Cullen/Frost Bankers, Inc.

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Greetings, ladies and gentlemen, and welcome to the Cullen Frost Bankers, Inc.

Fourth Quarter Earnings Conference Call. At this time, all participants are on a listen-only mode. A brief question and answer session will follow the formal presentation. If anyone should require operator assistance during the conference, please press star zero on your telephone keypad. As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Mr. A.B. Mendez, Senior Vice President and Director of Investor Relations. Thank you. Please go ahead.

Thanks, Donna. 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 and the Private Securities Litigation Reform Act of 1995 as amended. Please see the last page of text in this morning's earnings release for additional information about the risk factors associated with these forward-looking statements. If needed, a copy of the release is available on our website or by calling the Investor Relations Department at 210-220-5234. At this time, I'll turn the call over to Phil.

Thanks, A.B., and good afternoon, everybody. Thanks for joining us. Today I'll review the fourth quarter results for Cullen Frost, and our Chief Financial Officer, Jerry Salinas, will provide additional comments before you open it up for your questions. Well, in the fourth quarter, Cullen Frost earned $189.5 million, or $2.91 a share, compared with earnings of $99.4 million, or $1.54 a share, reported in the same quarter of last year. That represented an increase of 90%. You don't get to say that very often. Our return on average assets and average common equity in the fourth quarter were 1.44% and 27.16% respectively. That compares with 0.81% and 9.26% for the same period last year. These are very strong results. And along with our strategy of sustainable organic growth, they positioned us well heading into 2023. Now taking a closer look at the quarter, loan growth was solid and above our long-term expectation of high single-digits annual growth. Average loans, excluding PPP, in the fourth quarter were just over $17 billion, compared with average loans of $15.4 billion in the fourth quarter of 2021, an increase of 10.6%. For the full year of 2022, average total loans, excluding PPP, were up 11.3%. Our growth in loan balances for the fourth quarter versus the third quarter represented approximately two-thirds C&I growth and one-third consumer. CRE balances were basically flat. We booked $2.2 billion in new commercial commitments in the fourth quarter, and this is up by a non-annualized 9% from the third quarter, and demonstrated our staff's success from our calling and prospecting efforts earlier in the year. That said, I believe it's clear that the Fed's program of interest rate increases is having an impact on economic activity, especially in the commercial real estate sector as more borrowers evaluate the impact of the current environment on their projects. For example, I think it's interesting to look at our weighted 90-day pipeline at year end. It's down 14% from the previous quarter. However, the prospect component of that pipeline is up 19%. while the customer segment of that pipeline is down 32%. So as we continue to see potential deals come in from prospects as our strong available liquidity and our consistent underwriting shine through, our current customer base reflects the overall softening of the commercial real estate market. Average deposits in the fourth quarter were 44.8 billion, an increase of more than 9% compared with the 41 billion in the fourth quarter of last year. And for the full year, 2022, average total deposits were 44.6 billion, up 15.9% over 2021. And Jerry will talk more about recent deposit trends in his comments. We continue to see great growth in our consumer banking business. Average consumer loans were $2.3 billion in the fourth quarter, up by 22.6% over the fourth quarter last year. This is primarily from our consumer real estate products of HELOC, home equity, and home improvement. The outlook for these loans continues to be good and credit strong. In fact, the consumer loan growth in 2022 was 283% of our previous best year. The sharp increase in mortgage rates created the perfect environment for our secured consumer real estate loans, such as Home Improvement, Home Equity, and HELOC. Credit quality is outstanding in this portfolio, and our average credit score is 754. I'm also pleased that we recently began funding loans in our mortgage program. Our team has created a new mortgage loan process from the ground up to originate and service mortgage loans in keeping with the Frost philosophy, and we've created a great digital and mobile experience around it. Once we complete this pilot program, we'll roll out mortgage lending to customers on a or limited basis with the goal of opening it up to everyone later this year. Growth in new households continues. For the year, we added almost 26,000 new households, about 6.6% higher than the number of customers we had at the end of last year. While we believe this represents best-in-class organic growth, it was down slightly from last year's all-time high of almost 27,000 customers, and that's related to the lower net number of branches that we opened in 2021. Given the increase in opening since then, we expect to achieve all-time high number of new customers in 2023. In addition, our Frost Wealth Advisors has seen a record amount of new business. Regarding our branch expansion efforts, the original 25 Houston expansion branches have surpassed $1 billion of deposits, and they continue to exceed pro formas. Loans total totals $727 million at year end, including the additional branches we've opened in what we call Houston Expansion 2.0, At year end, we stood at 114% of our household goal, 170% of our loan goal, and 104% of our deposit goals. And we'll continue to add new locations in strong areas around the region. In Dallas, we are very encouraged by the early results of the new sites, which are doing even better than what Houston had achieved in the same timeframe. 