 15.5% through the end of the third quarter when compared with the third quarter of 2019. In the third quarter, 52% of our account openings came from our online channel, which includes our FrostBank mobile app, and online account openings were 73% higher compared to the third quarter of 2019. Our investments in enhancing our mobile and online experience proved timely during the quarantine. The consumer loan portfolio was $1.8 billion at the end of the third quarter, up by 6.7% compared to the third quarter of last year. Our growth is being driven primarily by consumer real estate loans. Our Houston expansion continues on pace with five new financial centers opened in the third quarter for a total of 20 of the 25 planned new financial centers. We expect to open two more in this quarter with the remaining three opening in early 2021. The fact that we've been able to continue our expansion plans through the pandemic and see very promising results is due to the dedication and skill of Frost bankers. When they've done the miraculous, what merely seems extraordinary tends to be taken for granted. But I want to acknowledge the commitment to the Frost philosophy and culture that our people have maintained during what has been a very unusual year. Of course, we realize the pressures impacting the banking industry in light of the current and projected economic and interest rate environment. and the importance of operating as efficiently as possible while providing the level of world-class customer service Ross is known for. I'm proud of our efforts over time, and in particular what we've accomplished this year, which Jerry Salinas has been reporting on as we've moved through 2020. Next year will be no different, and we're committed to improving our operating efficiency further. In that regard, I'll note that our executive team is committed to reduce our own salaries by 10% effective January 1st, as well as reducing my team's bonus targets by 5% and mine by 10% for the coming year. We're taking these actions despite the recognized success Ross has had managing through the pandemic and supporting our customers and communities. They represent management's desire to contribute to the current future long-term well-being of the company and reflect our commitment to our unique culture. All of us at Frost and all our lines of business will face these challenges together, and our company, as always, will emerge stronger than ever. Now, I'll 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 third quarter was 2.95%, down 18 basis points from the 3.13% reported last quarter. The decrease primarily resulted from lower yields on loans, which had a negative impact of approximately 11 basis points on the net interest margin, and a lower yield on securities, which had a three basis point negative impact. Combined with an increase in the proportion of balances at the Fed as a percentage of earning assets, which had about a seven basis point negative impact on the NIM compared to the previous quarter. Lower interest costs in the quarter reduced these negatives by about two basis points. The taxable equivalent loan yield for the third quarter was 3.73%, down 22 basis points from the previous quarter. The decrease in yield was impacted by decreases in LIBOR during the quarter as about two-thirds of our loan portfolio, excluding PPP, is made up of floating rate loans, and about 60% of our floating rate loans are tied to LIBOR. The PPP loan portfolio also had a negative effect on our loan yield as compared to the second quarter. During the third quarter, we extended the expected term of the PPP portfolio somewhat, which resulted in a yield on the PPP portfolio of 3.65%, during the third quarter as compared to 4.13% in the second quarter. This had a nine basis point negative impact on the comparison between the second and third quarter reported total loan yields. Looking at our investment portfolio, the total investment portfolio averaged $12.7 billion during the third quarter of about $180 million from the second quarter average of $12.5 billion. The taxable equivalent yield on the investment portfolio was 3.44% in the third quarter, down nine basis points from the second quarter. The decrease in the portfolio yield was driven by a decrease in the yield on our taxable portfolio. The yield on that portfolio, which averaged $4.2 billion during the quarter, was down 19 basis points from the second quarter to 2.21% as a result of higher premium amortization associated with our agency's MBS securities given faster prepayment speeds, and lower yields associated with recent purchases. Our municipal portfolio averaged about $8.5 billion during the third quarter, flat with the second quarter, with a taxable equivalent yield of 4.08%, up one basis point from the prior quarter. At the end of the third quarter, 78% of the municipal portfolio was pre-refunded or PSF insured. The duration of the investment portfolio at the end of the third quarter was 4.5 years, up slightly from 4.4 years last quarter. Regarding non-interest expense, for the third quarter, I'll point out that the salaries line item includes about $4.5 million in reductions in salary expense associated with truing up our incentive plans based on current expectations of projected payouts for the year. As Phil mentioned, in this environment, we continue to focus on managing our discretionary spending and looking for ways to operate more efficiently. Looking at the full year 2020, our previous guidance on expenses was that adding back the deferred expenses related to PPP loans, we expected an annual expense growth of something around 6%. Our current expectations would reduce that to something around the 3% range. With that, I'll now turn the call back over to Phil for questions.

