Second Quarter Earnings Conference Call

Greetings. Welcome to Colon For Us Bankers Incorporated's second quarter 2026 earnings conference call. At this time, all participants are in a listen-only mode. A question and answer session will follow the formal presentation. If anyone should require operator assistance during the conference, please press star zero on your telephone keypad. Please note this conference is being recorded. I will now turn the conference over to A.B. 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 Dan Geddes, Group Executive Vice President and CFO. Before I turn the call over to Phil and Dan, 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. As a reminder, this call is being webcast, and a webcast replay of the call will be available on our Investor Relations website at Investor.FrostBank.com. At this time, I'll turn the call over to Phil.

Thanks, A.B. Good afternoon, everyone, and thanks for joining us. Today, we'll review second quarter 2026 results for Colin Frost, and our Chief Financial Officer, Dan Geddes, will provide additional commentary and guidance before we take your questions. In the second quarter of 2026, Colin Frost earned $170.4 million, an increase of 9.7% compared to the $155.3 million earned in the second quarter last year. Her share earnings for the second quarter were $2.70, cents, an increase of 13% from the $2.39 in the second quarter of last year. Our return on average assets and average common equity in the second quarter were 1.3%, 15.41%, respectively. That compares with 1.22% and 15.64% in the second quarter of last year. Average deposits in the second quarter were $42.6 billion, an increase from $41.8 billion in the same quarter last year. Average loans grew to $22.6 billion in the second quarter, up from $21.1 billion in the second quarter last year. Cross Consumer Bank continues to stand out as an industry leader in both customer experience and organic growth. even as competition from new entrants to the Texas markets intensifies. Year-over-year, consumer checking account household growth accelerated from 5.3% reported last year to 5.7% this quarter, driven by our strongest quarter of customer growth since second quarter of 2023. We believe this continues to be some of the best, if not the best, organic growth in the industry. This high customer growth is also driving strong increases in non-interest income. Year-over-year non-interest income for a consumer is up $2.8 million and a 11% year-over-year increase. We've demonstrated remarkable consistency in organic growth since our expansion began in late 2018. Our success over the last seven and a half years of organic expansion has had a profound effect. During the expansion, consumer checking accounts have grown 47 percent. Said another way, a third of our customers are new to Frost since the expansion began. Now, these results are further evidence that, as I've said before, our organic growth strategy is both doable and scalable. We also see consistent above-average growth and organic growth in consumer loans. Consumer loans into the quarter with over $4.5 billion outstanding, reflecting year-over-year growth of $751 billion, a 20% annual growth rate. This growth was driven primarily by mortgage lending, which has year-over-year growth of $533 million, and second lien home equity products, which grew $198 million. Looking at consumer deposits, they were down 0.7% for the first quarter, reflecting primarily seasonal trends. Our commercial line of business is also showing impressive growth. As an example, our 90-day weighted loan pipeline increased 11% from the first quarter to the highest level in our history at $2.17 billion. It demonstrates good balance with about half representing C&I and half representing C&E, CRE. About 62% of our pipeline represents customer deals versus prospect deals of 38%. Looking at new loan commitments booked, the second quarter was up 23% from Q1 and marked the second highest quarterly total in two years. Four commitments booked. Remember that core relationships are defined as those under $10 million, made up 58% of the dollar amount of our commitments in the second quarter. In addition, growth from the previous quarter was good in all segments. C&I up 15%, CRE up 33%, energy up 47%, and personal up 13%. Now let's look at new relationships. New relationships were down 1% from the first quarter, but this was the fifth consecutive quarter over 1,000. The expansion continues to be a significant driver of commercial relationships and accounted for 33% of Houston's new relationships, 39% of Dallas's, and 24% of Austin's. Overall, the expansion accounted for 22% of commercial relationships. Finally, market disruption continues to be a tailwind for us. Year-to-date, new relationships from this source are up 65% compared to the same period last year. Our overall credit quality remains good by historical standards. Total criticized problem loans, which we define as those risk-graded 10, worse, total $917 million at the end of the second quarter, down from $989 million last quarter and $989 million a year ago. Decrease in the quarter was a result of several successful resolutions that had been anticipated in the prior quarters. Non-performing assets totaled $114 million at the end of the second quarter, up from $73 million last quarter and $64 million a year ago. The quarter-end non-performing asset figure represents 49 basis points of period in loans and 21 basis points of total assets, as compared to 33 and 14 basis points last quarter. The increase in non-performers mainly relates to one $54 million multifamily commercial real estate loan that is working through a sale of a property with an expected resolution in either the third or fourth quarter. This was partly offset by a $20 million paydown on a non-performing loan identified in the fourth quarter of 2025. Net charge-offs for the second quarter were $9.5 million, compared to $5.7 million last quarter and $11.1 million a year ago. Annualized net charge-offs for the second quarter represented 17 basis points of average loans, compared to 11 basis points last quarter and 21 basis points a year ago. In addition to our success in commercial and consumer business lines, I'm also optimistic about our efforts around expanding our wealth management and insurance brokerage businesses. I'll end by thanking our amazing staff for these outstanding results that we're achieving and recognizing that they make it all happen. And with that, I'll turn it over to Dan for some additional insights.

