Cullen/Frost Bankers Q1 2024 Earnings Call Transcript

Quartr
Provided by Quartr
April 25, 2024

There are 13 speakers on the call.

Operator

Greetings.

Operator

Welcome to CullenFrost 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. Please note this conference is being recorded. I will now turn the conference over to A.

Operator

B. Mendez, Senior Vice President and Director of Investor Relations. Thank you. You may begin.

Speaker 1

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 that 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.

Speaker 1

Please see the last page of text 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.

Speaker 2

Thanks, A. B. Good afternoon, everyone. Thanks for joining us. Today, I'll review the Q1 results for CullenFrost and our Chief Financial Officer, Jerry Salinas, will provide additional comments before we open it up to your questions.

Speaker 2

In the Q1, CullenFrost earned $134,000,000 or $2.06 per share compared with earnings of $176,000,000 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 $7,700,000 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 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.

Speaker 2

Our balance sheet and our liquidity levels remains consistently strong. Also as was the case in previous quarters, Golden Cross did not take on any Federal Home Loan Bank advances, participate in any special liquidity facility or government borrowing, access any broker deposits or utilizing the reciprocal deposit arrangements to build uninsured deposit percentages. And additionally, our available for sale securities represented more than 80% of our portfolio at year end at quarter end. Average deposits in the Q1 were $40,700,000,000 down 4.8% from the $42,800,000,000 in the Q1 last year. Average loans grew 10.4% to $19,100,000,000 in the Q1 compared with $17,300,000,000 in the quarter a year ago.

Speaker 2

We continue to see excellent results in our organic growth program. For example, we combined our Houston locations and the expansion they stand at 104% deposit goal, 164% of loan goal and 122 percent 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 Q1 close, we opened the 2nd new location on our 17 site Austin expansion project. Our next new Austin region location will open just after Memorial Day.

Speaker 2

At the end of the Q1, our overall expansion efforts had generated $2,000,000,000 in deposits, dollars 1,500,000,000 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 $1,400,000,000 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 for 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 Q1 increasing an annualized 13% on a linked quarter basis and hit a milestone of $3,000,000,000 in average balances outstanding. And we remain excited about the prospects for a new mortgage product, which is approaching 200 loans with about half coming in the first quarter.

Speaker 2

Looking at our commercial business, on a linked quarter basis, average loan balances increased and annualized 10.5% for C and I and 13.4% increase for CRE. Our new commitments booked in the 1st quarter were 24% less than the level booked in the Q1 of 2023. Our new commercial relationships were up 10% year over year and at 825 represented our highest level of 1st quarter relationships ever. This coincided with us achieving our highest level ever for calling activity in the Q1. New loan opportunities in our pipeline were up 15% year over year and were second only to the last year's spike after SVB's failure.

Speaker 2

Our weighted average pipeline stood at $1,460,000,000 up by 24% from the Q4 and by 17.5% from the Q1 last year. And regarding those 8 25 new relationships in the Q1 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 Q1, 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 debt and new non accrual loans at healthy levels.

Speaker 2

We're seeing some normalizations in credit risk ratings and we 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 Q1 were $7,400,000 compared to $10,900,000 last quarter and $8,800,000 a year ago. Annualized net charge offs for the Q1 represented 15 basis points for period end loans. Non performing assets totaled $72,000,000 at the end of the first quarter compared to $62,000,000 last quarter $39,000,000 a year ago. The quarter end figure represents just 37 basis points of period end loans and 15 basis points of total assets.

Speaker 2

Problem loans which we define as risk grade 10 or OAEM totaled $809,000,000 at the end of the first quarter and that's up from $571,000,000 at the end of the 4th quarter and $347,000,000 the same time last year. Three quarters of the increase was due to company specific C and I loans with the remainder being CRE credits of various types. And this growth in Q1 was fairly evenly split between loans in the OAEM or risk grade 10 and classified risk grade 11 categories and is 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 C and I credits with most of the balance in owner occupied real estate which are closely related to C and I loans.

