Cullen/Frost Bankers, Inc.

Thank you for your patience. The conference will be starting momentarily. Again, we would like to thank you for your patience. Conference will be beginning momentarily. Thank you. © transcript Emily Beynon Greetings. Welcome to Colin Frost Bankers Incorporated's third quarter earnings conference call. At this time, all participants are in a listen-only mode. A 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. Please note this conference is being recorded. I will now turn the conference over to A.B. Menendez, Senior Vice President, Director of Investor Relations. Thank you. You may begin.

Thanks, Sherry. 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 210-220-5234. At this time, I'll turn the call over to Phil.

Thanks, AB. Good afternoon, everyone, and thanks for joining us. Today, I'll review the third quarter results for Cullen Frost. Jerry's going to make some additional comments, and then we're going to open it up for your questions. In the third quarter, Cullen Frost earned $154 million, or $2.38 a share, compared with earnings of $168.1 million, or $2.59 a share, reported in the same quarter last year. Our return on average assets and average common equity in the third quarter were 1.25% and 18.93%, respectively, and that compares with 1.27% and 20.13% for the same period last year. This solid performance can be attributed to the execution of our sustainable organic growth strategy and the commitment to our culture that develops deep customer relationships and provides world-class customer service. And all this happens because of the hard work and dedication of our Frost Bank staff. As in the past, our balance sheet and our liquidity levels remain strong. As an example, at quarter end, our cash liquidity at the Fed equals 17% of our deposit base. Also during the quarter, Cullen Frost did not take on any federal home loan bank advances participate in any special liquidity facility or government borrowing, access any broker deposits, or utilize any reciprocal deposit arrangements to build insured deposit percentages. Let me also say our available for sale portfolio represents 82% of our portfolio at quarter end. So in short, basically with our balance sheet, what you see is what you get. Our average deposits were stable in third quarter at $40.8 billion, less than a percent change from the previous quarter. Average loans grew to $18 billion in the third quarter compared to $17.7 billion in the second quarter, an annualized growth rate of 6.8%. As I mentioned, we're laser-focused on our efforts to achieve organic growth, and I'm very pleased with our results. For example, to update you on our physical expansion efforts, for our combined Houston expansions, we stand at 107% of deposit goal, 162% of loan goal, and 127% of our new household goal. As of quarter end, expansion loans represented 22% and deposits represented 18% of our total Houston market presence. For the Dallas market, we stand at 292% of deposit goal, 273% of loan goal, and 216% of our new household goal. While still relatively early in this effort, expansion loans and deposits represent approximately 9%, respectively, of Dallas market totals. And we're excited about our new Austin expansion effort, which has opened the first of 17 planned locations to double our presence in that market. But beyond these overall numbers, I wanted to take you a little deeper into the character of the expansion business. For example, in Houston, we stand at $1.4 billion in deposits and $1 billion in loans. Our deposit mix is 53% commercial, and 47% consumer, essentially mirroring our company profile. Two-thirds of the deposit relationships are under $1 million, and only four are over $10 million. Loans are 73% commercial, 27% consumer, and only eight customers have over $10 million. Similarly, in Dallas, Of our $325 million in deposits, 53% are consumer versus 47% commercial. And 72% of those deposits were under a million, no relationships over $10 million. Our $258 million in loans are 62% consumer and 38% commercial, which I think is remarkable. The reason I labored through that detail is to show you that the kind of business we've been successful generating in our expansion is core, stable, grassroots business which I believe will generate tremendous value over an extended period of time. I'm very pleased with results of these efforts and I believe that this strategy is both scalable and durable and I'm convinced we'll be doing this for a long time. Looking at our consumer banking business, we continue to see outstanding organic growth. We added 6,220 net new checking households in the quarter, bringing the year-to-date total to 22,800, a 12% improvement on 2022 year-to-date results. To give a perspective of the power and durability of our organic growth, let me point out that in the past 36 months, we've added 80,000 net new consumer checking households. This means we grew our core customer base by 23% in just three years. We believe these are industry-leading numbers and represent tangible evidence that the customer experience we offer and the reputation we've built set us up to be successfully competitive. As we look at these new households, we see that the quality of the growth is also high. A high percentage of the accounts are active, the balances are healthy, and the growth is balanced across all the segments we serve. These factors are evidence that the growth is sustainable and beneficial. Consumer loan balances, outstanding, were 2.8 billion at the end of the quarter, growing 26% year over year. In the third quarter alone, balances increased $181 million, or 7% in the second quarter. This robust growth was driven by our home equity products. In a market where it's becoming increasingly expensive to buy, many families are deciding to stay and fix up their home, and we've got the right products and services and relationships to help at this time. We have a long history of credit quality in the consumer banks, similar to what you're used to hearing about on the commercial side, and the weighted average credit score on the portfolio is 754. Delinquencies are low and stable at about 80 basis points. Charge-offs are also low and stable at 19 basis points for the year. Also, as we've noted, we're excited about the prospects for our new mortgage product, which is in its very early stages, but just recently opened up to all our markets in the state. Now, looking at our commercial business, I think it's an interesting story. Our new opportunities for the quarter were strong, but they were down 17% from the second quarter. However, that was because our second quarter new opportunities were an all-time high after the dislocations brought on by the SVB situation. And as you would expect, our declines for deals were also high and were almost two and a half times our quarterly average. Now looking at the third quarter and focusing on our weighted pipeline, that weighted pipeline is up 22% from last quarter, and it's our highest of all time at 1,918,000. Our previous high was during the second quarter of 2022 at 1,832,000. The increase comes from all categories, both customers up 18%, and prospects, up 25%. Both core, which we define as relationships under $10 million, and large, core up 26%, large up 20%, and both C&I up 23%, and CRE up 24%. Credit quality continues to be good by historical standards with classified and non-accrual assets flat and net charge-offs down quarter over quarter. Non-accrual loans total 67 million at the end of the third quarter compared with 68 million at the end of the second quarter, essentially flat for the quarter. The third quarter figure represents just 37 basis points of total loans and 14 basis points of total assets. Problem loans, which we define as risk grade 10 or higher, total 513 million at the end of the third quarter. That's up from 441 million at the end of the second quarter and 387 million this time last year. Virtually all the linked quarter growth was in the OAEM risk category or grade 10. Net charge-offs for the third quarter were $5 million. They were down from 9.8 million in the second quarter. Annualized net charge-offs for the third quarter represent 11 basis points of average loans, and year-to-date annualized net charge-offs are 18 basis points of average loans, which is below historic averages. Regarding commercial real estate, our overall portfolio remains stable with steady operating performance across all types and acceptable debt service coverage ratios and loan-to-values. Within this portfolio, what we'd consider to be the major categories of investor CRE, that is office, multifamily, retail, and industrial example, total 3.5 billion or 40% of CRE loans outstanding and are flat quarter over quarter. Our investor CRE portfolio has held up well with the average performance metrics remaining essentially unchanged quarter over quarter. and exhibiting an overall loan-to-value of about 54% and loan-to-cost of about 60% and acceptable reported debt service coverage ratios. Higher interest rates continue to be a challenge for our CRE borrowers and have impacted performance of some projects as compared to original pro formas. However, on average we're comfortable with the quality of the portfolio. As an example, The investor office portfolio, which has been top of mind since the pandemic, had a balance of $950 million at quarter end, and it exhibited an average loan-to-value of 52% and an average debt service coverage ratio of 1.46, up slightly from last quarter. 83% of this portfolio is stabilized with healthy coverage levels and less than 5% of the portfolio is considered spec, with even these few projects being in strong sub-markets with good leasing dynamics and strong experienced developers. Our comfort level with our office portfolio continues to be based on the character and experience of our borrowers and sponsors and the predominantly class A nature of our office building projects. And again, we're glad to be operating in Texas. So in closing, we remain optimistic for what lies ahead. We're capitalizing on opportunities, and I'm proud of all our bankers as they accomplish all of this across all our communities. Now I'll turn the call over to our Chief Financial Officer, Jerry Salinas, for some additional comments.

