Good day and thank you for joining us. Welcome to the Cullen/Frost Q1 Earnings Results call. At this point, all participants are in a listen-only mode. Following the presentations from our speakers, there will be a question-and-answer session. I would now like to turn the call over to your host, Mr. A.B. Mendez of Cullen/Frost, Director of Investor Relations. Please proceed.

Thanks, Christian. This morning's conference call will be led by Phil Green, Chairman and CEO; and Jerry Salinas, Group Executive Vice President and CFO. Before I turn the call over to Phil and Jerry, I need to take a moment to address the safe harbor provisions. Some of the remarks made today will constitute forward-looking statements as defined in the Private Securities Litigation Reform Act of 1995 as amended. We intend such statements to be covered by the safe harbor provisions for forward-looking statements contained in the Private Securities Litigation Reform Act of 1995, as amended. Please see the last page of text in this morning's earnings release for additional information about the risk factors associated with these forward-looking statements. If needed, a copy of the release is available on our website or by calling the Investor Relations department at 210-220-5234. At this time, I'll turn the call over to Phil.

Thanks, A.B. Good afternoon, everyone, and thanks for joining us. Today, I'll review first quarter results for Cullen/Frost and our Chief Financial Officer, Jerry Salinas, will provide some additional comments before we open it up to your questions. In the first quarter, Cullen/Frost earned $113.9 million or $1.77 a share compared with earnings of $47.2 million or $0.75 a share reported in the same quarter last year and $88.3 million or $1.38 a share in the fourth quarter of 2020. In a very challenging economic environment, our team not only continued to execute on our strategies, but also achieved some extraordinary accomplishments that I'll discuss in detail as we go through the call. Economic impacts of the pandemic continue to affect loan demand. Overall, average loans in the first quarter were $17.7 billion, an increase of 18% compared with $15 billion in the first quarter of last year. But excluding PPP loans, first quarter average loans of $14.9 billion represented a decline of just over 1% compared to the first quarter of 2020. Average deposits in the first quarter were $35.4 billion, and they were an increase of 30% compared to $27.4 billion in the first quarter of last year. Obviously, macroeconomic factors over the past year have impacted our deposit growth, but it's also been our experience over our history that Frost is a safe haven for customers in times of uncertainty. Our return on average assets and average common equity in the first quarter were 1.09% and 11.13%, respectively. We did not record a credit loss expense related to loans in the first quarter after recording a credit loss expense of $13.3 million in the fourth quarter. Our asset quality outlook is stable and experienced a meaningful improvement during the first quarter. In general, problem assets are declining in number and new problems have dropped significantly and are at pre-pandemic levels. Net charge-offs for the first quarter dropped sharply to $1.9 million from $13.6 million in the fourth quarter. Annualized net charge-offs for the first quarter were just 4 basis points of average loans. Nonperforming assets were $51.7 million at the end of the first quarter, down 17% from the $62.3 million at the end of the fourth quarter. A year ago, nonperformers stood at $67.5 million. Overall, delinquencies for accruing loans at the end of the first quarter were $106 million or 59 basis points of period-end loans, stable when compared to the end of 2020 and comparable to what we have experienced in the past several years. Of the $2.2 billion in 90-day deferrals granted to borrowers that we've discussed on previous calls, only about $11 million remain in deferment at the end of the first quarter. Total problem loans, which we define as risk grade 10 and higher, were $774 million at the end of the first quarter compared with $812 million at the end of the fourth quarter. Energy-related problem loans continued to decline and were $108.6 million at the end of the first quarter compared to $133.5 million for the previous quarter. To put that in perspective, total problem energy loans peaked at nearly $600 million early in 2016. In general, energy loans continued to decline as a percentage of our portfolio, falling to 7.5% of our non-PPP portfolio at the end of the first quarter. As a reminder, that figure was 8.2% at the end of the fourth quarter, and the peak was 16% back in 2015. We continue to work hard to rationalize our company's exposure to the energy segment to appropriate levels. Overall, we find that credit quality is improving. When the pandemic started last year, we assembled teams to analyze the non-energy portfolio segments that we considered the most at risk, which included restaurants, hotels, entertainment, sports, and retail. The total of these portfolio segments, excluding PPP loans, represented just $1.6 billion at the end of the first quarter. Our loan loss reserve for these segments was 4.9%. The credit quality of individual credits in these segments is mostly stable or better compared to the end of the fourth quarter, and the outlook is improving although macroeconomic trends impacting some segments will take time to fully digest. The Hotel segment, where we have $286 million outstanding, remains our most at-risk category. However, we believe our exposure to any significant loss is minimal. I'm very proud of our team's ability to build relationships with new customers in challenging times, particularly when so much effort was put into helping existing small business customers get PPP loans. During the first quarter, we added 55% more new commercial relationships than we did in the first quarter of last year. A good portion of those mentioned PPP is the reason they came to Frost, but even more of them are just from the continued hard work by our bankers and the level of service that we provide. New loan commitments booked during the first quarter, excluding PPP loans, were down by 16% compared to the first quarter of 2020, which was before the economic impact of the pandemic had been felt. Regarding new loan commitments booked, the balance between these relationships