Cullen/Frost Bankers, Inc.

Greetings. Welcome to Colin Forrest Bankers, Inc. Second Quarter 2024 Earnings Conference Call. At this time, all participants are in a listen-only mode. A brief question and answer session will follow the formal presentation. If anyone should require operator assistance during the conference, please press star zero on your telephone keypad. As a reminder, this conference is being recorded. I would now like to turn the call over to A.B. Mendez, Senior Vice President and Director of Investor Relations. Thank you. You may go ahead.

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

Good afternoon, everyone, and thanks for joining us. Today I'll review second quarter results for Colin Frost, and I'm accompanied on the call by our CFO, Jerry Salinas, and Dan Geddes, who will offer additional comments. Before I discuss the quarter, I'm sure you all saw our recent announcement of Jerry's retirement as of the end of the year after a brilliant career of almost 40 years at Frost. Throughout that time, Jerry's been a part of virtually every major initiative that we've undertaken, and I've been blessed to work with him during that entire time, and he will be missed. And rest assured, we plan on squeezing as much work out of him as possible before his well-deserved retirement. Jerry will be succeeded as CFO by Dan Geddes, who joins us on the call today. Dan has broad experience over his 25 years at Frost, having served in the credit function, headed our commercial real estate division in Houston, successfully executing our initial organic expansion strategy in Houston 1.0, and in leading the San Antonio headquarters market as regional president overseeing all our commercial activities there. In the second quarter, Cullen Frost earned $143.8 million, or $2.21 a share, compared with earnings of $160.4 million, or $2.47 per share, reported in the same quarter last year. Our return on average assets and average common equity in the second quarter were 1.18% and 17.08%, respectively. and that compares with 1.3% and 19.36% for the same period last year. These results are due to our Frost bankers and are continuing to execute on our organic growth strategy. Average deposits in the second quarter were $40.5 billion, down 1.2% from $41 billion in the second quarter last year. As was the case in previous quarters, Cullen-Frost didn't utilize any federal home loan bank advances, broker deposits, or reciprocal deposit arrangements to build insured deposit percentages. Average loans grew by more than 11% to $19.7 billion in the second quarter, and that compared with $17.7 billion in the second quarter of last year. I'll now call on Dan Geddes to review the results from our expansion programs.

Thank you, Phil. I echo your sentiments about Jerry. His will be very big shoes to fill, and I look forward to leveraging his institutional knowledge as we move through this transition period. We continue to see excellent results in our organic growth program. For our Houston expansion on a combined basis, what we call Houston 1.0 and 2.0, we stand at 102% of deposit goal, 142% of loan goal, and 119% of our new household goal. Breaking out the two, Houston 1.0 stands at 97% of the deposit goal, having recently experienced similar commercial deposit trends as the legacy company, 142% of loan goal and 117% of new household goal. Houston 2.0, which we expect to complete later this year or early in 2025, we stand at 205% of deposit goal, 142% of loan goal, and 158% of our new household goal. For the Dallas market expansion, we stand at 141% of deposit goal, 187% of loan goal, and 178% of our new household goal. We have the first three locations in our Austin expansion project open, with several more planned to open before the end of this year. At the end of the second quarter, our overall expansion efforts have generated $2.2 billion in deposits, $1.5 billion in loans, and added 50,783 new households. As Phil and Jerry have mentioned in the past, for perspective, the largest acquisition in our history was a company with $1.4 billion in deposits. In addition, the successes of the earlier expansion projects basically are funding the current expansion. We expect the Houston expansion to fund the Dallas and Houston expansions in 2025, with 2026 being the year that three expansion efforts are accretive to earnings. Since we began the expansion five years ago, we have added 58 locations to our branch network in the expansion regions, or about one new location every month for the last five years. Those 58 locations now represent 30% of our entire branch network across Texas. The expansion branches are growing at an impressive rate and becoming a more meaningful part of Cullen Frost. For the second quarter, Growth in average loans and deposits in the expansion branches were up an unannualized 9% link quarter, and both average loans and deposits were up 47% year over year. The expansion now represents 7.6% of total loans and 5.4% of total deposits for our entire company. For perspective, at the same time last year, the expansion represented 5.8% of loans and 3.6% of deposits of our company. For the respective regions of Houston and Dallas, the expansion represents 23% of Houston's loans and 21% of deposits. For Dallas, the expansion is already at 14% of loans and 14% of deposits. And now I'll turn the call back over to Phil. Thanks, Dan.