Speaker 2

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 to values. Within this portfolio, what we consider to be the major categories of investor CRE, office, multifamily, retail and industrial, for example, totaled about $4,000,000,000 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 loans of value and underwriting of about 53% and average weighted debt service coverage ratio of about 1.47. The investor office portfolio specifically had a balance of $983,000,000 at quarter end 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 2nd 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.

Speaker 2

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 Q1 when Frost achieved the highest scores nationwide in the Greenwich Excellence Award for the 8th consecutive year and the highest ranking for banking customer satisfaction in Texas and J. D. Power's retail banking satisfaction study for the 15th consecutive year. These are unprecedented achievements.

Speaker 2

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.

Speaker 2

And now I'll turn the call over to our Chief Financial Officer, Jerry Salinas for some additional comments. Thank you, Phil.

Speaker 3

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 volumes we've been able to achieve. Looking at the Q1, growth in both average loans and deposits was approximately 9% when compared to the previous quarter. And for the Q1, 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.

Speaker 3

Our net interest margin percentage for the Q1 was 3.48%, up 7 basis points from the 3.41% reported last quarter. Some positives for the quarter include higher volumes of both loans and balances at 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 4th quarter. Looking at our investment portfolio, the total investment portfolio averaged $19,300,000,000 during the Q1, down $510,000,000 from the 4th quarter. During the Q1, investment purchases totaled $187,000,000 with $112,000,000 of that being Agency MBS Securities and $75,000,000 in municipals.

Speaker 3

The net unrealized loss on the available for sale portfolio at the end of the quarter was $1,590,000,000 an increase of $199,000,000 from the $1,390,000,000 reported at the end of the 4th quarter. The taxable equivalent yield on the total investment portfolio in the Q1 was 3.32%, up 8 basis points from the 4th quarter. The taxable portfolio, which averaged $12,500,000,000 down approximately $582,000,000 from the prior quarter, had a yield of 2.83%, up 8 basis points from the prior quarter. Our tax exempt municipal portfolio averaged about $6,800,000,000 during the Q1, up about $73,000,000 from the Q4 and had a taxable equivalent yield of 4.27%, up 1 basis point from the prior quarter. At the end of the Q1, approximately 70% of the municipal portfolio was pre refunded or PSF insured.

Speaker 3

The duration of the investment portfolio at the end of the Q1 was 5.5 years, up from 5 years at the end of the 4th quarter. Looking at deposits, on a linked quarter basis, average total deposits of $40,700,000,000 were down $459,000,000 or 1.1 percent from the previous quarter. We did continue to see a shift a mix shift during the Q1 as average non interest bearing demand deposits decreased $720,000,000 or 4.9 percent, while interest bearing deposits increased $61,000,000 or 1% when compared to the previous quarter. Based on 1st quarter average balances, non interest bearing deposits as a percentage of total deposits were 34.3% compared to 35.7% in the 4th quarter. The cost of interest bearing deposits in the Q1 was 2.34%, up 7 basis points from 2.27% in the Q4.

Speaker 3

Looking at April month to date averages for total deposits through yesterday, they are up about $134,000,000 from our first quarter average of $40,700,000,000 with interest bearing up $332,000,000 and non interest bearing down 100 and $98,000,000 month to date. Customer repos for the Q1 averaged $3,800,000,000 basically flat with the 4th quarter. The cost of customer repos for the quarter was 3.76%, up 1 basis point from the 4th quarter. The month to date April average balance for customer repos was down approximately $42,000,000 from the 1st quarter average. Looking at non interest income expense on a linked quarter basis, I'll point out a couple of items.

Speaker 3

Trust and investment management fees were down 1 $100,000 or 2.7 percent impacted by lower estate fees down $1,500,000 Estate fees can be lumpy as they are based on the value and number of estates settled. Insurance commissions and fees were up $5,600,000 or 44%. Property and casualty and benefit company bonuses, which are typically received in the Q1, contributed $3,400,000 to the increase. Benefit commissions were up $2,100,000 as the first quarter is typically the strongest quarter for those commissions. As a reminder, the 2nd quarter is typically the weakest quarter for insurance commissions and fees given our typical yearly renewal cycle.