Thank you, Phil. Let me start off by discussing our branch expansion growth. As a reminder, this performance now includes 11 additional branches opened in trade areas outside of our announced expansions in Houston, Dallas, and Austin. During the second quarter, our branch expansion delivered $0.16, or 5.8 percent, of EPS accretion and $0.30 year-to-date, or 5.9 percent, of EPS accretion.

We continue to be pleased with the volumes we've been able to achieve.

On a year-over-year basis, average loans grew 38%, representing 13.4% of total loans, up from 10.5% a year ago, and contributed 53% of the growth, while average deposits grew 20%, representing 8.7% of deposits versus 7.4% in the same period last year, and contributed 72 percent of the growth. The expansion branches have now grown to 3 billion in loans, 3.7 billion in deposits, and have added over 100,000 new households. We have opened five new locations since our last call, one in the Austin region, one in the Dallas region, one in the San Antonio region, and two in the Fort Worth region. Our current plan is to open an additional five branches over the balance of 2026. Now moving to second quarter financial performance for the company. Our net interest margin percentage was 3.75% for the quarter, up one basis point from the 3.74% reported last quarter. Net interest margin was positively impacted by a volume shift of earning assets from lower yielding balances held at the Fed into both loans and investment securities. These were somewhat offset by both increased volumes of interest-bearing deposits and higher overall cost of deposits. Looking at our investment portfolio, the total investment portfolio averaged $20.6 billion during the second quarter, up $796 million from the previous quarter. Investment purchases during the quarter totaled $2.2 billion, consisting of $1.95 billion of agency MBS securities yielding 5.32 percent and 259 million of municipals yielding 5.57 percent on a tax equivalent basis. Maturities during the quarter included 375 million of treasuries with an average yield of 3.35 percent, 211 million of municipals at an average tax equivalent yield of 5.46% and $427 million of agency MBS paydowns. The net unrealized loss on the available-for-sale portfolio at the end of the quarter was $1.15 billion compared with the $1.04 billion reported at the end of the previous quarter. The taxable equivalent yield on the total investment portfolio during the quarter was 3.96%, up 11 basis points from the previous quarter. The taxable portfolio averaged $13.6 billion, up $840 million from the prior quarter, and had a yield of 3.51%, up 12 basis points from the 3.39% in the prior quarter. Our tax-exempt municipal portfolio averaged $7.1 billion, flat with the prior quarter, and had a taxable equivalent yield of 4.87%, of 14 basis points from the prior quarter. At the end of the second quarter, approximately 68% of the municipal portfolio was pre-refunded or PSF insured. The duration of the investment portfolio at the end of the second quarter was 4.9 years, down from 5.2 years at the end of the first quarter. Looking at our funding sources, on a linked quarter basis, average total deposits of $42.6 billion were up $394 million from the previous quarter. The increase was approximately 80% in interest-bearing and 20% in non-interest-bearing deposits. Phil mentioned the consumer deposit's seasonal second quarter behavior. I wanted to give some additional color on how commercial deposits performed as the second quarter ended and how overall deposits are looking thus far in July. Average commercial deposits for the month of June increased about $770 million, or 3.6%, compared to the average for the month of March, with even growth in checking accounts, money market accounts, and CDs. Thus far in July, we are seeing continued trends of deposits firming, with average July deposits up an annualized 3.9%. The cost of interest-bearing deposits in the second quarter was 1.61%, up six basis points from 1.55% in the first quarter. Customer repos for the second quarter averaged $4.4 billion, up $219 million from the first quarter. The cost of customer repos for the quarter was 2.65%, down five basis points from the first quarter. Looking at non-interest income and expense, I'll point out a couple of seasonal items impacting the linked quarter results.