Thank you, Phil. I wanted to start off first by talking a little bit more about our Houston 1.0 expansion results. As Phil mentioned, we've been very pleased with the volumes we've been able to achieve. Looking at the third quarter, link quarter annualized growth in average balances for these locations was 46% for deposits. That's $170 million growth link quarter, and on loans, 52% annualized growth, or $133 million quarter over quarter for loans. I'm sorry, the 46 was for deposits. And for the third quarter, Houston 1.0 contributed six cents to our quarterly EPS. Now moving to our net interest margin. Our net interest margin percentage for the third quarter was 3.4%, down only one basis point from the 3.45 reported last quarter. Some positives for the quarter included higher yields on loans and balances at the Fed, combined with higher loan volumes. These positives were primarily offset by higher cost of deposits and customer repos compared to the second quarter. Looking at our investment portfolio, the investment portfolio averaged $20.6 billion during the third quarter, down $721 million from the second quarter. During the quarter, we did not make any material investment purchases and sold about $361 million in municipal securities at a small net gain as we took advantage of market dislocations which allowed us to improve interest income going forward. The net unrealized loss on the available for sale portfolio at the end of the quarter was $2.2 billion, an increase of $600 million from the $1.6 billion reported at the end of the second quarter. The taxable equivalent yield on the total investment portfolio in the third quarter was 3.24%, flat with the second quarter. The taxable portfolio, which averaged $13.6 billion, down approximately $216 million from the prior quarter, had a yield of 2.76% of five basis points from the prior quarter. Our tax-exempt municipal portfolio averaged about $7 billion during the third quarter, down $505 million from the second quarter, and had a taxable equivalent yield of 4.26%, down one basis point from the prior quarter. At the end of the third quarter, approximately 71% of the municipal portfolio was pre-refunded or PSF-insured. The duration of the investment portfolio at the end of the third quarter was 5.7 years, up from 5.2 years at the end of the second quarter, impacted by duration, extension, and both our municipal and MBS agency portfolios. Looking at deposits, on a linked quarter basis, average deposits of $40.8 billion were basically flat with the previous quarter, as they were only down $179 million, or 0.4%. We did continue to see a mixed shift during the quarter as non-interest bearing demand deposits decreased $408 million or 2.7%, while interest bearing deposits increased $229 million or 0.9% when compared to the previous quarter. Based on third quarter average balances, non-interest bearing deposits as a percentage of total deposits were 36.3% compared to 37.1% in the second quarter. Noninterest-bearing deposits totaled $14.8 billion at the end of the quarter, with 96% of that amount being commercial demand deposits. During the individual months of the third quarter, we did see the average balances in the noninterest-bearing accounts begin to stabilize. During last quarter's call, I noted that July's average balance was down $202 million from the June average. The full month-to-date average for July was $14.84 billion down only 173 million from the June average. Our August average was flat with July, and the September average was down only 60 million to 14.78 billion. For October month today through yesterday, the average non-interest bearing deposit balance is 14.52 billion, down 259 million from the September average. Looking at total interest bearing deposits, they've been relatively stable during the period, Average interest-bearing deposits were $26.0 billion during the quarter, up $229 million, or 0.9%, from the second quarter. For October month-to-date average, the balance in interest-bearing deposits through yesterday was $26.3 billion, up $102 million from our September average. We do continue to see a shift in the mix in interest-bearing deposits to higher-cost CDs from lower-cost savings, IOC, and MMA. The cost of interest-bearing deposits in the third quarter was 2.12%, up 25 basis points from 1.87% in the second quarter. Customer repos for the third quarter averaged 3.5 billion, down 183 million from the 3.7 billion averaged in the second quarter. The cost of customer repos for the quarter was 3.67%, up 15 basis points from the second quarter. Looking at our non-interest income on a lean quarter basis, I just wanted to point out a couple of items. Trust and investment management fees were down 1.8 million or 4.5% compared to the second quarter, driven by decreases in estate fees of 1.1 million, real estate fees of 673,000, and tax fees of 413,000, partly offset by an increase in investment fees of 750,000. Estate fees and real estate fees can fluctuate based on the number of estates settled. or property sold respectively, while tax fees, by their nature, are typically higher in the second quarter. Other charges, commissions, and fees were up 1.0 million, or 8.6%, compared to the second quarter, impacted by increases in various accounts, including money market income up $282,000, letter of credit fees up $155,000, and annuity income up $121,000. Other income was up 3.0 million, or 29%, when compared to the second quarter, impacted by higher public finance underwriting fees, up $1.6 million, and higher combined derivative and foreign exchange income, up $1.8 million. Looking at our projection of full-year 2023 total non-interest expenses, we continue to expect total non-interest expense for the full year 23 to increase at a percentage rate in the mid-teens over our 2022 reported levels. This does not include the potential impact of the SBIC special assessment which has not yet been finalized. The effective tax rate for the first nine months of the year was 16.3%. Our current expectation is that our full-year effective tax rate for 2023 should approximate 16.5% to 17%, but that can be affected by discrete items during this fourth quarter. Regarding the estimates for full-year 2023 earnings, our current projections don't include any additional changes to the Fed funds rate through the rest of 2023, Given that rate assumption and our expectation of 2023 non-interest expense growth of mid-teens, which does not include the impact of the FDIC special assessment, and given our strong performance this quarter, we believe that the current meet of analyst estimates of $9.22 is too low. With that, I'll turn the call back over to Phil for questions.

