Cullen/Frost Bankers, Inc. Q2 FY2020 Earnings Call

Ladies and gentlemen, thank you for standing by. And welcome to the Cullen/Frost Second Quarter Earnings Conference Call. At this time, all participants are in a listen-only mode. After the speakers' presentation there will be a question-and-answer session. Please be advised that today’s call is being recorded. I would now like to hand the conference over to your speaker today, Avi Mendes, Senior Vice President and Director of Investor Relations. Thank you. Please go ahead, sir.

Thanks, Janice. This morning's conference call will be led by Phil Green, Chairman and CEO; and Jerry Salinas, Group Executive Vice President and Chief Financial Officer. 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 that Act. 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 Investor Relations at 210-220-5234. At this time, I'll turn the call over to Phil.

Thanks, Avi. And good morning, everybody. Thanks for joining us. Today I'll review second quarter results for Cullen/Frost; and our Chief Financial Officer, Jerry Salinas, will also provide additional comments and then we’ll open it up for your questions. In the second quarter, Cullen/Frost earned $93.1 million or $1.47 per share compared with earnings of $109.6 million, or $1.72 per share in the same quarter of last year and $47.2 million or $0.75 a share in the first quarter of this year. Beyond the financials, the second quarter was an extraordinary one for Frost. To respond to the COVID-19 pandemic, we've continued serving customers with appointments in our bank lobbies, at our motor banks, with our online and mobile banking service, with around-the-clock telephone customer service and at our network of more than 1,200 ATMs. I'll talk in more detail about our Houston expansion and our Paycheck Protection Program loans. But for now, I'd like to point out that we have been completing our organic growth initiatives and still achieving the same award-winning level of customer service for which we are known, despite having more than two-thirds of our employees working remotely. In fact, during the second quarter, we learned that Frost had achieved its highest-ever Net Promoter Score with a jump from 82 to 87. That's a score that would be the envy of many well-known brands, and it's a testament to our core values and our ability to consistently take care of our customers' needs, especially during trying times. More recently, we learned from Greenwich and Associates that Frost was identified as a standout in their response to the pandemic based on customer surveys. In fact, Frost was one of only two banks to be named a standout in both the small business banking and middle market banking categories. I mentioned the Paycheck Protection Program. As of June 30, when PPP loan applications were initially scheduled to end, we had helped nearly 18,300 of our customers obtain PPP loans, totaling more than $3.2 billion. In the state of Texas, Frost was number one in PPP lending; in San Antonio, Fort Worth and Corpus Christi, Frost was number one in terms of PPP loans approved. In San Antonio, we had more PPP loans than Bank of America, Chase and Wells Fargo combined. We did well helping businesses of all sizes, but I'm particularly pleased that more than three quarters of our PPP loans were for $150,000 or less, and close to 90% were for $350,000 or less. PPP applications have been extended into August, and we're still taking anywhere from a few to 50 applications per day. Through July, we’ve taken an additional 500 applications for over $22 million, or an average size of about $45,000. Meanwhile, we're setting up processes to help borrowers obtain loan forgiveness. We've heard many messages of thanks from our customers whose businesses were aided by PPP, and the efforts of Frost bankers have helped save hundreds of thousands of jobs. Those results are more reflective of our culture and our philosophy than even the numbers we're reporting today for the second quarter. Average deposits in the second quarter were $31.3 billion, up by more than 20% from $26 billion in the second quarter of last year, and the highest quarterly average deposits in our history. We're grateful for the confidence our customers have placed in us during these times. Average loans in the second quarter were $17.5 billion, up by more than 20% from $14.4 billion in the second quarter of last year. That includes our strong showing in PPP loans, but our loan total would have been up approximately 5% even without PPP. In the second quarter our return on average assets was 0.99% compared to 1.4% in the second quarter of last year. Our credit loss expense was $32 million in the second quarter, compared to $175.2 million in the first quarter of 2020 and $6.4 million in the second quarter of 2019. That first-quarter provision was significantly influenced by our energy portfolio stress scenario of oil at $9 per barrel for the remainder of 2020. Oil prices have since stabilized at levels well above that assumption, and the energy borrowing base re-determinations are 95% complete. Net charge-offs for the second quarter were $41 million, compared with $38.6 million in the first quarter and $7.8 million in the second quarter of last year. Annualized net charge-offs for the second quarter were 0.94% of average loans. Second-quarter charge-offs were related to energy borrowers that have been discussed for several quarters. Non-performing assets were $85.2 million at the end of the second quarter compared to $67.5 million at the end of the first quarter, and $76.4 million at the end of the second quarter last year. At the current level, non-performing assets represent only 22 basis points of assets, which is well within our tolerance level and lower than our average non-performing assets over the past nine quarters. Overall delinquencies for accruing loans at the end of the second quarter were $91 million, or 51 basis points of period-end loans. Those numbers remain within our standards and comparable to what we've experienced in recent years. The payment deferrals we have