Cullen/Frost Bankers, Inc.

Ladies and gentlemen, thank you for standing by. The conference will be beginning in just a few moments. Once again, thank you for standing by, and we will be beginning in a few moments. Thank you. Greetings. Welcome to Call in for Us Bankers Inc. fourth quarter and full year 2023 results 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. Mendez, Senior Vice President and 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 Angieri, 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.

Thank you, A.B. Good afternoon, everybody, and thanks for joining us. Today, I'll review fourth quarter results for Colin Frost and our Chief Financial Officer, Jerry Salinas. We'll provide additional comments before we open it up for your questions. In the fourth quarter, Cullen-Frost earned $100.9 million, or $1.55 per share, compared with earnings of $189.5 million, or $2.91 a share reported in the same quarter last year. Now, these results were affected by a $51.5 million one-time FDIC insurance surcharge associated with the bank failures that happened early in 2023. Our return on assets and common equity for the fourth quarter were 82 basis points and 13.51% respectively, and that compares with 1.44% and 27.16% for the same quarter, same period last year. For full year 2023, the company's annual net income available to common shareholders was $591.3 million. That's an increase of 3.3% compared to 2022 earnings available to common shareholders of 572.5 million. On a per share basis, 2023 full year earnings were $9.10 a share compared to $8.81 a share reported in 2022. As we mentioned in this morning's press release, just for the one-time FDIC insurance surcharge, our yearly earnings would have been up by approximately 10% over 2022. This solid fourth quarter and full-year performance is due to the continued strong execution of our organic growth strategy by Frost Bankers. who provide our customers with top quality service and experiences that make people's lives better. Our balance sheet and our liquidity levels remain consistently strong. Frost remains very well capitalized, and it has a 45% loan-to-deposit ratio. Also, as was the case in previous quarters, Cullen Frost did not take on any home loan 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. And additionally, our available for sale securities portfolio represented more than 80% of our portfolio total at quarter end. Our average deposits grew in the fourth quarter to $41.2 billion, up an annualized 3.5% from the $40.8 billion in the previous quarter. Average loans also grew in the fourth quarter to $18.6 billion, compared with $18 billion in the third quarter. That was an annualized increase of 14.3%. We continue to see excellent results from our organic growth program. For example, our original Houston expansion locations stand at 103% of original deposit goal, 155% loan goal, and 122% of our new household goal. For what we call our Houston 2.0 locations, the last of which will open this year, we stand at 297% of deposit goal 351% of loan goal and 185% of new household goal. As of quarter end, expansion loans and deposits represented approximately 24% and 19% respectively of our total Houston market presence. For the Dallas market expansion, we stand at 217% of deposit goal, 269% of loan goal, and 198% of our new household goal. While still relatively early in this effort, expansion loans represent approximately 12%, and deposits represent approximately 10%. of Dallas market totals. We've opened up almost two-thirds of our planned locations in the Dallas market, and we look forward to their growth as these locations mature past the startup phase. And we're also excited about our new Austin expansion effort, where we plan to open 17 locations to double our presence in that market, as we've mentioned before. And the first of those opened in 2023, and the next is scheduled to open in April. Keep in mind that we've been successful generating core, stable, grassroots business in our expansions, and that will generate significant value over the long term. At year end, our overall expansion efforts had generated $1.9 billion in deposits and $1.4 billion in loans, even though many of these locations are still early in their development. Looking at our consumer banking business, we continue to see outstanding organic growth, and we ended 2023 with a record net new household growth of 28,632 households. Again, that's net growth, and it's 12 percent higher than last year's net household growth. In the past three years, we've added 81,000 net new consumer checking households. That's 2.6 times more than the three years before that. And that shows that our organic growth strategy combined with our customer experience and reputation is key to our success. We have the right products and services and relationships to help customers in our markets. Also, as we've noted, we're excited about the prospects for our new mortgage product. We completed the product rollout in December, to the last of our regions, which was the Houston region. And in the fourth quarter, we approached the milestone of originating our first 100 mortgages, and we expect faster growth in 2024. Looking at our commercial business, our weighted pipeline is at $1.175 billion, and that was down from the record that we set of $1.918 billion in the third quarter. In the fourth quarter, we brought in 960 new relationships. That's the third highest quarterly amount ever, up an unannualized 8.7% over the third quarter, and up 21% over the fourth quarter last year. This shows me that our success in growing our business organically includes not only a consumer, but also commercial business as well. For the full year, New commercial relationships added $806 million in new loan balances and $800 million in new deposits. Credit quality continues to be good by historical standards, with non-accrual loans down from the previous quarter and net charge-offs at healthy levels. Problem loans, which we define as risk rate 10 or higher, totaled $571 million at the end of the fourth quarter. That was up from the $513 million at the end of the second quarter and $320 million this time last year. This growth in the fourth quarter was evenly split between loans in the OAEM and classified categories. Another way of saying risk grade 10 and risk grade 11 categories. Non-performing assets, total $62 million at the end of the fourth quarter. compared with $68 million last quarter and $39 million a year ago. The year-end figure represents just 32 basis points of period-end loans and 12 basis points of total assets. Net charge-offs for the fourth quarter were $10.9 million compared to $5.2 million last quarter and $3.8 million a year ago. Annualized net charge-offs for the fourth quarter represent 23 basis points of average loans, and full-year charge-offs were 18 basis points of loans. Regarding commercial real estate lending, our overall portfolio remains stable with steady operating performance across all asset types and acceptable debt service coverage ratios and loan devalues. Within this portfolio, what we would consider to be the major categories of investor CRE, that is office, multifamily, retail, and industrial as examples, total $3.9 billion or 44% of total CRE loans outstanding. Our investor CRE portfolio has held up well with the average performance metrics slightly improved quarter over quarter. exhibiting an overall average loan-to-value of about 53% and weighted average debt service coverage ratio of about 1.44. The investor office portfolio in particular had a balance of $891 million at quarter end, which was down from $959 million the prior quarter. That portfolio exhibited an average loan-to-value of 49% and an average debt service coverage ratio of 1.54 and healthy occupancy levels, all of which improved from the prior quarter. Our comfort level with our office portfolio continues to be based on the character and expertise and experience of our borrowers and sponsors, as well as with the predominantly Class A nature of our office building projects. And again, we're glad to be operating in Texas. More than 90% of our office portfolio projects are in frost markets, which are Texas's major metropolitan areas. We continue to see good economic growth and strong levels of in-migration of both people and businesses. I also wanted to note that from September 30th to December 31st, Total investor office outstandings decreased 7 percent from the linked quarter, and total commitments decreased by 9 percent. Finally, I'll point out that we've just rolled out a new Frost marketing campaign and brand refresh designed to emphasize the great customer experiences we provide in order to differentiate our voice in a crowded banking marketplace. We've been talking for some time about the need to invest in marketing capabilities to complement the organic success we've been achieving, and we're optimistic about the impact this will make in customer acquisition. So in closing, we remain optimistic for what lies ahead. We're capitalizing on opportunities. We're enhancing and expanding our brand, and I'm proud of everything that our Frost teams are accomplishing across our communities. And now I'll turn the call over to our Chief Financial Officer, Gary Salinas, for some additional comments.