Thanks, Jerry, and we'll open it up for questions now.

Thank you. If you would like to ask a question, please press star 1 on your telephone keypad. A confirmation tone will indicate your line is in the question queue. You may press star 2 if you would like to remove your line from the queue. And for participants using speaker equipment, it may be necessary to pick up your handset before pressing the star. Our first question is from Steven Alexopoulos with JP Morgan. Please proceed.

Hi, everyone. Hey, Steve.

Hey, Steve.

I want to start. So on the deposit side, Jerry, to follow up where you just left off with the non-interest bearing at $14.9 billion, $14.8 billion. It's pretty stable. In fourth quarter, we typically see some window dressing, right, from companies that it picks up a bit. Can we safely say that we're now at a bottom for the non-interfering deposits?

You know, Stephen, I think that, you know, certainly when I look at it, I feel today versus three months ago feel a lot more comfortable with where they're at. Obviously, you've seen, and I kind of tried to give that sort of color in my commentary, we are seeing little downward ticks, but it's really been stable, you know, in my mind. Those small $100 million, $200 million decreases have been relatively stable, as you've said, and we've seen historically the fourth quarter is the best quarter, right, as companies try to do some window dressing. So, you know, I don't know that I can confidently say that we're at the bottom, but I certainly feel a whole lot better today than I did a quarter ago.

Got it. Okay. And then on the loan side, I've been able to piece together all the color you gave on consumer and commercial, but there's no doubt loan growth picked up this quarter. Can you give us, you know, drill down why? Is it just these new markets coming online when you look at the growth? And it sounds like you're pretty optimistic. You think it's sustainable, this improvement you're seeing?

