Cullen/Frost Bankers Inc
NYSE:CFR
Earnings Call Analysis
Q4-2023 Analysis
Cullen/Frost Bankers Inc
Cullen/Frost Bankers demonstrated a robust performance marked by growth in key areas during the fourth quarter. Average deposits climbed to $41.2 billion, a modest annualized increase of 3.5%, while average loans saw a more substantial jump to $18.6 billion, reflecting an impressive 14.3% annualized surge. These numbers reinforce the bank's effective strategy to expand its footprint, particularly in Houston and Dallas where the expansion efforts have yielded deposit and loan achievements significantly surpassing their initial goals.
With organic growth underpinning its success, Cullen/Frost celebrated a remarkable uptick in consumer banking, amassing 28,632 new households in 2023 alone. This accomplishment signifies a 12% improvement over the prior year's growth, evidencing the bank's capacity to attract a considerable customer base through a mix of quality service and adept market presence. Additionally, their residential mortgage product roll-out is building momentum, setting the scene for more robust growth in the coming year.
Turning to profitability, Cullen/Frost experienced a slight compression in net interest margin (NIM), dipping 3 basis points to 3.41% for the quarter. However, the bank managed to navigate the higher costs and deposit volumes adeptly. With a steadfast strategy in place, the bank is not aggressively pursuing deposit growth but maintains a healthy outlook for NIM improvements and net interest income growth, which is expected to fall between 2% to 4% for the upcoming year.
The bank's executives have cautiously projected the year ahead, factoring in potential Fed funds rate cuts. They anticipate mid- to high single-digit loan growth and modest deposit growth ranging from 1% to 3%. Executive sentiment implies an expected increase in net charge-offs, returning to historical norms of 25 to 30 basis points, up from the recent low levels. This prudent guidance also presumes a steady effective tax rate akin to 2023's 16.1% benchmark.
Cullen/Frost is actively investing in marketing initiatives aimed at reinforcing the customer experience and distinguishing its brand in a competitive landscape. This strategic move aligns with the bank's commitment to organic growth and customer acquisition. Concurrently, the bank places a strong emphasis on expense management, striving to balance its ambitious expansion with cost containment. Although the bank acknowledges an elevated expense growth in the short term due to technological and marketing investments, it anticipates a potential moderation in expense growth rate beyond 2024.
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Greetings. Welcome to Cullen/Frost Bankers Inc. Fourth Quarter and Full Year 2023 conference call. [Operator Instructions] Please note this conference is being recorded. I will now turn the conference over to AB. Mendez, Senior Vice President and Director of Investor Relations. Thank you. You may begin.
Thanks, Sherry. This afternoon's conference call will be led by Phil Green, Chairman and CEO; and Jerry Salinas, Group Executive Vice President and CFO. Before I turn the call over to Phil and Jerry, I need to take a moment to address the safe harbor provisions. Some of the remarks made today will constitute forward-looking statements as defined in the Private Securities Litigation Reform Act of 1995 as amended. We intend such statements to be covered by the safe harbor provisions for forward-looking statements contained in the Private Securities Litigation Reform Act of 1995 as amended. Please see the last page of text in this morning's earnings release for additional information about the risk factors associated with these forward-looking statements. If needed, a copy of the release is available on our website or by calling the Investor Relations department at (210) 220-5234. At this time, I'll turn the call over to Phil.
Thank you, A.B. Good afternoon, everybody, and thanks for joining us. Today, I'll review fourth quarter results for Cullen/Frost and our Chief Financial Officer, Jerry Salinas, will provide additional comments before we open it up for your questions. In the fourth quarter, Cullen/Frost earned $100.9 million or $1.55 per share compared with earnings of $189.5 million or $2.91 a share reported in the same quarter last year. Now these results were affected by a $51.5 million onetime FDIC insurance surcharge associated with the bank failures that happened early in 2023. Our return on assets and common equity for the fourth quarter were 82 basis points and 13.51% respectively, and that compares with 1.44% and 27.16% for the same quarter -- same period last year. For full year 2023, the company's annual net income available to common shareholders was $591.3 million. That's an increase of 3.3% compared to 2022 earnings available to common shareholders of $572.5 million. On a per share basis, 2023 full year earnings were $9.10 a share compared to $8.81 a share reported in 2022. As we mentioned in this morning's press release, just for the onetime FDIC insurance surcharge, our yearly earnings would have been up by approximately 10% over 2022. This solid fourth quarter and full year performance is due to the continued strong execution of our organic growth strategy by Frost Bankers who provide our customers with top quality service and experiences that make people's lives better. Our balance sheet and our liquidity levels remain consistently strong. Frost remains very well capitalized and has a 45% loan-to-deposit ratio. Also, as was the case in previous quarters, Cullen/Frost did not take on any home loan advances, participate in any special liquidity facility or government borrowing, access any broker deposits or utilize any reciprocal deposit arrangements to build insured deposit percentages. And additionally, our available-for-sale securities portfolio represented more than 80% of our portfolio total at quarter end. Our average deposits grew in the fourth quarter to $41.2 billion, up an annualized 3.5% from the $40.8 billion in the previous quarter. Average loans also grew in the fourth quarter to $18.6 billion compared with $18 billion in the third quarter. That was an annualized increase of 14.3%. We continue to see excellent results from our organic growth program. For example, our original Houston expansion locations stand at 103% of original deposit gold, 155% loan goal and 122% of our new household goal. For what we call our Houston 2.0 locations the last of which will open this year, we stand at 297% of deposit gold, 351% of loan goal and 185% of new household gold. As of quarter end, expansion loans and deposits represented approximately 24% and 19%, respectively, of our total Houston market presence. For the Dallas market expansion, we stand at 217% of deposit goal, 269% of loan goal and 198% of our new household goal. While still relatively early in this effort, expansion loans represent approximately 12% and deposits represented approximately 10% and of Dallas market totals. We've opened up almost 2/3 of our planned locations in the Dallas market, and we look forward to their growth as these locations mature past the start-up phase. And we're also excited about our new Austin expansion effort, where we plan to open 17 locations to double our presence in that market, as we've mentioned before, and the first of those opened in 2023 and the next is scheduled to open in April. Keep in mind that we've been successful generating core stable grassroots business and our expansions, and that will generate significant value over the long term. At year-end, our overall expansion efforts have generated $1.9 billion in deposits and $1.4 billion in loans even though many of these locations are