Speaker 3

The other non interest income category was down $6,900,000 primarily related to $4,400,000 in card related incentives as those incentives are received in the Q4 each year and a $3,500,000 4th quarter recovery of a previous loss accrual. Salaries and wages were up $1,400,000 as increased salaries and higher incentive accruals were mostly offset by stock compensation expense, which was lowered by 8,200,000 dollars 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 $7,900,000 impacted by higher payroll taxes and 401 expenses related to annual bonuses paid during the Q1 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 $6,400,000 or 9.6 percent. The decrease was driven primarily by donations expense, which was down $3,500,000 and professional services down $2,900,000 Regarding our guidance for full year 2024, our current projections include 2 25 basis point cuts for the Fed funds rate over the remainder of 2024 with one cut in September and another one in November.

Speaker 3

This is down from 5 cuts in our January guidance. For the full year of 2024, 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.

Speaker 3

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 reported 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 loans. Regarding taxes, our effective tax rate for the full year of 2023 was 16.1% and we currently expect a comparable effective rate in 2024, no change to this guidance.

Speaker 3

With that, I'll now turn the call back over to Phil for questions.

Speaker 2

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

Operator

Thank you. Our first question is from Casey Haire with Jefferies. Please proceed.

Speaker 4

Yes, thanks. Good afternoon, everyone.

Speaker 5

I guess starting off with the NII guide, so you guys are leaving it intact despite you're 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 it's the higher funding cost pressure that's keeping it intact, just a little more color on the NII dynamics.

Speaker 3

Yes, it's certainly some of that. And also, we're talking about higher for longer. As we've talked about the competitive fields out here for deposits, I think the higher that 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 yields and I think that pressure will just continue. We continue to see that especially in the non interest bearing side where people are continuing to move their deposits.

Speaker 3

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.

Speaker 5

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 30 4%. And then what about betas from here?

Speaker 3

Yes. The betas really at this point, 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.

Speaker 3

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 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 4 or 5, 6 months ago.

Speaker 3

But there's still some stuff out there going on. So from that standpoint, I expect some pressure on the beta, but I don't expect it to change significantly.

Speaker 5

Okay. And the DDA mix at 34, it sounds like there's more pressure. Just wondering how much more in

Speaker 3

the Yes. I would think that yes, 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 100,000,000 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 softer for us on DDA.

Speaker 3

And so that's not really unusual to us. I think I mentioned in the January call, we were already seeing DDA down, probably $400,000,000 between the time of the call compared to the Q4 average. I think what we continue to do is we just continue to be focused on growing relationships. I think we really feel very comfortable with what we're doing, keep plugging along with that. There's not a lot we can do.

Speaker 3

We think 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.

Speaker 5

Thank you.

Operator

Our next question is from Steven Alexopoulos with JPMorgan. Please proceed.

Speaker 6

Hi, everyone.

Speaker 2

Hi, Steven.

Speaker 7

Maybe to

Speaker 6

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, is your you're thinking 1.5% above or has that potential improvement lessened now?

Speaker 3

It probably lessens a little bit now. Part of it again is when we're talking this whole conversation is about the non interest bearing deposits and obviously that's a big impact on that number. So given what the pressure that we saw there, a little bit more than we expected in the Q1. And as I responded on the previous question, not really ready to increase our guidance. It's really more related what happens there.

Speaker 3

And I think that will really drive a lot of it. The month of April, like I said, doesn't look unusually bad. And 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. 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 yes, at this point, we're we'll just kind of have to see where it plays out.

Speaker 3

But yes, I think the big swing factor is what happens with those DDA volumes.

Speaker 6

Got it. Okay. And then thank you. On the loan growth side, so you guys had solid loan 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?

Speaker 8

You

Speaker 2

know, Stephen, I don't have that number at hand. I can tell you what some of the new customers have done to loan growth. Jerry can help me out with that. But just to talk a little bit about it, the it was interesting that a lot of the activity we saw in pipeline increase is was customer related. And as opposed to prospects, I thought that was interesting.