In our consumer bank, we continue to see excellent growth across the board. Average balances in consumer loans were up more than 22% for $571 million year over year. This excellent loan growth was driven by record consumer real estate lending, which is comprised of both second lien home equity loans as well as our new mortgage products. Mortgage loan fundings were $76 million in the quarter, which is over three times our first quarter fundings. So we're gaining momentum as this product matures. At quarter end, our mortgage portfolio stood at $132.4 million. And I should also mention how proud we are that CNN underscored recently rated Frost as the best mortgage lender in Texas. This is going to be a great asset class for us. Average balances in consumer deposits have returned to positive growth territory with the year-over-year increase of 1.4% or $253 million. Finally, we continue to see high-quality, industry-leading checking household growth of 5.8%. we do not offer any of the cash incentives to become a customer that have become so commonplace in the industry because people are choosing Frost based on our reputation for outstanding service, which has been recognized by J.D. Power 15 years in a row. Our investments in our organic expansions in Houston, Dallas, and Austin as well as our investments in marketing are driving these stellar results in our consumer bank, and we expect this to continue. Looking at our commercial business, on a length quarter basis, average loan balances increased an annualized rate of 8.7% for CNI and 10% for CRE. In the second quarter, we brought in 977 new commercial relationships, an increase of 19% on a length quarter basis, which represented the second highest quarterly increase ever. This coincided with us achieving our second highest level of quarterly calling activity within 1% of the record high that we set in the first quarter. New loan commitments, totaled $1.98 billion in the second quarter, an increase of 58% compared with the first quarter, and an increase of 29% compared to the second quarter last year. The split of commitments booked in the second quarter was about 54% for larger credits and 46% for core credit, so good balance there. Credit is good by historical standards with net charge-offs and non-accrual loans, both at healthy levels. We continue to see some normalization in credit terms of risk rating migrations in the portfolio as we come off historic lows in problem loans, but we've not experienced higher credit losses as our borrowers and the Texas economy overall has so far proven to be resilient. Net charge-offs for the first quarter were $9.7 million compared to $7.4 million and $9.8 million a year ago. Annualized net charge-offs for the second quarter represented 19 basis points of period in loans. Non-performing assets totaled $75 million at the end of the second quarter compared with 72 million last quarter and 69 million a year ago. The quarter end figure represents just 38 basis points of period end loans and 15 basis points of total assets. Problem loans, which we define as risk grade 10 or higher, some refer to this as OAEM loans, totaled $986 million at the end of the second quarter. That's up from $810 million at the end of the first quarter and $442 million this time last year. The growth in the quarter was mainly due to a few larger C&I credits, mostly in the classified substandard category. About 22% of our problem loans overall are tied to investor commercial real estate. Slightly less than 50% are related to CNI credits, with most of the rest in owner-occupied real estate loans, 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 loans to value. Within this category, what we would consider to be the major categories of investor CRE, office, multifamily, retail, and industrial as examples, total 4.1 billion or 46% of CRE loans outstanding. Our investor CRE portfolio has held up well. with the average performance metrics stable to slightly improved quarter over quarter, exhibiting an overall average loan-to-value at underwriting of about 52% and average weighted debt service coverage ratio of about 1.55. The investor office portfolio specifically had a balance of $981 million at quarter end and that portfolio exhibited an average loan-to-value of 52%, healthy occupancy levels, and an average debt service coverage ratio of 1.57, which is slightly improved for the third consecutive quarter. Our comfort level with our office portfolio continues to be based on the character and expertise of our borrowers and sponsors and the predominantly Class A nature of our office building projects. And with that, I'll turn it over to Jerry.