extended to customers due to the pandemic-related slowdown have had some impact on delinquencies. To the end of the second quarter, we granted 90-day deferrals totaling $2.2 billion. Of loans whose deferral period has now ended, about $1.1 billion, only $72 million worth have requested a second deferral. Total problem loans, which we define as risk grade 10 and higher, were $674 million at the end of the second quarter, compared to $582 million at the end of the first quarter, which happened to be a multi-year low. A subset of total problem loans—those graded 11 and worse, which aligns with the regulatory definition of classified—totaled $355 million, or about 12% of Tier 1 capital. Energy-related problem loans were $176.8 million at the end of the second quarter, compared to $141.7 million for the previous quarter, and $93.6 million in the first quarter of last year. To put that into perspective, in 2016 total problem energy loans totaled nearly $600 million. Energy loans in general represented 9.6% of our non-PPP portfolio at the end of the second quarter; if you include PPP loans, energy loans were 7.9%. As a reminder, the peak was 16% back in 2015, and we continue to diversify our loan portfolio and moderate our exposure to the energy segment. As expected, and as we discussed in the first-quarter call, the pandemic's economic impacts on our portfolio have been negative but manageable. During our last conference call, we discussed portfolio segments that have had increased impact from economic dislocations brought on by the pandemic. Besides energy, we've narrowed these down to restaurants, hotels, aviation, entertainment and sports, and retail. The total of these portfolio segments, excluding PPP loans, represented almost $1.6 billion at the end of the second quarter. Like the energy portfolio, we continually review these specific segments and have frequent conversations with those borrowers to assess how they're handling current issues. Combined with our risk assessments, these conversations influence our loan loss reserve for these segments, which was 2.52% at the end of the second quarter. Overall, our focus for commercial loans continues to be consistent, balanced growth, including both core loan components—relationships under $10 million in size—as well as larger relationships, while maintaining our quality standards. We're hearing from customers in all segments that the economic impact of the pandemic, as well as the uncertainty ahead, have had an impact on our results. New relationships are up by about 28% compared with this time last year, largely because of our strong efforts in helping small businesses obtain PPP loans. When we asked these businesses why they came to Frost, 34% of them told us that PPP was a key factor. The dollar amount of new loan commitments booked through June dropped by about 3% compared to the prior year. Regarding new loan commitments booked, the balance between relationship sizes went from 57% larger and 43% core at the end of the first quarter to 53% larger and 47% core so far in 2020, which is about where it was this time last year. The market remains competitive. For instance, the percentage of deals lost to structure increased from 61% this time last year to 75% this year. Our weighted current active loan pipeline in the second quarter was up 24% compared with the end of the first quarter. The first-quarter numbers were low and reflected uncertainty about the pandemic's effect. On the consumer side, we continue to see solid growth in deposits and loans, despite the impact from the pandemic and the reduction in customer visits to our financial centers. Overall, net new consumer customer growth rate for the second quarter was 2.2% compared to the second quarter of 2019. Same-store sales, measured by account openings, were down by 30% through the end of the second quarter, as lobbies were open by appointment only and through drive-thru and tellers. In the second quarter, 59% of our account openings came from our online channel, which includes our Frost Bank mobile app. Online account openings in total were 72% higher compared to the second quarter of 2019. The consumer loan portfolio was $1.8 billion at the end of the second quarter, and it increased by 4.3% compared to last year. Overall, Frost bankers have risen to the unique challenges presented by the pandemic and its resulting shutdowns with a mix of keeping our standards and sticking to our strategies, along with a remarkable amount of flexibility and adaptability. Our Houston expansion continues on pace, with four new financial centers open in the second quarter and two more opened already in the third quarter for a total of 17 of the 25 planned new financial centers. Those new financial centers include our location in the Third Ward where customer response has been enthusiastic, even though our lobbies are open by appointment only. Our employees managed those new financial center openings while most of them were working remotely due to the pandemic, and also while working non-stop to help our business customers stay afloat with PPP loans. That commitment and dedication reflect what Frost's workforce philosophy and culture is all about. As I mentioned earlier, we've gained a lot of new business relationships through our PPP efforts, and customers that are new to us are learning what a long-time customer has always known: that Frost is a source of strength for customers and our communities and also a force for good in people's everyday lives. I told our team that their efforts are historic and heroic, and I'm extraordinarily proud of our company that we've been able to help so many small businesses get through these extraordinary times. It's clear that many pandemic challenges remain, particularly here in Texas, but the spirit and dedication of Frost employees who live our philosophy and culture every day gives me optimism that we will help our customers find a way through this situation and come out stronger. And now I'll turn the call over to our Chief Financial Officer, Jerry Salinas for some additional comments.