was nearly even, with 49% larger and 51% core at the end of the first quarter. We will continue to keep this balance in mind. In total, the percentage of deals lost to structure was 70%, and it was fairly consistent with the 73% we saw this time last year. However, keep in mind, we believe that's a high number, and it illustrates the competition out there through underwriting. Our weighted current active loan pipeline in the first quarter was up about 1% compared with the end of the fourth quarter. So, though modest, it was good to see some improvement. Consumer banking also continues to see outstanding growth. Overall, our net new consumer customer growth rate for the first quarter was up 255% compared to the first quarter of 2020, 255%. Same-store sales, as measured by account openings, were up by 18% through the end of the first quarter when compared to the first quarter of 2020 and up a non-annualized 11% on a linked-quarter basis. In the first quarter, 36% of our account openings came from our online channels, including our Frost mobile app. We believe this compares very well to the industry. Online account openings were 35% higher when compared to the first quarter of 2020. Consumer loan portfolio was $1.8 billion at the end of the first quarter, up by 1.4% compared to the first quarter of last year. We're nearing the completion of our previously announced Houston expansion. We opened the 23rd of the planned 25 new financial centers in April, and the remaining two will be opened in the coming weeks. Overall, the new financial centers are exceeding our expectations. This is one of the extraordinary accomplishments that I mentioned earlier. Our team's performance of keeping the momentum going in Houston despite the pandemic and all the work we put into PPP is a true credit to our outstanding staff. Now let me share with you where we stand with the expansion as of March for the 22 locations we had opened at that time and it excludes PPP loans. Our numbers of new households were 144% of target and represent over 8,700 new individuals and businesses. Our loan volumes were 212% of target and represented $263 million in outstandings. Let's look at the mix of this portfolio. About 85% represent commercial credits with about 15% consumer. They represent just under half C&I loans, about 1/4 investor real estate, 15% consumer, and around 10% nonprofit in public finance. Finally, with only three loans over $10 million, over 80% are core loans. Now let's look at deposits. At $343 million, they represent 114% of target. They represent about two-thirds commercial and one-third consumer. We've seen increasing momentum over the last year when we were about 68% of our target. What I hope this demonstrates and what's important to understand is that the character of the business we are generating through the expansion is very consistent with the overall company. It's just what we do. And you can see that its profitability will be driven by small and midsized businesses. I'm extremely proud of what our organization has been able to do in Houston, and I believe you should be, too. We've built a platform that will add to shareholder value for years to come. And that's why I'm happy to share that we will be taking the lessons and skills we've learned in the Houston market to a very similar opportunity we have before us in Dallas early next year with 25 new locations over a 30-month period. This will put us on a path to triple our number of locations in that dynamic market over that time. Turning now to PPP. Our team was ready to respond when the SBA reopened the application process in January. To date, we've taken in about 12,400 new loan applications in the second round of PPP with over $1.3 billion funded. Combined with our total from the first round last year, we funded more than 31,000 loans or $4.6 billion, just amazing. We've also been working hard to help those borrowers get loans forgiven. We've invited all of the round one borrowers to apply for forgiveness, and we've submitted 70% of those loan balances to the SBA, and we've received forgiveness on about 50% already. Because this process is vital to our borrowers, we're doing all the work in-house with Frost bankers. We haven't outsourced any of these efforts. We're excited to announce that on April 15, we've launched a new feature for our consumer customers called $100 overdraft grace. This feature is an investment in our organic growth strategy. And at the same time, we believe it will make a difference in our customers' lives. It clearly sets us apart from both traditional bank competitors and neo banks. As a result, we expect it to further increase the rate of new customer growth in our already growing consumer bank. Also this month, we received some good news from third-party organizations that assess our customer service. The Greenwich Excellence awards for Frost has had the highest scores for superior service, advice, and performance to small business and middle market banking clients for four consecutive years. Let us know that our already high overall satisfaction and Net Promoter scores went up even higher over 2020, while many of our competitors saw declines. And I'm very pleased to let you know that J.D. Power and Associates, just this week announced that Frost once again received the highest ranking in customer satisfaction in Texas in the retail banking satisfaction study. That's the 12th consecutive year we've had the highest scores in Texas. When you put it all together, the solid financial results, the healthy numbers in deposits and loans, all the new relationships, the goodwill from our PPP efforts, the Houston expansion and the customer service accolades show that when we care about customers and work to be a force for good in their everyday lives, we'll be rewarded. And I don't just mean rewarded in a financial sense. I mean the sense that people recognize that we're doing something important and we're doing it better than just about anyone else. 2020 was a tough year, and 2021 hasn't been easy so far, but things are looking up. And that's due to everything that our employees have been doing for our company and our customers in these difficult times. I'm very optimistic about our outlook. I appreciate all their hard work. And I'm proud of them, and I'm proud to be at Frost. Now I'll turn the call over to our Chief Financial Officer, Jerry Salinas, for some additional comments.