Regarding non-interest income, insurance commissions and fees were down $7.9 million.

Recall that the first quarter is a seasonally strong quarter for annual renewals. Salaries and wages were up $6.8 million compared to the linked quarter, primarily impacted by our annual merit increases starting in May and higher headcount related to branch expansion. Our benefits expense was down $9.5 million impacted by lower payroll taxes and 401k expense, a normal trend as the first quarter is normally higher due to payment of annual incentive payments. Regarding our guidance for full year 2026, our current outlook includes one 25 basis point hike for the Fed funds rate in the third quarter. We expect net interest income growth for the full year to fall in the range of 4.75 to 5.25%. This reflects both an increase and narrowing of our prior guidance range of 3.5 to 5%. For net interest margin, we expect an improvement of about 10 to 13 basis points compared to our full year 2025 net interest margin of 3.66%. This narrows the range compared to the 10 to 15 basis point improvement last quarter. We expect full-year average loan growth to be in the range of 7% to 8%. This increases the prior guidance of 6% to 7%. Regarding deposits, we expect full-year average growth to be in the range of 2% to 3%, unchanged from prior guidance. Based on current projections, we expect non-interest income growth of 7.5% to 8.5%, up from the prior guidance range of 4% to 5%. Regarding non-interest expense. We expect growth to be in the range of 4.5% to 5% year-over-year, down from the prior guidance of 5% to 6%. Regarding net charge-offs, we expect full year 2026 to be in the range of 15 to 20 basis points of average loans. Our effective tax rate expectation for full year 2026 is in the range of 15.5% to 16%, lowering the upper end from 16.5% in the prior quarter. Regarding stock purchases, I want to mention that during the second quarter, we utilized $90 million of our $300 million approved share repurchase plan to buy back approximately 655,000 shares. And with that, I'll now turn the call back over to Phil for questions. Thanks, Dan.

Okay, we'll open it up for questions now.

Thank you. If you would like to ask a question, please press star 1 on your telephone keypad. A confirmation tone will indicate your line is in the question queue. You may press star 2 if you would like to remove your question from the queue. And for participants using speaker equipment, it may be necessary to pick up your handset before pressing the star keys. Our first question is from Dave Rochester with Cantor Fitzgerald. Please proceed.

Hey, good afternoon, guys. I just wanted to start on the NII guide. the improvement there. I was curious what the impact was of the addition of the rate hike, which I think you said was in the third quarter. Which month was that in?

In September.

Okay. And so this is just one quarter impact, so probably not much of an impact on the overall?

Not on the overall, but I think we typically have said it's around $2 million a month. impact, and that's still the case. So you get the impact of the last quarter.

And then just, I guess, on the competitive front, we've just heard from some of the Texas banks that competition is really heating up for larger loans, and it sounds like some of that pressure is being driven by banks entering the market. It doesn't really sound like you're having a real issue with that, just given the pipelines you talked about earlier. But are you seeing any pickup in those pressures? And if you just comment on the deposit side as well on that front, that'd be great.

Yeah, I would say we are seeing a pickup on competition on the lending side. And it's mainly around structure. And when we are losing deals, the preponderance of those are structure. We're competing on price. We've said we're going to do that, particularly for good relationships, good prospects that are out there. And you have to. You have to find out what the market is, and you have to engage at a market price. And so we're doing that. And I was looking at some numbers on the CNI side. We're not losing much to price this last quarter. I was proud of our people for finding out what the clearing price was and being able to get deals done on that basis. The place where I've seen more deals that we were unsuccessful on, and you're right, we are being successful. But when we've seen deals that we've lost, it's mainly been CRE. and that's been some price but a whole lot of structure and it just seems like the market is continuing a bit of a race to the bottom on some of these structures so you got to be really careful and make sure you're doing business with the right people and and you know varying on what you would like to do in some cases because you always do that and for the best quality people you're going to do the best you can on structuring terms and and as you said

again we're being successful but yeah talking to our people we hear clearly that there is more or competition as relates alone it's all about I think I think the deposit environment seems to be where we're seeing some competition, and generally it's for large balance opportunities where you'll see some just really competitive rates out there for either CDs or money markets. Some come with it some, I guess, urgency. If there's not an action within a certain time period, that rate will go away. You know, that's really not the way we handle our customers or opportunities. You know, we want to be transparent, and when we put out a rate, unless the market changes, you know, we're going to live by that rate. So I'd say that that's where you're seeing a lot of the competition, and you saw kind of an increase in our deposit costs. And some is just the natural shift, I would say, just with the market indicating likely higher rates. You're probably seeing some just behavior-defined yield, and so we've seen that. But others, it's our decision to not lose business, and so we're making that decision sometimes on deposit price. And so we're we're being competitive.