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

Thank you. At this time, I would like to remind everyone, in order to ask a question, please press star 1 on your telephone keypad. Again, press star 1 on your telephone keypad. And your first question comes from the line at Bradley Galey. Your line is now open.

It's Brady. Good afternoon, guys. I wanted to start with the dynamics of the PPP loans. I know last quarter, I believe I remember you recognized about 20% of those PPP fees. It sounds like if you've extended, you know, the assumed duration of that portfolio, maybe it was less than that in the third quarter. But how much was realized in the third quarter of the PPP loans?

I think the number was pretty comparable. You know, we did put some additional loans on during the third quarter, and we did extend the expected life there just a little bit more than we expected originally. But I think that the amount that we recognized in the second quarter associated with that fee was in the $21 million range. So really pretty comparable with the second quarter.

Okay. Okay. And, you know, I know you guys have been talking about the full-year NIM, you know, ex-PPP coming in a little above 3%. You know, you're three-quarters of the way through, so we're getting close. But is that still the right way to think about the full-year NIM for you guys?

I think at this point that's kind of where we're at based on what we're seeing so far. You know, I think the third quarter probably gives you a pretty good feel of kind of the projection for the rest of the year, given just that we've got one quarter left. And that will get us, I think, to kind of the range that we've – guidance that we've given for the quarter – excuse me, for the year.

Okay. Then, you know, finally for me, we have seen some companies, especially some smaller banks there in Texas, reengage in the buyback. You know, is that, as deferrals come down and maybe you guys feel a little more comfortable, is that something that you're thinking about doing, re-engaging in the share repurchase plan?

You know, Greg, right now, it's not something that's on our radar screen immediately. As you know, it has been over time, and I suspect at some point we will re-engage, but Right now in the environment, you know, we're focused on dividend, protecting that, providing capital for the growth that we're seeing. But at some point, yeah, it'll come back.

Okay, got it. Thanks, guys.

Thank you.

Your next question comes from the line of Dave Rochester. Your line is now open.

Hey, good afternoon, guys. How you doing? Hey. Good, good. On the expense guide, the 3% growth, that's from the $835 million reported in 2019. Is that right? Less the $7.5 million roughly in deferred expenses you mentioned?

Yeah, it's from the reported 19 number, right? And so we're adding back the $7 million in deferrals that we talked about in the second quarter to our 2020 number. So, yeah, I think you're thinking about it right, Dave. Gotcha.

Okay. I just want to make sure there. And then on the NIMM, Is the thinking that effectively the NIM will probably continue to just drift lower from here, X the PPP fee amortization, assuming the curve persists maybe even through next year as loans and securities continue to reprice? And then what does that ultimately mean for the NII trend over time? Do you guys think that you can grow NII with that kind of a NIM headwind?

I think as far as your view of the NIM, that's really kind of where we're at right now. Obviously, there's not a lot of opportunities to invest. We've got, I think, between $6 billion and $7 billion at the Fed on any given day and earning 10 basis points. There's just not a lot of opportunities out on the yield curve right now. We continue to say we're going to be opportunistic and we pay attention, but we've got quite a bit of liquidity, and it's probably true for a lot of our competitors as but just not ready to stick our toes in the water as of yet. So there would be some potential there. Phil mentioned that loan pricing is still obviously competitive as a structure. So I think your view that it's going to be a tough road, especially in 2021, given this sort of a rate environment, I think that I'd have to agree with you that there is some potential to grow the net interest income, like we said, to the extent that we decided to invest some of that liquidity.