Thank you, Phil. Looking first at our net interest margin. Our net interest margin percentage for the first quarter was 2.72%, down 10 basis points from the 2.82% reported last quarter. The decrease was impacted by a higher proportion of earning assets being invested in lower-yielding balances at the Fed in the first quarter as compared to the fourth quarter, partially offset by the positive impact of the PPP loan portfolio. Interest-bearing deposits at the Fed earning 10 basis points averaged $9.9 billion or 25% of our earning assets in the first quarter, up from $7.7 billion or 20% of earning assets in the prior quarter. Excluding the impact of PPP loans, our net interest margin percentage would have been 2.59% in the first quarter, down from an adjusted 2.75% for the fourth quarter. The taxable equivalent loan yield for the first quarter was 3.87%, up 13 basis points from the previous quarter. Excluding the impact of PPP loans, the taxable equivalent loan yield would have been 3.77%, basically flat with the prior quarter. Average loan volumes in the first quarter of 17.7 billion were down 260 million from the fourth quarter average of 17.9 billion. Excluding PPP loans, average loans in the first quarter were down about 184 million, or 1.2% from the fourth quarter, with about three-quarters of that decrease related to energy loans. To add some additional color on our PPP loans, as Phil mentioned, we funded over 1.3 billion of round two PPP loans during the first quarter. This was offset by approximately 580 million in forgiveness payments during the quarter on round one loans, bringing our total round one forgiveness payments to approximately 1.4 billion. At the end of the first quarter, we had approximately 73 million in net deferred fees remaining to be recognized, with about one-third of this related to round one loans. With respect to round two loans, given the smaller dollar size of the loans and changes in the forgiveness process, we expect this portfolio to have a shorter average life than the round one portfolio. As a result, we currently expect about 90% of the remaining net deferred fees to be recognized this year. Looking at our investment portfolio, the total investment portfolio averaged 12.2 billion during the first quarter, down about 335 million from the fourth quarter average of 12.6 billion. The taxable equivalent yield on the investment portfolio was 3.41% in the first quarter, flat with the fourth quarter. The yield on the taxable portfolio, which averaged 4 billion was 2.06%, down 6 basis points from the fourth quarter as a result of higher premium amortization associated with our agency mortgage-backed security given faster prepayment speed, and to a lesser extent, lower yields associated with recent purchases. Our municipal portfolio averaged about 8.2 billion during the first quarter, down 154 million from the fourth quarter, with a taxable equivalent yield of 4.09%, flat with the prior quarter. At the end of the first quarter, 78% of the municipal portfolio was pre-refunded or PSF insured. Investment purchases during the first quarter were approximately 500 million and consistent with about 200 million in each of treasuries and mortgage-backed securities respectively, with the remainder being municipal. Our current projections only assumed that we make investment purchases of about 1.4 billion for the year, which will help us to offset a portion of our maturities and expected prepayments and calls. Regarding non-interest expense looking at the full year 2021, we currently expect an annual expense growth of something around the 3.5% to 4% range from our 2020 total reported non-interest expenses. And regarding the estimates for full year 2021 earnings, given our first quarter results, in our assumption of similar to improving credit metrics to those we saw in the first quarter, we currently believe that the current mean of analysts' estimates of $5.42 is too low. With that, I'll now turn the call back over to Phil for questions.

Thank you, Jerry. We'll now open it up for questions.

Your first question is from Ken Zerbe from Morgan Stanley.

I guess first question in terms of the allowance for credit losses ex-PPP. It looks like in your press release you said it went up 2 basis points, so I believe to 1.77%. Can you talk about why it went up? I mean, just think given the context that most of the banks are materially releasing reserves? Thank you.