OK. And then maybe just a big picture question on the guidance shifts. NII got better. Your outlook for fees got better. Your outlook for expenses got better. And I guess I'm trying to dig into what was it in the the expense side? Was it just the better result this quarter that gives you a lower starting point for the second half? what was it that allows you to tweak that expense guide lower while revenue expectations are increasing?

So, some of it is just the second quarter performance, and now we have a half a year versus, you know, just looking at it with a quarter. So, we just have more information so we can, you know, have a better sight into how we expect to perform for the full year. You know, We also, you know, just are seeing opportunities in the marketplace to hire. And so if that comes to fruition, you know, it may be on the higher end if we see, you know, more opportunities to hire, you know, bankers that are displaced. But I would say in general, it's just having more more line of sight and and feeling like, you know, for the first half of the year, we just, you know, we had expense growth, you know, for four and a half, four point six percent. And feel like for the back half, we're going to have some our seasonal fourth quarter likely increase in expenses on salaries and wages. and that's kind of typical when we award our stock awards. Some of those, by their nature, are vested immediately, and so you'll likely see fourth quarter exhibit what it generally has. But all in all, I feel like everybody here has done a really excellent job of managing expense growth. And in a lot of areas, it's like I've mentioned in the prior calls, are just a higher base in terms of expansion growth. When you're growing 10 to 15 branches at 130 branches at the beginning, that's going to be a higher percentage than 13 to 15 branch growth at 210 branches. And so some of it is just scale that we've now reached that we feel better about the rate of growth.

Appreciate it. Maybe if I could sneak in one last one on the purchases of securities. $2.2 billion this quarter. You talked about accelerating that to offset some of the deposit cost pressures. What are you targeting for purchases in the back half? And then given any runoff that you're expecting, what kind of net growth are you expecting for securities in the back half?

So our plan, we're going to increase this about $750 million with that pull forward that we did last quarter to protect the NIM. And so just looking at our investments for the back half, we have about a billion dollars more to spend in the back half of the year. And, you know, the difference, those will likely be split up, you know, roughly half and half between agencies and municipals. We're leaning likely a little bit more towards municipal purchases, or if the market were to give us an opportunity, we reserve the right to shift that to either one way or the other. But that's kind of where our purchase plan is headed. And did I answer all your components to that question?

Yeah, I think that's good. Thank you very much for taking on my question.

Our next question is from Jared Shaw with Barclays. Please proceed.

Good afternoon.

Thank you, Jared.

Maybe on the deposits, as we go into a likely rising rate environment, what's the expectation around beta there with some of the mix shift that you've had over the last few quarters and looking at the expansion market impact? Sure.

Right now, we're running like 46% beta on our interest-bearing deposits, and we expect that to go down slightly, I would say, to the low 40% range throughout the rest of the year. You know, just anticipating competitive pressures and our changes in our money market rates for the tiers that I mentioned last quarter, kind of the $100 to $250 and the $250 to $1 million on our consumer side. So, given those changes in just the competitive environment, that's where we would expect the beta to kind of drift to.

All right, thanks. And then looking at the buyback, you know, increasing the amount this quarter, how should we, you know, is this sort of a good level that we should be thinking about going through the rest of the year, or is there some opportunistic element of the buyback in 2Q? you?

There was some opportunistic, I think. And then just like we've mentioned, just our plan was to be consistent with our buyback, a portion, and then to hold back a portion for some opportunistic. And then a third element to hold back some dry powder for that, I'll call it a macro event that the market just goes down that you want to hold back.

So I would say that our our plan would be to to have you know a third of that element you know kind of be in play and then the other two-thirds you know to depending on what the opportunity is okay thanks and just finally for me when we look at the the uh the npl change and you called out the multi-family um is there a specific reserve or charge off that was taken in the quarter uh with that or you know once that's resolved later in the year, there could be something that flows through. Go ahead.