Thank you, Phil. I want to start out by giving some additional financial information on our PPP loan portfolio. As Phil mentioned, we generated over $3.2 billion in PPP loans during the quarter. Our average fee on that portfolio was about 3.2% and translates into about $104 million. Our direct origination costs associated with these loans totaled about $7.4 million, resulting in net deferred fees of about $97 million. About 20% of the net fees were accreted into interest income during the second quarter. Looking at our net interest margin, our net interest margin percentage for the second quarter was 3.13%, down 43 basis points from the 3.56% reported last quarter; excluding the impact of our PPP loans, the net interest margin would have been 3.05%. The 43-basis-point decrease in our reported net interest margin primarily resulted from lower yields on loans and balances at the Federal Reserve, as well as an increase in the proportion of balances at the Fed as a percentage of earning assets, partially offset by lower funding cost. The taxable-equivalent loan yield for the second quarter was 3.95%, down 70 basis points from the previous quarter, impacted by the lower rate environment with the March Fed rate cuts and decreases in LIBOR during the quarter. The yield on the PPP loan portfolio during the quarter was 4.13% and had a favorable 3-basis-point impact on the overall loan yields for the quarter. Looking at our investment portfolio, the total investment portfolio averaged $12.5 billion during the second quarter, down about $463 million from the first-quarter average of $13 billion. The taxable-equivalent yield on the investment portfolio was 3.53% in the second quarter, up 7 basis points from the first quarter. Our municipal portfolio averaged about $8.5 billion during the second quarter, flat with the first quarter, with the taxable-equivalent yield also flat at 4.07%. At the end of the second quarter, over 70% of the municipal portfolio was pre-refunded or PSF insured. The duration of the investment portfolio in the second quarter was 4.4 years compared to 4.6 years last quarter. Looking at our funding sources, the cost of total deposits for the second quarter was 8 basis points, down 16 basis points from the first quarter. The cost of combined fed funds purchased and repurchase agreements, which consists primarily of customer repos, decreased 80 basis points to 0.15% for the second quarter from 0.95% in the previous quarter. Those balances averaged about $1.3 billion during the second quarter, up about $36 million from the previous quarter. Looking to non-interest expense, total non-interest expense for the second quarter decreased approximately $3.5 million, or 1.7%, compared to the second quarter last year. The expense decrease was impacted by the $7.4 million in PPP loan origination costs that were deferred and netted against the PPP processing fee, which were amortized into interest income as a yield adjustment over the life of those PPP loans. Excluding the favorable impact of deferring those origination fees related to PPP loans, total non-interest expenses would have been up $3.8 million, or 1.9%, compared to the second quarter last year. In addition to the reduced expense run rate during the second quarter due to the pandemic effect on the business environment, we continue to focus on managing our discretionary spending and looking for ways to operate more efficiently. As we look out for the full year, adding back the $7.4 million in deferred expenses related to the PPP loans I mentioned previously, we currently expect annual expense growth of something around 6%, which is down 2.5 percentage points from the 8.5% growth guidance we gave last quarter. Regarding income tax expense, we did recognize a $2.6 million one-time discrete tax benefit during the quarter related to an asset contribution to a charitable trust during the second quarter. Excluding the impact of that item, our effective tax rate on year-to-date earnings would have been about 3.1%. With that, I'll turn the call back over to Phil for questions.