Thank you, Phil. Before I begin with my prepared remarks about the quarter, I did want to say that as I head into these last few months of my career here at Frost, I want to say that I am deeply honored and humbled to have had the opportunity to work for such a remarkable company with an outstanding culture for over 38 years, all of which I've spent working for Phil. I feel truly blessed to have had this opportunity, including serving as CFO for the past 10 years. While I look forward to the next chapter, I will truly miss my incredible teammates who have made this journey so special. I know that Dan will do an outstanding job in his new role as CFO. Looking at our net interest margin, our net interest margin percentage for the second quarter was 3.54%, up six basis points from the 3.48% reported last quarter. The increase was primarily driven by higher volumes of loans, along with higher yields on loans and investment securities. These positives were partially offset by higher costs of interest-bearing deposits and, to a lesser extent, lower balances at the Fed compared to the first quarter. Looking at our investment portfolio, The total investment portfolio averaged $18.6 billion during the second quarter, down $696 million from the first quarter. During the second quarter, investment purchases totaled $337 million, with $235 million of that being agency MBS securities, yielding 5.69%, and $102 million in municipals, with a taxable equivalent yield of $550 million. The net unrealized loss on the available for sale portfolio at the end of the quarter was $1.63 billion, an increase of $42 million from the $1.59 billion reported at the end of the first quarter. The taxable equivalent yield on the total investment portfolio in the second quarter was 3.38%, up six basis points from the first quarter. The taxable portfolio, which averaged $12 billion, down approximately $489 million from the prior quarter, had a yield of 2.92%, up nine basis points from the prior quarter. Our tax-exempt municipal portfolio averaged $6.6 billion during the second quarter, down $207 million from the first quarter, and had a taxable equivalent yield of 4.30%, up three basis points from the prior quarter. At the end of the second quarter, approximately 71%, of the municipal portfolio was pre-refunded or PSF insured. The duration of the investment portfolio at the end of the second quarter was 5.5 years, flat with the first quarter. Looking at deposits, on a lean quarter basis, average total deposits of $40.5 billion were down $215 million or 0.5% from the previous quarter. We did continue to see a mixed shift during the second quarter, as average non-interest-bearing demand deposits decreased 298 million, or 2.1 percent, while interest-bearing deposits increased 83 million, or 0.3 percent, when compared to the previous quarter. Based on second quarter average balances, non-interest-bearing deposits, as a percentage of total deposits, were 33.8 percent compared to 34.3 percent in the first quarter. The cost of interest-bearing deposits in the second quarter was 2.39%, up five basis points from the 2.34% in the first quarter. Looking at July month-to-date averages for total deposits through yesterday, they're down about $140 million from our second quarter average of $40.5 billion, with interest-bearing being down $60 million and non-interest-bearing down $80 million month-to-date. Customer repos for the second quarter averaged $3.8 billion, basically flat with the first quarter. The cost of customer repos for the quarter was 3.75%, down one basis point from the first quarter. The month-to-date July average balance for customer repos was down approximately $120 million from the second quarter average. Looking at non-interest income and expense on a linked quarter basis, I'll just point out a couple of items. Insurance commissions and fees were down $4.4 million, or 23.9%. As I've mentioned in previous quarters, property and casualty and benefit company bonuses are typically received in the first quarter. These bonuses contributed about $3.1 million of the decrease when compared to the first quarter. In terms of non-interest expenses on a linked quarter basis, benefits expense was down $7.2 million, or almost 20%, impacted by lower payroll taxes and 401 expenses related to annual bonuses paid during the first quarter. Deposit insurance was down $6.3 million as we recognized $1.2 million in special FDIC assessments in the second quarter compared to $7.7 million related to the special assessment in the first quarter. Looking at capital, during the second quarter, We did buy back $30 million of our stock. That translates into a little over 300,000 shares at an average price of $99.50. Regarding our guidance for full year 24, 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. That is consistent with our previous guidance. Looking at loans, On a year-to-date average basis, loans are up 10.8% compared to last year-to-date. We now expect full-year average loan growth in the range of high single digits to low double digits, a little higher than our previous guidance. Looking at deposits, the current year-to-day average is down 3% compared to last year-to-date. We now expect full-year average deposits to be flat to down 2%. That is down from our previous guidance of flat to growth of 2%. We expect net interest income growth in the range of 2% to 3%. The upper end of our guidance is down from our previous guidance of growth in the range of 2% to 4%. The net interest margin percentage is still expected to trend slightly upward each quarter for the remainder of the year. Based on year-to-date growth and current projections, We are projecting growth in non-interest income in the range of 2% to 3% up from our previous guidance of flat to up 1%. Based on year-to-date results and current projections, we are projecting non-interest expense growth in the range of 6% to 7% on a reported basis. That is down from the 6% to 8% previous guidance. I will say, however, that we continue to be focused on bringing that expense growth percentage down. 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 loans. And regarding taxes, our effective tax rate for the full year 2023 was 16.1%, and we continue to currently expect a flat to slightly higher effective rate in 2024. With that, I'll now turn the call back over to Phil for questions.