No, Steve, and with all of that, it's still, I think, you know, high single digits growth. And that's kind of what our sustainable target has been for a while. So I would hope that it is. It would be our goal that it is. You know, we've looked hard at where it's coming from. Like I said, with that really big spike in the second quarter, you know, we talked about where it came from, and it was, by and large, a lot of good credits. It just didn't meet our structure, what we wanted to do. Maybe we were full in a category and didn't want to reach out in one particular area. And just talking to our people, a lot of banks just put their pencils down. And we have liquidity. People know that we're not always the place where people like to go to get money. the leggiest structure on a deal, but we're consistent, you know, through the good times and bad times. I think, you know, people realize that. And I think that we got a lot of phone calls and a lot of opportunities to do stuff. And I mentioned how many we declined because I didn't want people thinking that, oh, well, look, Cullen Frost got some loan growth. They must be just taking other people's problems. You know, that's not what's happening. And we're just seeing a lot of good opportunity. I think part of it, Well, it's a lot of things. It's our reputation for strength and stability in times like these. But, man, our people are great at sales and calling and developing relationships. They're held accountable to it. They've been doing a good job. You know, when you have a balance sheet like ours, it puts you in a good place to take advantage of opportunities. And I think that's what we've been seeing. It's hard to pin down on any one particular thing because I think it's been pretty consistent. I might speak a little bit more about it because I just had a recent conversation about the expansion growth. I tried to give you some feel for it's pretty granular in terms of what's coming on, but I had a conversation about what kind of deals are we seeing And a lot of it is, it's owner businesses, right? They have a business-to-consumer model. They're not really sexy businesses, in a sense, but they're just good, stable, long-term businesses that are a result of hiring community bankers in these communities we've gone in. So it is very diverse. The commercial real estate that we see there is mainly because someone wants to not pay rent anymore. They want to own their own building for their business. That slowed down some because rates are so high, but that's still going to be the arc, I think, of the kind of business we're doing. When I hear that, it makes me feel really good about just how core and how stable it is because that's really our wheelhouse.

Phil, if I could ask about Final One. So as we're probably, I don't know, two-thirds through earnings season, what we're hearing from the industry, particularly the larger regionals, because most of them are on this RWAO's epic diet, right? They're just shrinking assets. They're almost all tightening on expenses, right? A lot of them are guiding to flattish expenses for 2024. And to be quite frank, I don't know how to think about Colin Frost for 2024. And I'm not looking for like a number, But I want to know how you're thinking about it, because in many ways, this is going to be a great market for you to take bankers, right? I mean, as everybody's sort of on the sidelines, which you mentioned. So, you know, you're, I don't know, I think the number's 14% year over year. Are you thinking about, hey, this is a year that we're going to continue to expand and maybe expense growth stays at that rate? Or are you sharing some of your other CEOs, like, no, we need to tighten also, just because the environment's a little more challenging. How do you think about that?

Well, what we're thinking is that we've got a great opportunity to expand. And we have plans in place. We're doubling. We started the process doubling Austin in the middle of tripling Dallas. We think these are great opportunities. And we are getting good applicant flow, let me put it that way, in these markets. So it's not like we're going, oh, we need to hire more bankers because we've got an opportunity for this or that. I mean, we are hiring tons of bankers as a part of this expansion. And, you know, there's plenty of work to go around there. So we are hiring, but it's a part of our strategy that we've put in place already. We're having good success there. We are not backing off and saying, oh, look, we need to cut expenses now because, I don't know, because whatever. We are winning competitively, I'll just say it. And now is the time for us to keep moving forward. Now, do Jerry and I talk with the folks about, you know, what they're spending and what the trend is? And we want it to be lower next year just because, you know, there's a limit to what you can do. you can do over time. And we want to be prudent about all this stuff. But no, we're not in a retrenchment mode at all.

Jerry, you want to talk some about expenses? No, I mean, I think Phil said it. And we've been very focused, as he said. And Stephen, you know us. Our focus on expenses continues. Certainly, when you look at the percentage, someone may roll their eyes. But obviously, we've talked about the things that we're doing to grow the business and grow our product selection and expand our marketing. I think those have all been, and improve our technology, those have all been smart things that we're doing. And as he said, you know, our guidance for our team has really been that, you know, we've kind of given guidance to this mid-teen sort of growth this year, but certainly would expect that, you know, when we talk in January, that that's not the sort of growth we'll be giving from a target standpoint.

Okay. Thanks for all the color.

Our next question is from Dave Rochester with Compass Point. Please proceed.

Hey, good afternoon, guys. Nice quarter.

Thank you. Thank you.

On your outlook for higher EPS versus consensus, are you guys assuming you've reached the bottom now in NIM and NII, given your rate outlook? You've been pretty stable here for a couple quarters now. Are you thinking that trend continues? And then when do you think you could get back to NII growth?