still early in their development. Looking at our Consumer Banking business, we continue to see outstanding organic growth, and we ended 2023 with a record net new household growth of 28,632 households. Again, that's net growth, and it's 12% higher than last year's net household growth. In the past 3 years, we've added 81,000 net new consumer checking households. That's 2.6x more than the 3 years before that. And that shows that our organic growth strategy, combined with our customer experience and reputation is key to our success. We have the right products and services and relationships to help customers in our markets. Also, as we've noted, we're excited about the prospects for our new mortgage product. We completed the product rollout in December to the last of our regions, which was the Houston region. And in the fourth quarter, we approached the milestone of originating our first 100 mortgages, and we expect faster growth in 2024. Looking at our commercial business, our weighted pipeline is at $1.175 billion, and that was down from the record that we set of $1.918 billion in the third quarter. In the fourth quarter, we brought in 960 new relationships. That's the third highest quarterly amount ever up an unannualized 8.7% over the third quarter and up 21% over the fourth quarter last year. This shows me that our success in growing our business organically includes not only a consumer but also commercial business as well. For the full year, new commercial relationships added $806 million in new loan balances and $800 million in new deposits. Credit quality continues to be good by historical standards with nonaccrual loans down from the previous quarter and net charge-offs at healthy levels. Problem loans, which we define as risk grade 10 or higher totaled $571 million at the end of the fourth quarter. That was up from the $513 million at the end of the second quarter and $320 million this time last year. This growth in the fourth quarter was evenly split between loans in the OAEM and classified categories. Another way of saying risk grade 10 and risk rate 11 categories. Nonperforming assets totaled $62 million at the end of the fourth quarter compared with $68 million last quarter and $39 million a year ago. The year-end figure represents just 32 basis points of period end loans and 12 basis points of total assets. Net charge-offs for the fourth quarter were $10.9 million compared to $5.2 million last quarter and $3.8 million a year ago. Annualized net charge-offs for the fourth quarter represent 23 basis points of average loans and full year charge-offs were 18 basis points of loans. Regarding commercial real estate lending, our overall portfolio remained stable with steady operating performance across all asset types and acceptable debt service coverage ratios and loan to values. Within this portfolio, what we would consider to be the major categories of investor CRE that is office, multifamily, retail and industrial as examples, totaled $3.9 billion or 4% total CRE loans outstanding. Our investor CRE portfolio has held up well with the average performance metrics slightly improved quarter-over-quarter, exhibiting an overall average loan to value of about 53% and weighted average debt service coverage ratio of about 1.44. The investor office portfolio, in particular, had a balance of $891 million at quarter end, which was down from $959 million the prior quarter. That portfolio exhibited an average loan-to-value of 49% and an average debt service coverage ratio of 1.54 and healthy occupancy levels, all of which improved from the prior quarter. Our comfort level with our office portfolio continues to be based on the character and expertise and experience of our borrowers and sponsors as well as with the predominantly Class A nature of our office building projects. And again, we're glad to be operating in Texas. More than 90% of our office portfolio projects are in Frost markets, which are Texas' major metropolitan areas. We continue to see good economic growth and strong levels of in-migration of both people and businesses. I also wanted to note that from September 30 to December 31, total investor office outstandings decreased 7% from the linked quarter and total commitments decreased by 9%. Finally, I'll point out that we've just rolled out a new Frost marketing campaign and brand refresh designed to emphasize the great customer experiences we provide in order to differentiate our voice in a crowded banking marketplace. We've been talking for some time about the need to invest in marketing capabilities to complement the organic success we've been achieving, and we're optimistic about the impact this will make in customer acquisition. So in closing, we remain optimistic for what lies ahead. We're capitalizing on opportunities. We're enhancing and expanding our brand, and I'm proud of everything that our Frost teams are accomplishing across our communities. And now I'll turn the call over to our Chief Financial Officer, Jerry Salinas, for some additional comments.
Thank you, Phil. Let me start off by giving some additional color on our Houston 1.0 expansion results. As Phil mentioned, we've been very pleased with the volumes we've been able to achieve. Looking at the fourth quarter, linked quarter growth in average loans and deposits were $52 million and $78 million, respectively. Each representing approximately 24% annualized growth. And for the fourth quarter, Houston 1.0 contributed $0.07 to our quarterly earnings per share. Now moving to our net interest margin. Our net interest margin percentage for the fourth quarter was 3.41%, down 3 basis points from the 3.44% reported last quarter. Some positives for the quarter included higher yields and volumes of both loans and balances at the Fed. These positives were primarily offset by higher costs and volumes of deposits and customer repos compared to the third quarter. Looking at our investment portfolio. The total investment portfolio averaged $19.8 billion during the fourth quarter, down $723 million from the third quarter. During the quarter, we did not make any material investment purchases. The net unrealized loss on the available-for-sale portfolio at the end of the quarter was $1.39 billion, a decrease of $825 million from the $2.2 billion reported at the end of the third quarter. The taxable equivalent yield on the total investment portfolio in the fourth quarter was 3.24%, flat with the third quarter. The taxable portfolio, which averaged $13.1 billion, down approximately $471 million from the prior quarter had a yield of 2.75%, down 1 basis point from the prior quarter. Our tax-exempt municipal portfolio averaged about $6.7 billion during the fourth quarter, down about $252 million from the third quarter and had a taxable equivalent yield of 4.26%, flat with the prior quarter. At the end of the fourth quarter, approximately 71% of the municipal portfolio was pre-refunded or PSF insured. The duration of the investment portfolio at the end of the fourth quarter was 5.0 years down from 5.7 years at the end of the third quarter. Looking at deposits. On a linked-quarter basis, average deposits of $41.2 billion were up $356 million or 3.5% on an annualized basis from the previous quarter. We did continue to see a mix shift during the quarter as average noninterest-bearing demand deposits decreased $126 million or 0.9%, while interest-bearing deposits increased $482 million or 1.9% when compared to the previous quarter. Based on the fourth quarter average balances, noninterest-bearing deposits as a percentage of total deposits were 35.7% compared to 36.3% in the third quarter. Looking at January month-to-date averages for total deposits through yesterday, they are basically flat with our fourth quarter average of $41.2 billion. For