Cullen/Frost Bankers, Inc.

Greetings. Welcome to Colin Frost Bankers Incorporated First Quarter 2024 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. Mendez, Senior Vice President and Director of Investor Relations. Thank you. You may begin.

Thanks, Jerry. 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, A.B. Good afternoon, everyone. Thanks for joining us. Today, I'll review the first quarter results for Colin Frost, and our Chief Financial Officer, Jerry Salinas, will provide additional comments before we open it up to your questions. In the first quarter, Colin Frost earned $134 million, or $2.06 per share, compared with earnings of $176 million, or $2.70 a share, reported in the same quarter last year. The first quarter results were affected by an additional FDIC insurance surcharge accrual of $7.7 million, or $0.09 a share, associated with the bank failures that happened in early 2023. Our return on average assets and average common equity in the first quarter were 1.09% and 15.22% respectively, and that compared with 1.39% and 22.59% in the same period last year. solid earnings from the first quarter demonstrate the success of our organic growth strategy and the hard work of our bankers. Our strength and stability, combined with our core values and strong corporate culture, allow us to continue providing world-class service to our customers, which results in sustained long-term growth. Our balance sheet and our liquidity levels remain consistently strong. Also, as was the case in previous quarters, Colin 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 uninsured deposit percentages. And additionally, our available-to-sale securities represented more than 80% of our portfolio at year end. Average deposits in the first quarter were $40.7 billion, down 4.8% from the $42.8 billion in the first quarter last year. Average loans grew 10.4% to $19.1 billion in the first quarter, compared with $17.3 billion in the quarter a year ago. We continue to see excellent results in our organic growth program. For example, we combined our Houston locations from the expansion. They stand at 104% deposit goal, 164% of loan goal, and 122% of our new household goal. For the Dallas market expansion, we stand at 174% of deposit goal, 212% of loan goal, and 185% of our new household goal. Just after the first quarter closed, we opened the second new location on our 17-site Austin expansion project. Our next new Austin region location will open just after Memorial Day. At the end of the first quarter, our overall expansion efforts had generated $2 billion in deposits, $1.5 billion in loans, and added over 46,000 new households. And it helps me to put this in perspective when I remember that the largest acquisition in our history was a company with $1.4 billion in deposits. Our consumer banking business continues to build momentum from the 2023's record net new household growth. And we added 6,600 net new checking accounts or households. to the quarter, and we had an annual growth rate there of 6.5%, which we believe continues to put us among the top-growing banks in the country. Average consumer loans saw steady growth in the first quarter, increasing an annualized 13% on a linked quarter basis, and hit a milestone of $3 billion, and average balance is outstanding. We remain excited about the prospects for a new mortgage product, which is approaching 200 loans, with about half coming in the first quarter. Looking at our commercial business, on a linked quarter basis, average loan balances increased and annualized 10.5% to CNI and 13.4% increase to CRE. Our new commitments booked in the first quarter were 24% less than the level booked in the first quarter of 2023. Our new commercial relationships were up 10% year over year, and at 825, represented our highest level of first quarter relationships ever. This coincided with us achieving our highest level ever for calling activity in the first quarter. New loan opportunities in our pipeline were up 15% year-over-year and were second only to the last year's spike after SBV's failure. Our weighted average pipeline stood at $1.46 billion, up by 24% from the fourth quarter and by 17.5% from the first quarter last year. And regarding those 825 new relationships in the first quarter that I mentioned, about half of those continue to come from the too-big-to-fail banks. We continue to use discretion as we look at our new loan opportunities. And as an example, I'd point out that in the first quarter, our deals lost were up by 24% year-over-year, and 82% of those deals lost were due to structure. Credit quality is good by historical standards with net charge-offs and new non-accrual loans at healthy levels. We're seeing some normalizations in credit risk ratings. And as we come off the historic lows and problems experienced in the years immediately following the pandemic and looking at some of the details, net charge-offs for the first quarter were $7.4 million dollars. compared to 10.9 million last quarter and 8.8 million a year ago. Annualized net charge-offs for the first quarter represented 15 basis points of period in loans. Non-performing assets totaled $72 million at the end of the first quarter compared to 62 million last quarter and 39 million a year ago. The quarter end figure represents just 37 basis points of period in loans and 15 basis points of total assets. Problem loans, which we define as risk grade 10, or OAEM, total $809 million at the end of the first quarter, and that's up from $571 million at the end of the fourth quarter and $347 million at the same time last year. Three-quarters of the increase was due to companies specific CNI loans with the remainder being CRE credits of various types. And this growth in first quarter was fairly evenly split between loans in the OAEM or risk grade 10 and classified or risk grade 11 categories and was mainly attributable to a few larger credits, some of which we expect relatively quick resolutions for. Less than 20% of our problem loans overall are tied to investor commercial real estate. About 50% are related to CNI credits, with most of the balance in owner-occupied real estate, which are closely related to CNI 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 consider to be the major categories of investor CRE, office, multifamily, retail, and industrial, for example, total about $4 billion or 46% of total CRE loans outstanding. Our investor CRE portfolio has held up well. with the average performance metrics stable quarter over quarter exhibiting an overall average loan to value and underwriting of about 53% and average weighted debt service coverage ratio of about 1.47. The investor office portfolio specifically, at a balance of $983 million a quarter in, and that portfolio exhibited an average loan-to-value of 53%, healthy occupancy levels, and an average debt service coverage ratio of 1.53, which is slightly improved for the second consecutive quarter. Our comfort level with the 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. In our last conference call, I mentioned that we had just introduced a new Frost Bank marketing campaign and brand refresh designed to emphasize our great customer experiences. We saw the proof points of that in the first quarter when Frost achieved the highest scores nationwide in the Greenwich Excellence Award for the eighth consecutive year, and the highest ranking for banking customer satisfaction in Texas in J.D. Power's retail banking satisfaction study for the 15th consecutive year. These are unprecedented achievements. No other bank can say those things, and I hope no other bank ever will, but when you think about it, That level of service is what our customers have come to expect from Frost. That's what we deliver on a daily basis, and it's what we mean when we talk in the new campaign about real-life examples of extraordinary customer service with the description, exactly what you unexpected. And none of this is possible without the dedication of our employees across Texas. Their commitment to our culture and their optimistic spirit make all of our successes possible. And I'm proud of everything that our Frost teams are accomplishing across all our communities. And now I'll turn the call over to our Chief Financial Officer, Jerry Salinas, for some additional comments.