Yes. Where are you seeing reinvestment rates today? I know you mentioned they were lower, and that makes perfect sense. I'm just curious where they are right now.

Oh, man, you know, I'm almost embarrassed to grab my file, to be quite honest with you. You know, I think the mortgage backs – I'll go to the MBSs that we purchased during the quarter just to give you a range there. Bear with me a second here. I think we were buying mortgage backs – See here, the agencies that we bought were at a 153. And I don't think we could get that today, to be quite honest with you. And as you heard me say, they're prepaying pretty quickly. I think on the muni side, we were looking at some 10-year stuff that's probably in the 139, 135 PE sort of range. Go ahead.

Yeah, no, I hear you. I mean, is there a thought to just keep the securities book stable from here or maybe grow it a little bit over time just to support an eye a little bit to the extent that maybe loan growth doesn't come roaring back?

Yeah, I think that's kind of the view that we're taking. Again, we keep saying that we're going to be opportunistic. We wish that we had other opportunities, but you're right. I mean, we will do something. We'll kind of hold our nose, if you will. and decide to spend some of it. But we really don't feel like it's the place we want to be in right now, to be quite honest with you.

Yeah. Maybe to switch into the loan pipeline that was positive to hear that was up 11% since last quarter. Where are you guys seeing the increase in activity there? And then you, again, mentioned the pickup in competition. I was just wondering in which areas you're seeing competitive pressures the most and if you're actually seeing spreads compressing.

Yeah, well, if you look at the – that 11 percent on a link order basis, not annualized. It spread pretty evenly. Commercial real estate activity is up 19 percent in terms of pipeline, and commercial CNI is up by 8 percent. The dollar amount of both of those is pretty comparable. And so, that's really where we're seeing it. In terms of competition, you are seeing pricing pressure return. We're not losing a lot to pricing because once we get to a customer that we think meets all our criteria, that we want to have a long-term relationship, we don't want to lose it for a few basis points. I think it's one real interesting area to me that we've seen is the increase in deals that we've lost to structure. If you look at – I'll give you two numbers here. One is if you look at large C&I loans, which we define large as over $10 million, 92% of the deals we've lost have been to structure. And if you look at commercial real estate deals to prospects, we're losing, of the deals we're losing, we're losing 92%, interestingly the same number, 92% to structure there as well. So, you know, I think it's been... a bit of a turnaround quarter for us from the second quarter. Obviously, that was a really tough quarter, but to see the 11% growth in pipeline was good. Also, another thing we look at is what we call our look to book and our rate ratio there. If you look year to date compared to last year, we've looked at about 6% more deals. That is, we've had opportunities to to look at a loan request, an actual request. And we're up in terms of booking by 11%. So we're doing a pretty good job of booking the deals that we're seeing. So, you know, it's a tough market. You know, any time you see that much loss to structure makes you worry a little bit. It's mainly guarantees. It's advanced rates, standardization periods, all those kinds of things. But even with all that, I'm pretty happy with our success rate that we're having.

Great. All right. Thanks for all the details, guys. Appreciate it.

Absolutely. Thank you. Thank you.

And your next question is on the line of Ibrahim . Your line is now open.

Hey, good afternoon. I just wanted to follow up one on just expenses and investments. So, Jay, I think your guidance implies expenses go back around $225 million plus or minus in the fourth quarter. Just talk to us in terms of when we look at the investments that you have ongoing in terms of the financial centers, obviously the tightening on the comp side, how should we think about expenses going into next year where you're going to continue to have the margin pressure? Just what's the best way to think about it internally? How's management thinking about that?

Sure, I think that Phil gave you a little bit of a view of how management is looking at it, and I'll defer to him a little bit, let him talk, and I'll follow up after his conversation.