Sure, Ken. Obviously, you know, Frost, you follow us for a long time, is obviously very conservative. We continue to be concerned about what's going on in certain industries, commercial real estate, for example. And just given where we are and the expectation of what could still come, whether that be a variant, whether that be issues associated with office buildings and whether employees come back to work, whether that's related to hotels and lodging. I think we just felt like it was too early in the process to release reserves. Our modeling results in the commercial real estate category would actually have required, if you will, from a modeling standpoint, that we have a lower reserve associated with them, but really in our evaluation, we created management overlays, just given the challenges that we potentially see out there in some of those COVID impacted industries. And so, I think Phil mentioned the COVID impacted industries there, they are still out there at 1.5 billion. We've got a reserve associated with them at 4.9%. So I think part of it is just, we're not out of the woods and don't feel like we're out of the woods. So now didn't really feel the need. And for certainly felt like we could substantiate the allowance that we've got on our books, and obviously, through the rest of the year, we'll continue to look at that. We didn't book a credit expense in the first quarter, given what we're seeing today. I don't expect to have a provision, to be quite honest with you, assuming the same sort of credit metrics that we saw on the first quarter. But again, a lot of it'll just depend on what our credit quality people are doing, our special assets people are doing, and what they're seeing in the marketplace. But at this point, given what we were seeing and what we were feeling, we felt like keeping our reserve basically flat was the way I looked at it to go from $175 million to $177 million. Basically solid, I thought was a good place for us to be. You did note that we only had $2 million in net charge-offs during the quarter. We were helped by a pretty strong recovery. We actually had recoveries of $4 million. So again, I think we're comfortable with where we're at and certainly are looking towards the rest of the year and hoping that things continue to improve. As we go through each of the quarters, we'll continue to evaluate our allowance and react accordingly.

Certainly makes sense. And then just my follow-up questions sort of a two-part question. I guess in terms of expenses, it looks like expenses came in noticeably lower than probably us in consensus we're expecting. So first question is what drove the lower expenses this quarter? But the second part is, can you just talk about the incremental expenses related to the Dallas expansion? And when do they start? Are they already part of your '21 estimates? Or is there your guidance that you gave?

Sure. Regarding the Dallas expansion, we really won't begin that until next year, and we don't provide guidance for 2022. If you're looking for an impact, I suggest referring back to what we mentioned about the Houston expansion. In that case, we noted that the first-year results showed a $0.19 negative impact because expenses start before the operations begin. We discussed opening 25 branches over two years, while this expansion will take a bit longer, over 30 months. That's the context to consider if you're trying to adjust your 2022 estimates. As for expenses in the quarter, we had some deferred fees linked to the origination of the PPP loans, which was about $4.8 million. That amount was capitalized and netted against the fees, accreted into interest, so it's having an effect. Additionally, we maintained our processes and programs to cut expenses last year, and I believe the team did well in that regard. We're seeing some of that impact in the first quarter, and we will keep focusing on expenses. That's how I'd respond. Do you have another question? I can't recall the third part.

No, you addressed both parts of my expense question. I am okay. So thank you very much.

The next question is coming from Jennifer Demba from Truist Securities. Your line is open.

In terms of the Dallas branch expansion, what kind of loan-to-deposit growth would you expect from those offices? Would it be materially different from the Houston expansion or roughly the same?

Jennifer, I believe it will be about the same from our perspective at this time. Given the competitiveness of the Dallas and Houston markets, I don't think our Dallas teams would allow Houston to surpass them. So, I expect it will be quite similar. Dallas is an excellent market for business, especially for small and midsized companies, and I see it as a significant opportunity for growth. In my view, it will be at least as successful as our Houston expansion.

Any lessons learned from the Houston expansion that you'll bring forward for the Dallas in that you picked up over the last couple of years, as the world has shifted a little bit?

Yes. I think the one lesson you learn, and it's basic, it’s about people. That's a foundational thing. You want to hire people that are consistent with your culture who are excited about being part of an organization like ours. And if you do the right job hiring people in these submarkets, they can really be successful with everything that we bring to the table supporting them. I think that's been the best thing to learn. The other thing we've learned is we're getting pretty good at bringing them on. And I want to emphasize every time that we're not bringing on teams. We're not lifting teams out and putting them in our organization, we're talking to individuals and people that believe in what we're doing and want to be a part of it. And we're also finding that when you do that well, that you begin to get follow-on from people in the organizations that have come over and said, hey, this is what we thought it would be. And I know this person or that person who'd be really great with this. And so you have a little bit more certainty about who you're bringing on and the fit as you move along through the strategy. I think that's what we've seen in Houston, and we'll continue to expand in Houston. There are some submarkets that we want to be in that we didn't pick up on the first time. And just through regular growth of our business, we're going to want to continue to expand there, and I think we've got good momentum there. We've got good follow-on, like I talked about in that market. So I feel like that's going to be successful. But that's one thing, I think, that we've learned. And those things I see, Jennifer, it’s really important to go through the steps. Don't skip steps. We know what we need to do to develop a market. We know that we need to be there early with the community leader, like six months early, before we open up the branch. We surround them with a team. We get them involved. If you have a market for you, where I think one of our early ones in Houston, we had someone leave earlier. We weren't able to close on bringing in a community leader, and that branch suffered early on because you couldn't do all the steps that you needed. So we're really focused on bringing the people on. And while, as Jerry mentioned correctly, there won't really be much of an impact this year of that expansion, we hope to open our first location in January of next year in Dallas. There's a lot of effort that we've been undertaking to understand the submarkets we want to be in, and there'll be even more effort about bringing on the right people for those markets. And there’s a whole lot of spade work that has to happen before you actually execute this stuff. I am so excited about doing it though. I'm really looking forward to what it's going to do for us.