Yeah, I was just going to say, just to talk about the non-performer overall, I figure I might get some question on it, but the increase in non-performers, it's basically a net of a paydown of an existing non-performer and the additional paydown of the existing one related to the shared national credit every distribution business that talked about in January and that case you said we had allocated a specific reserve that one ten given recent events will only be free and so that's going to grew up this month, and that was a payback. The new non-performance, a $55 million multifamily credit, as I mentioned, it's in the Austin region. The owners are negotiating a sale. It's one of the few remaining loans from the 2022 vintage that was underwritten back rates and costs were much, much lower. For some time now, those loans have been taken out by private credit, but in this case, they've got a third-party equity partner that's unwilling to participate further to do what it takes to make that happen so that precipitates the sale. and without going in too much detail, in situations like this, one party can be hesitant to cover the expenses for the benefit of another party, which leaves the project in unbow until you get a sale that resolves. I think, as I said, there's expected to be little, if any, impact on the bank. But until that sale occurs in this situation, we need to be classified as a non-performer. And that's what we've done. And I can't recall if we have a specific reserve on it. If we do, it's very small, but we expect that it's got a guarantor on it. We expect that we take it. Have a little reserve on it?

We do, about a million and a half.

A million and a half. Yeah, pretty small. And it may be seen if we hopefully need it.

Our next question is from Casey Herr with Autonomous Research. Please proceed.

Great, thanks. I wanted to touch on the NII guide again. So basically, you guys are pointing to negative beta as the year progresses, but a little bit of NIM expansion. So I'm guessing that is fixed rate asset repricing and a rebound in loan yields to offset the deposit headwind pressure. Maybe just a little bit more color on that. And where are new money loan yields today? versus that at 617, and maybe spot loan yields at June 30.

So a lot of it is just fixed rate repricing, whether that be fixed rate loans or in our investment portfolio. So our fixed rate loans, what we're anticipating for the back half is a little bit over half a billion. And, you know, we'll probably pick up somewhere, you know, north of 120, 125 in a spread between what's rolling off and what we're able to replace it with. When you look at our investments for the rest of the year, we're anticipating getting back about a billion five in the, let's say call it 360, 365 range. And so we certainly have the ability to, you know, I think we're looking at yields in the, you know, 525, you know, 540. So let's call it a pickup of 170 to 180, you know, for reinvesting, you know, that part that's coming back. I would say, you know, Looking at, you know, really where we are on our loan yields, you know, I think it just depends on the mix. So, you know, I think what I would expect is continued, you know, depending on where we grow in the back half of the year, we're seeing some opportunities on the CRE, and generally those get higher yields than what our average yields are overall. We are seeing growth on the mortgage product, and those are probably a little bit on the lower side of what our average yield is, and we're making that conscious decision to grow that portfolio, you know, we feel like that's a strategic decision. And, you know, just to go off on a little bit of a tangent on the mortgage, right now, the numbers that we got, we're able to, our mortgage loans are attracting 45% new customers to the bank. And this, as of this quarter, we've been able to convert those 45%, 35% of those. We've added a checking account or another account, and the average balances on those accounts are around $22,500, which is stronger than what our average deposit for a consumer is. And so I feel like that's been a really strong product for customer acquisition. And just also keep in mind, just one more thing on just where you're getting the NII. There is a $250 million treasury that's maturing in August that's yielding at sub-1%. So we'll have a pickup in the fourth quarter with that repricing.

Yep, gotcha. And then just one follow-up, just a big-picture question on the Texas marketplace. We're hearing from not just you, from everyone that's obviously very competitive with some new entrants. just wanted to draw upon you guys have been at this a long time you know how do you like how do you expect this to play out like is this just the new dynamic we'll we'll see this uh last for a number of years or you know what uh based on your experience how do you expect this um to play out oh that's a good question we've seen it a lot and i think it will normalize after probably a couple of years.

Some of these deals that are being made that are very structured light, you're never going to know if that's a good loan or bad loan for another couple of years. And then if things soften up, they'll see some things they wish they hadn't done, and it'll change their perspective on what they'll do going forward. We see that a lot. We see people who are very aggressive in the market, and then things turn a little bit, and they disappear. And that's one of the things that is, I think, well-known about our company is that we're always in the game. You know, I call it, you know, we're in the fairway. We may move to the left fairway a little bit, maybe to the right, but we're in the fairway, and we're easy to find, right? We're going to be in the marketplace. So I think it takes a couple of years for some of these aggressive things to work their way through. And, you know, people try to buy market share, right? They try to come into a market that, you know, they're aggressive. They're not crazy. I mean, it's a pretty standard playbook. I mean, I'm doing it in mortgage, right? And we've been very price competitive in that because we want to be an element of the market that has to be accounted for. For others, we're being accounted for. And so we are being very successful. Will we always be that same level of aggressive pricing? No, we're not. We're getting near a billion dollars there. And so, you know, our pricing will tighten up. So, I'm doing it, and that's sort of my perspective on it. It's been a couple of years that I've been doing that market. So, that's kind of what I would expect to see.