229% of the new household goal, 275% of loan goal, and 372% of our deposit goal. We added new financial centers at a rapid pace in the fourth quarter, and soon we'll be up to 13 locations under the program. Overall credit quality remains good. Problem loans, which we define as risk grade 10 and higher, totaled $322 million at the end of the fourth quarter, compared with $387 million at the end of the previous quarter and $691 million a year ago. We reported a $3 million credit loss expense in the fourth quarter. Net charge-offs for the fourth quarter were $3.8 million, compared with 2.8 in the fourth quarter of 2021. Annualized net charge-offs for the fourth quarter were non-basis points of period in loans. Non-accrual loans were $37.8 million at the end of the fourth quarter, an increase from the $29.9 million at the end of the third, which was the result of two small credits. With regard to the current economic environment, there are potential risks on the horizon that could result from higher interest rates continuing high inflation, and pockets of supply chain disruption. Overall, investor commercial real estate loan metrics remain stable and indicative of above average project operating performance across all portfolio asset types. While acceptable debt service coverage ratios are still reported for office, multifamily, office warehouse, and retail asset types, A year-over-year decline is observed at fourth quarter 22, primarily due to the impact of rising interest rates, higher operating expenses for multifamily, and the inclusion of now completed construction projects that remain in lease up. Regarding specifically the office portfolio, our optimism around this asset class stems from one, the character and experience of the sponsors, Two, the predominantly class A nature of most portfolio office projects. Three, tenant quality and lease duration. And four, strong existing office portfolio metrics, including low loan to value at an average number of 56% and weighted average debt service coverage ratio of 1.59 times for the current stabilized office assets. Office buildings outstanding at year-end were $1.8 billion, and of this amount, half was owner-occupied and half represented investor projects. Our energy loan portfolio concentrations remains in the single digits at 5.4% of loans, excluding PPP, at the end of the fourth quarter. Our energy borrowers as a whole have advanced rates and leverage ratios that are the lowest we've experienced in many years, as borrowers have continued a program of deleveraging and returning more to shareholders. The current oil and gas price environment continues to be favorable for them, and our borrowers generally have a bullish outlook for prices for the near and intermediate term. Ross will continue to offer energy lending with prudent structures, including appropriate advance rates and hedging structures to minimize risk. We've done a great job with closing out the PPP forgiveness process, so I want to say I remain proud of our team that worked so hard and the relationships that we've built and strengthened with customers when they needed the help most. We say this often that we've got a lot going on at Frost. We're expanding in the new areas with beautiful new financial centers. We're enhancing our consumer offerings with all new mortgage loans. We're strengthening our communities and growing our brand awareness with exciting new sponsorship opportunities that will pay dividends for many years. And best of all, we are continuing with our strategy of sustainable organic growth. It's kept our company strong and positioned us well for whatever the future holds. Day in and day out, our employees do all this while adhering to our core values of integrity, caring, and excellence, and by providing industry-leading customer service. That brought us to truly work hard to be a force for good in people's everyday lives. 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 fourth quarter was 3.31%. up 30 basis points from the 3.01% reported last quarter. Higher yields on both balances held at the Fed and loans had the largest positive impact on our net interest margin percentage. The increase was also positively impacted, to a much lesser extent, by a higher yield on investment securities and by higher volumes of both investment securities and loans. These positive impacts were partially offset by higher costs on deposits and both higher volumes and costs of repurchase agreements. Looking at our investment portfolio, the total investment portfolio averaged $20.1 billion during the fourth quarter, up $727 million from the third quarter average as we continue to deploy some of our excess liquidity during the quarter. We made investment purchases during the quarter of approximately $1.2 billion, which included $735 million in agency MBS securities, with a yield of 5.43% and $470 million in