Yeah, you know, I mean, I gave the example where, you know, our management teams decided to cut our salaries back 10% and the bonuses, you know, target levels to what I mentioned. No, we did that because we recognize that we need to take a leadership position with regard to efficiencies. There's work really the industry needs to do. We certainly need to do on top of what we've done already, and that's just the beginning of the process. We're beginning our planning for next year for the budget, and this is one of the early decisions that we're making. I think it was really interesting, and I was really proud, by the way, I should mention this, of yesterday in our board meeting when I mentioned that to the board that that was our decision. And their time when they have at the end of every meeting where they have their private session, they decided unilaterally to decrease their cash compensation by 10% too, which I thought was a really frost thing to do. So I think you're seeing leadership at the top, including our board and our commitment to see increased efficiencies.

No, that's commendable. I guess maybe ask differently. Do you think, you mentioned focus on positive operating leverage. Do you think the efficiency ratio can actually improve in this backdrop, or do you think that's going to be challenging?

I missed the part where you said, at the very end, your question, you said, did I think...

Yeah, do you think the efficiency ratio can improve from here in the current background?

Yeah, I mean, I think as Phil mentioned, you know, we are starting our process, and obviously we've had a lot of conversations, and so, you know, we know what we've committed to the board, and so we've got a lot of work to do there. We don't have all the plans in place, so I'd feel a little uncomfortable giving too much guidance. We'll give more color, obviously, in January. What we want all of you to know is we're taking it all very seriously, and we understand the the revenue pressure that we're under, and we're looking for all the efficiencies that we can. And, you know, some tough decisions will be made, and we'll have to make them, and we'll just continue to move forward there. You know, as far as, you know, what we're doing in Houston, we are committed to doing that. Phil has said that all along, and we're making significant progress there. You know, they're performing better than expected. So, you know, we'll continue to move there. We won't, you know, we're not going to slow that down at all. We may open a couple of locations here and there, but we're obviously going to be very prudent in what we do from that standpoint. There's going to be costs that we have to spend, whether that's from a technology standpoint, whether it's infrastructure, whether it's security related to technology. So we know we have some costs to spend there, but we also understand that in order to do that, we've got to do things more efficiently, and that's the sort of conversations that the executive team is in the middle of right now.

Got it. And I guess just shifting to Phil, give us a sense of, so you talked about like loan pipelines, there's some signs things look encouraging. Just give us a sense of what's the ground reality in terms of the economic outlook once we get to the elections next week. As you think about next year, are you more optimistic today in terms of what growth could look like relative to the headlines that we see, or are you more cautious?

You know, I'd respond positively. Two ways, with two items to that question. One is I think that the election, getting it behind everyone, is going to be a real positive. Whichever way it goes, it's just going to add more clarity. In the calls we've done with customers, there's been more uncertainty around that than anything else. And so I think once we can get past that, I think attitudes will steel themselves and we'll move forward. You know, I think the thing that makes me most optimistic going forward is that, you know, I don't want to blow past that number too fast. You know, we've seen new relationships up by 38%, almost 39%, compared to where it was last year. I mean, we go along at about, oh, I'm going to guess something like 450 a quarter in the commercial side. For the last two quarters, they've been in the high 770s. And, you know, while not all those relationships by far are borrowing money because there's lots of uncertainty today, whether it's from politics, whether it's from elections, whether it's from, you know, COVID for sure, and the health situation. I mean, those relationships are what generate growth for us going forward. And so that's the thing that makes me most positive. Another thing I'm positive about is just when you look at Houston, again, we've been spending money and our shareholders have been patient and, you know, it's a long-term strategy and all. But when I look at our loan pipeline, our active pipeline, you know, the Houston market is 50% higher in their loan pipeline than any of our other markets. And the other markets aren't doing bad. So it's just... You know, we're just seeing payoff for that investment in that market, and I'm encouraged about that as well. You know, we'll finish up that plan for that first 25. We had hoped to be through by the end of this year. I mean, two or three are going to bleed over into the early next year, but it's understandable given the COVID environment and everything else. So we'll be through that. We've hired some great people, and I'm just really excited about what's going on there. So I am optimistic about our prospects going forward. I mean, look, rates are terrible. And, you know, we've got a big investment portfolio, lots of liquidity. Can't do anything about that. But as far as the part we can do something about, I am optimistic on how things are going right now. Now, that said, the virus has got to – You know, we've got to win on the virus, right? You know, as a nation, as a world, we've got to win on it. And, you know, if it gets worse or they shut things down, things will get worse. Hopefully we won't see that. And we'll be able to move past that next year. If we can do that, then I am optimistic for the coming year.