Thank you, 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 2 if you would like to remove your question from the queue. And for participants using speaker equipment, it may be necessary to pick up your handset before pressing the star keys. Our first question is from Steven Alexopoulos with JP Morgan. Please proceed.

Hi, everybody. Hey, Steven. Let me start. So you guys had good commercial loan growth. Can you talk about what you saw from a line utilization trend? Is that what drove the loan growth, or is this all share gains?

No, it wasn't line utilization, Steve. It was growth. I don't know if I didn't think of it in terms of share gains, but I guess we did do pretty well relative to the market. But it was just good activity. It was mainly, if you look at new commitments that we had, which I realize are not balances, but they're the basis of those balances. New commitments for the quarter were up strongly. About 80% of it was from CNI and Energy. We had a really good quarter on Energy this time. Some really well underwritten deals, good structures, and good relationships. You know, it was just good activity. Our people are working hard. I think I said we had our second highest quarter of calls in the second quarter. And, you know, things are just going well, to be honest.

Phil, on the commercial real estate side, you guys had good growth there. It's an area where many peers continue to pull away from. Are you just being opportunistic, stepping in where others are stepping back? Should that be a continued driver? of long growth in the back half?

Well, I think, you know, the balanced growth in CNI is really driven mainly by projects that have been put in place in the past, and you're seeing those fund up. I don't see that being a developing driver of, you know, balanced growth going forward. I mean, there will be some, and we are being opportunistic. in a number of different areas. I mean, you may think I'm crazy, but we did an office building loan in San Antonio in the quarter. And, you know, it was a great sponsor, great project, great metrics, et cetera. So it was mainly, though, about great people we wanted to bank and had relationships with. So we continue to bank people, not things. And we are taking advantage – you know, a business as it presents itself, and it's what we want to do.

Okay. Thank you. And then just finally, I want to ask you about your deposit strategy, if you will, because when the Fed started raising rates, I remember you guys were one of the first banks that started raising deposit rates for your customers. I think on the call you said you were going to share the benefit with them, and that was while many peers were not raising rates. and then there was a big lag for the industry, which you guys really didn't see. But with the Fed looking like they're about to cut now, what's your strategy? Do you take that benefit back more quickly? Do you see what the competitive environment does first? How are you thinking about it at this stage?

No, Stephen, you're exactly right with the history there. Our current expectations is that we would move in the same manner that we went up. We would kind of move back down in that same sort of manner. Obviously, I always give that caveat. We'll continue to look at what competitors are doing, but we were quick to go up and expect that we'd be able to make those same sort of decreases on the way down. Okay. Perfect. Thanks for taking my questions.

Thank you.

Our next question is from Dave Rochester with CompassPoint. Please proceed.

Hey. Good afternoon, guys. On the NII guide, appreciated all the color on your assumptions for rate cuts there. I think last quarter you mentioned you get roughly $1.4 million in a hit on a monthly basis for each 25 basis point rate cut. Correct me if that's wrong. But is that the same today? And just given what you just said in terms of moving deposit costs down at a similar pace as the increase on the way up, that's how you're thinking about it from the first cut, or is there a little delay? Thanks.

Yeah, no, right from the first cut is what we're currently thinking, but I'll continue to say we'll look at what the market is doing, but our current thought process is we will move immediately. As far as what the cost or the benefit, if you will, or the cost of the hike or cut, it is probably a little bit higher, and a lot of that is going to be dependent on how much liquidity we have. So that can move. Today, I'd probably tell you if you said it was $1.4 million, I'd tell you it might be in the range of $1.5 million to $1.6 million. So not too far different, but it's really going to be dependent on how much liquidity we have at the Fed. Okay. And that's per month, as you said, on a pre-tax basis.

Yep. Got it. All right. And then just following on the loan growth discussion, it sounded like you saw a decent amount of strength in CNI. You mentioned energy. Are there any other areas where you're seeing particular bright spots there?

No, I wouldn't say there's anything that stands out. The energy, I think, was most unusual in terms of its growth during the quarter. But, no, I think it's just been good growth overall. We've been seeing lots of good opportunities and taking advantage of them.

Yeah. Okay. And on the credit side, you talked about the problem loan increase. Some of that it sounded like was on the CNI front. Any patterns there or any color just on the industries where you saw a little bit of weakness?