Thank you, Phil. Let me start off by giving some additional color on our overall expansion results. As Phil mentioned, we continue to be very pleased with the volume we've been able to achieve. Looking at the first quarter, Growth in both average loans and deposits was approximately 9% when compared to the previous quarter. And for the first quarter, the profitability of the Houston expansion offset the cost associated with the additional expansion efforts in Dallas and Austin. Now moving to our net interest margin. Our net interest margin percentage for the first quarter was 3.48%, up seven basis points from the 3.41% reported last quarter. Some positives for the quarter include higher volumes of both loans and balances of the Fed and higher yields on loans and investment securities. These positives were partially offset by higher costs of interest-bearing deposits compared to the fourth quarter. Looking at our investment portfolio, the total investment portfolio averaged $19.3 billion during the first quarter, down $510 million from the fourth quarter. During the first quarter, investment purchases totaled $187 million with $112 million of that being agency MBS securities and $75 million in municipal. The net unrealized loss on the available for sale portfolio at the end of the quarter was $1.59 billion, an increase of $199 million from the $1.39 billion reported at the end of the fourth quarter. The taxable equivalent yield on the total investment portfolio in the first quarter was 3.32%, up eight basis points from the fourth quarter. The taxable portfolio, which averaged $12.5 billion, down approximately $582 million from the prior quarter, had a yield of 2.83%, up eight basis points from the prior quarter. Our tax exempt municipal portfolio averaged about $6.8 billion during the first quarter, up about $73 million from the fourth quarter, and had a taxable equivalent yield of 4.27%, up one basis point from the prior quarter. At the end of the first quarter, approximately 70% of the municipal portfolio was pre-refunded or PSF insured. The duration of the investment portfolio at the end of the first quarter was 5.5 years, up from five years at the end of the fourth quarter. Looking at deposits, on a lead quarter basis, the average total deposits of $40.7 billion were down $459 million, or 1.1% from the previous quarter. We did continue to see a shift, a mixed shift during the first quarter as average non-interest bearing demand deposits decreased 720 million or 4.9% while interest bearing deposits increased 261 million or 1% when compared to the previous quarter. Based on first quarter average balances, non-interest bearing deposits as a percentage of total deposits were 34.3% compared to 35.7% in the fourth quarter. The cost of interest-bearing deposits in the first quarter was 2.34%, up seven basis points from 2.27% in the fourth quarter. Looking at April month-to-date averages for total deposits through yesterday, they are up about $134 million from our first quarter average of $40.7 billion, with interest-bearing up $332 million and non-interest-bearing down $190. $198 million month-to-date. Customer repos for the first quarter averaged $3.8 billion, basically slapped with the fourth quarter. The cost of customer repos for the quarter was 3.76%, up one basis point from the fourth quarter. The month-to-date April average balance for customer repos was down approximately $42 million from the first quarter average. Looking at non-interest income expense on a linked quarter basis, I'll point out a couple of items. Trust and investment management fees were down 1.1 million, or 2.7%, impacted by lower estate fees, down 1.5 million. Estate fees can be lumpy, as they're based on the value and number of estates settled. Insurance commissions and fees were up 5.6 million, or 44%. Property and casualty and benefit company bonuses, which are typically received in the first quarter, contributed 3.4 million to the increase. Benefit commissions were up 2.1 million, as the first quarter is typically the strongest quarter for those commissions. As a reminder, the second quarter is typically the weakest quarter for insurance commissions and fees, given our typical yearly renewal cycle. The other non-interest income category was down 6.9 million, primarily related to 4.4 million in card-related incentives as those incentives are received in the fourth quarter each year and a $3.5 million fourth quarter recovery of a previous loss accrual. Salaries and wages were up $1.4 million as increased salaries and higher incentive accruals were mostly offset by stock compensation expense which was lowered by $8.2 million. As a reminder, Our stock awards are granted in October of each year, and some awards, by their nature, require immediate expense recognition. Benefits expense was up $7.9 million, impacted by higher payroll taxes and 401 expenses related to annual bonuses paid during the first quarter and impacted by the normal trend for FICA taxes and 401 limits reset at the beginning of the year. Other non-interest expense was down 6.4 million or 9.6%. The decrease was driven primarily by donations expense, which was down 3.5 million, and professional services down 2.9 million. Regarding our guidance for full year 2024, our current projections include two 25 basis point cuts for the Fed funds rate over the remainder of 2024, with one cut in September and another one in November. This is down from five cuts in our January guidance. For the full year of 24, we currently expect full year average loan growth in the high single digits. That's up from our previous guidance of growth in the mid to high single digits. Full year average deposit growth in the range of flat to 2%. That's down from our previous guidance of growth in the range of 1% to 3%. Net interest income growth in the range of 2 to 4%, that has not changed from our previous guidance, with the net interest margin percentage expected to trend slightly upward each quarter for the remainder of the year. Non-interest income could be flat to up 1%, impacted by the pressure facing the industry on interchange revenues and OD fees, and also impacted by our high level of sundry income in 2023. That represents a slight improvement from our previous guidance of basically flat. Non-interest expense growth in the range of 6% to 8% on a recorded basis. This has not changed from our previous guidance. Regarding net charge-offs, we still expect those to go up to a more normalized historical level of 25 to 30 basis points of average loan. Regarding taxes, our effective tax rate for the full year of 23 was 16.1%, and we currently expect a comparable effective rate in 2024. No change to this guidance. With that, I'll now turn the call back over to Phil for questions.