Speaker 9

And I

Speaker 2

think also an area that we saw is that core loan growth, the under $10,000,000 relationships. I think is 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.

Speaker 3

One second, I might be able

Speaker 2

to get some info

Speaker 3

on the

Speaker 2

relationship impact.

Speaker 3

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

Speaker 6

Got it. Okay. And well, go ahead.

Speaker 2

So I just did find what I was looking for. In the Q1, we added $145,000,000 in new loan balances and $100,000,000 in deposits from new relationships over the last 12 months.

Speaker 10

That's about a quarter.

Speaker 6

About a quarter. Yes, part of the reason I asked, even though the industry has fairly modest growth this quarter, quite a few banks are coming out pretty bullish to see pipelines build and you guys 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?

Speaker 3

I think, I guess if you're asking, could it move up to the low double digits? I think what we're hearing in some of it is that we could, obviously, but 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 is still pretty bullish, there's a little bit still of concern about what happens to the rest of the year. So could it happen?

Speaker 3

Yes, I mean the numbers are trending really well, both on linked 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 instead of a 9%, could we be a 10% or 10.5% certainly. But again, we are getting we are hearing a little bit of word of caution some of our guys out in the feet. Yes.

Speaker 2

No, Steve, I'd say there are a couple of forces, are there a few forces that are on positive side, some on the negative? 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 high end of the market is doing really well and some of the low end is under some pressure.

Speaker 2

But so those offset themselves a little bit. But 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 within structure. So I think as we see some of the banks getting back in the game, 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.

Speaker 2

But overall, I think it's a I think it's got a good outlook. And one of the reasons is because that pipeline information that I showed you, as I mentioned a few minutes ago, just the growth in the linked quarter pipeline was strong, 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 is right some people are continue to be a little bit circumspect around the election probably might impact, but some people are willing to do till they get the lay of the land regulatory what they're going to be looking at. But I would I probably felt that a little bit more cautious last quarter, but interestingly what I've heard recently has been pretty good.

Speaker 6

Okay, sounds good. Thanks for all the color.

Speaker 2

Thanks.

Operator

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

Speaker 7

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 sum 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'd be great.

Speaker 3

Sure. Yes, on the let me give you those purchase yields first. I'll let's got those right here. So in the agencies we bought at 549 and the municipal is at 518 TE. What we're doing right now is, I don't see liquidity moving very much during the year.

Speaker 3

Loan growth has obviously been better than we expected. We have been targeting investment purchases of about $1,600,000,000 is I think the guidance that I've given $1,500,000,000 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.

Speaker 3

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 100,000,000 shy of that. Like I said, loan growth has been better. Deposits, like I said, a little bit softer than we expected even in that 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.

Speaker 3

And if there is a bias, it's probably a small bias to increasing that somewhat.

Speaker 7

Okay. And then just on your comment of less NII upside in a higher for longer type of scenario, was just curious where that NII sensitivity is now on delaying a cut. I think last quarter, you mentioned something like roughly $1,000,000 of benefit each month. What is that now roughly?

Speaker 3

Yes, I think a lot of it depends on timing. When we look at it, again, the cuts that we've got in our models are in the 2nd part of the year. And so again, depending on what's happening with balances at the Fed, I'd say that number is probably and again assuming they happen later in the year is probably closer to $1,400,000 a month benefit.

Speaker 6

Okay.

Speaker 7

Yes, free cash. 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?

Speaker 2

Okay. Well, let me take the question with regard to the increased problems, along with the risk rate tenant higher. 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.

Speaker 2

They're looking for actively looking for refinance now, but we need to recognize that 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 etcetera. We decided we're not all on the same page and that was one of them. There was a truck hauler. We saw have some issues with regard to volume.

Speaker 2

There was a company that moved into a brand new facility, fairly significant facility. They're getting used to that. They had an operating loss in the near term as they move that over. So we need to recognize that till they turn that around. Those are the things they are more like I said company specific.