Yeah, I think that, and I think I've been pretty consistent. The fourth quarter for us, I think, is going to be a little bit weaker. You know, I don't think it's, and it's not significant. The guidance I gave last quarter was I thought they'd be flattish, and I could even still say that with a downward bias. I mean, we were down one basis point, you know, between these quarters. So I'm kind of feeling that same pressure. I think that as I look out into 24, and we'll get more color in January, as I said, but I think we've talked a couple of times that we have some opportunities to with some reinvestment of some proceeds that are going to be coming to us pretty early in 2024 from maturities in our investment portfolio. And even though we haven't really decided, you know, what sort of an investment plan we'll put in place, just putting it on our imbalances at the Fed would be a significant improvement. I think we've made no secret of the fact that, you know, we've bought a billion dollars in Treasury securities that mature, I think, the first... The first tranche, say, first $250 million is on December 31st, so I really say basically they're all in early 2024, and it's at a 1%. So that's sort of a pickup that we're kind of projecting for most of 2024 as those securities get to be reinvested. And, you know, a lot of it will be dependent, you know, on what our assumptions are for lower rates, if that's the case in 2024 when we get to that forecasting period in January. But right now I do think that the same guidance I gave last quarter about kind of flattish to a little bit downward bias is kind of where I'm at for this fourth quarter.

Okay. Appreciate that. And then going back to the stats you were talking about on the non-interest bearing, it sounded like October was down, if I heard this right, maybe $260 million-ish from the September average. I know that will bounce around. I was just wondering if you had isolated what drove that pickup and the runoff there this month.

No, to be honest with you, there's so many accounts in there and there's lots of positives and negatives and a lot of volatility that goes in with those accounts. And to be honest with you, from my end, when I see a movement like that in a month, I tend to think it's pretty flattish. And we hope certainly that we've seen the drop, the bottom, as we said. Phil talked about the new relationships that we're adding. On the commercial side, it typically takes us a few months, you know, from three months to six months to get those commercial deposits on. So we continue to be pretty optimistic about it and hope the worst is behind us.

Good. Maybe one last one just on expenses. You mentioned the mid-teens growth guide, and that implies a little bit of a wider range, I guess, since we only have one quarter left. and it seems like a midpoint would imply a little bit of a step up in expense growth in 4Q. Are you thinking maybe more at the bottom end of that range at this point, since you came in a little bit lower this quarter?

Yeah, I was joking a little bit earlier today. Yeah, I was joking a little bit earlier of what does mid-teens mean, right? Because in my mind, that's one number, and it could be a different number in your case. Yeah, I will say, Dave, that I'm feeling that My expectation today versus where we were a quarter ago is that we'll be lower. You know, we had a really, you know, we beat for the quarter, and some of it was on the expense side coming in lower than we had expected. And, you know, we do a lot of settlements on incentives and kind of look and see where all those incentive plans come in. Some of our incentive payments are issued in vests in the fourth quarter. So there's a little bit of uncertainty there, but... If you're looking at where I was a quarter ago versus where I am today, yeah, I certainly feel like it will be a little bit lighter than I thought we would be.

Yeah. When I saw the growth at the slower rate this quarter versus what we expected, I figured that that was going to be a response. I appreciate it. Thank you, guys. Sure.

Our next question is from Abraham Puala with Bank of America. Please proceed.

Good afternoon.

Hey, Ibrahim.

Hey, so first you talked about growth maybe somewhat slowing as we look into next year. Just give us a sense of how customers are holding up when we think about this lagged effect of the Fed rate hikes, maybe consumer demand slowing down a bit. I'm not sure whether or not that's happening in your markets, but give us a sense of just the resiliency of the customer base where if any place we're using softness from a credit quality perspective, And it may not be within Frost's loan book, but just in the market where you're seeing some softness.