Thanks, Jerry. We'll now open up the call for questions.

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 two if you would like to remove your question from the queue. For participants using speaker equipment, it may be necessary to pick up your handset before pressing the star keys. Our first question is from Casey Hare with Jefferies. Please proceed.

Yeah, thanks. Good afternoon, everyone. I guess starting off with the NII Guide, So, you guys are leaving it intact despite, you know, you getting less cuts. The loan growth sounds like it's coming in a little bit stronger than even your revised high single-digit guide. So, I guess it's just the higher funding cost pressure that's keeping it intact, just a little more color on the NII dynamics.

Yeah, that's certainly some of that. And also, you know, we're talking about, you know, higher for longer. You know, as we've talked about the competitive fields out here for deposits, I think the longer that rates stay higher, I think we'll continue to see more pressure on deposits. We've been talking, obviously, for a while now about – customers looking for higher yield and I think that pressure will just continue. We continue to see that especially in the non-interest bearing side where people continue to move their deposits. We continue to see a little bit downward trend there and I think just the uncertainty there is going to make us just stay with our original guidance even given the cuts, the reduction of a couple of cuts.

Okay, great. And maybe just following up on that, so What is your NII guide assume in terms of DDA mix? I believe it fell to 34%. And then what about betas from here?

Yeah, the betas really at this point, you know, we're not assuming because we don't have any rate hikes in them, we're not assuming any significant movements in the betas. I think our cumulative beta moved up from, if I remember correctly, we were at a 42 and we moved up to 43. I'd expect that we'd have that sort of potential pressure. We're not seeing a lot of movement in the interest-bearing, the non-time accounts. We tweaked some downward, actually, a little bit. So at this point, you know, you may see that same sort of increase of 1% quarter over quarter, but I don't expect that to change drastically. Of course, we'll continue to keep an eye on what's going on in the market. I don't hear nearly as much crazy CD pricing as we've heard, call it four, five, six months ago, but there's still some stuff out there going on. So from that standpoint, you know, I expect some pressure on the beta, but I don't expect it to change significantly.

Okay, and the DDA mix at 34, it sounds like there's more pressure. Just wondering how much more. Yeah, I would think that, yeah.