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

Thanks. I have a follow-up question just on the low-neal discussion. Did the change in Stouffer throughout the quarter have any impact on low-neal this quarter that may help boost the loan yield as we go into the third quarter? We saw that in a few other competitors that have big floating rate books and was curious if that impacted you at all as well.

There's about a one-basis point impact of that SOFR index being, I think, around three basis points higher last quarter than this quarter. So the impact to our loan yield was about a basis point. Yeah, I think when we looked at kind of the loan yields, you know, a lot of it was just, it's not one thing, it's several, and some of it is just mixed, is what ended up increasing. We did decide to refinance some commercial real estate and put them on longer terms, and part of that, we did lower the yield because at that point, the construction risk and the lease-up risk had been removed, and so the choices were do we want to keep those loans on the books or do we want them to be refinanced into the permanent market? And this commercial mortgage program has grown, and it's around $700 million. And it's to our kind of choice developers that we have had a long relationship with and on properties that we feel like are, I'll call them legacy properties, that they're very lowly leveraged and have high debt coverage ratios that we feel really good about putting some longer terms than what we typically would do in terms of being just a construction lender and then letting a permanent lender kind of take us out.

Okay, very helpful. And then just a big picture question on the outlook. You've increased the revenue guide for both season NII and then taken down expenses. So it feels like we're coming into this positive operating moment that we've been waiting for as we've moved to the back end of your branch expansion plan. And I'm curious, as you look into 27, without giving specific guidance for 27, is that a trend that you would expect to continue?

Yeah, I mean, I think we're around 140 basis points of positive operating leverage for this quarter, and I think even for year-to-date. And so that's a significant moment, and we recognize that, and we see that 27, again, without giving guidance, I would say that with the tailwinds that we have with loan growth and with these just overall, I would say, growth in funding sources and deposit growth, And with just, again, what I mentioned on our ability now to have just a higher base of expense to grow at, that I feel good about 27 being a year that we can maintain positive operating leverage.

Thank you.

Our next question is from Peter Winter with T.A. Davison. Please proceed.

Thanks. Good afternoon. I wanted to ask about the margin. It's essentially at its highest level in 15 years. And obviously, with the updated guidance, you're still expecting some margin expansion in the second half of the year. But is there room to move it higher next year, or do you think we're getting closer to a plateau on the margin?

I would anticipate kind of third quarter being relatively flattish. And then, you know, I mentioned that Treasury that matures $250 million at less than 1% yield. So that helps in the fourth quarter, and so we should see an improvement in our NIM in the fourth quarter. And I still think there's, you know, depending on the rate environment, obviously, but if we kind of – if we see a positive sloping yield curve and, you know, kind of rates where we either – we have one hike, but it's barring just interest rates going down pretty severely quickly, that there is room to grow into 2027, the net interest margin, with a lot of just the repricing of fixed rate maturities.

Got it. And just with the fee income guidance, the update, it implies a nice increase in the second half of the year and much stronger for the full year. Can you talk about what is driving the better fee income growth versus January? Or is it just you're having more success cross-selling the newer clients? It's a nice increase, and I'm just wondering what changed versus the beginning of the year.

For our wealth management area, probably the growth in our managed assets with the market. We had anticipated less of a bull market. That's a big driver. We are gaining customers, albeit at I think a 2% or 3% rate in terms of managed accounts year to date. So that's a positive, and with all the changes that we've made in our wealth management and leadership, that's a positive trend early on. And we're optimistic that those changes in leadership will yield and maybe not – it may take a while, but looking in the back half of 27 and 28, that's an area that I would expect to continue to grow. There may be some growing pains as some advisors may or may not be on board with the new leadership. That may happen, but that gives opportunities for us to bring on new talent. So I would say that's the wealth management area. And I think the biggest key, and Phil mentioned it in his notes, is just our customer growth, both on the consumer and commercial side. That's a big driver of the interchange income, the fee income. Our ability to attract new customers is a big component of our fee growth and I think is really the underpinning of that growth. And, you know, there's been, you know, our interchange has been really strong and we expect it to finish the year strong. We're seeing good adoption in our Visa card. We're seeing good usage in our Visa card compared to our peers. And so we feel strong about our interchange and our fee income. We just are growing new customers is really at the root of it all.