January month-to-date through yesterday, the average noninterest-bearing deposit balance was $14.39 billion, down $309 million from the fourth quarter average affected by seasonality as those deposits tend to peak in the fourth quarter and soften in the first half of the year. For January month-to-date average, interest-bearing deposits through yesterday were $26.8 billion, up $309 million from our fourth quarter average. In the January month-to-date average, we do continue to see a shift in the mix in interest-bearing deposits to higher cost CDs from lower-cost products. The cost of interest-bearing deposits in the fourth quarter was 2.27%, up 15 basis points from 2.12% in the third quarter. Customer repos for the fourth quarter averaged $3.8 billion, up $225 million from the $3.5 billion average in the third quarter. The cost of customer repos for the quarter was 3.75%, up 8 basis points from the third quarter. The month-to-date January average for customer repos was basically flat with the fourth quarter. Looking at noninterest income and expense on a linked quarter basis, I'll just point out a couple of items. The other noninterest income category included a $3.5 million recovery of a fraud-related loss accrual that we recognized in the fourth quarter last year. Salaries and wages included approximately $8.8 million in higher stock compensation compared to the third quarter. As a reminder, our stock awards are granted in October of each year and some awards by their nature, require immediate expense recognition. The other noninterest expense category included a donation to our Frost charitable foundation of $3.5 million. Regarding estimates for full year 2024. Our current projections include five, 25 basis point cuts for the Fed funds rate over the course of 2024. For the full year of 2024, we currently expect full year average loan growth in the mid- to high single digits; full year average deposit growth in the range of 1% to 3%. Net interest income growth in the range of 2% to 4%, with a net interest margin percentage expected to be slightly higher for full year '24 than the 3.45% we reported for 2023. Noninterest income could be relatively flat given the pressure facing the industry on interchange revenues and OD NSF fees. Noninterest expense growth in the range of 6% to 8% on a reported basis. Regarding net charge-offs, we do expect those to go up in 2024 to a more normalized historical level of 25 to 30 basis points of average loans given the unusually low level we've seen in the last few years. Regarding taxes, our effective tax rate for the full year of 2023 was 16.1% and we currently expect a comparable effective tax rate in 2024. Going forward, given the wide range of analyst estimates and the results and impact on the mean of estimates, we do not plan to comment on consensus EPS as we have in the past and will instead provide our outlook for the major building blocks of our profitability. With that, I'll now turn the call back over to Phil for questions.
Thank you, Jerry. Now we'll open up the call for questions.
[Operator Instructions] Our first question is from Ebrahim Poonawala from Bank of America.
Maybe first question for Jerry. Your outlook with the 5 rate cuts for NII growth. You mentioned about 2% to 4%. Just give us a sense of the sensitivity -- my understanding is the balance sheet is still asset sensitive. So first, whether that's right or wrong. And then as the year progresses, do you expect NII to drift lower? Or do we build from fourth quarter levels? And are you just outrunning rate cut impact because of balance sheet growth and fixed rate asset repricing?
That's a lot. Let me first say that, yes, we still are asset sensitive. I think we've talked about this in the past, and I'll just kind of go through some of the pieces of it and fill in as I can remember your question. But one of the upsides that we talked about was that we've got projected about $3 million in proceeds from our investment portfolio. And about [ $1.4 billion, $1.5 billion ] if I remember correctly, is in the first quarter. So a big chunk of it comes in. And the yields that, that portfolio has -- I think we've talked in the past about some specific treasury securities that we had purchased. I think $750 million of that is going to mature here this month, and the yield on that portfolio was a little [ 102 ], I think it was. So some of what we're seeing is a pickup that we're going to get just from the -- even if we don't reinvest in investment securities, even in that rate environment that we've discussed, it would still be favorable to our net interest margin percentage. We've also seen some improvements, I was noting in our fourth quarter loan spreads that we booked, not huge, but there are some improvements during the quarter. I think that's going to be a positive to us as well. So no, I mean, I think overall, we're feeling good about net interest income and net interest margin based on where we're at. I mentioned that we continue to see a mix change, but the changes that we're seeing at this point, in my mind, aren't really material. I think especially in a rate environment where we've been for a while now, and even if you said it was flat, I think the bulk of the rate competition for the most part is gone. We still continue to see especially smaller banks, smaller local and regional banks, B, what I think is really putting out some unrealistic deposit rates that we're not going to match. I think we've always said to the community that we don't intend to be the highest rate in the market, but we do want to be competitive. In a rate environment, as we portrayed, I think we find ourselves being able to be more competitive on money market funds because our betas typically have been -- of a range, we'll take a money market, have been like 60%. In that the rate environment that we're talking about, some of those shorter duration investments that those funds would be making. They have 100% beta, if you will. So I think we'll find ourselves in a much more competitive situation. You heard me say we're not projecting a huge growth in deposits. I think that we feel really excited about the level of loans and deposits that are coming from our expansion branches. I think we're really excited about that. We've also talked about continually about the nice growth that we've had in commercial relationships. As we've said in the past, those relationships take a little bit longer to get all the accounts moved over and signature cards done, et cetera. So I think overall, we're not too aggressive on deposits. I think there -- it's still to be seen. We saw a little bit of a downtick, as I said in January, on the commercial DDA. But as we look at our trends, that's really pretty normal for us. So no, I think we're still feeling good about all that and still feel like we've got some room to improve on the NIM percentage and net interest income. We're not talking on net interest income. As I gave guidance on 2% to 4%, and that's given the rate environment that we're talking about. If you were -- if we were talking about a flat environment, just to give you some perspective, I'd probably be talking about increasing those percentage percentages, say, 1.5%. We feel a little bit nicer improvement in our NIM in that situation.
That was good color. And maybe a question just on loan growth. When I look at the period-end balance it would equate to about 5% growth starting out for the year. So it suggests that you don't expect as much momentum on loan growth looking forward. So maybe Phil, give us some perspective around customer sentiment and whether you are seeing that slowdown play out? And given that we're going -- entering sort of an election cycle, do you expect loan growth to be weighed down by that as well?