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

Your first question comes from our line of Brady Gailey of KBW.

Yeah, thanks. Good morning, guys. It's Brady Gailey.

Hey, Brady.

Good morning, Brady.

So I was a little surprised to hear that 20% of the PPP fees were captured in the second quarter. That seems a little higher than what some of the other banks have disclosed. Any color around how you're able to capture that amount of fees before any sort of forgiveness?

Really what we're assuming, Brady, is we look at those loans on a pool basis. We're looking at them over the expected term of those loans. We expect a big portion of those to pay off later this year. When I look out, our current expectation is we'll accrete about 60% of that fee in 2020, and about 40% of it in 2021.

Okay. And then, I heard your comments on the tax rate coming in lower, so it's actually negative for the quarter. But can you just go over that again, and is there anything else that's driving this tax rate to be lower than it normally is?

Well, unfortunately earnings are lower and we have a pretty big municipal portfolio, and obviously that higher tax-exempt income drives down the tax rate. We would have had a low effective tax rate for the quarter had we not had that $2.6 million credit. With that credit, it brought us into negative territory. So no, there's nothing unusual other than the $2.6 million discrete item that occurred in the second quarter.

And then finally, on last quarter's call we talked about the full-year net interest margin for you guys being a little above 3%. Now that we’re one more quarter into the year, does that still feel like the right NIM level?

I think the guidance we gave, Brady, was excluding PPP. That's the guidance you guys asked for, and yeah, I'm still comfortable with that.

Okay, great. Thank you.

Your next question comes from the line of Dave Rochester of Compass Point.

Good morning, guys.

Morning.

Good morning.

I appreciated the reserve on the more at-risk book you guys gave. I was just wondering what your energy reserve was following the charge-offs this quarter?

Energy reserve is about $40.8 million, which is about 2.86% coverage. That's down from the 6.58% that we had in the first quarter. Phil mentioned we had about $35 million in charge-offs related to energy in the quarter. Also, with the CECL allowance calculation we did last quarter, we had modeled conservatively when prices were much lower, and then the market improved during the quarter.

Right, so I had that at a little over $100 million last quarter, so with the $35 million charge-offs, you effectively released, I guess, about $28 million roughly? Is that right?

Right, yeah, exactly.

Okay. Got you. Appreciate that. And then what are you guys seeing for new loan yields overall and securities purchase yields at this point in the quarter, just with lower rates? I was curious where you're seeing those yields come in.

On the securities side, there's not a whole lot out there. We did purchase about $200 million during the quarter of mortgage-backed securities. Nothing spectacular, but certainly better than the 10 basis points we were earning at the Fed. Those purchases modestly improved our yield. Balances at the Fed remain a headwind for yield.

Our loan yields have been fairly consistent with previous quarters. We're seeing less usage of LIBOR, which is expected, and a bit more of the fixed component with people taking advantage of the current rate environment, but overall it's fairly consistent.

So if I back out the PPP fees from this quarter, I'd probably be closer to where the average is going forward. Are you looking for any more loan-yield pressure excluding PPP given what you're seeing in the market?

It depends on maturities and the fixed versus variable mix. We expect to see some compression here. An interesting item will be the replacement for LIBOR as we continue to move through 2021.

Okay, and then maybe one last one on the fee side. How much did fee waivers impact service charges and other fee lines, and what's the outlook going forward?

Fee waivers weren't a huge part of the second-quarter run rate; most of that occurred in the first quarter. What we saw in the second quarter was really a lower run rate. June and into July have been stronger than April and May. There's uncertainty due to the pandemic, but the trend in June and early July was positive compared to April and May.

Okay, great. Thanks, guys.

Thank you.

Your next question comes from the line of Steven Alexopoulos of JPMorgan.

Good morning, everybody.

Good morning.

Morning.

Just to follow up on the energy reserve, you said you were assuming $9 in the prior quarter. What level were you assuming now?