Yeah, I would say it was driven by two industries. One that we've, and I've talked about them both really over the last few quarters as we've had the interest rate increases. It would be in contractors. There were a couple of large contractors that We moved to the classified position based on their situation. And then we've had a couple of automobile dealers. One was a used car dealer. One was a new car dealer in the South Texas area. And, you know, car dealers have been pressed by, certainly the used car dealers have been pressed by the increase in interest rates, higher floor plan costs, If they're financing with buy here, pay here, their credit losses have been higher. They've sort of had a perfect storm, and they've had some dislocations in that industry, and we've talked about those over the last several quarters. The contractors are ones that we would like to believe have a path forward in the not-too-distant future, but we'll just have to see. But it's not commercial real estate. I will say there were a couple of multifamily deals that we did move to risk grade 10, and really that was because they had come upon their covenants and their loan agreements had been introduced at that time in that agreement after, say, about a three-year period. and they were below their covenants, and they are working to move those back, either through operations of the property or through a sale or refinancing of it. And we think those will both be just fine. But because of the situation with the covenant, you know, we elect to move that to risk grade 10. And I think we'll see more go into that. I think we'll see some of these flow out, and we'll see new ones go in. But I'm really not concerned with the with the multifamily situation and the debt service covenant ratios that might cause them to be in risk grade 10 at any one point in time.

All right, great. Appreciate it, guys. Thanks.

Good.

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

Good afternoon.

Hey, Abraham. Good afternoon.

So I guess first, Jerry and Dan, congratulations to each of you on the retirement and the new role. I know you have a few months, and I'm glad Phil is going to extract the last bit out of you, Jerry. But maybe I think I heard this earlier, this big picture question. I think when you shared the stats about the new branches, and it sounded like as we fast forward to 2026, all three – expansion sort of markets would be breakevens. Two questions on that. One, what's the drag to earnings or returns today because of this investment spend? And I'm just trying to get to what operating leverage that we should expect as we think about ROE, ROE once we get to 26. And is there more appetite or need to add a similar number of branches over the next five years once this is done?

Well, let me answer the second part. This is our strategy, and I hope that there'll continue to be really good opportunities in the state of Texas for us to continue to expand. We expect that they are. We're doing some work now on identifying those places and trying to see where the puck is going to go and not get behind that. You know, in 2026, I think as Dan said and as Jerry has said before, you know, we expect, you know, it's basically breakeven now. We're going to be adding on several locations in Austin. So I think we'll be, you know, basically breakeven next year. And other things equal, that's when you'd see some significant accretion, I think, from that program and continuing to move forward from there. But we've got to remember that, and that's a couple of years from now, but we've got to remember that if we do have opportunities to expand into very attractive markets, we're going to do it because, as I've said many times, this strategy is durable and it is scalable, and it's been very successful, and we're building great long-term value here.

Got it. Maybe I guess, Jerry, for you just around, and I think I heard you, you expect NIM to move higher third and fourth quarter. Just as we think about rate cuts and in the world where we get a series of rate cuts, one, does that drag continue or are there actions that you may take outside of deposits on the asset side at some point to change the complexion of the balance sheet or there's no such sort of plan to do anything?

Yeah, and as I mentioned, what our rate scenario is, we do have two rate cuts in there. And don't forget, I did say slightly higher in the next couple of quarters. So we're not talking about the sort of growth that we had between the first and second quarter, which really was a nice-sized growth. I think for us, the opportunities are really, as we've talked about before, investment opportunities coming out of that portfolio area. especially this year as we talk about the latter half of the year. I think we talked about the fact that we've got, I think it's like 500 million just in the fourth quarter that's under 1% right at 96 basis points. So we'll see some uptick there. From a fixed loan standpoint, the size of the portfolio that we have that are bullet sort of fixed rate loans are probably not as significant. But if you throw in amortizing fixed rate loans. You probably get proceeds of about $500 million through the rest of the year and then north of a billion next year. So we'll have opportunities there as well to reprice those at even higher rates than where we would be even if the rate environment was lower. So I think we do have those sorts of opportunities going forward. You will continue to see what we do on the, you know, on the asset side. We continually, you know, we're always looking at that. But right now, I think those and the ability to price down on the deposit side are probably things that we're focusing on.

And just one quick follow-up. Is it safe for us, given how you've talked about the investment spend, how expense growth is tracking this year, that as we look into next year, most likely that expense growth decelerates as opposed to accelerates compared to 2014?