Speaker 2

They're not really so much interest rate related except for the things that relate to used cars primarily, the buy here pay here dealers. That's true of both the 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 few quarters.

Speaker 2

But that's the kind of thing that we're seeing.

Speaker 7

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

Speaker 3

Sure. Yes. What you'll see in the 10 Q is we don't give a very detailed view there. I think the commercial real estate reserve coverage is like at a 148. But what 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.

Speaker 3

So the highest or the best or the worst, I guess, I should say, pass grade credits that we give them a 5% reserve. So and then anything worse than that. So if you start getting into 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.

Speaker 7

Great. All right. Thanks for all the color, guys. Appreciate it.

Operator

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

Speaker 11

Thanks. Good afternoon. I just wanted to, Phil, if I could follow-up on the problem loan discussion. Just 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 like C and I loans and continued increases in the problem loans sector?

Speaker 2

I don't see anything that's significant or a trend for the higher for longer on the C and I piece, to be honest. I think that 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 when they come to maturity.

Speaker 2

And so far, we've had really good experience, really good performance by our borrowers. But we could create scenarios where interest rates went higher and created more pressure, but we're not seeing that right now.

Speaker 11

Okay. And then just separately, the insurance commissions, it had really nice growth in 'twenty three, it was up almost 10%. But the Q1 year over year, it was down 3.5%. Is there anything unusual this quarter

Speaker 2

or just how are you

Speaker 11

looking at that on a full year basis?

Speaker 3

Yes. The one thing I'll say on the comparison to a year ago. So the Q1 last year had a very strong life insurance commissions. So we were probably unfavorable this quarter in that comparison by about $1,100,000 And the commissions on those policies are just one time. You earn a one time fee.

Speaker 3

It's not like 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 probably the biggest thing that affected us negatively compared to the Q1 last year. Although I'll say that benefits commissions were softer than I expected as well. Okay.

Speaker 3

Thanks, Jerry. Sure.

Operator

Our next question is from Catherine Mealor with KBW. Please proceed.

Speaker 9

Thanks. Good afternoon.

Speaker 3

Hey, Catherine. Hello.

Speaker 9

A question on expenses. I know that you left your expense guidance unchanged at the 6 percent to 8% growth rate year over year. Curious, I know you mentioned that FICA taxes in some kind of 1Q seasonality drove the higher expenses this quarter. Should we assume that we kind of fall back from this Q1 level as we go into Q2 and then grow from there? Or do you still think you grow from this run rate into next quarter?

Speaker 3

Yes. I think a couple of things I'll say is that we did get the additional surcharge of 7 $700,000 right 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 Q1 on expenses. Again, we are certainly impacted by the expansion that we're doing. And so we kept our guidance the same even though we were basically saw an additional almost $8,000,000 in expenses that we hadn't expected.

Speaker 3

And your question was a little muffled, but I think I heard you say that maybe the Q1 was higher from the benefits maybe. I think benefits tends to go down during the year. A lot of it has to do with things like 401 contributions matches that we have to make or payroll tax matches. In certain cases, employees, especially on the 401 may reach that limit pretty quickly, intentionally or unintentionally. And so then our we match up to 6%.

Speaker 3

If they reach that level, then 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 trajectory that we have other than take if you take the $7,000,000 out, I would expect that 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.

Speaker 3

I think we've done a good job this Q1 and continue to try to do that. But I would expect that they will continue to grow up just

Speaker 10

a little bit quarter over quarter.

Speaker 9

Yes, that's helpful. And to be clear, that 6% to 8% includes the $7,000,000 FDIC assessment?

Speaker 3

Exactly. Yes, we just we assumed this operating, if you will, for those purposes. So the $51,000,000 is in the number in 2023 because it's on an as reported and the $7,000,000 number is included in our 24 numbers.

Speaker 9

Okay, great. And then next question on fee service charges, I mean, seasonally also is usually lower in the Q1, but I know you've talked about interchange and some other things being softer in the Q1. 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?