What happened is prices were changing so much at the end of the first quarter that Moody's couldn't keep up, so we ended up doing an internal stress test. For our base case we used Moody's price of $26 per barrel for the second quarter of 2020, then moving up to $32 through the fourth quarter of this year, and then $42 into 2021.

Got you. I'm curious: the reserve decline this quarter was using some of the energy reserve and changing that. How did the economic forecast components of the reserve change in the quarter?

From an economic standpoint, the Moody's consensus scenario we use had GDP going down 23.5% in the second quarter with a bounce in the third quarter; unemployment improving by the fourth quarter. Texas looks a bit better. The net decrease in the allowance of $9 million was influenced by an improved economic outlook. One area that was different this time was commercial real estate: the CRE model is more sensitive to volatility and forecasted unemployment and GDP, and it required a higher reserve; however, based on specifics of our owner-occupied CRE portfolio performance, we made a reduction in that area.

That's helpful. It looks like the COVID-sensitive loan exposures came down nicely quarter-over-quarter to about $1.6 billion. Last quarter you gave the breakout of that in terms of energy, restaurant, hotel, etc. Could you give us that breakdown of the $1.6 billion?

The $1.6 billion does not include energy. The breakup is roughly: retail about $783 million, hotels and lodging about $261 million, restaurants $225 million, aviation $194 million and entertainment $120 million. They have a combined allocated allowance of 2.52% at the end of June.

I'll give a little more detail on allowances by sector. The reserve for restaurants was 4.34%. On hotels it was 1.21%. Reserve on sports and entertainment was 4.58%. Reserve on aviation was 2.8%. And the reserve on total retail combined was 2.06%.

That's really helpful. If I could squeeze one more in, just following up on the tax rate: what's your outlook for the tax rate for the second half?

Adjusted, without the discrete item in the quarter, the year-to-date rate would have been about 3.1%. I'd say a reasonable range would be 3% to 5% going forward. I don't expect it to go any lower than the current low levels.

3% to 5%. Okay. Thanks for taking my questions.

Your next question comes from the line of Jennifer Demba of SunTrust.

Thank you, good morning.

Morning.

Good morning.

Your net charge-off levels have been more elevated than typical for Cullen over the last couple of quarters. Are you anticipating that will remain the case over the next two or three quarters?

I am not anticipating the same elevated levels. The thing that drove charge-offs this quarter—about 80%—was resolution of legacy loans we've been discussing for some time. Some credits that had been moving through processes for years were finally resolved, including one that needed to sell assets in a market where capital had left the energy industry, and COVID compounded those issues. We recorded charge-offs on that credit, but we've reduced balances to manageable levels. There are a couple more energy-related credits in the portfolio, but they're not large. I expect energy charge-offs not to be at the same level as in the second quarter. As we look forward, I do expect problem loans (risk grade 10 and higher) to increase, particularly in the services area of energy, which has been hit hard. That may lead to more classified loans and perhaps further charge-offs, but many of those relationships have historically managed through cycles. A key point is problems do not necessarily equal losses. Also, for areas like hotels and restaurants, some loans that move from construction to operation may be classified as problem loans until we see operating performance. So while I expect problem loans to increase as the pandemic continues, I believe they remain manageable, given our underwriting discipline and structures in our credits.

Thank you. And of the $674 million in problem loans, how much of that is in the sectors you mentioned—energy, restaurant, hotel, aviation, entertainment and retail?

The $674 million total problem loans includes energy, which was about $177 million. The non-energy sectors we discussed total about $40 million of problem loans spread across restaurants, hotels, sports and entertainment, aviation and retail. So the problems are spread across different areas rather than concentrated entirely in those sectors.

I also want to clarify our management overlay on energy. Our price deck for management overlay is $30 for 2020, $36 for 2021, $40 for 2022 and $45 for 2023. We stress that at 75% to arrive at our management overlay in energy.

And Jennifer, just to be clear, problems may increase if the pandemic deepens. Problem grades signal greater risk, not necessarily losses. Our underwriting, guarantees and structures make a material difference in outcomes. We've taken a lot of actions and established processes to manage through this period, and I feel good about our disciplines going in to the crisis.