municipal securities with a taxable equivalent yield of about 5.38%. For 2023, our current expectation is that we would invest an additional $4 billion of our excess liquidity into investment purchases during the year or about $2.2 billion net of projected inflows during the year. The taxable equivalent yield on the total investment portfolio in the fourth quarter was 3.09%, up 15 basis points from the third quarter. The taxable portfolio, which averaged $12 billion, up approximately $534 million from the prior quarter, had a yield of 2.41%, up 21 basis points from the prior quarter, impacted by the higher yields on recently purchased agency MBS securities. Our tax exempt municipal portfolio averaged about 8.1 billion during the fourth quarter, up about 193 million from the third quarter, and had a taxable equivalent yield of 4.17% of eight basis points from the prior quarter. At the end of the fourth quarter, approximately 76% of the municipal portfolio was pre-refunded or PSF insured. The duration of the investment portfolio at the end of the fourth quarter was 5.8 years, up from 5.3 years at the end of the third quarter, impacted by the extended duration of our agency MBS securities in this higher rate environment. Looking at deposits, on a lean quarter basis, average deposits were down $1 billion, or 2.3%, with about half of the decrease coming from demand deposits and half coming from interest-bearing deposits. Customer repos for the fourth quarter averaged $3.6 billion, up $1.6 billion from the $2 billion average in the third quarter. We have seen some deposit flows into our repo product during the quarter. Total combined deposits and customer repos in the fourth quarter averaged $48.3 billion, up $571 million from the prior quarter. The cost of interest-bearing deposits for the quarter was 1.16%, up 54 basis points from the third quarter. Regarding credit loss expense, During the fourth quarter, we booked credit loss expense of $3 million, which represents the first quarter we've booked a credit loss expense this year. The credit loss expense was driven by growth in unfunded commitments. Unfunded commitments grew $698 million during the quarter, ending at $12.5 billion at the end of the year. Looking at non-interest income on a linked quarter basis, trust and investment management fees were up $1.1 billion, or 3%, as increases in estate fees of $1.6 million, investment fees of $860,000, and real estate fees of $529,000 were partly offset by a decrease in oil and gas fees, down $2 million due to lower commodity prices. Service charges on deposit accounts were down $639,000 or 2.8%, primarily as a result of lower commercial service charges, down $1.5 million, largely resulting from a higher earnings credit rate on analyzed balances. Partially offsetting this decrease was a $756,000 increase in combined consumer and commercial overdraft charges. Insurance commissions and fees were down $1.5 million, or 11.2% from the third quarter, as a result of lower life insurance commissions, which were down $706,000 and also impacted by our normal business cycle. Other income was up $7.1 million, primarily due to a $5.1 million distribution received from an SBIC investment. Regarding total non-interest expenses, total non-interest expense was up $23.4 million, or 9.1%, compared to the third quarter. The primary drivers were salaries and wages, up $9.5 million, or 7.5%, and other expenses up $13.3 million, or 29.2%. compared to the third quarter. The increase in salary and wages was impacted by a $6.4 million increase in stock compensation as those stock awards are made in October of every year and some, by their nature, are expensed immediately. Additionally, accrued incentives were up $1 million from the prior quarter. The increase in other non-interest expense of $13.3 million was impacted by higher fraud-related losses of $4.7 million, $4 million related to a licensing negotiation, and marketing and advertising of $2.7 million, which is typically higher in the fourth quarter. Looking at our projection of full-year 2023 total non-interest expenses, we expect total non-interest expense for the full year 2023 to increase at a percentage rate in the mid-teens over our 2022 reported level. Our continued expansion in Houston and Dallas and the introduction of our mortgage product accounts for about 2.5% of that projected growth. Also impacting the projected growth rate is significant investments that we will be making in information technology for both people and infrastructure, investments in marketing in both advertising and people as we focus on expanding the communication of our value proposition and expense growth is also impacted by costs associated with continued support of our staff. The effective tax rate for the fourth quarter was 13%, or about 13.8%, excluding discrete items. Our current expectation is that our full-year effective tax rate for 2023 should be in the range of about 14.5% to 15.5%, but that can be affected by discrete items during the year. Regarding the estimates for full-year 2023 earnings, Our current projections include a 25 basis point Fed rate increase in February, followed by a 25 basis point decrease in July. Given those rate assumptions and the 2023 non-interest expense growth of mid-teens, we currently believe that the current mean of analyst estimates of $10.89 is reasonable. With that, I'll now turn the call back over to Phil for questions. Thank you, Jerry. We'll open it up for questions now.