Thank you, Phil. Let me start off by giving some additional color on 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 fourth quarter, lean quarter growth in average loans and deposits were $52 million and $78 million, respectively, each representing approximately 24% annualized growth. And for the fourth quarter, Houston 1.0 contributed $0.07 to our quarterly earnings per share. Now moving to our net interest margin, our net interest margin percentage for the fourth quarter was 3.41%, down three basis points from the 3.44% reported last quarter. Some positives for the quarter included higher yields and volumes of both loans and balances at the Fed. These positives were primarily offset by higher costs and volumes of deposits and customer repos compared to the third quarter. Looking at our investment portfolio, the total investment portfolio averaged $19.8 billion during the fourth quarter, down $723 million from the third quarter. During the quarter, we did not make any material investment purchases. The net unrealized loss on the available for sale portfolio at the end of the quarter was $1.39 billion, a decrease of $825 million from the $2.2 billion reported at the end of the third quarter. The taxable equivalent yield on the total investment portfolio in the fourth quarter was 3.24%, flat with the third quarter. The taxable portfolio, which averaged $13.1 billion, down approximately $471 million from the prior quarter, had a yield of 2.75%, down one basis point from the prior quarter. Our tax exempt municipal portfolio averaged about $6.7 billion during the fourth quarter, down about $252 million from the third quarter, and had a taxable equivalent yield of 4.26%, flat with the prior quarter. At the end of the fourth quarter, approximately 71% of the municipal portfolio was pre-refunded or PSF insured. The duration of the investment portfolio at the end of the fourth quarter was 5.0 years down from 5.7 years at the end of the third quarter. Looking at deposits, on a linked quarter basis, average deposits of $41.2 billion were up $356 million, or 3.5% on an annualized basis from the previous quarter. We did continue to see a mixed shift during the quarter as average non-interest-bearing demand deposits decreased to $126 million, or 0.9%, while interest-bearing deposits increased $482 million, or 1.9%, when compared to the previous quarter. Based on the fourth quarter average balances, non-interest-bearing deposits as a percentage of total deposits were 35.7%, compared to 36.3% in the third quarter. Looking at January month-to-date averages for total deposits through yesterday, They are basically flat with our fourth quarter average of $41.2 billion. For January month to date through yesterday, the average non-interest-bearing deposit balance was $14.39 billion, down $309 million from the fourth quarter average, affected by seasonality as those deposits tend to peak in the fourth quarter and soften in the first half of the year. For January month to date average, interest-bearing deposits through yesterday were $26.8 billion, up $309 million from our fourth quarter average. In the January month-to-date average, we do continue to see a shift in the mix in interest-bearing deposits to higher-cost CDs from lower-cost products. The cost of interest-bearing deposits in the fourth quarter was 2.27%, up 15 basis points from 2.12% in the third quarter. Customer repos for the fourth quarter averaged $3.8 billion, up $225 million from the $3.5 billion average in the third quarter. The cost of customer repos for the quarter was 3.75%, up eight basis points from the third quarter. The month-to-date January average for customer repos was basically flat with the fourth quarter. Looking at non-interest income and expense on a linked quarter basis, I'll just point out a couple of items. The other non-interest income category included a $3.5 million recovery of a fraud-related loss accrual that we recognized in the fourth quarter last year. Salaries and wages included approximately $8.8 million in higher stock compensation compared to the third quarter. As a reminder, our stock awards are granted in October of each year, and some awards, by their nature, require immediate expense recognition. The other non-interest expense category included a donation to our Frost Charitable Foundation of $3.5 million. Regarding estimates for full year 2024, our current projections include five 25 basis point cuts for the Fed funds rate over the course of 2024. For the full year of 2024, we currently expect Full year average loan growth in the mid to high single digits. Full year average deposit growth in the range of 1 to 3%. Net interest income growth in the range of 2 to 4%, with the net interest margin percentage expected to be slightly higher for full year 24 than the 3.45% we reported for 2023. Non-interest income could be relatively flat given the pressure facing the industry on interchange revenues and OD and SFCs. Non-interest expense growth in the range of 6% to 8% on a reported basis. Regarding net charge-offs, we do expect those to go up in 2024 to a more normalized historical level of 25 to 30 basis points of average loans, given the unusually low level we've seen in the last few years. Regarding taxes, our effective tax rate for the full year of 2023 was 16.1% and we currently expect a comparable effective tax rate in 2024. Going forward, given the wide range of analyst estimates and the resultant impact on the mean of estimates, we do not plan to comment on consensus EPS as we have in the past and will instead provide our outlook for the major building blocks of our profitability. With that, I'll now turn the call back over to Phil for questions.

Thank you, Jerry. Now we'll open up the call for questions.

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 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. Our first question is from Abraham Poonwala from Bank of America. Please proceed.