Your next question is from Steven Alexopoulos from JPMorgan.

I wanted to first follow up on the increase in new commercial relationships that you cited for the first quarter. Are these customers coming from banks of all sizes? Or is there one cohort struggling more than others now to retain customers, and maybe can you include in your response what is the friction point that these customers are citing when they're moving over to Frost?

Well, the main source of these relationships, not the only, but the main source is what I call the too big to fail, the big three, let's say. I hesitate to say that there's any one that is providing a much greater share than any other. We choose to compete against those three banks in the Texas market, and it's not an accident. We compete very well with them, and we're not afraid of competing with them. And so that makes sense to me that that's where we'd see most of our new relationships. And then your second part of your question, I'm sorry, Steven?

What is the friction point? When customers switch over, there's such a significant increase that you're observing this year. I'm curious about what reasons they are giving, especially since moving a commercial relationship is a bigger challenge than a consumer one. What is the decisive factor that encouraged this shift? Are you noticing more customers transitioning to your services now?

I'd say it's PPP, I mean, more than anything else. You know it matters where you bank. It's like the woman that only she didn't realize 13 years ago that where she opened a checking account would be an existential decision for her business, whether she could get a PPP on it when she needed it. And that really is, I think, the biggest outsized reason we're seeing. I've got a number in here somewhere about how many of these relationships were PPP. Yes. Phil, if I can chime in just a bit. The other thing we've heard in the case of the PPP loans is that in some cases, it's some of our customers that had successful PPP experiences with us, referring some of their friends and prospects. In other cases, people had such a bad experience at their bank with PPP and have heard the successes we've had and how easy it was to get it done with us that we've seen them come in that way. The other thing that I've heard mentioned also as far as them moving over is really, in some cases, some of those too big to fail, as Phil mentioned, are really referring some of these customers more to call centers. So they don't necessarily have that same relationship manager that they could call and look in the eye, shake hands with, or go to lunch with sort of thing. And so, because of their size, in some cases, they're being deferred more to call centers. We've heard that come up as well.

That's helpful. To shift gears. So looking at the new program for overdraft, which is interesting, when you say with that program that customers need to make a deposit after the overdraft, you say as soon as possible? What exactly does that mean? A couple of your peers that have launched that give 24 hours, but what does that mean as soon as possible?

Well, first of all, that's not our program. Our program is that if you've got a direct deposit with us, that gives the deposits at least $500 a month. We'll pay your overdraft of $100 or less. We won't charge a fee.

Yes, as direct deposits to qualify for the program.

You have to have a direct deposit as soon as possible.

Yes, you have to have a direct deposit to qualify for the program.

Yes. And so once you establish a direct deposit, you qualify for the program. And the reason, that's how we would define a relationship that way, right? If you've got a direct deposit, you've got a relationship. And you get that benefit.

Got you. And then just finally, on this program, what's the anticipated reduction in service charge revenue from the program?

Yes. I think the number that we're projecting is I think we looked at this first quarter, and we saw that our consumer NSFOD fees would be down about $1 million. So I think that's about 17% of what we saw in the quarter. Obviously, going forward, a lot of it will be dependent on the sort of activity we have, but that's what we saw the impact in the first quarter. It would have been in the first quarter.

Okay. So Jerry, what's the full year impact, just the full year revenue impact?

I would say that it will depend on the volumes. For a quarter at $1 million, it could be less than that, based on the level of activity.

I don't think the impact will be significant. There are two factors to consider. As activity increases, we will naturally see a rise in overdraft activity. Essentially, we're investing some of that anticipated increase. I believe we could end up with overdraft fees being relatively stable compared to 2020. It's a new program, so we will have to see how it develops, but I think it's a great opportunity for us to stand out.

Your next question is from Brad Gailey from KWB.