Thank you. The floor is now open for questions. If you would like to ask a question, please press star 1 on your telephone keypad at this time. A confirmation tone will indicate your line is in the question queue. You may press star 2 if you would like to remove your question from the queue. For participants using speaker equipment, it may be necessary to pick up your handset before pressing the star keys. Once again, that is star 1 to register a question at this time. The first question today is coming from Ibrahim. Poonawalla Bank of America, please go ahead.

Hey, good afternoon. First wanted to follow up on remarks around commercial real estate. So you noted two things. One, you mentioned the impact from rate hikes was having an impact on the pipeline cooling off. But at the same time, we talked about the strength of your book. But give us like, how do you see this playing out? If interest rates don't get cut one, And maybe this may not play out at first, but do you see credit pain in the sector across your markets to manifest themselves over the next 12 months across multifamily office? And how do you think that translates to impacting cash flows for your customers? Maybe it has a pressure on rent rolls as we look out. Would love some color on that and just your thought process around both the risk for the market and how it may come back and translate in terms of risk to frost. Thank you.

Okay, thanks, Ibrahim. Well, you know, we are seeing some tightening on debt service coverage ratios, as I mentioned, but we don't expect, let's take multifamily, for example, to be underwater on those. The word that I got from our credit people was, I'll quote, is that we feel pretty good about it. If you look at, I think I gave you what our loan-to-value on offices was, it was about 56%. If you look at our loan-to-value on multifamily, you know, it's 58%. About half of our deals will be completed in 23, the other half in 24. So I don't think there's a lot of, pressure today as it relates to our portfolio. I'll also hear from our people that rents are keeping up for now, so that's helping things, but costs are also increasing. I think in this market, if you have issues, it's been kind of what everyone's been hearing. It's going to be the lower class office buildings where you're losing tenants and you've got some risk around that. I didn't want to give the feeling that we've got problems. I just want to make sure I'm being honest that things are tightening up. If you took a look at our portfolio, I was asking about the office portfolio. I think we have $44 million of what might be problem credits on what is the portfolio, which is probably over a billion. So you don't really have much that are issues, and they're kind of specific. So again, I don't want to give the impression things are too or too negative, but I do want to give the impression things are not as good as they were. I would also say that, you know, property taxes is a big problem around here, and they've seen a big increase, so when you combine that with interest rates, and then also operating costs on apartments, multifamily, it's going to create some pressure, but at this point, not so much. Again, offices are probably the biggest concern, I'd say, generally in the market because I don't think anybody's figured out what's going to happen with offices over the next couple of years. We're still trying to figure it out as a business. So I'm sorry I don't have any better clarity than that, but that's what we're seeing, Ibrahim.

Well, that's helpful, Kalendon. One, Jay, you mentioned about the earnings outlook for the year. Give us a sense of what you expect in terms of net interest income growth for the year and how you see that trending Do you expect NII continues to grow given just what you expect in terms of loan and deposit growth, or do you see some trajectory where NII declines quarterly at some point in 2023? Yeah, sure.

I think that, you know, I said last quarter we got a little bit into 2023, and we were talking about the NIM percentage. You know, I think that, you know, we're currently – I don't expect that, you know, the fourth quarter was our peak. I still think that obviously we had a nice increase between the third and fourth quarter, 30 basis points. I don't see that sort of a growth, you know, coming into the first quarter. But certainly we do see – do expect some improvement. And in my mind, I think given our assumptions that we'll see a rate increase in February and then a decrease in July – I would expect that our NIM, probably given our assumptions, probably peaks in the third quarter. As far as, you know, we're not going to give specific percentage growth on net interest income, but, you know, it's year over year. I think we grew between 21 and 22, say 30%. I don't think we'll be there based on kind of what I'm seeing, but You know, I think we're going to have strong growth this year compared to last.

Thank you.

Sure.

Thank you. The next question is coming from Steven of JP Morgan. Please go ahead.

Hi, everybody. I wanted to start on the deposit side. So the outflows of noninterest bearing were fairly sharp, a bit more than we were looking for. And I know you mentioned repos, but could you give a little bit more color what you saw in the quarter, what you might still see at risk of moving out of non-interest bearing? And where do you see that mix stabilizing?