Good afternoon.

Hey, Abraham.

I guess maybe first question for Jerry. Your outlook with the five rate cuts for NRI growth, you mentioned about 2% to 4%. Just give us a sense of The sensitivity, my understanding is the balance sheet is still asset sensitive. So first, whether that's right or wrong. And then as the year progresses, do you expect NII to drift lower or do we build from fourth quarter levels? And are you just outrunning rate cut impact because of balance sheet growth and fixed rate asset repricing?

That's a lot. Let me first say that... You know, yes, we still are asset sensitive. I think we've talked about this in the past. I'll just kind of go through some of the pieces of it and fill in as I can remember your question. But one of the upsides that we talked about was that we've got projected about $3 million in proceeds from our investment portfolio. And about $1.4 billion, if I remember correctly, is in the first quarter. So a big chunk of it comes in. And the yields that that portfolio has, I think we've talked in the past about some specific Treasury securities that we had purchased. I think $750 million of that is going to mature here this month, and the yield on that portfolio was a little $102, I think it was. So some of what we're seeing is a pickup that we're going to get just from the, even if we don't reinvest in investment securities, even in that rate environment that we've discussed, it would still be favorable to our net interest margin percentage. We've also seen some improvements, I was noting, in our fourth quarter loan spreads that we booked. Not huge, but there are some improvements during the quarter. I think that's going to be a positive to us as well. So no, I think overall we're feeling good about net interest income and net interest margin based on where we're at. I mentioned that we continue to see a mixed change, but the changes that we're seeing at this point in my mind, aren't really material. I think especially in a rate environment where we've been for a while now, and even if you said it was flat, I think the bulk of the rate competition for the most part is gone. We still continue to see, especially smaller banks, smaller local and regional banks, be what I think is really putting out some unrealistic deposit rates that we're not going to match. I think we've always said to you, to the community that we don't intend to be the highest rate in the market, but we do want to be competitive. In a rate environment as we portrayed it, I think we find ourselves being able to be more competitive on money market funds because our betas typically have been of a range, we'll take money market, have been like 60%. In the rate environment that we're talking about, some of those shorter duration investments that those funds would be making You know, they have 100% beta, if you will. So I think we'll find ourselves in a much more competitive situation. You heard me say we're not projecting a huge growth in deposits. I think that we feel really excited about the level of loans and deposits that are coming from our expansion branches. I think we're really excited about that. We've also talked about, continually, about the nice growth that we've had in commercial relationships. As we've said in the past, those relationships take a little bit longer to get all the accounts moved over and signatures, cards done, et cetera. So I think overall we're not too aggressive on deposits. I think it's still to be seen. We saw a little bit of a downtick, as I said, in January on the commercial DDA. But as we look at our trends, that's really pretty normal for us. So no, I think we're still feeling good about all that and still feel like – we've got some room to improve on the NIM percentage and net interest income. You know, we're not talking on net interest income. You know, I gave guidance on 2% to 4%, and that's given the rate environment that we're talking about. If we were talking about a flat environment, just to give you some perspective, I'd probably be talking about increasing those percentages, say, 1.5%. And we'd see a little bit nicer improvement in our NIM in that situation.

That is good color. So thanks for your patience there, Jerry. And maybe a question just on loan growth. When I look at the period end balance, it would equate to about 5% growth starting out for the year. So it suggests that you don't expect as much momentum on loan growth looking forward. So maybe, Phil, give us some perspective around customer sentiment and whether you are seeing that slowdown play out. And given that we're entering sort of an election cycle, do you expect loan growth to be weighed down by that as well?

Yeah, it's good question, Abraham. I think that. With regard to sentiment, I believe that things are slowing some with regard to that, and I think some of it is what you mentioned that typically happens with an election year. People are wanting to know what the regulatory environment is going to look like, so I think there's some of that. I think there's just a general. slow down and some other things in interest-sensitive areas, say like obviously real estate, commercial real estate deals, some interest-sensitive areas like, let's say, used cars, for example, if you're looking at a specific segment. So there is some of that. And I looked at our pipelines also. Our new loan commitments were up about 9%. link quarter annualized. So, you know, recent activity's been good, but when I look at our opportunities, they're down a little bit from where they were last year. They're down about 7%. On a link quarter basis, they're down about 17%, depending on whether you're looking at a customer or prospects. Prospects are down about 26%. So, That just shows what's kind of going into the hopper, if you will. It says to me that we're slowing in terms of what's available and what we're seeing. I should point out that if you did look at our core loans, which are those loan relationships under $10 million, that if you look versus last year, those are actually up 28%. So we've seen most of the slowdown year over year to be in larger deals. And I think that represents... you know, that expansion strategy. You know, it is a very core business-centric strategy, and we've had really good growth there, so I think that's propping that up. So, yeah, I would agree that things look a little bit slower. Not bad. As I said, Jerry, you know, has guided us to, you know, high single-digits loan growth, and I think that's a realistic number for us, and we'll get through the election and see where that takes us.

Thank you both.

Our next question is from Steven Alexopoulos with JP Morgan. Please proceed.

Hi, Phil. Hi, Jerry.

Hey, Steve. Hey, Steve.

I want to start. So on expenses, so Jerry, the guidance was off reported expenses. So if I take the FDIC charge out, I get the midpoint like 12% expense growth, something like that for 2024. Now, I'm curious, because you guys used to be a mid-to-high single-digit expense grower, but you're having this really great success with all the expansion. How do we think about expenses beyond 24, right? Do you go to the next market or deeper and existing and the expansion continues? Like, should we think about Frost as being a low double-digit expense bank while you continue for the next several years on expansion, or does it throttle down at some point?