I wanted to start just with the amount of cash that you all are sitting on. You're seeing on $10 billion of cash that's basically earning little, I mean that's a huge lever for you all to pull at some point to start to move those funds into the bond book, where obviously, the yield is a lot higher. Maybe just talk about how you think about when is the right time to pull that lever. And if you look at the yield curve today and it's off, but it's still not great. So do we start to see that today? Or do you wait for rates to go a little higher?

Brady, I'd like to share some thoughts on this. The simple answer is that we're going to wait a bit longer. We could be mistaken, but our expectation is that rates will increase. We made this decision last August when the 10-year yield was around 80 basis points, and it has been beneficial for us. We don’t consider ourselves expert bond traders, but we truly believe that with the economy reopening and the amount of fiscal and monetary stimulus in place, it makes sense that we will see an impact. We want to be prudent with our shareholders' money. I anticipate we may make a move later this year, possibly in the third quarter, though it could be later. We believe there will be an increase in rates as things open up and improve, and the Fed seems amenable to this direction. One thing I'm really proud of is the cost reductions we implemented last quarter. We had about $70 million in expenses for our 2020 run rate, an additional $50 million in 2021, totaling around $120 million in savings. This has allowed us to maintain flexibility and operating leverage, which is paying off. I feel optimistic about our outlook and the prospects for the business over the next few years, although we could be wrong. It reminds me of something George Foreman said: everyone has a plan until they get hit. The work we did to reduce expenses has enabled us to hold off on utilizing our liquidity build. We have a significant amount of liquidity available. Jerry, what’s our current situation?

We're at $12 billion, Phil.

Around $12 billion now in the Fed, and I think we employ this later this year. That will help us some this year, but it's also going to help us as we move into 2022. I'm not very optimistic on loan growth through the rest of this year. We could see some, but I mean, business has got tons of liquidity, and I'd love to see some, but I'm not going to bet on it. I think later in the year, I think we could see it. I think in 2022, we're going to see it. And I think that could build some momentum in 2022 going into 2023. The Fed has said that they'll begin increasing rates in 2023. And maybe they can wait that long, but let's say they do. I think that's going to give us some tremendous tailwinds as far as that develops. And then as we move past that, now we'll be in the '20, '23, 2024. And so we've got these investments that we've made in the Houston market that will be mature at that point. And we'll be beginning to see some maturity in some of the balance investments. So I really feel, in my opinion, things set up very well for us if that's the scenario that we get, and that's what I'm hoping we'll see.

Yes, that makes sense. And longer term, I mean, if you look in the first quarter, cash to average earning assets was 25%. It sounds like it's even higher than that as of today. But where would you like to keep that longer term? I think pre-COVID that was running about 5% to 7% of average earning assets. Does that feel like a more normalized level of cash to earning assets?

Yes, Brady. I think we've been running slightly above that. We weren't in the double digits. If you had asked me, I would have said we were typically in the 8% range. What I want to emphasize is...I'm sorry?

Go ahead.

No, I was going to say, yes, for us, we've always been a little bit different, right? We typically have more liquidity than most. But yes, right now, where we're at is really way up there. And yes, not something that we would expect to have longer term, and I think something in the mid- to high single digits, it's where we'd be.

Okay. And then Phil, congrats on the Houston expansion, and it's exciting to hear about Dallas. You could have bought a bank in Houston, but you didn't and you could have bought a bank in Dallas, but you didn't. A lot of people are talking about Texas being a fairly active geography for M&A. Is Frost kind of out of the M&A game at this point and more pursuing organic de novo strategy from here out?

I believe the straightforward answer is yes. An acquisition is never completely off the table. I’ve often stated that any acquisition that aligns with our company’s goals would need to enhance our ability to execute our organic strategy in new areas, creating platforms we haven't previously established. A prime example I often refer to is North Texas in 1998 with Overton. Currently, I can't think of a better market than Texas from an economic perspective, especially regarding services for small businesses. To illustrate our focus on organic growth, let me share some insights on net new checking households. Looking back to 2018, we achieved 1,500 net new checking households in a month just once before September 2020. However, from October to March, we reached that figure four times, with one occurrence affected by the February freeze. The numbers were 1,534 in October, 1,851 in December, 2,178 in January, and 3,178 in March. This is why our emphasis is on organic growth, and Houston has significantly contributed to that. The initiatives we have in place, such as the $100 overdraft grace, are attracting attention, and our digital marketing has improved. Therefore, I prefer not to spend our shareholders' funds on risky acquisitions. I am confident in our current strategies and excited about our future prospects.

Yes. That makes sense and clearly it's working for you guys. Keep it up and thanks for the color.