Got it. And I'm sorry if I missed it, Phil. Did you mention who you're losing these loans to on structure? Are these other banks or are these non-bank financials who are stepping in?

Ibrahim, I haven't heard that it's non-banks. I mean, there's some of those out there. You know, usually when I've heard reports on this, it's everywhere, right? It could be small banks, large banks, banks our size. It could be private equity. I haven't heard anything different, so I think it's pretty broadly based. People are starving for yield, and it doesn't surprise me that it's getting more competitive.

Got it. Thanks for taking all my questions.

You're welcome.

Your next question comes from the line of Jennifer Demmel. Your line is now open. Thank you.

Good afternoon.

Hey, Jennifer.

Hi. You're seeing very nicely from the second quarter. Do you think these lineups have a good run rate going forward, and could you expect pretty healthy growth again in the fourth quarter, or do you think that that that incremental improvement is kind of slowing down?

You know, I think that, yeah, we were glad. I think in the second quarter call we said that we were starting to see in July that some of those accounts, especially as it related to service charges on deposits, where a big component of that is ODNSF and then the interchange fees and debit card fees there were trending up. And we did continue to see improvement there in the third quarter. A lot of it, as Phil mentioned, really is going to depend on what happens from an economic standpoint with the pandemic. I think the numbers that we're seeing in October are a little bit softer than the growth that we've been seeing in the third quarter. So, you know, it'll be interesting to see how it plays out. The numbers are better, but again, we're not seeing that same sort of accelerated rate that we saw during the second quarter.

Great. Thanks so much.

Sure. Your next question comes from the line of Peter Winter. Your line is now open. Thanks. Good afternoon.

Peter. You guys had just a small addition to reserves. I was just wondering if you could talk about what drove the increase to reserves, and do you think at this point you're done at least on building reserves?

You know, I think that really the increase in reserves, a big portion of it I think was related to the energy book. You know, the models indicated that we needed some additional dollars there, and then also some of the work we did in management overlays in the oil field services side of the book showed some increases there. So I think our specific reserves in energy, for example, were, you know, like 2.3 million, and the second quarter up to 8.4 million. So I think that's where we saw the bulk of the increase, and it was really related, like I said, to specific work associated, I think, primarily with the oil field services.

And would you say you're done, you think, at this point, building results?

You know, I think that obviously that really has a lot to do with kind of what happens. But I will say that obviously we feel very comfortable with where we're at today. You know, when you looked at our provisions, you can see that we're down, you know, from the second quarter. You saw the charge-offs were down to, you know, $10 million. That's 22 basis points on average loans. That's much closer to our normalized levels that we typically like to run. So I think we're certainly feeling positive about it, but still cautious, to be honest. I think anybody that didn't say they're cautious in this environment would be somewhat misleading. So we feel good, obviously, of where we are, but continue to be cautiously optimistic going forward. Phil, any other color you want to add?