Well, Steve, I'll talk broadly a little bit, and then Jerry might throw in some color. You know, I think there are two Frosts, right? I mean, there is what I'll call Legacy Frost, which is our business that we've built up over the 155 years, and then there's Expansion Frost, which is, you know, a company that has really come into its own with its ability to grow organically in markets and build households and accounts. And we're going to keep leaning into that. And our experience shows that it's great and it's worthwhile with the shareholder. I mean, for Houston to be 25% represented by expansion, I think that's pretty remarkable. And I think it shows that we'll take share in this gain. So that'll be higher. I would like to believe, though, if we go past this year, that even though we're going to continue to be expanding, I'd like to see our expense growth rate be a little bit less because we have made, you know, we talked about the generational investment in IT that we made, you know, earlier this year. I think it was we talked about it. We talked about, you know, the marketing expenses that we've built up, which, you know, we really need to build that infrastructure. And so Some of this is building things up that I hope we don't have to continue to do. So I think our expense rate will be elevated from what it was historically, but mainly because of our growth strategy and our expansion strategy. But when you look at the legacy part of the bank and how we operate on a regular basis, I think we're still pretty tight, and I'll be proud of our expense management on that basis. Jerry, any thoughts?

Yeah, I agree with everything Phil said, Stephen. I would say that, you know, even in this environment, you know, we won't go into a lot of details, but I'll tell you that, you know, we continue to make sure that we're looking at for any, looking very closely at any requests, you know, for additional capitalizable items or for new FTEs. We're really focused on that. So it's not like, you know, the door is open and everything's getting approved. And so, you know, I'm very much In the campus, Phil says that we need and we will try to continue to control expenses. I think he talked about a couple of things, but just to give a little bit more, you know, put a little bit more meat on it. Some of the things that we've talked about from technology and from marketing, to give the two examples that he mentioned, weren't really in our full run rate, you know, for all of 23. So some of the lift that we're seeing is just, you know, trying to get the full year impact of some of those expenses. Some of the people were retired until late in the year, for example, whether it's in the IT area or in the marketing area, and some of those programs hadn't started. So some of it is just trying to get that into our run rate. So, you know, I agree with Phil. I would expect that going forward, I don't see us going back to a 3% to 4% growth given, you know, our organic expansion rate. strategy, but I would hope that operating at these higher levels is certainly not our current expectation based on what we're seeing. Of course, in this environment, we did continue to do some things for our employees where we've done, I think, a great job of taking on some additional costs corporate-wide that had previously been covered by the employees. As an example, we cover more of the medical that we did historically. And, again, some of those things just trying to be more competitive and at the same time treating our employees with grace and knowing what a competitive market that we're operating in. So long-winded answer to say I agree with Phil. I don't think we'll be operating at this level past, you know, this year that we're talking about. And we continue to be focused on trying to manage those expenses.

You know, Stephen, I'd also point out that, you know, With regard to the expansion, I mean, you know, the numbers are the numbers, and we're proud of them, what we're able to do. But I'll just throw a couple things out there, too, that, you know, we're looking at and, you know, you might be interested in. When someone comes here, we'll survey, you know, a broad group of people who are new customers. We'll ask them, you know, what influenced you most in choosing Frost as your bank? And the number one... response is convenient locations. And number two, a close second is recommendation from a friend. And it drops off by about a third being 24-7 live customer support. And then it drops off by about that, by about, say, 15% to convenient ATM network. And then it goes to other and a lot of different things. But it shows in what we ask our customers, what are the things that brought you here? And remember the growth we've had, growth in households, and those are the responses our customers have given us. And the other thing I'll point out, and we've said this before, and I'll update this and give a little bit more color. If you look at our Houston expansion, which is still, we've still got some developing, you know, new branches there which aren't fully, you know, we only had one, I think, in the five-year anniversary, but that was recently. But if you look at those, the relationships, the new accounts that are open in Houston, 85% of the Houston expansion new accounts are opened within five miles of a Frost Financial Center. And 44% of the Houston expansion new accounts are located within two miles. Again, we're not trying to process transactions at these locations, but we are projecting our brand into these communities, and we're leveraging our value proposition. And you heard me say that the number two reason was reference, referrals from a friend. So I like to look at it as a virtuous cycle of what we're doing, how it's all working together. So we're going to continue to lean into that. And will it cost some expense money? Yes, it will. We're being careful with it. But we really believe it's generating success for the long term.

That's great color. I wanted to ask about commercial real estate. It was funny, this quarter in particular, I fielded a ton of questions from investors that they want to buy your stock here. They like where it's trading. They love all these expansion metrics. Commercial real estate concentration is the thing that's keeping them nervous. And I'm sure you've seen the articles too, Phil, the vacancy rates almost 20% for office at Dallas, Houston, Austin. So my question to you is, what's your perspective on the commercial real estate market? Like you see these markets from the ground level. Is this exaggerated? You know, when you look at your portfolio, I don't think you have vacancy rates anywhere near that. But can you give us some color on your Cree exposure in those markets? You didn't seem overly concerned, but maybe we could flush that out for the investors on the call.