Yeah, the non-interest bearing. I think, you know, what I said on the non-interest bearing is, you know, that's really been kind of the area that I've been concerned about, you know, that, you know, we had some exposure there. And I continue to think that's really the area where we have the most exposure there. You know, with rates where they're at today, and we all know there's some pretty nice rates out there, I think that it really is compelling a lot of treasurers and CFOs to make sure that they're managing their liquidity well and looking for alternatives. I think that certainly we can be competitive in a lot of situations, but there's probably going to be cases where we're going to see some deposit outflow, especially on some of the larger balances. I think that's where most of the risk is. I don't think we're unique to anybody. I think that from a deposit rate standpoint, our rates, I think, are competitive with banks. I think the challenge becomes trying to compete with some alternative sources. But I do expect that the commercial side on the commercial DDA is probably the most at risk in my mind. Got it. Okay.

Jerry, in terms of the loan-to-deposit ratio, it moved up slightly through 2022. I hear what you're saying, I'm putting liquidity to work in the securities book, but should we expect a similar trend through 2023, just basically funding loan growth with deposit growth?

You know, I think that for 2023, I think the Probably the bigger unknown in my mind is more what happens on the deposit side than what happens on the loan side. I think Phil's given some good color of what we're seeing in loans. I think without knowing exactly what happens in the economy, there might be a little uncertainty there. But I think we feel pretty confident. I think it's that deposit side. So you could, because we've always said the loan to deposit ratio from our standpoint is really a resultant fact, right? We're really out to grow both deposits from a relationship standpoint and loans. So I think that given that I don't project that we'll have the sort of increase in deposits that we've had the last couple of years, I expect that to be much more muted in 2023. You may get some improvement in that ratio just simply because the denominator decreases. Got it. Okay.

And then finally, on the expense side, so you reported mid-teens expense growth 2022 basically in line with what you had guided for the year, now guiding mid-teens for 2023 and more investments that you'll have to make. When you guys take a longer-term view, do you think for a period of time, even beyond 2023, we stay in this mid-teens range or do you see this as sort of a two-year scenario and then we get back to something more normal after that? Thanks.

Steve, it's a good question. I think the simple answer is 2023 is an unusual year for us. I expect to see our run rate on expense growth to go down in 2024. Jerry mentioned the IT investments, mentioned marketing. As I've talked to investors over the last couple of years, I've been Pretty open that there, you know, there's some things we're going to invest in, you know, we're going to invest in physical distribution. And I hope by now we've proved to everyone that that's, that's a payoff for shareholders are going to continue to be, we're going to continue to do that. That's we sort of set that aside. Okay. So, but we're also going to invest in people and, and you saw those numbers on salaries. I mean, they're pretty sobering, but we were competing in the marketplace. I THINK WE'RE BEING SUCCESSFUL THERE. I THINK WE'VE REACHED A PLACE WHERE WE'RE TOUCHING BOTTOM. AND I WAS LOOKING AT OUR TURNOVER RATES. YOU KNOW, LAST YEAR IT WAS IN 2021 OUR TURNOVER WAS 20, CALL IT 23% THIS YEAR. IT WAS, EXCUSE ME, IN 2022 It was 14%. It was down from 23% in 21. So that tells me that we are hitting the right balance on what we need to be paying people. We've done a lot on benefits, making sure that we have comparative and really top quality benefits in areas of health care and retirement, those kind of things. So we really focused on that. We said that we're going to invest and marketing, that that was one area that we really hadn't done. One of the key areas that we hadn't done, we needed to. And we've hired some great talent there. We did that last year. So we've got those costs, but we've also got some additional media that we're going to be investing in, and we need to. Look, I think we've been winning on account growth and growing the business, and I think we've done it. without, you know, sort of with a marketing hand tied behind our back. I think if we get that out from behind our back, it's going to really help us. So I'm optimistic about that. And then the third one, or the fourth one, that we said we're going to be investing in is IT and cyber. And that's the big number that Jerry is talking about. You know, because we are, you know, as we looked at this and did our planning for this year, You know, we really call this a generational investment in IT. And it's really, I'd say around, if you're interested, I'd break it down into, say, three areas. One is customer experiences and growth, which really revolve a lot around digital, mobile for the consumer and commercial businesses. We are almost doubling our number of digital agile teams. We're going from six to 11. two of them in the commercial area. We're speeding up modernization on certain core systems. There are three of them. We need a new loan system. We need to invest in real-time payments, which is a developing competitive issue. And we need to take care of our check processing system, which is at end of life. We're a big correspondent bank provider. So, yeah, checks are going away. but they're not gone, and we process a lot of them. So that's probably 35% in terms of that core modernization. And then we need to continue to expand our efforts on I'll call it information security and fraud mitigation. That's probably the other 15%. And that's a big percentage increase. We've increased IT. Let's see. We've been 11%. For 19 and 20 and 22, it was up 8% in 21. We really backed down expenses all over the bank that year. But in 2023, we're looking for a 24% increase in IT-related expenses. And that's a generational investment in necessary IT. And I say it's necessary because, remember, our success at competing And I believe we're winning at the organic growth competition is from an empathetic customer service experience and from great technology. And we can't sleep on that technology piece. Now, having said all that, I don't believe those are investments that we're going to have to make at the same level as we look in the next year, in 2024. So it is, it's a big number. We hate spending money. We hate wasting it even worse. And so we don't think we're doing that, but we do need to do this to compete where we are, and I think we'll see that run rate go down as we hit 2024 and beyond.