I think that, you know, they're pretty well known, right? It's deals that were underwritten that, you know, have seen on a floating basis that have seen the higher rates and operating costs are up. You know, there are... Honestly, I don't pay a lot of attention to other banks, but I know our credit numbers are really strong. I don't get the sense we've had a tremendous problem here in the state. We said we're glad we're operating in Texas. We really are. I think it makes a huge difference. I don't see things. You mentioned I said it was slower next year. I don't remember that. I don't feel like it's going to be that much slower. I talk to customers. It's kind of funny. When you go out and talk to them, I was with a construction guy, and he looked at me and said, I'm really interested in how you see the economy. And I said, well, I almost was embarrassed saying it. I said, I don't think it's that bad. And he looked at me and said, that's how I think too. And we almost felt embarrassed for each other that we said it like we were going to get canceled or something. because there's, I guess if you watch too much TV you think it's supposed to be bad, but I think it's more worry about than there is actual problems today. And I'm not trying to be Pollyanna, it's just most people when you talk about their business, and there's problems here and there. We talked about some increase in our risk rate tens. So there's some issues. But it's not bad. If I had to pick, let's say, okay, let me see. So I would say probably, you know, you buy here, pay here, you know, use cars. It's got some pressure because they're a rate-sensitive business. And so that's probably some issues. I mean, if you've got an office building that's refining now and you don't have the capacity or the willingness to right-size it, there could be some issues there. And then there's just the one-off thing that's just business that we see. We've seen some things in, let's say, contractors. There was a big electrical contractor, but they had government work, which is always a little bit dicey for our experience, but they're working hard to right that shift. But if you didn't bid the right way and cost went up, you got a fixed rate deal, Mixed cost deal, that could be some issues. So those are the kind of things we're seeing. But like we said on our prepared comments, they're holding in there. And look, I'll say, let's take multifamily. They were underwritten two years ago, two and a half years ago. It's in construction. They're going to have to, if rates don't go down, they'll have to right-size some of this stuff. But they know that, and we've been talking to them about that. And it matters who you're doing business with and who your sponsors are. And so it's not something that we're really worried about at this point. And I think most of that stuff matures, you know, or has to be dealt with in 25 and 26. There's very little of it. I think there's 17. 17% in 20. Yeah. And I'll give you one other thing that, because maybe you think I'm whistling past the graveyard. There was a multifamily deal we're aware of in North Texas, a customer. It was right at one times coverage, okay? And that thing sold at a 4.5% cap and a gain to the borrower. So, you know, just because, I mean, Ed told me there's still a lot of demand for that out there, and so even though you might not be making a debt service coverage ratio somewhere, if you're in the right asset class, there's still some demand for what you've got. So I know I didn't answer you very specifically, but I think things are still hanging in there pretty well right now. And the final thing I'll say is, As it relates to the consumer, they've still got a job. In Texas, the unemployment numbers look pretty good. As long as they've got a job, even though they may be spending down their savings, they're able to hang in there and spend money.

Got it. That is good, Colin. Thanks, Phil. Apologies if I missed it, but can you remind us in terms of new branch of store openings over the next year, like what's – in the pipeline, be it in Austin or Dallas?

Let's see, that's a good question. I'm going to have to guess a little bit here, but I'm going to guess 15-ish or so locations.

Yeah, I think some of it's going to be dependent. We were having some conversations earlier this week, especially when you talk about a market like Austin. You know, where we've got a, you know, the permitting process is different. We're having to deal with different municipalities and such. So that can kind of affect, you know, certainly, you know, the number that we're talking about. But I think the last number I saw combined in 24 was around 15, I think, across all three markets. I think it makes sense.

Got it, 15 combined. And how would that compare, Jerry, to what we did this year in 23?

I think it would be right now a little bit lower than where we were in 23.

Understood. All right. Thank you for taking my questions.

Our next question is from Manan Ghasalia with Morgan Stanley. Please proceed.

Hey, good afternoon. I wanted to check in on deposit data. You spoke about seeing a mix shift from lower-cost to high-cost deposits again this quarter. Can you help us think through peak deposit betas in 2024 as rates stay high for longer and also give some color on the competition that you're seeing?

Yeah, you know, so right now for August, I'll talk a little bit about 2023. You know, so for the third quarter, I think cumulatively on this cycle, we're up 2%. We were at, on interest bearing, we were at 37% in the second quarter. We're at 39% at the end of the third quarter. I'd expect that same sort of a little clip between the third and the fourth quarter on interest bearing and on same sort of movement on total deposits. I think we increased from 23% to 25% through the end of the third quarter. You know, Right now, from a competitive standpoint, we try to keep an eye, and we do keep an eye on our competitors, really at all levels. We don't feel like we need to be the top, but we do want to be competitive, and we look at rates weekly. I think we've seen more competitive pressure today in the last couple of recent weeks. It's been more on the CD side. I think that's really what large consumers and commercial customers are looking for is, you know, kind of what the CD rates are to keep it at the bank. And so that's where we're seeing most of the pressure. And we tend to price, you know, we keep an eye on what the comparable treasury security is doing to determine our pricing there. So I think we're really pretty competitive and feel good about where we're at.

Got it. And maybe a follow-up on expenses. I know you noted the expense growth rate would likely come down next year. But at the start of this year, when you guided to the mid-teens expense growth, I think you mentioned you'd be investing in some IT and cyber projects, upgrading a couple of core systems. And I think you also noted that the timing of several large projects were just coinciding in 2023. So should we think about some of these one-time costs coming out next year? Or are these multi-year investments that you're making in the business?

Yeah, I think most of the things that we're talking about are multi-year investments. Most of these are going to be either positions that we hired from new IT staff or projects that will get capitalized. I think what we've seen is that some of this has moved into later parts of 23 a little bit. And so feeling a little bit of some of the upside that we probably are seeing when we talked about earning expense guidance being a little bit lighter than where we originally thought had a little bit to do with some of that timing. So we're not really – I'm not thinking anything that comes to mind immediately of one-time sort of expenses that were driving that expense growth this year. It was more people and capitalized projects. Like I said, we have a little bit that's moving into next year, but as Phil said, we don't expect certainly that our expense growth for next year will be, you know, in the double digits that the mid-teens that I've been discussing for this year.

Does that help? It doesn't sound like there's a large chunk of investments that are getting delayed and moving from this year to next year.

Yeah, I think that'd be a good conclusion.

Thank you.