Yeah, I would think there'll continue to be pressure there. I don't expect it to, I expect that it would move down a little bit, but I don't expect a drastic change at this point. You kind of heard the movement that we have in that category was down a couple of hundred million year to date. And as a reminder for us, the first half of the year, Historically, and maybe these are not historical times, but historically the first half of the year is always soft reports on DDA. And so that's not really unusual to us. I think I mentioned in the January call we were already seeing DDA down, you know, probably 400 million between the time of the call compared to the fourth quarter average. I think what we continue to do is we just continue to be focused on growing relationships You know, I think we really feel very comfortable with what we're doing, the successes that are being reported out there, and we'll just continue to keep, you know, plugging along with that. There's not a lot we can do. Customers are looking for higher averages, and we're going to do what we can. But I would expect, back to your question, I would expect there might be a little bit of pressure for that to go down a little bit as well.

Thank you.

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

Hi, everyone.

Steven.

Maybe to start, so to follow up on Casey's question on NII, Jerry, last quarter I thought you said that NII up 2% to 4%. I was assuming 5 rate cuts. But if we didn't get any cuts, we would add like 1.5% to that. increase, is it still the same? If we get no cuts this year, do you think at a percent and a half above, or has that potential improvement lessened now?

You know, it probably lessens a little bit now. Part of it, again, is, you know, when we're talking, you know, this whole conversation is about the non-interest bearing deposits, and obviously that's a big impact on that number. So, you know, given what the pressure that we saw there, a little bit more than we expected in the first quarter, and, you know, as I responded on the previous question, not really ready to increase our guidance, it's really more related what happens there, and I think that'll really drive a lot of it. The month of April, like I said, doesn't look unusually bad, and You know, it's a little tough to really address all of this because for us, from a cyclical standpoint, this is where we would typically be. You know, we'd be a little bit softer, and we've kind of said that for a while now that the first half of the year would be softer. So, yeah, at this point, we'll just kind of have to see where it plays out. But, yeah, I think the big swing factor is what happens with those DDA volumes. Got it.

Okay. And then, thank you, on the long-growth side, so you guys had solid long-growth. and really in a quarter where the industry has not much loan growth to speak of at all, how much of the loan growth is coming from current customers borrowing more, really a sign of the health of the markets, versus just pure market share gains, like new customers to the bank?

You know, Stephen, I don't have that number at hand. I can tell you what some of the new customers have done to long growth. Jerry can help me out with that. Just to talk a little bit about it, it was interesting that a lot of the activity we saw in pipeline increase was customer related. And as opposed to prospects, I thought that was interesting. And And I think also an area that we saw is that core loan growth, the under $10 million relationships, I think the activity there was better than the large loan deals. And I think that reflects our expansion growth. And so it's pretty broadly based. And so that's what we're seeing. One second, I might be able to... Some info on the relationship impact.

I guess what I'd say is from the numbers that I'm looking at, it looks like maybe about a, you know, let's talk about the period end growth between December and March. About a quarter of it, I'm going to say, is related to new customers.

I just did find what I was looking for. In the first quarter, we added $145 million in new loan balances and $100 million in deposits from new relationships over the last 12 months. That's about a quarter.

About a quarter. Yeah, part of the reason I ask, you know, even though the industry has fairly modest growth this quarter, quite a few banks are coming out pretty bullish to seeing pipelines build. And you guys are already up low double digit in terms of year over year on loan growth. Jerry, I know you said high single digit, but if you're seeing the same pipeline build, it would seem that puts you in a pretty good position to maybe even do better than high single digit. Do you just want to be conservative here?

You know, I think, you know, I guess if you're asking, could it move up to, you know, the low double digits? You know, I think what we're hearing in some of it is that we could, obviously, but, you know, just hearing some of the conversations with the regional presidents, I mean, there is a little bit of slowness going out there. Some of this growth is coming from commitments that were originated last year. So although everybody's still pretty bullish, there's a little bit still of, you know, concern about what happens to the rest of the year. So, You know, could it happen? Yeah. I mean, the numbers are trending really well, both on a link quarter and a year over year. I think we were, both of them were north of 10%. So we could kind of tweak up into, you know, instead of a, you know, a nine, could we be a 10% or 10 and a half? Certainly. But again, you know, we are getting, we are hearing a little bit of a word of caution from some of our guys out in the field.