You know, from an expense growth standpoint, I mean, I think that's what we've been saying, right, is that the plan would be that the expense growth would not be at the same level of the growth that we had projected. What I will say is that, you know, we're running a pretty tight ship right now. We're doing a lot of things that we need to do. We guided down on that expense growth, and, you know, Dan's going to be the new sheriff in town. So we're still trying to get the growth down this year. But there will be some things that we have to do that we know we have to do. So I've said before, I don't expect that our growth rate will be back in that, you know, 3% to 4% to 5%. I still think that we're probably talking about growth in the higher single digits. And that's all going to be refined and, you know, would be discussed at the January call.

Good. Thank you.

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

Thanks. Good afternoon. If I could just follow up on expenses. You know, I hear you that you lowered the top end of the range for expenses for this year, but it does imply a pretty steep ramp in the second half of the year. And that's on top of core expenses coming down this quarter, if I exclude FDIC. So could you just talk about what type of expenses initiatives you have in the second half of this year that's driving that?

Yeah, one of the things that we have every year in the fourth quarter are restricted stock awards. And there's quite a few of them that, by their nature, that best immediately. Some of them are age-based. And given some of those awards, you'll see that expense growth. And if you look at our historical trends on expenses, you'll see that the fourth quarter goes up pretty significantly. That's the main driver that comes to mind. Again, we're continuing to put these initiatives in place, so our run rate naturally is growing. But as I said, you know, we are looking and trying to ensure that, you know, if we are approving expenses, that there are things that we really absolutely need to do. But I think what you're looking at is primarily driven by increases in compensation associated with true-ups of incentive plans and then the issuance of the restricted stock is probably the biggest piece of it.

Got it. Can I just ask a big-picture question? If I think about the branch expansion, it's really starting to pay some strong dividends, and you've got this long runway for growth as you open up more branches. Are there opportunities maybe to close some underperforming branches or consolidate branches that are kind of close to one another to kind of help manage the expense and offset some of these costs?

Peter, I think there are in a number of cases. And we are closing older locations in these markets, and we're moving them to new locations. I don't know that we count those in the expansion numbers, but that is happening. And so, you know, rest assured, we are looking at locations that are, you know, underperforming and that we don't need. I think we've had good luck to not have a lot of those because, frankly, we were underbranched. If you look at the various competitors in the state, so we didn't have a lot to make up there, you know, backfill as far as closures go. So, yeah, we do that, and it's not unusual for us to close an old one and get it in a new location that we think has better growth prospects.

Thanks, Phil. Mm-hmm.

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

Hey, good afternoon.

Good afternoon.

I wanted to come back to the Loan and Deposit Guide. So loans up, high single to low double digits, deposits slatted down 2%. Does cash come down? What makes up the difference? I asked because you highlighted your plan to cut deposit rates as Fed rates come down. but loan growth feels really strong here, so just trying to see where the offset is and what the appetite is to allow deposits to run down a little if you need to.

Yeah, no real appetite to run down deposits. We really are a relationship bank. We're really focused on deposits, and with a loan-to-deposit ratio at 50%, loan growth at 12% really doesn't scare me. As Phil said, we're going after great opportunities, and we're glad that we have those opportunities to be growing today. The thing that will probably be more of a handle that we can move, if you will, would be the investment portfolio purchases. We had started the year, I think, at $1.6 billion is what we thought we would purchase. Last quarter, I said we brought that down to $1.2 billion. We're probably closer to $900 million right now. We've bought maybe half a billion of that year to date, and so just have projected maybe another $400,000 to make. So, At this point, that's really the mechanism that we've used in that scenario where deposits might be a little bit softer. And we really don't, you know, our projections are pretty light in the second half. We do see some growth. You know, and those could obviously be better, but we just really don't feel any conviction at this point and felt like that's the right thing to do. And so from an investment portfolio standpoint, that's the one that's really easy for us right now to just put the brakes on. Given where rates are today, if we went out and invested, in some cases we might earn a little bit less than where we're at today. I think the purchases that we made were slightly better, but that's really what we would move more than anything else is what we would do in the investment portfolio.

I think Jerry's right on that. Your question really, I think, brings up something that we need to keep in mind, and it is that our loan growth is good, but our What it really is is relationship growth, because we don't make any loans that we don't get the deposit relationship. And so in this environment, you've got good loan growth here, but you're getting those deposit relationships underneath that, that because of where rates are today and the efficiency that businesses are employing with their deposits and their cash, you're not seeing as much deposits here. following on is I think we will see in the future as these things normalize and as the rates normalize. So while you may not see the deposit growth now, I'm encouraged that you'll see it in the future.