It's a good question, Ebrahim. I think that -- with regard to sentiment, I believe that things are slowing some with regard to that. And I think some of it is what you mentioned that typically happens with an election year. People are wanting to know what the regulatory environment is going to look like. So I think there's some of that. I think there's just a general slowdown and some other things in interest-sensitive areas, say, like obviously, real estate, commercial real estate deals, some interest-sensitive areas, I would say, used cars, for example, if you're looking at a specific segment. So there is some of that. And I looked at our pipelines also. Our new loan commitments were up about 9%. And linked quarter annualized. So recent activity has been good, but if I want to look at our opportunities, they are down a little bit from where they were last year. They're down about 7%. On a linked quarter basis, they're down about [ 17 ] depending on whether you're looking at a customer or prospects, prospects are down about 26%. So that just shows what's kind of going into the hopper, if you will, says to me that we're slowing in terms of what's available and what we're seeing. I should point out that if you did look at our core loans, which are those loan relationships under $10 million, that if you look versus last year, those are actually up 28%. So we've seen most of the slowdown year-over-year to be in larger deals. And I think that represents that expansion strategy. It is a very core business-centric strategy, and we've had really good growth there. So I think that's propping that up. So yes, I would agree that things look a little bit slower, not bad. As I said, Jerry has guided us to a high single-digit loan growth, and I think that's a realistic number for us. And we'll get through the election and see where that takes us.
Our next question is from Steven Alexopoulos with JPMorgan.
I want to start. So on expenses, so Jerry, the guidance was off reported expenses. So if I take the FDIC charge out, gather at the midpoint like 12% expense growth, something like that for 2024. Now I'm curious because you guys used to be a mid- to high single-digit expense grower, but you're having this really great success with all the expansion. How do we think about expenses beyond '24, right? Do you go to the next market or deeper in existing and the expansion continues. Like should we think about Frost as being a low double-digit expense bank while you continue for the next several years on expansion? Or does it throttle down at some point?
Well, Steve, I'll talk broadly a little bit and then Jerry might throw in some color. I think there are 2 Frosts, right? I mean there is what I'll call legacy Frost, which is our business that we've built up over the 155 years and then there is expansion Frost, which is a company that has really come into its own with its ability to grow organically in markets and build households and accounts, and we're going to keep leaning into that. And our experience shows that it's great, it's worthwhile of the shareholder. I mean we're used to be 25% represented by expansion. That's -- I think that's pretty remarkable. And I think it shows that we'll take share in this gain. So that will be higher. I would like to believe, though, if we go past '20 -- past this year, that even though we are going to continue to be expanding, I'd like to see our expense growth rate be a little bit less because we have made -- we talked about the generational investment in IT that we made earlier this year, I think it was what we talked about it. We talked about the marketing expenses that we've built up, which we really need to build that infrastructure. And so some of this is building things up that I hope we don't have to continue to do. And -- so I think our expense rate will be elevated from what it was historically, but mainly because of our growth strategy and our expansion strategy. But when you look at the legacy part of the bank, and how we operate on a regular basis. I think we're still pretty tight. And I'll be proud of our expense management on that basis. Jerry, any thoughts?
Yes. I agree with everything Phil said, Steven. I would say that even in this environment, we won't go into a lot of details. But I'll tell you that we continue to make sure that we're looking at for any -- looking very closely at any request for additional capitalizable items or for new FTEs. We're really focused on that. So it's not like the door is open and everything is getting approved. And so I'm very much in the campus still says that we would -- we need and we will try to continue to control expenses. I think he talked about a couple of things, but just to give a little bit more -- put a little bit more meat on it. Some of the things that we've talked about from technology and from marketing to get the 2 examples that he mentioned, weren't really in our full run rate for all of '23. So some of the lift that we're seeing is just trying to get the full year impact of some of those expenses. Some of the people have retired until late in the year, for example, whether it's in the IT area or in the marketing area, and some of those programs hadn't started. So some of it is just trying to get that into our run rate. So I agree with Phil, I would expect that going forward, I don't see us going back to a 3% to 4% growth given organic expansion strategy. But I would hope that these -- operating at these higher levels is certainly not our current expectation based on what we're seeing. And of course, in this environment, we did continue to do some things for our employees where we've done, I think, a great job of taking on some additional costs corporate-wide that had previously been covered by the employees. As an example, we cover more of the medical that we did historically. And again, some of those things just trying to be more competitive and at the same time, treating our employees with grace and knowing what a competitive market that we're operating in. So long-winded answer to say I agree with Phil. I don't think we'll be operating at this level past this year that we're talking about, and we continue to be focused on trying to manage those expenses.
Steven, I'd also point out that -- with regard to the expansion, I mean, the numbers are the numbers, and we're proud of them and what we're able to do. But I'll just throw a couple of things out there, too, that we're looking at. And you might be interested in. If when someone comes here, we'll survey a broad group of people who are new customers and will ask them what influenced you most in choosing Frost as your bank. And the #1 response is convenient locations; and number two, a close second is recommendation from a friend. And it drops off by about 1/3 being 24/7 live customer support and then it drops off by about that by about, say, 15% to convenient ATM network and then it goes to other and a lot of different things. But it shows in what we ask our customers how -- what are the things that brought you here and remember the growth we've had and growth in households, and those are the responses our customers have given. And the other thing I'll point out, and we said this before, and I'll update this and give a little bit more color. If you look at our Houston expansion, which is still -- we still got some developing new branches there, which aren't fully -- we only had one, I think, in the 5-year anniversary, which -- that was recently. But if you look at those -- the relationships, new accounts that are open in Houston, 85% of the Houston expansion new accounts are opened within 5 miles of a Frost Financial Center. And 44% of the Houston expansion new accounts are located within 2 miles. So, again, we're not trying to process transactions at these locations, but we are projecting our brand into these communities, and we're leveraging our value proposition. And you heard me say that the number two reason was reference referrals from a friend. So it's -- I like to look at it as a virtuous cycle of what we're doing, how it's all working together. So we're going to continue to lean into that. And will it cost some expense money? Yes, it will. We're being careful with it, but we really believe it's generating success for the long term.