I've seen here a couple of, forces, you know, are there a few forces that are on the positive side, some on the negative. You know, I just talked to some of our people about how it looks. I've just done some calls yesterday, got back from it, and their opinion was that they're seeing good activity. And there is kind of a bifurcation of the, you know, the high end of the market's doing really well, and some of the low end is under some pressure. But, you know, so those offset them significantly. themselves a little bit but you know activity is good but we're also being careful on what we're seeing in structure like I said we lost 82% of the deals lost with in structure I think as we see some of the banks getting back in the game you know they're getting back to where they were before I guess and a little bit more aggressive than we'd like to be so that'll be a little bit of a limiter on us if the market gets out of hand But overall, I think it's got a good outlook. And one of the reasons is because, you know, that pipeline information that I showed you, you know, like I mentioned a few minutes ago, just the growth in the link core pipeline was strong. The number of new relationships is strong. So we're doing well competitively. And I think the market in Texas is still reasonably good. I think Jerry's right. continue to be a little bit circumspect around the election probably might impact what some people are willing to do until they get the lay of the land regulatory what they're going to be looking at but I probably felt that a little bit more cautious last quarter but interestingly what I've heard recently has been pretty good sounds good thanks for all the color thanks

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

Hey, good afternoon, guys. Back on the NII guide, I was just wondering what your assumptions are for liquidity trends. You're baking into that. It sounds like you made some securities purchases this quarter. Is the plan to grow that book some from here to reduce some of that cash and take some of the asset sensitivity off the table? And if you have those purchase yields on those different segments, that would be great.

Sure. Yeah, let me give you those purchase yields first. I've got those right here. So in the agencies, we bought at a 549, and the municipals at a 518TE. What we're doing right now is I don't see liquidity moving very much during the year. Loan growth has obviously been better than we expected. We have been targeting investment purchases of about $1.6 billion, is I think the guidance that I've given, $1.5 billion for the year. We're talking about scaling that back somewhat. Part of it is we just want to continue to be opportunistic in this environment. And so you'll probably see us. I don't know that it will affect the liquidity number much, but I'm thinking that we probably won't reach that number this year. We'll probably be a few hundred million shy of that. You know, like I said, loan growth's been better. Deposits, you know, like I said, a little bit softer than we expected, even on the non-interest-bearing side. So all things being equal, I think the net-net of it is you won't see a whole lot of change in the liquidity. And if there's a bias, it's probably a small bias to increasing that somewhat. Yeah.

Okay. And then just on your comment of less NII upside and a higher for longer type of scenario, I was just curious where – that NII sensitivity is now on delaying a cut. I think last quarter you mentioned something like roughly a million dollars of benefit each month. What is that now, roughly?

Yeah, I think a lot of it depends on timing. When we look at it, you know, again, the cuts that we've got in our models are, you know, in the second part of the year. So, again, depending on what's happening with balances at the Fed, I'd say that number's probably, and again, assuming they happen later in the year, it's probably closer to $1.4 million a month benefit.

Okay. On a pre-tax basis. Yep, pre-tax. Okay. Great. And then on just credit, you mentioned maybe, if I heard this right, a few larger credits impacting the problem loan trends this quarter. I was just hoping to get some detail on those. And then where are you on your office reserve ratio at this point?

Okay, well, let me take the question with regard to the increased problems along with which risk rate 10 and higher. You know, as I said, it was industry or company-specific related. There was... And I've talked about some of these before. There's a large construction company that missed some bids in one segment. They're actively looking for a refinance now, but we need to recognize that a risk rate 10 in the interim period. There was a factoring company that we increased risk rate 10 just because of some perspective on borrowing base, computation, et cetera, we decided we're not all on the same page. That was one of them. There was a truck hauler we saw have some issues with regard to volume. There was a company that moved into a brand new facility, a fairly significant facility. They're getting used to that. They had an operating loss in the near term as they moved that over, so I need to recognize that until they turn that around. Those are the things. They're more, like I said, company specific. They're not really so much interest rate related except for the things that relate to use cars primarily, the buy here, pay here dealers. That's true both for consumer on the car side and also on the trucking side. That's the closest thing to an interest rate impact that we've seen. So we've had some of that, but that's not new for us. We've been talking about that for the last few quarters. But that's the kind of thing that we're seeing.

Appreciate the color. And then just on the office reserve ratio at this point, if there's any update there.

Sure. Yeah, what you'll see in the 10Q is we don't give a very detailed view there. I think the commercial real estate reserve coverage is like at a 148. But some of what we do with the overlays, just to give you a little bit of the inside baseball there, is that for, and this is for non-owner occupied and construction office buildings under construction. So, you know, the highest, or the best, or the worst, I guess I should say, pass grade credits, that we give them a 5% reserve. And then anything worse than that, so if you start getting into, you know, a 9, which is a watch, and a 9 and worse, they actually get a 10% reserve. So as I look at these numbers on a combined basis, that brings the – and this, again, this is only investor office and any office buildings under construction. That combined reserve would be at a 372 is what I'm sure. Great.

All right. Thanks for all the call, guys. Appreciate it.

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

Thanks. Good afternoon. I just wanted to, Phil, if I could follow up on the problem loan discussion. If we're in this higher for longer rate environment, because I heard your comments that these aren't interest rate related yet, but the longer that we're in this higher for longer rate environment, do you see more pressure on CNI loans and continued increases in the problem loans sector?