Just something to add to that is when we're out in the marketplace, having the ability to provide capital in this market puts us at a competitive advantage in looking at the impact of new relationships in our year-to-date loan balance growth, 38% of that is from new relationships. And we're able to get $249 million in new relationship deposits. And a lot of that is because we can, our pencils aren't down. We are open for business. And so we're able to bring in new relationships with these loans.

Thanks, Dan.

Got it. That's great, Carla. Maybe the second part of the question is, you know, peers are saying that they expect a pretty sizable pickup in loan growth as rates come down. Is that something you expect as well? I mean, loans are already growing 11% year on year for the first six months. Could you see an acceleration from here of rates come down?

No. Not necessarily. I don't think we're thinking of it that way. I mean, what we're doing is we're We're making calls. We're developing relationships. And I don't think it would move us one way or another. I think what we might see is if we get some clarity in the election, the political process, it's clear to me that just from talking from our loan officers and relationship managers that there are a number of companies that are as is typical. They're waiting to see which way the political winds blow, and based upon what they see, it'll give them some visibility in terms of primarily what kind of regulation they might see. And once that clears up and they understand where they are, I think you'll see businesses that might be holding off today move forward. At least that's what we've heard from a lot of our people. So I've heard less talk about once rates go down, than I've heard about once the environment gets more clarity with regard to what kind of administration we might have making the regulatory decisions.

Got it. Thanks very much. And Jerry, all the very best. And Dan, looking forward to working with you.

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

Hey, good afternoon.

Hey, Brandon.

So just following up on the last line of questioning, and just could you speak broadly as far as what you're seeing from a competitive standpoint in your markets? Remember last call you mentioned how some lenders were kind of getting back in the game, but could you just speak as far as what you're seeing today?

I think it's getting more competitive. I think where we had – let's take commercial real estate – I think we're seeing people move back in. I think we were hopeful that you'd see more people requiring guarantees. I think there are a lot of players that are not doing that. And so I think we're seeing it slide a little bit back to where it was before. But as some people that have been out of the market, pencils down, as they say, are coming back in, you're seeing some more competition. I think we're seeing maybe – And the real estate side, a little more competition from the smaller banks. Just an observation, but that's kind of what we're seeing. Dan, any thoughts on your?

I see kind of this second half. We had a really strong second quarter in terms of closings. And with what Phil mentioned about just the uncertainty in the environment, I see that it being a little slower just in looking at our weighted pipeline. But in terms of competition from the other banks and lenders in the marketplace, we certainly kind of see it from the community banks in the markets that we're in. We'll see it from some regionals or some regionals that decide to get into our markets. And so we're seeing some new players uh, who are coming into our markets, uh, in the, over the last kind of six months to a year. So I could see the competition picking up.

Got it. Got it. And how has that impacted pricing discipline? Right. You know, you increase your local guy, so I assume you're getting the right pricing, but has there been any pressure there?

Oh yeah. Yeah. There's always pricing pressure, but actually if you look at the deals that we've lost, About three-quarters of the deals that we've lost have been due to structure. And that's the thing that concerns us most. You know, with our cost of deposits and our cost of funding, I'd argue that we're one of the low-cost producers in the marketplaces in regards, you know, the cost of funding. And, therefore, we can be very competitive on pricing. And remember, we're booking or we're banking – relationships first, and so if someone passes the test to be a Frost customer and they're willing to live within our structures, shoot, we don't want to lose that after all that development for a few basis points. So we'll be very competitive on price, but structure's a different deal. We have been and will be disciplined as it relates to structure. And so that's where we're seeing more of our losses.

Got it. Thanks for taking my questions.

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

Thanks. Good afternoon.

Good afternoon.

One more follow-up to the margin. As we think about the NII guide for the year, Do you think, and this is a little bit of a follow-up we've already answered, but do you think you'll continue to see NIM expansion through the back half of the year kind of equal to the pace we've seen? Or does that expansion start to moderate in the back half of the year, but maybe the average earning asset growth kind of moderates or maybe even grows a little bit? How do we think about the balance between those two things?

Yeah, no, I think the rate of growth would be quicker or higher in the first half of the year and slower in the second half of the year.

Yeah, again, we're – But still an upward trending margin, you think?

Exactly, yeah.