Thanks so much.

Thank you.

The next question comes from the line of Ken Zerbe of Morgan Stanley.

Thanks. Good morning.

Good morning, Ken.

I want to ask about the PPP fees. You recognized 20% in the quarter. Most banks expect to accelerate PPP fees when loans are paid off. If you recognized 20% this quarter and you expect 60% in 2020, does that imply when the loan is forgiven you'll see zero accelerated amortization of those PPP fees?

It would have to be pretty significant to affect that. We're recognizing fees ratably based on an assumed average life roughly around 24 months. We'll be looking at it monthly to see if it is accelerating, but we expect a big chunk to pay off in late third quarter into the fourth quarter, and our current assumption is something close to another 20% in each of 3Q and 4Q to reach about 60% recognized this year.

Okay, and if those loans don't get forgiven and they get pushed out, what happens to the fees if you've already recognized them?

We're recognizing the fees as we accrete them. If the average life turns out to be shorter or longer, we'll reflect that in future accretion. We don't currently expect the average life to be significantly shorter than our assumption.

On expenses, the 6% annual growth assumption—does that imply total non-interest expense levels around the 2.25% to 2.30% of assets range over the next couple of quarters?

Yes, that math would put you in that general range. Given the guidance we've given, you wouldn't be far off.

Perfect. Thank you.

Your next question comes from the line of Ebrahim Poonawala of Bank of America.

Good morning. Jerry, on margin you said you expect the full-year margin to be slightly over 3% excluding PPP. Could you tell us the amount of securities coming up for maturity in the back half of the year? I'm trying to get to whether the margin will be in the 2.90s by year-end.

We had some agency maturities in July. Between now and year-end, I'd estimate around $600 million to $750 million of cash flow maturing that we can reinvest. Those maturities, combined with limited market yields, are a headwind for margin.

Is any of the deposit increase in 2Q likely to leave the bank, which would be beneficial to margin as excess liquidity declines?

This is an unprecedented time and it's hard to be precise. Some of the increase is associated with PPP and some will be spent out; our model assumes some of that will flow out. Historically about 85% of growth is from our own customer base and 15% new customers. We do see growth in commercial DDA, which is not interest-bearing. It's hard to predict deposit behavior precisely, but we expect some of the excess liquidity to decline over time.

Phil, just a big-picture question: across your Texas markets, do you have confidence things will get better? Did you see deterioration into the quarter as COVID cases increased, and how should we think about the economy over the next 12 months?

There are mixed signals. Some sectors are strong—automobile dealerships had record months in May, and some distributors are up. Construction and roadwork are still active. On the other hand, energy-related surface fracking activity is very weak and service activity is depressed. Municipal budgets may constrain certain projects going forward. Since Memorial Day we've seen greater mask usage and local authorities and customers have been more cautious, which gives hope the infection trends can improve. The next six months will be heavy lifting—grinding through economic impacts—and many small businesses may run out of steam without continued fiscal support. Ultimately, a medical solution—effective therapeutics or a vaccine—will be crucial for a full recovery. There are positives and negatives; the path forward remains uncertain.

That's good color. Thanks a lot.

Your next question comes from the line of Peter Winter of Wedbush Securities.

Good morning. I was wondering on the Houston branch expansion: in the past you said it takes about 27 months to breakeven and you lose about $1.5 million before breakeven. In this environment, how does that impact those metrics?

Those were average numbers when we entered the program. To update you: on our pro forma targets we're at about 143% of target on new relationships, about 83% of target on deposits, and over 200% of target on lending. Momentum is positive and we believe we will reach breakeven faster and with less pre-breakeven loss than originally anticipated.

On expenses, you keep lowering expense growth guidance. What drivers have allowed you to lower that target this quarter?

The run rate is lower and we continue to manage discretionary spend. Travel, meals and entertainment were down, marketing spend was reduced, and we deferred some discretionary hires. We've also improved back-office processes during the PPP program and automated tasks, which should yield efficiency gains. We're being careful about replacing positions and looking for ways to operate more efficiently. Those actions led us to lower the expense-growth outlook.

Okay. Thanks for taking my question.

Your next question comes from the line of Michael Rose of Raymond James.