I don't see anything that's significant or a trend for the higher for longer on the CNI piece, to be honest. Again, with the exception of some of the auto dealers that I talked about who are running portfolios credit and having some issues there, I don't really see that so much. I think the impact is going to be more on real estate, commercial real estate, and what people – what they were financing at before and where they are today. And those things are going to have to be solved by borrowers and sponsors coming in and supporting their projects, you know, when they come to maturity. And so far, we've had really good experience, really good performance by our borrowers. But, you know, we could create scenarios where interest rates went higher and created more pressure, but we're not seeing that right now.

Okay. And then just separately, the insurance commissions, it had really nice growth in 23. It was up almost 10%. But the first quarter, year over year, it was down 3.5%. Is there anything unusual this quarter, or just how are you looking at that on a full-year basis?

Yeah, the one thing I'll say on the comparison to a year ago, so the first quarter last year had a very strong life insurance commissions. So we were probably unfavorable this quarter in that comparison by about a million-one. And the commissions on those policies are just one-time, you know, you earn a one-time fee. It's not like, you know, benefit commissions or property and casualty that tend to be a little bit more of an annuity. So that was a little bit lumpy. That was probably the biggest thing that affected us negatively compared to the first quarter last year. Although I'll say that benefits commissions was softer than I expected as well.

Thanks, Jari. Sure.

Our next question is from Catherine Miller with KBW. Please proceed. Thanks.

Good afternoon.

Hey, Catherine.

A question on expenses. I know that you left your expense guidance unchanged at the 6% to 8% growth rate year-over-year. I'm curious. I know you mentioned that FICA taxes and some kind of 1Q seasonality drove the higher expenses this quarter. Should we assume that we kind of fall back from this first quarter level as we go into second quarter and then grow from there? Or do you still think you grow from this run rate into next quarter?

Yeah, I think a couple of things I'll say is that, you know, we did get the additional surcharge of $7.7 million from the FDIC that we didn't know anything about when we gave the guidance in January. And we've been really trying to run a tight ship here in this first quarter on expenses. You know, again, we are certainly impacted by the expansion that we're doing. And so we kept our guidance the same, even though, you know, we were basically saw an additional almost $8 million in expenses that we hadn't expected. And your question was a little muffled, but I think I heard you say, you know, that maybe the first quarter was higher. from the benefits maybe. I think benefits, you know, tends to go down during the year. A lot of it has to do with things like 401K contributions, matches that we have to make or payroll tax matches. In certain cases, employees, especially on the 401K side, may reach that limit pretty quickly, intentionally or unintentionally. And so then our We match up to 6%. If they reach that level, then, you know, the match stops. The same thing for the FICA. After they reach a certain level, of course, there's no more contribution there. But so benefits will go down certainly just trend-wise. I don't see the, you know, the trajectory that we have. You know, other than, you know, if you take the $7 million out, I would expect that, you know, you'll see a little bit of growth quarter over quarter in expenses based on what we're seeing today. But like I said, I feel good about where we're at. I think we've done a good job this first quarter and continue to try to do that. But I would expect that they will continue to grow up just a little bit quarter over quarter.

Yeah, that's helpful. And to be clear, that 6% to 8% includes the $7 million FDIC assessment.

Exactly. Yeah, we assumed it's operating, if you will, for those purposes. So the $51 million is in the number in 2023 because it's on an as reported, and the $7 million number is included in our 24 numbers.

Okay, great. And then maybe a question on fees, service charges. Seasonally also is usually lower in the first quarter, but I know you've talked about interchange and some other things being softer in the first quarter. So would you expect that to also increase as we go into the next couple of quarters, or is this also a good kind of lower run rate for service charges?

Yeah, I think that the thing with service charges, the upside to it has been the commercial service charges. In some cases, you know, it works against you, right, because in some cases customers may decide to pay more for services through hard dollar charges rather than through keeping the balances. So that's some of it, and so that's been impacting the growth. But, you know, we've done a lot of things. I will say in favor of the customer as it relates to, especially on the consumer side on OD fees. And we continue to see good growth there, but a lot of it, as Phil mentioned, you know, we're just blowing those accounts pretty significantly. And, you know, I really kind of try to say that I don't expect those are going to grow. And obviously there's some guidance out there, potentially a lot of pressure that, you know, on that, on those fees. So, you know, we've really been, I will say in some ways pleasantly surprised, but I don't see that having a lot of growth from where we are today. You know, I think it'll just continue to be pressure in that category for the rest of 24. It's kind of the numbers that I'm seeing right now.

Very helpful. Thank you.