You know, Peter, I'll give you an example. and I'm going to talk about an area that's kind of funny to talk about. I want to talk about overdraft fees. And, Dan, what was our growth in overdraft fees?

That our overdraft charges were year over year were up 17%. And so my guess is overdraft was in that kind of double-digit.

It's like strong double-digit growth, right? Well, it seems like we do everything we can to not charge somebody an overdraft. You know, we've got overdraft grace we put in place where, you know, you can overdraft us $100, and we don't charge you anything. We're like having a good buddy that will spot you $100. I don't have any buddies that will spot me $100. But, you know, our forgiveness levels on overdraft used to be were double what the industry is. they're not far off from that so it's you know for us to grow an area where we've been more and more diligent and not being a burden to our customers but still offering them a product that they like i mean people use it because it's convenient okay well so there's something that otherwise we would have been moving down and it's growing in you know let's say 15 because i don't have the exact 14.4. 14.4, okay. It's going 14.4. The reason that grows at that level is because we're growing customers. When you're growing consumer customers at 5.7% year over year, they're going to use your products, and that's what's happening. And check hard, Dan mentioned. Yes, there's an element of usage that we've seen for some reason. the usage of our check cards is is increasing i have you know it could be related to demographics we've got some interesting information on demographics i'm not sure if i can keep my train of thought here but all those things are really core elements of what happens when you grow your business organically and I think you're seeing that and since I'm talking about organic growth and I'm talking about you know how people use your products I've talked about check card use this is something I think is really interesting that we were just looking at recently because you know that we're growing our distribution footprint and we're doing it in a some people might believe an old-school way we're actually engaging with communities by putting physical locations there and frost bankers okay some people think that's but here's some demographic information for you if you look at our current distribution of consumer customers we have 42 percent of our consumer customers or Millennials or Gen Y or Gen Z, 42%. If you look at our growth in customers over the last 12 months, 82% of our new consumer customers are 45 years old or less. That means 82% for millennials, Gen Y or Gen Z. And so not only is our growth rate and industry leading, but the fact that we're able to engage that demographic, which is really the lifeblood of how a company grows and how these account relationships evolve over time, I think is a tremendous opportunity for us. And interestingly, when you look at why customers choose us, now remember, in consumers, 82% of our growth is from 45 years or less. And the highest percentage of that growth is in the Gen Z, you know, which is less than 29 years old. What's the number one reason? Because we asked them and we have the results. I've got them sitting in front. The number one reason for people coming to choose for us, number one, is convenient locations. That's true both of people who open the branch, open the deposit in the branch, and customers that open their account online. Current locations, I mean, convenient locations. Reputation is number two. Recommendation of a family member is number three. I can go all the way down the line. We have all the, you know, by the way, competitive interest rates is about. third low of stone. So we operate a very simple business, honestly. We are banking people in communities. We're going to where they live and where the businesses are, and we're expanding relationships. And what do you know? Your growth in consumer your fee income is growing. You know, you say the same thing on the commercial. We talked about that. You know, look at the growth that's happening in commercial service charges, in commercial, you know.

Commercial service charges are up 22% year-over-year, and billable services are up almost 10% year-over-year.

So, I mean, none of this is magic. It's just hard work. Our people are great. at growing our business and engaging communities through organic expansion. You know, that's what we've named this thing for the last several years. And we're going to keep doing it, and I'll expect to continue to see these kinds of results. Sorry to go on and on, but that's what we're seeing.

No, the growth is impressive, so I appreciate all the detail. Thank you.

Our next question is from David Chivarini with Jefferies. Please proceed.

Hi. Thanks for taking the questions. I wanted to ask about loan growth. So you took the guide up 7% to 8% from 6% to 7%. You mentioned about the pipelines being up 11% over the past 90 days. Now, you also mentioned about how aggressive the market is. Can you talk about the drivers behind what you're seeing to generate this growth?