Our next question is from Brady Galey with KBW. Please proceed.

Hey, thank you. Good afternoon, guys. Hey, Brady. But maybe just to ask the expense question a little differently. As I look over the last, I don't know, three or four years, you made a big investment in Houston, big investment in Dallas, now a big investment in Austin. I know that was a big piece of the abnormally high expense growth. As you think about it going forward, are there still markets out there where you want to make a substantial new investment, or do you think with these three – I mean, you're kind of in the three big spots there in Texas. With these three, are you kind of done making these large investments in a new market?

Well, Brady, I mean, look, we've got – We've got a lot of, first of all, we have a lot of work left to do. So we've got to finish up Dallas. We were just starting Austin. And we've got a pretty big network that we're going to continue to deal with and continue to grow in the normal course of business. But I don't want to be too far out in front of that. But look, like I said earlier, we're going to be doing this for a long time. I mean, there are great markets to be in in this state. There are great markets to be in out of this state. I'm looking way down the road. I mean, I'm just saying, I don't think there's anything about our business model that ends when we get through doing 17 branches in Austin. And so maybe to answer your question another way, The way to think about our company is probably that we've got this legacy part of our company that operates very efficiently and very profitably and it's got a lot of control in terms of expenses and that kind of thing. And then we have this expansion element of our company that is a growth and expansion component and that has higher growth rates just you know it's the nature of that kind of business and what we believe is the combination of those two and they do two different things right there's a legacy kind of piece and there's you know there's this new expansion piece maybe we'll probably always be you know as long as we're doing a little bit higher on average than others but But another way to think of it, too, is a lot of these expansion assets are going to be creating the money and the revenue to fund future expansions, too. So that's not a real specific answer, but it's sort of how we think about the business right now.

Yeah, that helps. And then we've seen some of your peers do a partial bond restructuring. I know y'all's bond yield is around 3.25%. So, you know, if you mark to market that bond yield, you'd probably be picking up at least a couple hundred basis points. How do you all think about, you know, restructuring a piece of the bond book? And, you know, your TCE is in the mid-4% range. Like, does that matter? I know Common Equity 301 is a lot higher. But does the TCE matter when you consider a possible bond restructuring?

Brady, I'll say that, you know, we have not discussed this. any sort of a bond restructuring. You know, I think that we've got, obviously, we've got the securities in available for sale. We think it gives us the most amount of flexibility. We like the transparency that it provides through equity. And, you know, I think from a tangible capital standpoint, we don't spend a lot of time thinking about it. You know, we're obviously aware of it. As we said earlier, we haven't made any investment purchases this year. You know, I think if we do put a program in place, we'll certainly, whatever program we put in place, we will certainly consider the potential implications of the new capital regime that's out there for banks that are $100 billion, you know, that would have to include OCI. So we're not, you know, it's nothing that we're not aware of. It's more that at this point, you know, it's not been really something that's been part of our conversation. So anyway, anything else I would say, I kind of make it up, but it's not something that we really talked about going forward.

Okay, and then finally for me, it looks like the share count went down just modestly in the third quarter relative to the second quarter, so maybe a modest amount of share buybacks. Your stock was at a year-to-date low. I know it's up pretty nicely today, but it's still relatively cheap today. versus where you all have been trading earlier this year? How do you think about a share buyback with the stock at this level?

Yeah, I think we didn't spend a lot of money, but we got in earlier than I would have liked in retrospect. I don't have the numbers right in front of me, but I think it was around $11 million that we spent in the quarter. It's just something that we'll talk about. You know, there is, you know, on one side, you know, we're having the conversation, like you said, about, you know, how much are people paying attention to tangible capital. And on the other side, you know, I'm talking about what a great bargain our stock is, even before today especially. So it's just a conversation we'll continue to have. It won't have big implications. I think at this point we're probably, we've got a $100 million program that expires in January. We've probably utilized $30 million of it, if I remember correctly. So it won't have huge impacts, but it's something that we consider to continue to discuss. But again, it's not going to have a big impact.

Okay. Thanks for the call, guys.

Our next question is from Michael Rose with Raymond James. Please proceed.

Hey, good afternoon. Thanks for taking my questions. Phil, I noticed your comments about, you know, optimism. around home equity and, you know, just looking at the average balances, we don't have them for this quarter, Q's not out, but just over the past quarter, a couple quarters, it seems like that's over half the average loan growth. Just wanted to, you know, kind of size the opportunity, you know, as we move forward and particularly as you roll out the mortgage product. Thanks.

I'm sorry, Michael, did you ask me the outlook for that or what would you say? I mean, I agree with your understanding your numbers, but what were you asking?

Just if you could size the opportunity as we move forward, because you did sound fairly optimistic going forward. And then as you layer in mortgage, consumer mortgage, I know the market's not great, but you're in Texas, just trying to get a sense for what the growth opportunity is. And I think that home equity consumer line is about 12.5% of the portfolio. Just where do you think that could get to over time? Thanks.