Yeah, what I would say, Stephen, is that, first of all, I read that Wall Street Journal article late in the year about, you know, the vacancy rate in Texas. Let me tell you what, that vacancy rate in Texas is going to be high for a long, long time. And you know why? It's downtown real estate. Some of those buildings, this is my opinion, some of those buildings, you know, I don't know if they'll ever be filled. Some of them probably from the 1980s or 90s. So, you know, you've got that. You've got that. Now, I'll recognize Austin's got new buildings there, and they've got significant vacancies. So I'm not trying to whistle past the graveyard. I'm just trying to say there's some element of that vacancy that it's different than other vacancies. Not all created equal. But what I would say about commercial real estate is You know, we saw an increase, you heard me say, we saw an increase in problem loans this quarter. That's risk rate 10 or higher. But it really wasn't from commercial real estate at all. In fact, if you look at, you know, what happened, let's take commercial office. We had three paydowns of investor office that, you know, totaled $95 million in You know, one of them, they paid off her cash. Long came due, paid it off her cash. It was a significant deal in a downtown major market. We had one that was in a medical center of a major market. You know, they put lots of cash in it and refinanced the rest. We had another one that we sold. It was a completely performing loan, but the owner had some other problems other places, and it was in Austin. And we... We said, look, you know, we got a really good bid for that loan. We sold it. We took a, you know, I think it was a 7% discount on it to do it. But those are three examples of investor office in Texas where we're operating where, you know, it worked out okay because you've got the right structures, the right locations, and the right sponsors for these things. None of these things were guaranteed. And so... You know, the increase in problem credits this quarter was really more related to just banking business, you know, where you've got, you know, you've got someone, there was one credit that came up late. They've got an inventory write-down they notified us about. I think it, you know, we're still looking into exactly why it happened. They are two I think it probably relates to an accounting, at least some to an accounting system, perpetual inventory system they put in, but we'll see. But, you know, they've basically, you know, been operating with an understated cost of goods sold. They had to write down some inventory. So that's an unusual thing that happens in business at times. It doesn't have anything to do with interest rates or or office building vacancy rates. There was another that was a liquor distributor that lost a supplier. And they've got to cut some overhead. They'll be fine. But it's those kind of basic banking things that are the reason we saw the increase in risk rate 10 and higher. And it wasn't because of the real estate at all. In fact, that's sort of improved. You know, and the other thing I'll say is, you know, we're not stopping doing business in the Texas market. I mean, granted, we're in the Texas market, and thank goodness. I mean, I'd put it up against any market in the U.S. And, you know, we're still seeing opportunities. There are fewer of them, and... And competition for the really good deals is still there, but we're still seeing opportunities in commercial real estate that make total sense to us because of the properties and the structure and the sponsors for the deals. My worry right now isn't really commercial real estate. I mean, we've been working on it for, golly, how long? 18 months or whatever. But what I've been seeing... And let's take these payoffs we talked about. And we also have one that was a risk rate 11 last year. I didn't even mention it. It was a $41 million deal. It's not an office building. It's an industrial deal. There was a hole in it. It was a great piece of property for a credit tenant, but rates go up. There's a hole in it. The owner sells it. He brings cash to the table. So that's not really... It's been performing the way I think we hoped it would. Will there be some issues? I'm sure there will be, have been a few. I think we've got one non-performing office building we talked about a few quarters ago. But, you know, it is not a train wreck in the markets we're in and the relationships we're in in commercial real estate. And we're watching it and we'll keep talking to people I mean, I'll keep going on with this answer, but, I mean, these are things that need to be said. You know, you could say, well, what's the biggest exposure, you know, on paper? And it's probably your construction portfolio for multifamily, you know. And it's because the debt service coverage ratios of those things improved a little bit, but they're still not where they'll need to be to get them refined or get a permanent financing. But when you look at that, you know, I think only 6% of those come due in this year. I think 75% of them come due in 26 or later. And then when you look at the people behind them, and I'm not going to name names here, but if you look at the people we do business with, they understand this business. It's just not like somebody who thought, gee, let's, you know... let's get in the multifamily business and, you know, find a banker that will bank us. I mean, these are people that have been doing this a long time. And I feel really good about their relationships and how they take care of their business. Again, I'm not saying we can't have problems, but this is how life is on a day-to-day basis around here. And so, anyway, that's what I know.

That's great, caller. Thanks for taking the time to flush that out because it is a a major concern. And, you know, most of us just read these articles and we don't know what's in your portfolio like you do, Phil. So it's nice to hear you walk through it and that you're, you know, confident things could happen, but you feel pretty good on your exposure. So thanks for taking my question. I do.

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

Hey, good afternoon, guys. Hi, Dave. I was hoping you Hey, was hoping you guys could talk about what's your NII guide mean for the NIM trajectory. You've got the low rate security rolling off this month. Then you've got the rate cuts coming in later in the year. So there's a thought that you get some expansion here in the first half of the year, then maybe that turns south in the back half of the year. And then what does that mean for the exit NIM by the end of the year? Is that going to be higher than where you were this quarter? Are you thinking that might be lower? And then you mentioned deposit betas earlier. I was just wondering what your guys' thoughts were on how fast you can move those deposit costs down since you were very focused on being proactive, I know, on the way up. Are you thinking you can bring those down just as fast, basically assuming the same type of beta on the way down? Thanks.

Yeah, I guess I'll start with that last question first. You know, I think the thought process is that we could go down just as fast but at the same time, I'll say that we don't ignore the market. I said earlier, we're not going to feel like we need to lead the market, but we're going to be competitive. So, you know, I would answer the question by saying that, yeah, we were up fast. I think we've kept up all along with all the hikes, and I feel like we can be pretty aggressive going down, but we're not going to keep our head in the sand, and if the market's not moving down as quickly as we thought it might, you know, we'll certainly react accordingly. As far as the NIM, I guess what I'd say is that, yeah, we are relatively flat, flattish all year. And so, yeah, I think you said it. We really kind of take a step up in the first quarter as a current expectation. We do have in our projections a cut in March. But so we do take a hike up in the NIM that first quarter. And then really kind of given the conversation that we had earlier, And a lot of it will be dependent on liquidity, right, and what happens with deposits, how much we're keeping at the Fed, et cetera. But right now, our guidance I would give is once we're in the first quarter, the rest of the quarters will be relatively flat. So we get a lot of the help in that first quarter.

Okay. What are you guys assuming for the NII or the NIN impact from a single rate cut at this point?

You know, the answer I'd give you is about a million dollars a month. And again, I think that's one where it'll be dependent on what happens with how much liquidity we've got at the time it happens. Could be more if there was more liquidity on the balance sheet.

How are you guys thinking about managing the securities book through the year? I know you didn't purchase anything this past quarter. You've got the securities rolling off this quarter. Is the thought to just let that run off this year, plowing any kind of cash flow into loans or paying down borrowings, that kind of thing, or are you gonna be replacing some of that along the way?