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

Hi. Good afternoon. I wanted to ask about deposit pressure. Most banks spoke about how deposit pressure eased in the first quarter. Do you think there's something related to your specific customer mix or the fact that you are accelerating growth in new markets? What do you think is driving that incremental pressure on deposit costs for you guys relative to what we're seeing in the broader market?

You know, from a cost standpoint, I will say that, you know, we're really not feeling, you know, from a market standpoint, not feeling a lot of pressure on the deposit costs. We need to be competitive, and we are. I think we've got to, you know, we've decided we're competing primarily on the 90-day CD. It's really more the pressure is coming on the non-interest bearing, and I think it really just continues to be the scenario where, you know, rates at these higher levels continues to put pressure, both on commercial customers, and consumer customers of looking for balances. I will say that when we look at the balances, especially on the interest-bearing side, and it's true I think both in consumer and commercial, is that we have seen increases from February to March, small increases, and then March to April as well. on that interest-bearing side. So I think competitively, pricing-wise, I think, you know, things are going right. I think, you know, historically, like I said, our balances just tend to be softer in this first quarter. But, you know, we're going to compete on the pricing. You know, we're not going to be the highest. We've never intended to be the highest. But we do keep an eye on what's going on there, and we make decisions, obviously, on where we want to compete. But as I said earlier, we're not seeing a lot of pressure from on what I'll call the interest-bearing non-CDs, if you will, so the MMA specifically, not seeing a lot of pressure there yet competitively. So we really haven't moved those rates for a while now.

Got it. And then maybe on the loan side, you spoke about the deals lost being up because of structure. Where are you seeing this competition coming from? Is it private credit? Is it other banks? Is part of the reason for maybe the weakness in NIM because you're skewing to higher quality and lower yielding loans right now?

First part of your question, I'd say it's mainly banks that we're seeing. And it's the same old story. You know, it's guarantees, it's loan values, it's, you know, terms, all that. So there's some of that. I don't know, you know, where it could be, you know, certainly vis-a-vis private credit, you know, we're getting lower yields than they're able to achieve, albeit with higher risk on your case. But, yeah, you're probably going to see that we've got a little bit lower yield on average, but not by a lot, because we tend to be on the higher quality piece of the credit curve.

Got it. Okay. And if I could just have a clarification on one of your comments on the security side. I think you said the duration of that book was up about half a year to 5.5 years. Okay. Is that entirely from the move up in rates or are you taking on a little bit more duration to lock in the benefits of higher rates?

No, like I said, we really didn't do a lot of purchases in the first quarter. I think some of it was that we had about a billion dollars in treasuries that were, you know, at the end of the year, let's say call it $750 million of it, that were maturing the first few days of January, so that was affecting it. And I think there might be a little bit more extended duration on the mortgage facts, but we haven't added a whole lot of duration with anything that we've done in the first quarter.

Great, thank you.

Our next question is from John Armstrong with RBC Capital Markets. Please proceed.

Hey, thanks. Good afternoon, guys. A couple questions. Phil, should we expect the potential problem loans to continue to migrate higher, or is that not necessarily true?

Yeah, John, the... First of all, I'll say problem loans, right? The old potential problem loans is a category that we don't use anymore. But with a risk rate of 10 and higher, should we expect an increase? I would say maybe. And the reason I say that is because we were at such low levels. Really, the industry was at unsustainably low levels with everything you know, coming out of the pandemic for credit quality, right? And so we're still not where we are, I would say, normal. But we are seeing what I would call some reversion to mean. So that would tell me, yeah, we probably ought to expect it to go up some. At the same time, some of these that we've added, you know, We're looking for some, you know, reasonably quick turnarounds on that. I mean, we just try to be realistic with these risk rates that we're adding. And, you know, it's not a death sentence or anything. It's just recognizing that we perceive some elevated risk. But we do work on them. They work to get to correct, and the companies work to correct. And so I'm hopeful that with some of these that we brought on this time, we'll see them move out. But we could also see some more move in because, again, we're really coming off at really unsustainable levels. So that's why I say maybe. I'm not concerned with credit quality. I mean, I know I'm paid to worry as a cross-banker, and so I guess there's that part of me that's always going to be concerned with it. But, you know, I think credit quality is good. I mean, we spent a lot of time looking at our commercial real estate portfolio and you know, very granular level. And, you know, I'll just tell you that, you know, probably if somebody said Austin office building, you know, they would run for the hills. But I'm going to tell you, I think our Austin office building portfolio is solid, man. You know, I've looked at the, you know, I've looked at, I've looked at the multifamily deals. People would say, oh man, Austin, you know, it's got It's got reduction in the interest rates. You know, the housing prices have come off 11%. You know, got a lot of supply coming on, et cetera, et cetera. But I look at our multifamily and the Austin market, I feel great about it. And so it depends on the deal. It depends on your sponsors, how they're operating. As far as the Austin house prices being down 11%, they're up 50% over the two years before that, right? So. I mean, there's this headline stuff, and then if you really look below it and you spend time on it, I mean, I feel great about the commercial real estate portfolio for us. Our people have done a heck of a job underwriting it, and part of the reason I feel great is the same reason that we lost 82% of the deals to structure this quarter. Our folks know how to book these things. That doesn't mean we won't have problems, and I'll talk to you about some that have popped up and all, but Not something that gives me any worry. I think it's interesting what's happening with the, you know, the company-specific stuff on the CNI side. We're going to have to see whether or not we continue to see things pop up there. And some of these guys may not be able to solve their problems, you know. But, you know, most of them will. But that's just banking, you know. It's a risk business. And I really think we have a handle on it. Anyway, just felt the need to say that.