I would agree with Jerry. The weakness I think we're seeing in the energy sector is around service. because there's not a lot of activity there. The weakness is the rate, that rate of that weakness is slowed. You know, the equipment utilization number is down, but it's not down by near as much as what it was before. But still, you've got service people that are under pressure. You know, we've, by and large, and historically performed pretty well in service, and really it's not that big of Part of our portfolio, it's under $200 million, probably under $170 million. But it's something that we're watching. I think, you know, the bottom line is kind of what we've been saying, what Jerry said earlier. It's what's demand going to do and, you know, what's COVID going to do to demand? You know, if we end up, you know, locking the place down again and, you know, you're going to see demand numbers go down and you'll see prices reduce and you can see problems increase. But we've been able to manage a fair amount of stability recently. And I feel good about the people that we've banked and our structures and the work that our people are doing, you know, working with our customers. So we'll just have to see how it goes from now. Unfortunately, like everything else, I think at some level it all still revolves around the virus and how we do there.

Okay. That's very helpful. And then if I could just follow up on expenses. You guys have come in better on expenses now, two quarters in a row. And then the guidance that you gave implies that there's going to be a big jump in the fourth quarter. Can you talk about what's driving the increase? I know you mentioned the $4.5 million on the incentive accruals, but what's driving that?

Right. Yeah. So there are certain things that happen in the fourth quarter, you know, for some stock compensation awards that occur that in October that vest immediately, and so we deal with those expenses in the fourth quarter, so we're dealing with that. We've also got, you know, some decisions that need to be made as it relates to marketing expenses, for example, related to advertising, you know, and how much do we want to do. We want to be sensitive to that, even while managing expenses. Obviously, we think that we want to be dutiful and diligent in how we spend those dollars. We've had a lot of success in Houston, so we want to make sure that we do what we need to do. So some of those decisions are still being made. As we talked about, the executive team is looking a lot at open positions that would be filled in the fourth quarter and whether those need to be filled. And so that projection is really based on our best information, but we continue to spend time not only on looking at how we can be more efficient in the 2021, some of that will go into the fourth quarter of this year also. But right now, the guidance we've given is based on the best information we have. You know, we're going to do things that we need to do, obviously. We've talked about, you know, as many others have, about branch locations. Do we need to make decisions about closing branches that may be not as, you know, as – profitable or necessary. You know, we're building new branches, obviously, in Houston and have others in the plan. And so we just want to make sure that things that we do make sense to us organizationally. So we'll do what we need to do. And some of the work that we're doing will affect the fourth quarter. But at this point, we don't have those commitments tied up. Okay.

That's really helpful. Thanks. Your next question comes from the line of Stephen Alex Fox. Your line is open.

Buddy. Hey, Steve. So first, I had a big picture question. So when I think about Colin Frost, I've always thought about you guys as a company that plays a long game, right? You invest in the franchise, take great care of your employees, your customers, et cetera. I'm somewhat surprised by the expense initiative. Can you talk about what prompted that?

Which initiative are you talking about, Steve? Are you talking just generally? Are you talking about something specific? I just want to make sure I'm answering your question. Direct question.

No, I mean, well, you talked about reducing your own salaries, right, improving efficiency for next year. I mean, we've been through periods before where you've had revenue pressure, and I don't recall a message like this before. It seems somewhat new. And I'm curious what prompted, I don't know if this came from yourself, from the board, like what prompted this? It seems to be a bit of a shift strategically. Yeah.