Got it. Thanks for all that color. Really appreciate it. You're welcome.

Thank you. The next question is coming from Dave Rochester of Compass Point. Please go ahead.

Hey, good afternoon, guys. Just a quick one on the NII guide. Was curious what the impact is you see for the rate hike in February and then the rate cut in July, what the NIM sensitivity is to those moves that you're baking in. And it sounded like you're assuming a positive and maybe more muted deposit growth trend for the year. Was just wondering if you could give an update on the total deposit beta assumption you're now baking into that. Thanks.

Well, I guess I'll just start with the deposit betas. I mean, I think we ended up the year kind of where we expected we would be. We'd said that we'd be about 30% on interest bearing and about 20%, 20 to 25% on total. And that's really kind of where we ended up. So I think for, we were higher in the fourth quarter. I think I said in the third quarter that I thought we have to be a little bit more aggressive than we were, but we ended up cumulatively exactly where we expected. In the fourth quarter, you know, as far as betas for, for next year, or for this year, excuse me. I mean, I think basically what we're assuming is that we would have the same sort of increase that we had in the first quarter in February is kind of where we'd go back. I think we're assuming a little bit more aggressive betas, say where we were at about 30% on interest bearing. I think we're probably assuming right now that we'd be somewhere closer to the 33% to 35%. And then our assumptions are that we take all that back in July. We'll just have to see. I think we said all along is we want to see kind of where the market is. But those are our current assumptions today. And I think you had one other question on the market.

Yeah, just to the rate moves that you guys are looking at, the hike in February and then the cut in July, how much that we think will move the NIMS.

Yeah, you know, from a NIM standpoint, I don't think it's going to have a significant impact on the percentage itself. Like I said, we want to be careful. We don't really give all that sort of level detail guidance. But what I have said is I do think the percentage will peak in the third quarter, you know, just right before our projected decrease. And I think that, you know, we're feeling good about where we're at. A lot of it will be dependent on what happens on those deposits. As I've said, you know, yeah, do I feel like it's a little bit more muted in 2023 than it was in 2022? Yeah, most certainly. I mean, I think we saw some of that just in the link quarter movement, although a lot of it was moving into repo. And so, you know, we had certain customers coming out of the money market account and choosing to move into the repo account because of some, you know, sort of a operational processes and money flow issues that they liked more in the repo, and also the fact that that product is collateralized. So we did see some movement there. So I tend to have less concerns, although it's still going to be relatively soft. It's going to be softer than we saw this year on the interest-bearing side, but most of the risk is on the commercial DDA, in my opinion. As far as what we think a 25 basis point hike gives us, It gives us about, on a pre-tax basis, a little over $3 million a quarter.

Okay, great. And maybe just one last quick one. On the 159 debt service coverage ratio you gave on the office book, that's an updated figure for today's rates. Is that right?

Yes, that's where we stand on average today.

Okay, great. Thanks, guys.

Hey, Dave, I just want to make sure, when I said around a little over three, that's on an after-tax basis. I couldn't remember if I said pre-tax or after-tax.

Okay. Thanks. All right. Sure.

Thank you. The next question is coming from Brady Gailey of KBW. Please go ahead.

Hey, thanks. Good afternoon, guys. Hey, Brady. I wanted to start with your comment about growing the bond portfolio, I think, on a net basis of about $2.2 billion in 2023. If you look at the amount of cash that Frost still has, at least on an average basis in the fourth quarter, it was 24% of average earning assets. It feels like you could do potentially more than the $2 billion adding to the bond book, especially as the rates are more attractive today. Is there some possible upside to the amount of bonds that you'll consider adding in 23?