And your next question is from Ebrahim Poonawala from Bank of America.

First, yes, it's good to see a bank organically investing and being proud of those investments. So it's good to see you do that. I guess one question, Phil, as we come to the end of earnings season. You just said that you're not optimistic of loan growth picking up in this year, driven by the liquidity that businesses are sitting on, which is a little bit of a contrast to what we've heard from, I would say, 75%, 80% of your peers who've talked about a pickup in the middle of the year. Talk to us in terms of are you being overly conservative in when you're messaging this? Or do you think some of your peers might be a little ahead of themselves in expecting a loan growth rebound in the summer?

Ebrahim, as a Frost banker, I tend to take a conservative stance. We are noticing some improvement in commercial real estate, but we haven't observed a significant change in commercial and industrial loans. We track our potential business with a metric we call "look to book," which reflects our inquiries versus actual bookings. Community banking bookings have decreased by about 12%, or approximately 6% from what they had previously booked. Year-over-year booking declines include a 70% drop in public finance due to a strong prior year with several large deals, and we purposely reduced our involvement in energy loans, resulting in a 40% decline. Overall, we are trying to streamline our position in that area. Businesses seem cautious about expansion, and supply chain issues may be preventing actions they might have taken otherwise. We do have a higher proportion of commercial and industrial loans compared to others, and since we haven't seen a rebound in that sector yet, I remain skeptical about strong growth for the rest of the year. While things could improve by year-end, that is my current perspective.

Got it. Understood. I have one follow-up, Jerry, regarding expenses. Your guidance suggests that expenses will increase back to the $220 million to $225 million range. Could you remind us of the factors that will contribute to higher expenses compared to first quarter levels?

Sure. Let me gather some information. One thing I will point out is that the expansion in Houston is impacting growth, increasing noninterest expenses by about $10 million. Additionally, as we noted, the branch openings have been slower than we anticipated. Looking ahead, there are factors that could influence us, including commission revenues linked to certain parts of our revenue streams where revenues have intentionally been softer this quarter due to advertising and marketing. We expect to see some improvement there. It's an area where we have been very cautious; while managing our expenses, we did not want to drastically reduce the marketing budget as we believe it is crucial for customer growth. Therefore, you will see some increases in that area. Those are likely the two significant points I would highlight. We are also going to continue to increase our spending on technology, furniture, and equipment, which we have already seen rise in the first quarter, and this trend is incorporated into our forecasts.

Got it. And Jerry, earlier you talked about like a $4.8 million PPP-related. Was that a PPP expense that's running through the expense line, if you don't mind clarifying that?

Sure. Under accounting guidance, you capitalize the origination costs. There were $4.8 million in origination costs that come out of expenses and are netted against the fee, which gets accreted into income. Therefore, if we did not have those PPP loans, expenses would have been $4.8 million higher.

Your next question is from Dave Rochester from Compass Point. Your line is open.

Just back on the expense guide real quick, specifically regarding the Dallas piece. If we look at 2018 and 2019, annual expense growth was around mid- to high single digits. Would you say that’s generally in line with what you expect at this point without needing to provide an exact number?

We're somewhat reluctant to provide any guidance. It's our policy not to offer guidance beyond the current year. I was merely trying to share some thoughts for you to consider as you look back at Houston.

Yes, Jerry also highlighted this point. One of the things we have considered and discussed with investors is that we are effectively operating as two companies. While it’s one company with one culture, we have what I would refer to as the core aspect of the business, which is very profitable, efficient, and operates smoothly. On the other side, we have the expansion aspect where we are investing capital and operational resources into markets for growth. Like any business, whether it's in technology or another sector, launching something new comes with associated costs. If we try to merge the expansion aspect with the core aspect, it can create confusion. It can be beneficial for us to evaluate the business separately in these two areas, as both are performing as we intended, and perhaps even better than we anticipated. However, when we combine them, it obscures the clarity of our overall operations. For instance, at the beginning of 2020, we experienced a 10% increase in expenses, much of which was due to our expansion efforts. We don't want to give the impression that we are frivolously spending money; in reality, we are quite cautious with our expenditures, but a significant portion of those expenses will be related to expansion over time.

Yes. Okay. I appreciate that. And maybe back on the question on securities. Appreciated your thoughts there on maybe putting some more cash to work around 3Q or after that. It sounds like you're sort of expecting higher rates later this year. So I was just curious, is it a certain level of the tenure you're looking at? Is it 2% plus? Is it higher meeting rates, any kind of benchmark to look at to know that you guys are right there and starting to put money to work? Any other parameters there we can look at?