Yeah. You know, I don't think of it that way. First of all, it didn't come from the board. You know, this is coming from our management team. You know, like I said, you know, I talked to the board about it yesterday. I convinced them it was the right thing to do, and they came back and reduced their own. So, you know, we're all of one mind on this. I think one of the things that's different about – let's take 08, all right? We had the financial crisis. We were not in mortgage. We had the opportunity because we had liquidity. We had earnings. We had taxable income. We had the ability to go into the municipal market, which was not a part of QE at that time, and get some incredible yields and investments during that period of time. And really through the, you know, eight years, plus years after that, you know, 10 years or so after that, you know, those kinds of opportunities are not available. You know, we see this as a longer period of time for the banking industry where you've got not just low short-term rates, which has happened in the past, but you've got low long-term rates. And then you've got the COVID environment and the uncertainty around all that. And, you know, we just... We're just doing our job. We are protecting our earning stream. We are doing what we're asking our customers to do, which is make sure that your business is running efficiently and you're able to take care of your obligations. So it's just part of our culture. It's a part of integrity, caring, and excellence. We do what is necessary to play the long game. And believe me, this is a long game. It's so long that I remember back to the 1980s. So when you go back there, you look at some of the things that we had to do. This is nothing compared to that. I was essentially CFO during that period of time, and my job was to sell everything that wasn't tied down that could generate any capital because there was a big red line drawn around Texas, and there was no capital for nobody in this state. And Dick Evans and the lending guys, their job was to work out loans over time. So as I recall, I think I got one raise in six years back during that period of time. So you go back through the Great Depression or the money panic of the early 1900s, you name it, this organization has responded and done what we need to do. So our view on this is... It's consistent with what we've done over the long term, and it's also consistent with the long-term view of the company. Because we need to show, we need, as an industry, to continue to be more efficient, to apply the lessons that we've learned and the things that we have been able to do, some of them on the fly that have made us very efficient. We need to make sure that we're applying those lessons going forward. And, you know, look, It's part of our culture to do the right thing, to not just say what to do but help lead it. And, you know, if you're not able to show with your actions what you mean, then it's really just empty words. So that's what this is about. Okay.

That's helpful. And when you think about next year, what's the right measure that you're after? Is it to actually improve the efficiency ratio year over year or Is it to show pre-pre-growth? How are you going to measure how much needs to get done?

It's directional. And what we're seeing, as Jerry's talked about, is we're seeing pressure on revenues. And so if your revenues are under pressure and if the Fed's telling you that they could be for some time, then what you need to do is you need to make sure that you rationalize your expenses around those revenues, and that's what we're doing. And it's a directional process. and it's beginning, and it's something that we're always careful on, on expenses, as we talked about. We are culturally careful on that. We've got a conservative corporate culture, but we're in a situation where revenues, we think, will be under pressure for the industry for possibly a couple of years, and hope's not a strategy.

That's very helpful. And just finally, we've seen other banks undertake efficiency initiatives. Quite a few of them have done it with the help of outside consultants. Are you bringing somebody in from the outside to help out with this?

Oh, heck no. In my 40 years here, we've done that before. My experience with those has been they're very short-term in nature. They're expensive to shareholders. and they end up taking your watch and telling you what time it is. What we're talking about doing is really doing deep dive thinking. We want to be smart about our business. We want to do the right thing, do things that are lasting, long-term, and with the view in all this to keep and improve the customer experience. We're not interested in doing anything that devalues our value proposition and our customer experience because that's really what is so key to our growth and success. And my experience with consultancies around expenses don't have that same view.

Yep, I've had the same experience. Okay, thanks for taking my questions.

Absolutely.

Our next question comes from the line of Brady Gale. Your line is open.

Hey, thanks for taking the follow-up, guys. I just wanted to ask, you know, we'll see what happens, but, you know, Biden is leading in the polls right now. He's talking about increasing the corporate tax rate from 21% to 28%. You know, if that pans out, do you have any idea what the impact would be to Colin Frost's tax rate at a 28% corporate tax rate?

Brady, of course, all that's going to be dependent on what taxable income is, right? The simple way to do it, if you're modeling it, for us, it's really pretty simple. It's just a third increase. If you think it's going to be 9%, you'd raise it by a third to 12%. It's really almost as simple as that. But obviously, it's going to be dependent on what the forecast is for pre-tax earnings.

Okay, great. Thanks, guys. Sure.

Sure.

There are no further questions at this time. You may continue.

Okay. Well, we want to thank everybody for your participation in the call today, and we'll be adjourned.

This concludes today's conference call. You may now disconnect. Presenters, please stand by.