Yes. And then as we start to price in cuts in the back half of the year or as we get into 25, whenever that comes, what is your outlook on how the margin kind of initially reacts when we start to see said cuts?

You know, again, it depends on timing, but I think based on our current assumptions, you know, starting in September, you know, that's really what my guidance was based on. So we still see some upticks. Again, that kind of slows down the growth, but we do continue to see that sort of growth projected out through the rest of this year.

Great. Is it still an expansion, but just less as we get cut to that kind of million and a half that you were talking about?

Right, yeah. I mean, that's the thing. Like I said, we do have some investments. As I mentioned, the big part of it is the $500 million. So if you're reinvesting stuff, that $500 million in Treasury is at 96 BIPs. But even the rest of the fundings are probably in the three handles on them or high twos. And so all those will provide you with some upside. And again, given what happens with the fixed-rate loans that reprice, we'll have some pickup there as well.

And then today, any color on just the new growth, the new loans you're putting on relative to new deposits you're putting on? What would you say those two rates are, the new loan yields and the new deposit costs today that spread?

Well, the new deposit costs are going to be the same, right? They're really going to mirror whatever's going on in the existing portfolio. We do very minimal deposits. exception pricing on the loan on the loan excuse me on the deposit side so you you have some but you know you're not going to have a lot of that and as far as the back book and you know we're probably right now in the weighted average rate of say a 670 or something in that range is the back book and current stuff going on north of eight all right thank you appreciate it sure

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

Thanks. Good afternoon.

Hey, John.

Hey, John. A little bit of cleanup here, but Phil, you talked about the mortgage business opportunity earlier in the call, and it looks like those volumes have really picked up. Can you talk a little bit about the driver of that and where this can all go and, you know, when it shows up in a material way?

You know, John, I go back to – when we announced that effort over a year ago. And I believe we said we expected that the mortgage book could be in excess of the consumer book that we had at that time, and so over a five-year period. So I don't think we, you know, have come off of that. And, you know, it's just – It's a new thing, and we're getting our people used to making recommendations on it. You're getting the realtor community understanding what it is, and we've got just great service, and I think it's just going to be a great asset class for us.

Another thing to add is that 30% of our mortgage borrowers are new to the bank, so this opens up an opportunity to bring in new customers through this incredible product and an incredible experience.

Okay. Question for maybe Phil or Dan. What is the significance of the plan when you talk about the performance of the new branches? It looks like all are either on plan or ahead of plan, but as an outsider, what does that really mean and what's the benchmark that we can use there?

Well, when we started, John, you might recall, we started this strategy and we looked at the performance of the 40 branches that we had opened up over the last eight years prior to that time. And we said that we looked at the average of that and we said if we could do the average of that in the markets that we were going to be in, we felt like we would have a really successful strategy for our shareholders. And so that's what we based it on. And then we began measuring what our performance was versus that. We kept it fairly consistent, although I know that we've changed that some. Dan, you might talk about that.

Yeah, I mean, we've tweaked it with Dallas. We learned a lot from Houston 1.0. And as much as it pains me, Dallas is outperforming Houston at the same time period, but it goes back to our blue book of continuous improvement. And so we learned what workbook could we do better, and Dallas is just doing a great job, as you can see from their performance. And so I would expect the same from Austin as well.

Okay. That helps.

John, I would say it's fairly consistent. I mean, we'll move it up depending upon a particular market. But we want to keep it somewhat consistent because we want to be able to compare, just like Dan did, and he was only half joking that Dallas is outperforming Houston, so that makes him mad. But we can have a consistent comparison between in these markets. I think that's helpful to us. We'll try and keep it that way. Again, make adjustments for the markets that we're in, but we'll keep it fairly consistent.

Some of those adjustments are the timing. What we learned in Houston is the timing of when loans and deposits in new households. We've looked at those trends to make sure that, again, that we're being consistent, but we're being fair. Okay.

Well, the growth numbers are great, so that's impressive. Jerry, you know, 10 years, it's probably 40 earnings calls, so thank you for everything. And I was just going to say, I'm wondering what the 40-year retirement gift is like at Colin Frost. Does Phil get you a belt buckle or boots or a watch or, you know?

We'll have to see. I'll let you know, John. Okay. Thanks for bringing it up to him.

All right. Thanks for everything.

Thank you.

Thanks, Sean.

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

All right. Well, thanks, everyone, for your support and for your questions and interests, 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.