Yeah. Well, the mortgage portfolio is a great asset class for us. I think over time, this is back a year ago when we started talking about it, I think we said, I can't remember exactly what we said, but the impression we wanted to give you was that, hey, this could be mortgage itself over time could be what the consumer real estate portfolio was at that time, just by itself. And so that's, we still think, good you know this is a long-term product long-term relationships so we feel really good about it and remember we're not doing a refi program so i don't care that the refi market's down in fact i love it because it's allowed us to get i don't know what 90 people or so that we were able to bring in great great mortgage professionals you know to build that you know that infrastructure uh over the last year so we're all about putting people in homes and that's uh I think we're going to have a chance to do that for a long time. I think that, you know, I saw a number, Michael, that a percentage of people that had a, what was it, a 3% mortgage was like over 60%. It's amazing. And if you looked at the people that had under, I think it was five, it's like 90-something percent of the mortgages. So, you know, if you want to, I mean, people are not moving, right? And so I think that this home equity product has got legs. This home improvement product has got legs for a while. The rate of growth has been so high, you know, 20s, mid-20s sometimes, that I think that just by its nature, the law of numbers, it has to go down in terms of percentage. But I still think the volume should be pretty good because it just fills a gap that people need right now.

Great. I appreciate the caller. And just one final for me, so I guess the potential problem loans were up about 16%. Q1Q, any notable trends in there, anything to read in that, or just more kind of normalization of credit off of a very low base? Thanks.

Yeah, the numbers I've looked at were the – I think where I saw the change was in the risk rate 10s. Really, I think there were four credits that made up the vast majority of that, and they were like different businesses. You know, there were a couple of real estate properties. Actually, they were smaller office buildings. You know, they had kind of idiosyncratic things, and we don't feel that bad about them, but, you know, we felt they – remember, this is OAEM. This is a lighter classification – And then there was something, a midstream energy trading company, you know, that it's just a business kind of thing. I mean, we find a bank, and then we got, what was the other one? Oh, I think it was a buy here, pay here outfit. I think that's what that was. And so kind of an interest-sensitive business. You know, we've seen some of that. That was the kind of thing. It didn't give me a lot of heartburn. It's just reflective of the environment we're in. But I didn't think it said anything in particular about how we're doing things. In fact, I think it shows that we were doing our business pretty well. And again, I've said since the beginning of this that it's a risk business. And will we see some hiccups here or there? Of course we will. But I feel really good about how we've done things. I feel really good about the customers. Not every one of them has performed like we want, but most of them have. And I feel pretty comfortable with it.

Great. I appreciate the call. Thanks.

And our final question is from Brody Preston with UBS. Please proceed.

Hello, everyone.

Hello.

Hey.

I was just wondering, I wanted to follow up on Office. I was wondering if you happen to have what the reserve against the Office portfolio is and how you think about that moving forward, just given some of the larger banks are putting up pretty hefty reserves against their Office portfolios.

Let's see. Let's see what we have here.

Yeah, I'm looking at what I've got. I've only got commercial real estate as a group. What I'm looking at, Rhody, I don't have the office, but certainly I think that number, if I'm looking at this correctly here, is 1.45 on all commercial real estate. And certainly if you get with AB, we can certainly provide you that detail. I don't think I've got it here in front of me.

Okay, great. I'll follow up.

I will say that I'm not going to do anything just because the large banks are doing something, just so you know.

Got it. I did also, Gary, I'm sorry to go back to expenses.

Sure. Hey, Brody, so I'm getting a chat real quick. I'm seeing that our reserve is 2.2% on office.

Okay, great. Thank you very much for that. I did just want to touch on expenses. A couple quarters ago, you said you thought of the long-term kind of expense growth rate for the bank as high single digits. I just wanted to ask, would it be fair to say that the Austin build-out will be mildly additive to that kind of long-term growth rate when you think about planning for next year?

You know, I think that the way we tend to look at it is, and again, it's going to be dependent on how big an expansion we really typically would originate. But when I gave that sort of guidance, that was inclusive, would be inclusive of what we were doing.

Okay. Got it. That's helpful. And then the last one that I had was, I'm sorry if you said it earlier and I missed it. Do you happen to have, you know, for the fixed rate portion of the loan portfolio, what's coming due over the next 12 months, and what the yield pickup on that would be?

No, I don't think I've got that handy with me, Brody, but again, I think that's something certainly AB can get it to you.

Okay, maybe if I could just ask one more. Sure, of course. Do you happen to have what excuse me, the percent of the portfolio that SNCCS is?

Yeah, I think it's 4%. Let me double check that, but that's my recollection. Hold on just a sec. Yeah, at the end of September, that portfolio was, the SNCCS portfolio was $789 million. or 4.3% of the period end loans.

Awesome. Thank you very much. I appreciate it. Sure.

We have reached the end of our question and answer session. I would like to turn the conference back over to Phil for closing remarks.

Thanks, everyone. We appreciate your participation today and your interest. We'll be adjourned.

Thank you. This will conclude today's conference. You may disconnect your lines at this time, and thank you for your participation. include today's conference. You may disconnect your lines at this time and thank you for.