Hey, thanks for taking my question. As we think about loan growth moving forward with the energy reduction strategy and momentum in Houston, how should we think about loan growth?

It's hard to be precise. We've been focused on PPP recently, but our pipeline was up on a year-over-year basis. Historically we've targeted high single-digit loan growth. We could see growth in the third quarter, but longer-term growth depends on economic and health developments that affect borrower activity. So while high single digits has been our target, visibility is limited right now.

Understood. On reserve levels, many banks said the heavy reserve build is done. How should we think about your reserve levels now? It looks like the reserve was down ex-PPP a couple basis points. Is that the right way to think about it?

We built reserves fairly early and aggressively in the first quarter with that large $175 million provision. The second quarter reduction reflects improved assumptions and some charge-offs against prior allowances. I feel good about where we are and the work we've done, but future provisions will depend on how the pandemic and economy evolve. We have dedicated teams reviewing energy and commercial real estate weekly and ongoing close communication with relationship managers and customers. That helps us stay ahead of emerging problems and manage reserves appropriately.

We feel good about where we're at, but it depends on how the second half of the year goes. If conditions worsen, the reserve could increase; if conditions improve, provisions could decline. We're actively monitoring the portfolio.

Thanks for the color. One last question: if you look at pre-tax, pre-provision earnings, have you bottomed? When might that stabilize?

I think we're around the bottom and it will depend on how the economy and pandemic evolve. There's also political and macro uncertainty. If the environment stabilizes and economic activity returns, earnings should recover. Right now it's hard to be definitive.

Alright. Thanks for taking my question.

Your next question comes from the line of Jon Arfstrom of RBC Capital.

Thanks. Good morning, everyone.

Hey, Jon.

Good morning, Jon.

Just a couple follow-ups: on deferral numbers, it sounds like you have about $1.1 billion whose deferral period has ended. Any reason to think second deferral requests will be different in the second half?

We don't have any indication right now that second deferral requests will spike. At this point it's trending similarly, though we continue to monitor it closely.

How does the pipeline compare to the end of the fourth quarter? It feels okay but narrower than normal—thoughts on construction projects?

On a year-over-year basis, our gross pipeline was up about 8% weighted; compared with the end of the first quarter it was up 24%. Commercial industrial is weaker; commercial real estate and consumer pipelines are stronger. Our consumer pipeline has grown significantly, though it represents a smaller portion overall. Construction pipeline activity is mixed and we continue to moderate our energy exposure.

Last one: oddly, this environment might be good for you in terms of market share. How are you approaching calling on new business and getting people back into the field?

We're doing a lot of outreach via video calls and other remote channels. PPP gave us a strong reputational boost and brought in many new relationships. Our new relationship counts have increased notably, from around 30 a week to over 100 a week in recent weeks, many driven by PPP. The market remains competitive, especially on structure, but our reputation for stability and strong customer service positions us well to gain share. People are cautious about moving relationships, so it's work, but we're seeing momentum, especially in Houston.

That helps. Thanks, guys.

Your final question comes from the line of Matt Olney at Stephens Inc.

Thank you. Follow-up on the investment securities portfolio: yields ticked a little higher in 2Q, which surprised me. Given commentary on upcoming maturities, it sounds like security yields should materially decline in the back half of the year. Is that right, and how should we think about the magnitude?

The improvement between Q1 and Q2 was partially due to tactical sales and purchases—some relatively low-yield securities matured or were sold and were replaced with slightly higher-yielding purchases. Going forward, for maturing securities the yield environment is challenging; we struggled to find comparable yields in the market. We did spend some liquidity on purchases in the second quarter and may do more, but rates are low, so reinvestment yields will be a headwind.

Are there any larger, chunky maturities at the back of the year we should be aware of?

No, maturities are fairly ratable. We had about $200 million of maturities in the second quarter that we replaced. One point of reference: about $50 million of maturing municipals yielded about 2.79% previously; you won't find much like that now. But there isn't a single large chunk coming that would change the outlook dramatically.

Okay, great. Thank you.

Sure.

There are no further questions in queue. Do you have any closing remarks?

Thanks, everybody, for your participation today. We'll be adjourned.

Thank you for your patience. Ladies and gentlemen, you may now disconnect.