I listened to Powell speak yesterday, and he mentioned substantial improvement. I think we will recognize it when we see it. Generally, we expect to see movement upward, and I believe the timing will be suitable for us later in the year. Personally, I could be completely mistaken, but I anticipate we'll see something in the range of 175 to 200 basis points over the next few months. If we don't need to act, we won't, but I expect that we will likely start entering the market in the late third quarter or possibly the fourth quarter. I don't want to commit to a specific timeline, but so far, our approach has been effective. It's our belief that things will continue in this direction.

Okay. And maybe one last one just on loan pricing. Have you guys hit general parity at this point on where new loan yields are coming in versus where the book yield is ex all the PPPs and whatnot?

No. I'll answer it in two ways. What impressed me was that from the third quarter to the fourth quarter, our pricing has remained quite stable and strong, even as LIBOR continues to decrease by a few basis points each quarter. However, when I compared the previous book to the current book, I still see that the new book is overall about 30 basis points lower than the previous one.

Next question is from Jon Arfstrom from RBC Capital Markets.

Jerry, what would you say is like a median or average branch size for your company in terms of deposits?

I'm trying to see if I have anything to share. On average, we tend to be larger than most. Please hold on.

As you're thinking through it, let me ask this question. Any reason why the Houston and Dallas branches can't get to your corporate average? And how long does it take to get there?

Jon, looking at the FDIC database, I would say that the headquarters branches in a city are usually much larger, which is likely why they might not represent the average of our branches. When we assess our position in the marketplace, we typically exclude any branches with deposits of $500 million or more, whether they belong to us or to competitors. This allows us to analyze normalized branches without the influence of headquarters. I believe that if you take this approach, there should be no reason why these locations wouldn't align with our other branches over time.

Okay. I was just kind of looking for like a median is maybe a way to get to that type of number?

Yes. Let me see if I can find anything here. It looks like it's about $200 million. I'll have A.B. verify that with you. What Phil mentioned is really part of our usual process; when making comparisons, we exclude the major downtown centers and calculate an average based on that.

And is the strategy to put branches in areas that are faster growing? I mean, from the outside, we all hear about this tremendous growth in Texas. But is that the general strategy is to put branches in places that are growing quickly, where you just don't have the presence?

I would say it varies. There are certainly some areas that fit this criterion. We tend to seek out markets that are experiencing growth, even if the rates of growth differ. Our focus is on consistent growth across markets. We also look for regions where we currently do not have a presence, as we see significant value in that. We're not deterred by the presence of large competitors in those areas because we view them as our competition. These are just a few of the factors we consider.

Two more questions here. Do you need to be larger in Austin as well over time?

Yes, I believe so. Austin is very interesting to us due to the current market dynamics and significant growth. However, our strategy focuses on small- and mid-sized businesses, which is where we see profitability. Austin has a lot of potential with major companies like Facebook, Indeed, Google, and Tesla moving in. We need to watch for follow-on small businesses because relying solely on a consumer or real estate strategy can make profitability tougher. I'm optimistic about our prospects, but I have more confidence in the established opportunities we see in Dallas. We will need to evaluate the benefits of expanding our branches in Austin. We plan to continue growing in the market, but replicating what we've done in Houston or Dallas will take more time.

Okay. Last question. How would you compare San Antonio in terms of growth against, say, Dallas or Houston? How does it stack up?

I would say that Dallas is growing faster. And Austin is growing faster. Given what's going on with Houston and the energy slowdown for a while, I would say we're comparable to Houston. Jerry might have some different thoughts. But the thing that's great about San Antonio is it doesn't seem to have the high highs or the low lows.

That's not all I was going to say, yes, exactly.

It's very stable. It creates lots of cash flow and lots of capital. It always has for us to expand in other markets. It's a great market to be in. It's great having the market share that we have here, and we don't intend to give it up. So even if it were a little bit slower, it is more stable, and it has a lot of benefits in that regard.

The conversation we had with the Dallas Fed economists highlighted how San Antonio stood out a bit. This was based on more recent data, particularly from March and April. What surprised us was the relative strength of San Antonio's performance. The economist mentioned that San Antonio seemed to have rebounded quicker than expected. As Phil pointed out, San Antonio typically doesn't experience the extremes that Dallas or Houston do; it tends to maintain a steady pace. However, what we've been hearing recently is that our performance has exceeded expectations.

All right. Thanks for all the fun. I appreciated.

Yes. And one last thing about the branch, the figure I provided of around $200 million is quite accurate.

I'm following no further questions at this time. I'll now turn the call back over to Mr. Phil Green for closing.

Okay. Well, we thank everybody for your participation on the call today and your interest and all your questions. So thanks for that, and we'll be adjourned.

Ladies and gentlemen, this concludes today's conference call. You may now disconnect.