Okay. Yep, yep. So it doesn't sound like you guys feel the need to build reserves from here. I mean, I hear your charge-off guidance, and I respect that, but it doesn't feel like you have more pressure coming, at least in your mind, in terms of credit.

I don't feel it right now. I mean, you know, can we – Can we see it get worse? Sure, sure it can. Jerry can speak to the formula better than I can. But I think we feel really good about where the reserve is today. And I think another thing I might say about the reserve is you might recall, you know, we built it up during that COVID period, and we never took it out.

And so, you know, I think it was – Yeah, I think that's a little bit different than others. Yeah, we pretty much stayed there in – We really haven't. If you look at our reserve coverage percentage, it really hasn't moved around very much. And, you know, I wouldn't expect that it'll, you know, it's going to move, you know, a couple of basis points here and there. But I don't envision at this point any significant reason that we'd see that reserve number increasing. Again, you know, if you're assuming a pretty normal sort of credit quality environment.

Yep. Okay. Jerry, as long as you have the mic – You changed the presentation of the expansion contribution for the quarter. If you can share it, what kind of contribution did Houston 1.0 have this quarter?

Yeah, I think it was. Last time we rounded to seven, let me make sure I was going to say, I think we rounded to six this quarter, but let me just check. Yeah, that's exactly right. They were seven cents last quarter, six this quarter.

Okay. And the... When you say Houston is funding Dallas and Austin, that's 1.0 and 2.0, is that right, together?

Correct. Yeah, I was just netted the two, and I was trying to keep it simple. Maybe I confused it. Yeah, Houston together is funding the other expansions. That was really, as we had talked about this and planning it out, that was certainly the way we hoped things were going to work out, that if these financial centers began to mature, they would begin to pay for the future expansions, and it certainly worked out that way.

Yeah, well, that's great. Those are great numbers. So, okay. Thank you. I appreciate it.

One comment I'll make that Catherine had asked about expenses. And one thing I wanted to clarify, and I made a comment in my comments about the late quarter in salaries. So for us, a lot of the stock awards are given in October. And so they do affect the fourth quarter. And so typically, salaries for us are higher in that fourth quarter. And because by their nature, a lot of these stock awards immediately pass and, as a result, are immediately expensed. So I think if you looked at the growth in salaries expensed between the third quarter and fourth quarter last year, you'll get some sort of expectation-wise what you might expect to see between the third quarter and fourth quarter this year. just to give a little bit of a better color there.

In the interest of time, we're going to ask that you please limit to one question and one follow-up question. Our next question is from Abraham Punwala with Bank of America. Please proceed.

Hey, good afternoon. Just one very quick one, Jerry, for you around the securities book. Sorry if I missed this. Should we expect, one, the securities securities portfolio to grow from one Q average levels or stay flat? And second, could you confirm I think you mentioned you have another billion dollars of security that you expect to buy what the pickup in the yield is on the investment versus what's rolling off? Thank you.

Good. Yeah, I would expect all things being equal. We may be down a little bit, but it's going to be relatively flat. We're expecting cash flow, I think, of about a billion, too. And the weighted yield of those are about a 226. And that's impacted somewhat. We've got 500 million that doesn't mature until the fourth quarter, and those are some Treasury securities at 96 basis points. And, you know, right now I think, you know, you heard kind of what we were buying. I would expect that, you know, if you're talking about something in the 5.5 versus that rounded to, you know, 225, you've got some nice pickup potential there.

So does that imply, Jerry, that NII should keep growing from the first quarter levels as we move through the year, and fourth quarter we'll probably see a lift again from the securities yield going higher?

Yeah, that's kind of what I would expect, yeah, that the net interest income is on a little bit of a positive trajectory. I think for us the low was probably last year sometime in the, I would say, second or third quarter.

Perfect. Thank you.

We are kind of expecting small pickups for the rest of the courts moving forward.

Got it. Thank you.

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.

Okay. Well, we thank everyone for their interest and we adjourn. Thank you.

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