Speaker 3

Yes. I think that the thing with service charges, the upside to it has been the commercial service charges. In some cases, it works against you, right, because in some cases customers may hold decide to pay more for services through hard dollar charges rather than through keeping the balances. So some of that's some of it and so that's been impacting the growth. But 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.

Speaker 3

And we continue to see good growth there, but a lot of it, as Phil mentioned, we're just growing those accounts pretty significantly. And 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 that will have a lot of So 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. I think it will just be continue to be pressure in that category for the rest of 2024s is kind of the numbers that I'm seeing right now.

Speaker 9

Very helpful. Thank you.

Operator

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

Speaker 8

Hi, good afternoon. I wanted to ask about deposit pressure and most banks spoke about how deposit pressure eased in the Q1. 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?

Speaker 3

From a cost standpoint, I will say that we're really not feeling from a market standpoint, not feeling a lot pressure on the deposit cost side. We need to be competitive and we are. I think we've got a we've decided we're competing primarily on the 90 day CD. It's really more of the pressures coming on the non interest bearing. And I think it really just continues to be the scenario where rates at these higher levels continues to put pressure both on commercial customers and consumer customers of looking for balances.

Speaker 3

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 in the 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 things are going right. I think historically, like I said, our balances just tend to be softer in this Q1. But we're going to compete on the pricing. We're not going to be the highest.

Speaker 3

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 on what I'll call the interest bearing, but 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.

Speaker 8

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?

Speaker 8

And is part of the reason for maybe the weakness in

Speaker 2

First part of your question, I'd say it's mainly banks that we're seeing structure and it's the same story. It's guarantees, it's loan values, it's terms, all that. So there's some of that. I don't know where it could be certainly visavisprivate credit, we're getting lower yields than they're able to achieve, albeit at higher risk on your case. But yes, 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.

Speaker 8

Got it. Okay. And if I could just have a clarification on one of your comments on the securities side. I think you said duration of that book was up about half a year to 5.5 years. 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?

Speaker 3

No, like I said, we really didn't do a lot of purchases in the Q1. I think some of it was that we had about $1,000,000,000 in treasuries that were at the end of the year, let's say call it $750,000,000 of it that were maturing 1st few days of January. So that was affecting it. And I think there might have been there might be a little bit more extended duration on the mortgage side. We haven't added a whole lot of duration with anything that we've done in the Q1.

Speaker 8

Great. Thank you.

Operator

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

Speaker 4

Hey, thanks. Good afternoon, guys. Couple of questions.

Speaker 2

Yes, John.

Speaker 4

Phil, should we expect the potential problem loans to continue to migrate higher? Or is that not necessarily true?

Speaker 2

Yes, 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 the risk grade 10 and higher, should we expect to increase? I would say maybe. And the reason I'd say that is because we were at such low levels.

Speaker 2

Really the industry was at unsustainably low levels with everything coming out of the pandemic for credit quality, right? And so we're still not where we are, I would say, normal. And so but we are seeing some what I would call some reversion to mean. So that would tell me, yes, we probably ought to expect it to go up some. At the same time, some of these that we've added, we're looking for some recently quick turnarounds on them.

Speaker 2

And we just try to be realistic with these risk rates that we're adding. And it's not a best sentence or anything. It's just recognizing that we perceive some elevated risk. But we do work on them and work to get to correct them and the company's work to correct them. So I'm hopeful that with some of these that we brought on this time, we'll see them move out.

Speaker 2

But we could also see some more move in because again we're really coming off with 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 gross banker. And so I guess there's that part of me that's always going to be concerned with it.

Speaker 2

But I think credit quality is good. I mean, we spent a lot of time looking at our commercial real estate portfolio and very granular level. And I'll just tell you that probably if somebody said Austin office building, they would run for the hills. But I would tell you, I think our Austin office building portfolio is solid, man. I've looked at the I've looked at the multifamily deals.

Speaker 2

People would say, oh, man, Austin, it's got reduction in the interest rates, the housing prices have come off 11%, got a lot of supply coming on, etcetera, etcetera. But I look at our multifamily in 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 were up 50% over the 2 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.