That's great color. I wanted to ask about commercial real estate. It was funny this quarter, in particular, I feel that a ton of questions for investors that they want to buy your stock here, they like where it's trading. They love all these expansion metrics. Commercial real estate concentrations, I think that's keeping them nervous. And I'm sure you've seen the articles to fill the vacancy rate is almost 20% for office in Dallas used in Austin. So my question to you is, what's your perspective on the commercial real estate market? Like you see these markets from the ground level, is this exaggerated. When you look at your portfolio, I don't think you have vacancy rates anywhere near that. But can you give us some color on your [ CRE ] exposure in those markets, you didn't see were overly concerned, but maybe we could flush that out for the investors on the call.
Yes. What I would say, Steve, is that first of all, I've read that Wall Street Journal Article late in the year about the vacancy rate in Texas. Let me tell you what. That vacancy rate in Texas is going to be high for a long, long time. You know why? Because it's downtown real estate. Some of those buildings -- this is my opinion. Some of those buildings, I don't know they'll ever be filled. Some of them probably from the 1980s or '90s. So you've got that and you've got that. Now I'll recognize Austin's got new buildings there, and they've got significant vacancy. So I'm not trying to whistle past the graveyard. I'm just trying to say there's some element of that vacancy that it's different than other vacancies, okay. Not all created equal. But what I would say about commercial real estate is -- we saw an increase -- you heard me say we saw an increase in problem loans this quarter. That's risk rate 10 or higher. But it really wasn't from commercial real estate at all. In fact, if you look at what happened, let's take commercial office. We had 3 paydowns of investor office that totaled $95 million. One of them, they paid off our cash loan came due, paid it off for cash is a significant deal in a downtown major market. One, we had one that was in a medical center of a major market. They put lots of cash in it and refinance the rest. We had another one that we sold. It was a completely performing loan, but the owner had some other problems, other places, and it was in Austin. And we said, look, we got a really good bid for that long. We sold it. We took I think it was a 7% discount on it to do it. But those are 3 examples of investor office in Texas where we're operating, where you worked out okay because you've got the right structures, the right locations and the right sponsors for these things. None of these things were guaranteed. And so the increase in problem credits this quarter was really more related to just banking business where you've got you've got someone -- there is one credit that came up late. They've got an inventory write-down. They noted by us about, I think, we're still looking into exactly why it happened. They are 2, I think it probably relates to an accounting -- at least some to an accounting system, perpetual inventory system they put in, but we'll see. But if you got a -- they basically been operating with an understated cost of goods sold, we had to write down some inventory. So that's an unusual thing that happens in business at times, doesn't have anything to do with interest rates or office building vacancy rates, right? There was another that was liquor distributor that lost a supplier, and they've got to cut some overhead. They'll be fine. But it's those kind of basic banking things that are the reason we saw the increase in risk rates. And higher and it wasn't because of the real estate at all. In fact, that sort of improved. So -- and the other thing I'll say is we're not stopping doing business in the Texas market. I mean, granted, we're in the Texas market and thank goodness. I mean, it's -- I'd put it up against any market that in the U.S. and we're still seeing opportunities. There are fewer of them, and competition for the really good deals is still there, but we're still seeing opportunities in commercial real estate that make total sense to us because of the properties and the structure and the sponsors for the deal. So my worry right now isn't really commercial real estate. I mean we've been working on it for all how long, 18 months or whatever. But what I've been seeing, let's take these payoffs we talked about. And we also have one that was a risk rate 11 last year. I was -- I did'nt even mention it was a $41 million deal. It's not an office building. It's an industrial deal. That there was a hole in it. It's a great piece of property for a credit tenant, but rates go up, there's a hole in it. We -- the owner sells it. He brings cash to the table. So that's not really -- it's been performing the way I think we hoped it would. Will there be some issues. I'm sure there will be, have been a few. I think we've got one nonperforming office building we talked about few quarters ago. But it is not a train wreck in the markets we're in and the relationships that we're in, in commercial real estate. And we're watching it and we'll keep talking to people. I mean I'll keep going on with this answer, but I mean these are things that need to be said. You could say, well, what's the biggest exposure on paper and it's probably your construction portfolio for multifamily. And it's because the debt service coverage ratios are those things improved a little bit, but they're still not where they'll need to be to get them refied or get a permanent financing. But when you look at that, I think only 6% of those come due in this year. I think 75% of them come due in '26 or later. And then when you look at the people behind them, and I'm not going to name names here, but if you look at the people we do business with, they understand this business. It's just not like somebody who thought, "Gee, let's -- let's get in the multifamily business and find a banker that will bank us." I mean, these are people who have been doing this a long time. And I feel really good about the relationships and how they take care of their business. Again, I'm not saying we can't have problems, but this is how life is on a day-to-day basis around here. And that's what I know.
That's great color. Thanks for taking the time to flush that out because it is a major concern. And most of us just read these articles that we don't know what's in your portfolio like you do, Phil. So it's nice to hear you walk through it and that you're confident things could happen, but you feel pretty good on your exposure.
Our next question is from Dave Rochester with Compass Point.
I was hoping you guys could talk about what's your NII guide means for the NIM trajectory. You've got the low rate securities rolling off this month and then you've got the rate cuts coming in later in the year. So is the thought that you get some expansion here in the first half of the year, then maybe that turns south in the back half of the year? And then what does that mean for the exit NIM by the end of the year? Is that going to be higher than where you were this quarter? Are you thinking that might be lower? And then you mentioned deposit betas earlier. I was just wondering what your guys' thoughts were on how fast you can do those deposit costs down since you were very focused on being proactive, I know on the way up. Are you thinking you can bring those down just as fast basically assume the same type of beta on the way down?