Our current expectation is that, I think I said earlier that we're projecting about $3 billion in cash flow from that portfolio. Right now we're projecting that, I'm sorry? We're projecting that $1.5 billion to $2 billion is what we would reinvest, more likely closer to the lower end. And we're really just kind of saying, you know, we've got our investment guys who really are paying attention to the market, and we'll just look where there's value, and we'll continue to try to be opportunistic. I think we've been successful in a lot of cases, and, you know, we'll just have to see what's happening. But that's what our current expectation is, is We spend about half of that liquidity. You know, we feel good about deposits, like I said, but, you know, kind of would like you know us well enough to know that we tend to keep a pretty high level of liquidity. But that's our guidance. You know, we'll spend about half of it.

About half of the runoff.

About half of the runoff, right, half of the billion and a half of the $3 billion that we expect.

Got it. And maybe just one last one. Where are you seeing securities yields at this point? I know they'll change through the year, but I'm curious.

Yeah, we're not buying anything. I think that the last time we talked, we were looking at mortgage backs, and I think they were a little bit, gosh, I almost hesitate to say, yeah, we really haven't been spending a lot of time with it. Our investment guys are. We haven't made any purchases yet. for two quarters now, but certainly north of five, and nothing's really enticed us. We just kind of want to see how this first quarter plays out. But if we do see something where we think there's real value, the good thing about an organization like ours is that the group that makes those sorts of decisions works very closely together. We're meeting all the time and certainly could make a decision really at the snap of a finger. So our guys are keeping their pulse on the market, but at this point, really haven't felt a lot of pressure that we need to do something today. Great.

All right. Thanks, guys. Sure.

Our next question is from Manon Gasalia with Morgan Stanley. Please proceed.

Hey, good afternoon. Good afternoon. You know, follow up to the question on liquidity. I mean, I guess if rates come down in line with the five rate cuts or so that you're estimating, non-interest-bearing deposits stabilized. Can you deploy more of those high levels of liquidity that you're keeping on your balance sheet? I know that the deposit rate of your forecasting is lower than the loan growth that you're forecasting, so presumably you will use some of that, but can you bring that 14%, 15% of assets and cash down meaningfully as we exit 2024?

I think it depends on what meaningfully means. You're never going to see us running with a billion dollars at the Fed, for example. That's just not the way we operate. But could we make some decisions that had us potentially, especially if we felt good about the economy, we felt good about what was going on with deposit growth and such, could we find ourselves in a position where we were deploying more of that liquidity? I'd say yes. But it's going to be dependent on a lot of factors, what's going on in the economy, those sorts

Got it. And then given your comments on expenses earlier, and there's some one-time or temporary nature of some of the expenses that you mentioned, at what point do you get back to positive operating leverage? So I know there's a bit of noise in the revenue line this year with the base effect of rising rates in 2023 and then the rate cuts in 2024. But if rates stabilize from there, how quickly do you think you can return to positive operating leverage?

You know, it's a math question. Honestly, I don't know the answer to, but here's what I do know, that the success that we're having developing these markets, as expensive as it is, will create significant positive shareholder value. Now, does that, you know, manifest itself in a positive operating leverage, you know, trend? Probably, but honestly, I'm not close enough to the math to tell you when it would happen. But it's, at some level, it's just basic business, and it's just a recognition of what we're developing and understanding the basic profitability of a of a regional community middle market-focused bank, because that's really what we're creating in these markets. You know, we're creating footprints that basically look like Frost Bank. And so, you know, whatever that profitability is for a bank like that, that's what we're generating. And I think that's going to be – that will be positive for a long time. And I'm confident we'll get back to, you know, to operating leverage markets positions that reflect that. Now again, like we talked about earlier, as long as we're continuing to do this and finding markets where it makes sense to grow and develop this for shareholders, depending upon how much we do in any one particular year, it can affect operating leverage on a particular year, but I think it would be wise for us to also look at what What is the operating leverage of what I would call the legacy company, the legacy bank? What is that doing as we're expanding in these markets? That's worth looking into also.

Yeah, we'd love some disclosure on that if available, but thank you for those comments.

Thank you. Our next question is from Peter Winter with DA Davidson. Please proceed.

Good afternoon. Cherry, you gave a little bit of a cautious outlook on fee income being relatively flat. You talked about the regulatory environment with overdrafts, fees, and interchange. Are you guys taking action on this now ahead of any regulation, or you just think it's going to be coming down the road this year?

Well, I'll talk about two pieces of it. You know, the thing for us on the overdraft fees is something that, you know, it's not going to be a growth product for us, right? The reason those revenues are growing is because we've had consistent account growth. We continue to do changes to the product to ensure that we're doing what we need to be doing from a fairness standpoint, and making sure we're serving the customers with grace. And so we're doing a lot of things beginning in 23 that those impacts haven't run completely through the annual financials for 23. And then we've got some additional items that we're considering doing to tweak the product that are telling me that all things being equal, we're not going to expect to see a lot of growth in those overdraft fees. On the interchange, that's really going to just be dependent. Our projections right now have those changes going into effect in the latter part of the year, so just based on the proposal that was out there. So we're not, you know, on the OD side, we're doing things that we're affecting that revenue ourselves by making some changes to the product that we're delivering to the customer, which is going to reduce our revenue. In the case of interchange, it's really based on the anticipated one-third reduction in those fees later this year. Okay.

Thanks.

So those are the headwinds that we're dealing with.

Got it. Thank you. And then separately, the earnings accretion from the Houston expansion has been really taking hold and becoming more accretive. Do you think that the Dallas expansion starts to become a creative for earnings this year? And then secondly, are there opportunities maybe to close some underperforming legacy branches to defray some of the costs with the new branch build out?