Speaker 2

And 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. We 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 popped up and all, but not something that gives me any worry. I think it's interesting what's happening with the company specific stuff on the C and I side.

Speaker 2

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. But most of them will. But that's just banking. It's a risk business.

Speaker 2

And I really think we have a handle on it. Anyway, just felt the need to say that.

Speaker 4

Okay. Yes. 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?

Speaker 2

I don't feel that way now. I mean, can we see it get worse? Sure, sure can. Jerry can speak to the formula better than I can. But I think we feel really good about where the reserve is today.

Speaker 2

And I think another thing I might say about the reserve, as you might recall, we built it up during that COVID period and we never took it out. And so I

Speaker 3

think it's Yes, I think that's a little bit different than others. Yes, we pretty much stayed there. And we really haven't if you look at our reserve coverage percentage, it really hasn't moved around very much. And I wouldn't expect that it will it's going to move 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, if you're assuming a pretty normal sort of credit quality environment.

Speaker 4

Yes. Okay. Jerry, as long as you have the mic, you changed the presentation of the expansion contribution for the quarter. What if you can share it, what kind of contribution did Houston 1.0 have this quarter?

Speaker 3

Yes, I think it was. Last time we rounded to $0.07 I think let me make sure I was going to say, I think we rounded to $0.06 this quarter, but let me just check. Yes, it's exactly right. They were $0.07 last quarter, dollars 0.06 this quarter.

Speaker 4

Okay. And the when you say Houston is funding Dallas and Austin, that's 1.02.0, is that right together?

Speaker 3

Correct. Yes, I would just net it the 2 and I was trying to keep it simple, maybe I confused it. But yes, 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 hope things were going to work out. If these financial centers began to mature, they would begin to pay for the future expansions and it certainly worked out that way.

Speaker 4

Yes. Well, that's great. Those are great numbers. So okay. Thank you.

Speaker 4

I appreciate it.

Speaker 3

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 linked quarter in salaries. So for us, a lot of the stock awards are given in October and so they do affect the Q4. And so typically salaries for us are higher in that Q4. And because by their nature, a lot of these stock awards immediately vest and as a result are immediately expensed.

Speaker 3

So think if you looked at the growth in salaries expense between the Q3 Q4 last year, you'll get some sort of expectation wise what you might expect to see between the 3rd, Q4 and Q4 of this year. Just to give a little bit of a better color there.

Operator

Our next question is from Ebrahim Poonawala with Bank of America. Please proceed.

Speaker 12

Hey, good afternoon. Just one very quick one, Jerry, for you around the securities book. Sorry, if I missed this. Should we expect, 1, the securities portfolio to grow from 1Q average levels or stay flat? And second, could you confirm, I think you mentioned you have another $1,000,000,000 of securities that you expect to buy, what the pickup in the yield is on reinvestment versus what's rolling off?

Speaker 12

Thank you. Sure.

Speaker 3

Yes, 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 $1,200,000,000 and the weighted yield of those are about a 226,000,000 and that's impacted somewhat. We've got $500,000,000 that doesn't mature until the 4th quarter and those are some treasury securities at 96 basis points. And right now, I think some of you heard kind of what we were buying. We've I would expect that if you're talking about something in the 5.5 versus that rounded to 225, you've got some nice pickup potential there.

Speaker 12

So does that imply Jerry that NII should keep growing from the Q1 levels as we move through the year and Q4 will probably see a lift again from the securities yield moving higher?

Speaker 3

Yes, that's kind of what I would expect. Yes, 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 the 2nd or third quarter.

Speaker 2

Perfect. Thank you.

Speaker 3

We are kind of expecting small pickups for the

Speaker 10

rest of the quarters moving forward.

Speaker 2

Got it. Thank you.

Operator

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.

Speaker 2

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

Operator

Thank you. This will conclude today's conference. You may

Powered by Quartr
Earnings Conference Call
Cullen/Frost Bankers Q1 2024
00:00 / 00:00