Yes. I guess I'll start with that last question first. I think the thought process is that we could be -- go down just as fast. But at the same time, I'll say that we are -- we don't ignore the market. I said earlier, we're not going to feel like we need to lead the market. But we're going to be competitive. So I would answer the question by saying that, yes, we were up fast. I think we've kept up all along with all the hikes and I feel like we can be pretty aggressive going down, but we're not going to keep our head in the sand. And if the market is not moving down as quickly as we thought it might, we'll certainly react accordingly. As far as the NIM, I guess what I'd say is that, yes, we are relatively flattish all year. And so yes, I think you said it. We really kind of take a step up in the first quarter as a current expectation. We do have, in our projections, a cut in March. But -- so we do take a hike up in the NIM in that first quarter and then really kind of given the conversation that we had earlier, and a lot of it will be dependent on liquidity, right? And what happens with deposits, how much we're keeping at the Fed, et cetera. But right now, our guidance I would give is it's -- once we -- in the first quarter, the rest of the quarters will be relatively flat. So we get a lot of the help in that first quarter.
Okay. What are you guys assuming for the NII or the NIM impact from a single rate cut at this point?
The answer I'd give you is about $1 million a month. And again, I think that's one where it will be dependent on what happens with how much liquidity we've got at the time it happens. It could be more if there was more liquidity on the balance sheet.
But how are you guys thinking about managing the securities book through the year? I know you've got -- you didn't purchase anything this past quarter. You've got the securities rolling off this quarter. Is the thought to just let that run off this year flowing any kind of cash flow into loans or paying down borrowings that kind of thing? Or are you going to be replacing some of that along the way?
Our current expectation is that -- I think I've said earlier that we're projecting about $3 billion in cash flow from that portfolio. Right now, we're projecting that -- I'm sorry? So we're projecting that $1.5 billion to $2 billion is what we would be invest more likely closer to that to the lower end. And we're really just kind of saying we've got our investment guys who really are paying attention to the market and we'll just look where there's value, and we'll continue to try to be opportunistic. I think we've been successful in a lot of cases. And we just have to see what's happening, but that's what our current expectation is. We spend about half of that liquidity. We feel good about deposits, like I said, but kind of would like -- you know us well enough to know that we tend to keep a pretty high level of liquidity. But that's our guidance. We'll spend about half of it.
Half of the runoff.
About half of the runoff, right? Half of the -- $1.5 billion of the $3 billion that we expect.
Got it. And maybe just one last one. Where are you seeing securities yields at this point? I know they'll change for the year, but curious?
Yes, we're not buying anything. I think that the last time we talked, we were looking at mortgage backs, and I think they were a little bit -- yes, I almost hesitate to say -- we really haven't been spending a lot of time with that our investment guys are. We haven't made any purchases for 2 quarters now, but certainly north of 5%, and nothing's really enticed us. We're really -- we just kind of want to see how this first quarter plays out. But if we do see something where we think there's real value. The good thing about an organization like ours is that the group that makes those sorts of decisions is -- works very closely together. We're meeting all the time and certainly could make a decision really at the snap of a finger. So our guys are keeping their pulse on the market, but at this point, really haven't felt a lot of pressure that we need to do something today.
Our next question is from Manan Gosalia with Morgan Stanley.
Follow-up to the question on liquidity. I mean I guess if rates come down in line with the 5 rate cuts or so that you're estimating, noninterest-bearing deposits stabilize, can you deploy more of that -- those high levels of liquidity that you're keeping on your balance sheet? I know that the deposit rate or forecasting is lower than the loan growth that you're forecasting. So presumably, you will use some of that. But can you bring that 14%, 15% of assets and cash down meaningfully as we exit 2024?
I think it depends on what meaningfully means. You're never going to see us running with $1 billion at the Fed, for example. That's just not the way we operate. But could we make some decisions that had us potentially -- especially if we felt good about the economy, we felt good about what was going on with deposit growth and such, could we find ourselves in a position where we were deploying more of that liquidity, I'd say, yes. But it's going to be dependent on a lot of factors, what's going on in the economy, those sorts of things.
Got it. And then given your comments on expenses earlier, and there is some onetime or temporary nature of some of the expenses that you mentioned. What point do you get back to positive operating leverage. So I know there is a bit of noise in the revenue line this year with the base effect of rising rates in 2023 and then the rate cuts in 2024. But if rich should stabilize from there, how quickly do you think you can return to positive operating leverage?
It's a math question. Honestly, I don't know the answer to, but here's what I do know that the success that we're having developing these markets as expensive as it is, will create significant positive shareholder value. Now does that manifest itself in a positive operating leverage trend, probably. But honestly, I'm not close enough to the math to tell you when it would happen. But it's -- at some level, it's just basic business and it's just a recognition of what we're developing and understanding the basic profitability of a regional community, middle market-focused bank because that's really what we're creating in these markets. We're creating footprints that basically look like Frost Bank. And so whatever that profitability is for a bank like that. That's what we're generating. And I think that's going to be -- that will be positive for a long time, and I'm confident we'll get back to operating leverage positions that reflect that. Now again, like we talked about earlier, as long as we're continuing to do this and finding markets where it makes sense to grow and develop this for shareholders, on how much we do in any 1 particular year, can affect operating leverage on a particular year. But I think it would be wise for us to also look at what is the operating leverage of the, what I would call, the legacy company, the legacy bank, what is that doing as we're expanding in these markets. And that's worth looking into also.
Would love some disclosure on that if available, but thank you for this comment.
Our next question is from Peter Winter with D.A. Davidson.
Jerry, you gave a little bit of a cautious outlook on fee income being relatively flat. You talked about the regulatory environment with overdraft fees and interchange. Are you guys taking action on this now ahead of any regulation? Or you just think it's going to be coming down the road this year?
Well, I'll talk about 2 pieces of it. The thing for us on the overdraft fees is something that it's not going to be a growth product for us, right? The reason those revenues are growing is because we've had a consistent account growth. We continue to do product -- do changes to the product to ensure that we're doing what we need to do from a fairness standpoint and making sure we're serving the customers with grace. And so we're doing a lot of things beginning in '23 that those impacts aren't -- haven't run completely through the annual financials for '23. And then we've got some additional items that we're considering doing to tweak the product that are going to -- that are telling me that all things being equal, we're not going to expect to see a lot of growth in those overdraft fees. On the interchange, that's really going to just be dependent. Our projections right now have those changes going into effect in the latter part of the year. So just based on the proposal that was out there. So we're not -- on the OD side, we're doing things that were affecting that revenue ourselves by making some changes to the product that we're delivering to the customer, which is going to reduce our revenue. In the case of interchange, it's really based on the anticipated 1/3 reduction in those fees later this year. So those are the headwinds that we're dealing with.