I'm going to step back a second on your question on non-interest income. The other thing that's affecting us, and I mentioned just one item in the quarter, you know, on the sundry income. We did have some nice sundry income throughout the year that we don't really project those sorts of items into our financials. So this $3.5 million recovery of a fraudulent wire that we had in the fourth quarter, obviously we've got items like that that go through our non-interest income that we don't forecast. And so that obviously has a downward effect, too, on our forecast going forward. As far as the Dallas is concerned, Our expectation is we're still opening locations in Dallas. As you know, the most expensive part of this expansion effort is just starting up those locations. As Phil said, the first one in Houston just reached its five years. As I talk about that profitability, we're really happy with where we're at. When I look at the individual pieces of it, and we're not ready to disclose overall kind of how we're doing. But the plan was, and it's working this way, is that as those Houston locations begin to mature more and more, they're going to start to offset the losses that we have associated with the expansions that have started more recently. So, you know, it's getting to the point where, you know, where Houston is going to carry more of the expansion costs of, you know, the Houston 2.0 and the Dallas. But Dallas, no, to answer your question, I don't see them being profitable this year just because we still have locations that we're opening, and there's not a lot of maturity yet. You know, although, as Phil said, man, they've performed really, really well. So as far as our projections to or our performance to our goals, we've done really well. But, no, we're not in a point where we say Dallas is going to be profitable next year. We are saying that Houston is paying more and more of the expansion that we're doing in So it's really working as we planned as those branches mature, really helping us pay for future expansions.

Great. Thanks, Jerry.

Sure.

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

Hey, thanks. Good afternoon, guys. Hey, Brady. Hey, Brady. I just wanted to circle back to the loan growth guidance to make sure we're understanding that right. the mid to high single digits, are you saying that's on an average basis, full year over full year? Correct. If you didn't grow loans a single dollar, you'd already be up 5% on an average year over year. So on an end-to-period basis, if you look period end to period end, that loan growth will take a decent step back from the 10% you did last year?

You know, I guess what I would say is that, you know, obviously we tend to rely more on the averages than we do on the period ends. But, you know, the guidance that we've got, you know, certainly we'll review that as we get through the quarter and as we get through the year. But right now, I feel like that sort of guidance is really very realistic based on what we saw I think this year, if I went back, if I'm remembering correctly, I think the full year average of 24, excuse me, 23 over 22 was a little under 8%. And so, you know, really we're guiding towards something in that arena, maybe a little bit better than that, without knowing exactly what sort of environment we'll be in. So, you know, I think that, you know, we're sticking with it. And, you know, if we can do better than that, that'll be great. And, you know, we continue to... you know, we have plenty of liquidity. We're not holding back. But at the same time, you know, all the deals that we're doing have to make sense to us. And, you know, I think we've been really good about growing relationships that we want to grow. We talked last quarter, I think it was, about an unusual amount of opportunities that have come our way just given from the stability that we have and the liquidity that we have available. But we're just not going to say yes to every deal that we get, right? We're going to be very selective and make sure that that these are the quality sort of relationships that we want to continue to develop. But we'll certainly continue to give guidance, and if it's upward on loan growth, we'll certainly support that. But at this point, this is kind of what we're comfortable with.

You know, just my tag on to what Jerry was saying about, you know, looking at deals and making sure they work for us. If you look at the third quarter and then compared to the fourth quarter, we saw a sharp uptick in the number of or the percentage of deals that were lost to structure versus pricing. We lost 66% of the deals in the third quarter to structure. And that compared to 76% of deals lost to structure in the fourth quarter. And a lot of that in the, I'd say the majority of that would be in the CRE space. So it's still competitive out there. And I think this shows that We're not just going to do whatever deal comes our way. We're still going to be careful making sure it's quality stuff and it's done our way.

Understood. Then my last question is just on the share repurchase. I saw the new $150 million of authorization. I think you brought back about $40 million of stock last year in 23. Should we expect Frost to be active on the buyback in 24th?

You know, I wouldn't, yeah, I think that certainly we'd like to have it available. You know, we'd like to have that tool in our toolbox should the opportunity arise. You know, I wouldn't count on us being significant buyers of our stock unless we really felt like there was an opportunity, something happened. We'd hate to be in a position where we thought we had a great value and we didn't have a program in place. So for us, it's just making sure that if there's some sort of market dislocation, and we think there's a great value for it, so we're able to take advantage of that without having to jump through a lot of hoops.

Okay, thanks, guys.

Our next question is from Brandon King with Truist Securities. Please proceed.

Hey, good afternoon.

Hey, Brandon.

So philosophically, with the expectation of no Fed cutting this year, how are you thinking about managing deposit costs lower You know, compared to your peers, you're a little more proactive with rates on the way up. And I just wanted to know just your insight on how you plan on managing that on the way down, certain account types, exception pricing, things of that nature.

Brandon, we don't. We do very minimal exception pricing. We do some, but it's not a big part of our business. So let me start with saying that. You know, I think we said earlier, you know, when we went up, we went up pretty fast. We reacted very quickly. Thought that that was the right thing to do for our customers. You know, we'll just really look at, I said earlier, I'd expect that the betas that we utilize going up will be kind of the first reaction that we have on a down cycle. But at the same time, you know, we're not going to have our head in the sand. And if there is a competition that that we feel we're competing against is really pricing a lot more aggressive than we are than we may have to react. We don't think we have to be the highest. We're not the highest today. I think we're fortunate in that, you know, having won the J.D. Power Award for 14 consecutive years. I'm looking at, Phil, I think it's 14 or 15, and the head of a consumer is going to get mad at me if I missed it. But, you know, that's based on, you know, customer satisfaction. So it's not all in the rates. We realize that. A lot of it is on customer service and what we do to take care of the customer, both on the commercial and the consumer side, but more on the consumer. And we've got a great app, mobile app, that I think we get a lot of credit for and that we really try to stay on top of and make sure that we're keeping that at the forefront. And so I don't feel like we have to be the highest, and we've proven that in our relatively stable deposit volumes. But we do have to be competitive, and that's what we really keep our eye on the most, is making sure that we're offering our customers a square view.

And Brandon, you probably know better than I do, but I mean, you know, money market funds are probably going to have to be, you know, they're going to be buying a lot of the market instruments, and those things are going to be going down pretty consistent with, you know, declines in rates, at least on the short end. So, you know, I think it's partly our expectation that they're, their movement in rates will be sort of inexorable. And they're where a lot of the competition is right now anyway. So that'll give us some ability to compete better against those particular products. And I think, as Jerry said, if we're competing straight up against a bank, we'll compete pretty well just being close on rate. It won't have to be the highest in the market.