You know, I think that, yeah, that's a possibility, obviously. You know, right now what we're really concerned with is just making sure we understand exactly what's going on with deposits. You know, I guess what I'd say is that it's something that we're talking about. You know, should we get the opportunity if we think something – we get an opportunity on the yield side with some sort of market correction, we could jump in. So there is that possibility. But I think right now we're really, you know, the numbers that we're given is really kind of the way we're modeling. You know, like I said, it's a never say never sort of thing. But I'd go with our projections. I don't expect, you know, let's not forget that, you know, in 2022, you know, we spent $8. 8.6 billion, I think, gross. And that year, we only had a little over 8.6 billion. We only had a little bit over a million in inflow. So net, we spent 7 and 1 half. So we've moved the needle quite a bit. And so we've made some purchases already in January of this year of a billion dollars, I think, roughly. So could we? Yeah, I don't see that as a high probability at this point. But yeah, that's always a possibility. given what happens in the market.

Okay. Then my second question is on mortgage. As that relatively new unit gets up and running for you guys, I think that's an originate and keep model, not an originate and sell model. So as that business continues to mature, do you think that that will push the loan growth outlook beyond the high single digit just because you'll have that new lever of loan growth as you keep those mortgages?

Good question, Brady.

I don't know if it goes above high single digits, but it will be added to it. I don't really have it in my mind enough to know how much that would move the needle. But yeah, it's going to be a significant part of the portfolio. The way I hope it turns out, Because if you look five years out, it'd be, you know, 10-ish percent of the portfolio. Back when we used to, you know, have them on the book before, I think we were around that area, you know, 10, 12 percent of the portfolio. So I just think directionally we'd be in that same level. So if you kind of took, well, what would that be and what kind of volumes would that be, you could sort of pencil out, you know, how much that might add to growth.

Okay. Great. Thanks, guys. Okay.

Thank you. The next question is coming from Manan Ghaslia, Morgan Stanley. Please go ahead.

Hi. Good afternoon.

I have a quick follow-up on the expense side. Are these expenses that you have pretty much set in stone for 2023, or do you have some flexibility depending on which way the overall environment goes? And then I also had a clarification on your comments on the run rate moving lower. Do you think that basically the growth rate moves lower off of the new expense base in 2023 as you go into 2024? Or do you think as you get the new loan system and check processing system, et cetera, running and the old one rolls off, that the actual dollars can stabilize or come down as you go into 2024? Thanks.

Well, my comments really weren't intended to indicate that the dollars would come down because, you know, obviously we're a growing company and we're going to continue to invest. My point is that I don't see us investing at the same level with some of these. I mean, for example, I didn't mention it, but take mortgage. We have bootstrapped that operation. We spent some serious money doing it. fantastic product. It's going to be a tremendous product for us going forward, but we don't have to rebuild that next year. So we're going to have that same level of cost structure, and it'll be higher because of inflation and growth, that kind of thing. But we're not going to have to bootstrap it. So that's really what I'm pointing out. I think we're making a lot of these generational investments that we're really going to be trying to harvest and we'll be dealing more with an increasing expense base, but just not increasing at the same level that we have been. That's my hope. That's what we're going to try to manage to.

Got it. All right, perfect. And then a follow-up on the prior questions on the securities book. I guess even if you don't get a market correction opportunity to make larger purchases here, given that we've come off the highs in yields, what would change your strategy to maybe accelerate some of the investments in that securities book?

Yeah, I think that if we felt like there was a correction that was significant that got our attention, I think that we would accelerate that.

Got it. And any thoughts on what

um once once the fed um begins to cut rates what your uh cash position should look like as a percentage of running assets you know i it's really not we've kind of been all over the board you know i think the the thing is today we've got you're right we've got more liquidity than we have have had um i think that we feel comfortable uh being able to bring that down to something much more normalized. But, you know, we don't have a number out there. A lot of it's going to be dependent on what we're seeing. You know, I think if, you know, if you've got, say, something in the, as far as earning assets are concerned, something in the range of 10% or lower, I mean, I think we could be, you know, somewhere in that range.

Got it. Thank you.

Once again, ladies and gentlemen, that's Star 1 to register any questions at this time. The next question is coming from Peter Winter of DA Davidson. Please go ahead.

Thanks. Good afternoon. So you guys are sitting on, you know, always sitting on very strong capital ratios, low credit risk. I was just curious what your thought is on share buybacks. I know it's not a focus, but what are your thoughts on share buybacks here?