Got it. And then separately, the earnings accretion from the Houston expansion has been really taking hold and becoming more accretive. Do you think that the Dallas expansion starts to become accretive to earnings this year? And then secondly, are there opportunities maybe to close some underperforming legacy branches to defray some of the costs with the new branch build-out?
Take -- I'm going to step back a second on your question on noninterest income. The other thing that's affecting us, and I mentioned just one item in the quarter on the sundry income. We did have some nice [indiscernible] income throughout the year that we don't really project those sorts of items into our financials. So this $3.5 million recovery of a fraudulent wire that we had in the fourth quarter. Obviously, we've got items like that, that go through our noninterest income that we don't forecast. And so that obviously has a downward effect too, on our forecast going forward. As far as the Dallas is concerned, our expectation is we're still opening locations in Dallas. And so as you know, the most expensive part of this expansion effort is just starting up those locations. And as Phil said, the first one in Houston just reached its 5 years. And so as I talk about that profitability, we're really happy with where we're at. And when I look at the individual pieces of it, and we're not ready to disclose overall kind of how what we're doing. But the plan was, and it's working this way is that as those Houston locations begin to mature more and more, they're going to start to offset the losses that we have associated with the expansions that have started more recently. So it's getting to a point where Houston is going to carry more of the expansion cost of the Houston 2.0 in the Dallas. But Dallas, no, to answer your question, I don't see them being profitable this year just because we still have locations that we're opening in. And there's not a lot of maturity yet. Although it's Phil said, they've performed really, really well. So as far as our projections to our performance to our goals, we've done really well. But no, we're not in a point where we would say Dallas is going to be profitable next year. We are saying that Houston is paying more and more of the expansion that we're doing. So it's really working as we planned as those branches mature, really helping us pay for future expansions.
Our next question is from Brady Galey with KBW.
I just wanted to circle back to the loan growth guidance to make sure we're understanding that right. The mid- to high single digits, are you saying that's on an average basis, full year over full year?
Yes.
So you -- I mean if you didn't grow loans a single dollar, you'd already be up 5% on an average year-over-year. So on an end-of-period basis, if you look period end to period end, mean that loan growth will take a decent step back from the 10% you did last year.
I guess what I would say is that, obviously, we tend to rely more on the averages than we do on the period end. But the guidance that we've got, we'll certainly will review that as we get through the quarter and as we get through the year. But right now, I feel like that sort of guidance is really very realistic based on what we saw. I think this year, if I went back, if I'm remembering correctly, I think the full year average of '24 -- excuse me, '23 over '22 was a little under 8%. And so really, we're guiding towards something in that arena, maybe a little bit better than that without knowing exactly what sort of environment will be in. So I think that we're sticking with it and if we can do better than that, that will be great. And we continue to -- we have plenty of liquidity. We're not holding back. But at the same time, all the deals that we're doing have to make sense to us. And I think we've been really good about growing relationships that we want to grow. We talked last quarter, I think it was about an unusual amount of opportunities that have come our way just given from the stability that we have and the liquidity that we have available. But we're just not going to say yes to every deal that we get, right? We're going to be very selective and make sure that these are the quality sort of relationships that we want to continue to develop. But we'll certainly continue to give up -- we'll give guidance, and if it's upward on loan growth, we'll certainly support that. But at this point, this is kind of what we're comfortable with.
Just my tag on to what Jerry was saying about looking at deals and making sure they work for us. If you look at the third quarter and then compared to the fourth quarter, we saw a sharp uptick in the number or the percentage of deals that were lost to structure versus pricing. We lost 66% of the deals in the third quarter to structure. And that compared to 76% of deals lost to structure in the fourth quarter. And a lot of that in the -- I'd say the majority of that would be in the CRE space. So it's still competitive out there. And I think this shows that we're not just going to do whatever deal comes our way. We're still going to be careful making sure it's quality stuff and it's on our way.
Understood. Then my last question is just on the share repurchase. I saw the new $150 million of authorization. I think you bought back about $40 million of stock last year in '23. Should we expect Frost to be active on the buyback in '24?
I wouldn't -- yes, I think that certainly we like to have it available. We like to have that tool in our toolbox should the opportunity arise. I wouldn't count on us being significant buyers of our stock unless we really felt like there was an opportunity something happened. We'd hate to be in a position where we thought we had a great value, and we didn't have a program in place. So for us is just making sure that if there's some sort of market dislocation, and we think there's a great value for us. So we're able to take advantage of that without having to jump through a lot of hoops.
Our next question is from Brandon King with Truist Securities.
Philosophically with the expectation of Fed cutting this year, how are you thinking about managing deposit costs lower? Compared to your peers, you're a little more proactive with rates on the way up. And I just wanted to know just your insight on how you plan on managing that on the way down? Certain account types, exception pricing things of that nature.
Brandon, we don't. We do very minimal exception pricing. We do some, but it's not a big part of our business. So let me start with saying that. I think we said earlier, when we went up, we went up pretty fast. We reacted very quickly. I thought that was the right thing to do for our customers. We'll just really look at I said earlier, I'd expect that the betas that we utilize going up will be kind of the first reaction that we have on a down cycle. But at the same time, we're not going to have our head in the sand. And if there is the competition that we feel we're competing against is really pricing a lot more aggressive than we are than one may have to react. We don't think we have to be the highest. We're not the highest today. I think we're fortunate in that having won the J.D. Power award for 14 consecutive years. I'm looking to Phil, I think it's 14 or 15 and the Head of the Consumer is going to get mad at me if I missed it, but that's based on customer satisfaction. So it's not all in the rate. We realize that. A lot of it is on customer service and how -- what we do to take care of the customer, both on the commercial and the consumer side, but more on the consumer. And we've got a great app, mobile app that I think we get a lot of credit for and that we really try to stay on top of and make sure that we're keeping that at the forefront. And so I don't feel like we have to be the highest, and we've proven that in our relatively stable deposit volumes, but we do have to be competitive. And that's what we're really keep on our eye on the most is making sure that we're offering our customers a square deal.