Got it. And that's helpful. And then I wanted to get more insight into your marketing plan and brand refresh. So what are the things that you're planning to do in 2024 that you weren't doing in 2023? And then could you talk about kind of the potential and scale of what you could envision that looking like maybe beyond 2024?

Well, as it relates to the marketing plan, we've really focused on just the look and feel. of our brand, how it looks in the marketplace, and trying to differentiate it from sort of the sea of sameness that's out there. And really trying to reduce the, for sure, the lack of awareness about our brand. And if you are aware, we really want to reduce indifference to the brand. And so we're trying to utilize things that just visually help us. There we're also, we put out some new ads that sort of reflect who we are and some of the amazing stories of customer service that we're going to have. And we do that with a little bit of humor and a wink that's typical of Frost Bank. And so I think the campaign that way is going to be really good. But if you look at it under the hood, I think we've done a lot better job. I know we have bringing in partners that are helping us do a better job with digital marketing and in effectiveness in our digital offerings. And really, that even translates into some of the direct mail pieces that we do, and a lot of that in connection with some of these branches that we're opening in these new markets, making sure that our response rates on that are improving. So we've seen some interesting results. in that with our new partners and i expect that to be something that helps drive uh drive customer acquisition going forward so we'll see right it's um i've learned everyone's a marketing expert let's see if this one works got it yeah i was just just trying to make just trying to get the sense of this is not kind of a herculean effort and just kind of more incremental on the margins no i don't think so i think it's i think it's you know we built our infrastructure in terms of our internal marketing resources and capabilities. So that is something that was really a part of what the expense-based growth was last year. By and large, there'll be some follow-on as those things annualize to a full year in 2024. But a lot of it is just utilizing the market spend that we have been spending but doing it in a more effective way. But it's not the same level of the, I go back to the generational investment that we did in IT. It's generational for marketing, but it's not the same size of that investment as IT was.

Great. Thanks for taking my questions.

Thank you. In the interest of time, we are going to ask that analysts please limit yourself to one question as we proceed. Our next question is from John Picari with Evercore ISI. Please proceed. John, your line is live. Okay. And our next question will be from Brody Preston with UBS. Please proceed.

Hey, everyone. I'm just going to wrap a few into my one here, if you don't mind. Sure. They're all on NII, Jerry, so it should make it a little bit easier. I know you're relying a little bit more on the averages than you are the period end, but if I am working off the period end, it looks like the loans and the deposit should fund the loans, and then you're going to reinvest half of the $3 billion in So you got about one and a half billion of cash flows left over from the securities book, naturally. I'm wondering if that's going to go into just kind of pushing off the remaining, you know, repurchase agreements that you have on board. And then secondly, I was wondering if you all would provide us with what the period end savings and interest bearing is. checking and money market accounts look like, just because it's a little over a week until we get the K, and we've got to update models in the interim there.

Yeah, you're saying just the period end rates?

No, the period end balances.

Oh, the period end balances. Yeah, we can get them here for you, and if we don't get them to you, AB can certainly give those to you offline if you want to do that.

Okay.

I'm sorry. I forgot your first question.

That's okay.

What are you trying to get at? I'm sorry.

I was saying if I look at the guidance and look at, like, the implied period end, I know you're relying more on the averages. I'm wondering, you know, it looks like the deposits can fund the loan growth that you got. I'm wondering what you're going to do with the additional billion and a half.

Yeah, I'm sorry. I apologize. Yeah. So you mentioned repos. So for us, customer repos is really these customers, for the most part, are really long-term customers. And there is a feature within that product that we make available to them that allows them to utilize the product. And so even though it's fully collateralized, they do take a haircut versus the respective MMA rate. And we may do a little bit of exception pricing there. But for the most part, it's really a very successful product for us. There are some transactional pieces of it that work to their benefit and they want to be in that product. But this isn't hot money in any way. These are long-term customers. A lot of them have deposit relationships as well, significant deposit relationships. So, you know, from our end, you know, we've got a significant amount of collateral. It really is a good operating business for us and We don't have any intention of reducing that sort of a product from that sample.

And what do you do with the additional billion and that half of cash flows then?

Yeah, so at this point, what we would probably do and what we're modeling is that we would continue to keep those balances to the Fed. I think I said earlier, we just kind of want to see what happens as far as deposits are concerned, deposit flows. And so from our assumptions today, we're really just increasing our balances at the Fed.

Understood. Thank you very much. Sure.

And our final question is from John Ostrom with RBC Capital Markets. Please proceed.

Hey, thanks for the opportunity. I'm going to tease Brody, but that's just cruel to box him into one question. I'm kidding, Brody. Anyway, just on mortgage, how material do you expect it to be in 2024? You said you're all built out, and I'm just curious on your willingness to hold it on the balance sheet, how big could it be, and do you expect to sell any of the production?

Well, I can answer the last part of it, as we don't expect to sell any of the production. So it's really curious if I have a better feel for But it's not going to be as much, you know, it's ramping up, right? And so I think what we said early on when we started this is we expected in five years it would be, you know, the same as the rest of the consumer portfolio. So at that point I think it was around a $2 billion estimate of what it would be. And so, you know, we're beginning to ramp up. It's a worse market than when we started, right, in terms of what's available out there housing-wise. But I would say it would be... I would, let me venture a guess, 200 million-ish. Okay. And someone in our mortgage department might have just fallen down when I said that.

Okay. All right. So not terribly material, but all on that.

No, it's not huge. It's not wagging the dog, but it is going to be just solid growth as we continue to develop that product.

Yeah. Okay. Thanks, guys. I appreciate it. Jerry, I think you should have said consensus is a little bit low. My calc is a little bit low, not by much, but that's my comment.

I appreciate your input. Thank you, John. Yep, thank you.

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

Okay, everybody. Thanks again for your interest in our company, and we'll be adjourned. Thank you.

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