Yeah, you know, it's really not something that's top of mind, to be quite honest with you. I think that... Right now, we really don't even have one in place. I think we had a $100 million one that expired. We expect that we'll bring that back into the toolbox here in the near future. But we had one for all of 2022. We didn't utilize it. We've got it primarily to ensure that if we did see some market correction on our stock, that we'd be in a position to take advantage of that. You know, right now it's, you know, I think from a multiple standpoint, I think we feel that, you know, that capital is better served through organic growth. And, you know, I think there were some concerns, not that we were concerned, but I think the market had some concerns about tangible capital. And given that concern and some of the questions we were getting, I can't see that we'd pull the trigger anytime soon.

Okay. And then... Just on office space, Phil, I heard your comments, most of your exposures to the A-type properties, but I was just wondering if you could comment what you're seeing on the B and C properties, like Houston and Dallas.

You know, just there really aren't many that have come to my radar portfolio-wise. you know, that I know of. You know, that's going to, you know, because that's going to depend on sponsorship, guarantees, equity, you know, all those kinds of things, right? So, but I can just tell you that, you know, what you're seeing all over the country is that, you know, the BNC property is just hard, you know, hard to get people into. And I can imagine there are some issues out there. It's, you know, I don't... don't have anything that's, you know, more complex than that. Just recognition that people aren't using as much office space, and it better be nice if you're going to try to get employees to go into it.

Got it.

Thanks.

Thank you. The next question is coming from John Afstrom of RBC Capital Markets. Please go ahead.

Hey, good afternoon, guys. I agree. You've got to be nice to get people back. That's a good comment. Most of my questions were scratched off, and Peter just took one of them. But you made a comment earlier, Phil, about the prospect pipeline versus your own pipeline and the difference between the two. Can you just talk about that a little bit more? And maybe that's more of a competitive environment question, but help us understand that a little bit more. Thanks.

Yeah, you know, we are getting lots of calls for deals, right? Because we've got liquidity. We've got consistent underwriting. People know what we do in the marketplace, you know. And as far as that goes, you know, underwriting is tightening up. It's coming our way, you know, as far as guarantees and equity and all that kind of stuff. But my point was, and I should also say that, you know, we don't, We're not looking to do all those deals. We bank people, not things. We bank relationships. But there might be some relationships that we've been wanting to have that we'll see the opportunity to do. And we're always on the lookout for that. And now the phone rings more. So we see prospect activity, to me, as more the advantage of us having the balance sheet that we do and reputation we do. But my point on our customers, to me, it's kind of like same-store sales. I know it's not that, but, I mean, you already have the customers, and the deals you have in the pipeline for them are the deals they're looking to do. They're new deals they're looking to do, right? They're not necessarily deals that are out there that already have been papered, already been, you know, that are in the marketplace that you might see with a prospect. So my point is, as I looked at it, to me it was like, okay, our customers, we've got their business. If we're not seeing new deals from them, it's because they're not doing new deals or they're slower on them. But we are still seeing good prospect deals that are out there in the marketplace just because of the advantages that we have. Maybe I'm off on that, but that's what it meant to me.

Okay. Good. That's helpful. And then just one other thing on the step up in IT and security expenses. Are you saying that's a permanent step up, or it's just kind of modernization and core spending related just for 23 years? are we talking about a growth rate in expenses slowing in 24 or your expenses kind of flattening out and coming down in 24? Thanks.

Yeah, John, it's growth rate. It's a growth rate coming down. I mean, once, once we bake this into our, you know, to our, you know, base expense load, I mean, it's, it's staying in there, you know, and there'll be some growth on it, you know, because inflation and all those kinds of things, but it's, but we won't be having to do the same thing. Again, our, Our growth rate for four out of the last five years or three out of the last four years before this year has been 11%. And IT is a cost that is, you know, it used to be health care was the out-of-control cost. I think it's clearly IT these days. But we will need to get it back down to those more historical levels. Okay.

All right. Thanks, guys.

Thank you. We're showing no additional questions in queue at this time. I would like to turn the floor back over to Mr. Green for closing comments.

All right. Well, we want to thank everyone for participating today and thank you for your questions and for your interest. We'll be adjourned.

Ladies and gentlemen, thank you for your participation and interest in Cullen Frost Bankers. This concludes today's teleconference. You may disconnect your lines or log off the webcast at this time and enjoy the rest of your day.