Brandon, you [indiscernible] better than I do. But I mean money market funds are probably going to be -- they're going to be buying a lot of the market instruments, and those things are going to be going down. pretty consistent with declines in rates at least on the short end. So I think it's partly our expectation that their movement in rates will be sort of [indiscernible] and there were a lot of competition is right now anyway. So that will give us some ability to be better against those particular products. And I think as Jerry said, if we're competing straight up against the bank we'll compete pretty well just being close on rate. It won't have to be the highest in the market.
Got it. And that's helpful. And then I wanted to give more insight into your marketing plan and brand refresh. So what are the things that you're planning to do in 2024 that you weren't doing in 2023? And then could you talk about kind of the potential and scale of what you could envision that looking like maybe beyond 2024?
Well, as it relates to the marketing plan, we've really focused on just the look and feel of our brand, how it looks in the marketplace and trying to differentiate it from sort of the CS sameness that's out there and really trying to reduce the -- for sure, the lack of awareness about our brand. And if you are aware, we really want to reduce indifference to the brand. And so we're trying to utilize things that just visually help us there. We're also -- we put out some new ads that sort of reflect who we are and some of the amazing stories of customer service that we're going to have, and we do that with a little bit of humor in a link that's typical to Frost Bank. And -- so I think the campaign that way is going to be really good. But if you look at it under the hood, I think we've done a lot better job. I know we have bringing in partners that are helping us to a better job with digital marketing and ineffectiveness in our digital offerings. And really, that even translates into some of the direct mail pieces that we do and a lot of that in connection with some of these branches that we're opening in these new markets, making sure that our response rates on that are improving. So we've seen some interesting results in that with our new partners, and I expect that to be something that helps drive customer acquisition going forward. So we'll see, right? It's -- I've learned everyone is a marketing expert if this one works.
Got it. Yes. I was just trying to get a sense of this is not kind of a Herculean effort and just kind of more incremental on the margins.
No, I don't think so. I think it's -- we've built our infrastructure in terms of our internal marketing resources and capabilities. So that is something that was a part -- really a part of what the expense base growth was last year by and large, there will be some follow-on as those things annualize to a full year in 2024. But a lot of it is just utilizing the market spend that we have been spending, but do it in a more effective way. So -- but it's not the same level of the -- I go back to the generational investment that we did in IT, it's generational for marketing, but it's not the same size of that investment as IT was.
[Operator Instructions] Our next question is from John Pancari with Evercore ISI. Okay. And our next question will be from Brody Preston with UBS.
I'm going to wrap a few into my one here, if you don't mind. They're all on NII, Jerry. So you make it easier. I know you're relying a little bit more on the average than you are at the period end. But if I am working on the period end, it looks like the loans and the deposits should kind of -- the deposits should fund the loans and then you're going to reinvest half of the $3 billion. So you got about $1.5 billion of cash flows left over from the securities book naturally. I'm wondering if that's going to go into just kind of pushing off the remaining repurchase agreements that you have on board? And then Secondly, I was wondering if you all would provide us with what the period-end savings and interest-bearing checking and money market accounts look like just because it's a little over a week until we get the [ K ], and we've got to update models in the interim there.
Yes. You're saying just the period-end rates?
No, the period-end balances.
Oh, the period-end balances. Yes, we can get them here for you. But -- and if we don't get them to you, A.B. can certainly give those to you off-line if you want to do that.
Okay.
I'm sorry, I forgot your first question that you...
That's okay.
What are you trying to get at? I'm sorry?
I was saying if I look at the guidance and look at like the implied period and I know you're relying more on the averages, I'm wondering, it looks like the deposits can fund the loan growth that you got. I'm wondering what you're going to do with the additional $1.5 billion?
Yes. I'll start Yes, I'm sorry. I apologize. Yes. So you mentioned repo. So for us, customer repos is really -- these customers, for the most part, are really long-term customers, and there is a feature within that product that we make available to them that allows them to utilize the product. And so even though it's fully collateralized, they do take a haircut versus the respective MMA rate. And we may do a little bit of exception pricing there. But for the most part, it's really a very successful product for us there are some transactional pieces of it that work to their benefit, and they want to be in that product. But this isn't hot money in any way. These are long-term customers. A lot of them have other -- have deposit relationships as well, significant deposit relationships. So from our end, we've got a significant amount of collateral. It really -- it's a good operating business for us, and we don't have any intention of reducing that sort of a product.
What do you do with the additional $1.5 billion of cash flows then because if you're targeting...
Yes. So at this point, what we would probably do and what we're modeling is that we would continue to keep those balances to the Fed. I think I said earlier, we just kind of want to see what happens as far as deposits are concerned, deposit flows. And so from our assumptions today, we're really just increasing our balances at the Fed.
And our final question is from John Arfstrom with RBC Capital Markets.
I'm going to tease Brody, but that's just cruel to box and then to one question. I'm kidding Brody. Anyway, just on mortgage, how material do you expect it to be in 2024. You said you're all built out. And I'm just curious on your willingness to hold them on the balance sheet, how big could it be? And do you expect to sell any of the production?
Well, I can answer the last part of it as we don't expect to sell any of the production. So it's really Jerry might have a better feel for that. But it's not going to be as -- it's ramping up, right? And so I think what we said early on, when we started this, we expected in 5 years, it would be the same as the risk of the consumer portfolio. So that's -- at that point, I think it was around a $2 billion estimate of what it would be. And so we're beginning to ramp up. It's a worse market than when we started, right, in terms of what's available out there. housing wise. But I would say it would be -- I would -- let me venture a guess, $200 million-ish. Some of our mortgage department, not just falling down when I said that.
Okay. All right. So not terribly material, but all on that.
No, it's not huge. It's not wagging the [ dog ], but it is going to be just solid growth to continue to develop that product.
Yes. Okay. I appreciate it. Jerry, I think you should have said consensus is a little bit low. [indiscernible] a little bit low not by much, but that's my comment.
I appreciate your input.
We have reached the end of our question-and-answer session. I would like to turn the conference back over to Mr. Green for closing remarks.
Okay, everybody. Thanks again for your interest in our company, and we'll be adjourned. Thank you.
Thank you. This will conclude today's conference. You may disconnect your lines at this time, and thank you for your participation.