On the loan side, you know, I think the one thing to consider when you mentioned kind of loan growth in our guide up is that we did have, you know, a record amount of bookings last quarter. and a little over $600 million are revolving lines that have less than 10% advanced against it. And, you know, that's a very low advance rate. And so we feel like that that's a tailwind for the back half of the year as those loans that are, you know, recently booked but not yet funded, you know, get to some normalized funding ratio. If we would have had the same funding ratio as we had last quarter, our average balances would have been up around $300 million. Some of that is in the energy area where you'd expect that their cash flow is improving and they're not having to advance on their lines. But the vast majority of it is on just C&I lines of credit that just aren't being used right now. So there's a big tailwind there. You mentioned kind of competition. You know, we're still winning on our – we mentioned it last quarter that we had won around a little over 80 percent of the opportunities with banks that had either been acquired or were the acquirer. And that rate is still, I think it's 78% cumulatively since really the start of this M&A. And so we've won nearly twice as many loan opportunities over the same time period from those banks. So we feel like when we have an opportunity that we're able to close it with, you know, competitive rates and structures. And to be honest, a lot of times they're just they're looking for consistency and they're looking for, you know, the banker that's been called on them for two years. And their banker may have left or doesn't know exactly what the credit credit culture will be of the new bank. So we're taking advantage of those opportunities. You know, there is competition, as Phil mentioned, in structure. Typically, recourse, if it's commercial real estate, with some C&I, we saw one opportunity where there was just not a lot of covenants or restrictions around what they could advance, and we just weren't comfortable with it. So, you know, we've kind of said we'll be really competitive on pricing, but structure, We're not going to sacrifice our credit for the sake of growth. It's going to be good growth.

Great. And then just a quick one on deposits. You mentioned about how July, decent growth here at 4% thus far. Is low to mid-single digits the right way to think about deposit growth for Cullen Frost? Your loan-to-deposit ratio is very low, so you can afford to grow loans faster. but just wanted to see if that low-to-mid single-digit is the right neighborhood.

Low-to-single-digit deposit growth? Is that what you said?

Low-to-mid single-digit.

Yeah, I think that for the near term with rates where there are, there's going to be competitive pressure. You know, I think that, you know, we have 2% to 3% for this year. And, you know, I would mention that the fourth quarter of last year, We did have a customer in the data center industry, and they had a capital raise where we saw that their deposits went up and then around $700 million, and then they were gone by the end of the quarter. So there's going to be a little bit of noise in the fourth quarter. There's also an estate that settled in the fourth quarter of last year around $200 million. So, you know, give or take almost a billion dollars for the fourth quarter of the end of last year that will not be here in the fourth quarter of 2026. So keep that in mind as you hear kind of our growth for the full year. But we feel like with the strategies that we've implemented, that that kind of – that range that you mentioned is reasonable for, you know, 2027 and beyond, you know, not knowing what the interest rate environment is, obviously being a big driver of deposit growth.

Very helpful. Thank you.

Our next question is from Janet Lee with TD Cowan. Please proceed.

Good afternoon. following up on your deposit beta question you've talked about the competitive pressure why do you expect the beta to come down a little bit and maybe could you talk about the spot deposit cost at exiting June yeah the I'll get you the answer your second question first and then get into the get into kind of our expectation of where our betas will be.

So kind of towards the – for the month of June, you know, our total deposit cost was 1.11. So, again, a little bit higher than the average. Interest-bearing, you're looking at 1.66%. And so, again, I think we're just anticipating as we kind of get into the back half of the year that we'll have to likely just be a little more competitive on some deposit opportunities and likely take advantage of opportunities to move business where you're going to have to look at the full relationship, both loans and deposits, and we could see just more of an opportunity driven by us offering an incentive for them to move from BankX to Frost.

got it but you're you're you're still expecting that a rate hike is beneficial to you on on both yeah and ii yes right okay um it looks like you're obviously still having very good growth in and and resi i believe you mentioned about 850 million resi target by the end of 26. um is there any change to that? Or do you, does the fact that the tenure is, you know, up relatively high versus before, like, does that, is that a concern at all?

The tenure being a concern? Or are you talking about that? Oh, I think I see what you're saying. I think the fact that rates are up, for example, of a 10-year, will tend to lower some of the refinance volume that we've seen. One of the reasons that we're so much ahead of what was a public goal of being $850 million at the end of the year, and we're halfway through, we're already a little bit over that, But, and as we sit here, I'm going to pay close to a billion dollars now, is we saw really strong refinance activity. Now, that wasn't our mortgages that were getting refinanced because we're doing the business. But I think you'll see refinancing activity slow. And so I'm going to guess the rate of growth for our mortgage originations is going to slow some. But really, home purchases and getting people in homes is the focus of what we do. And that's been, you know, over half of what our business is. So even if refinancings went to zero, I would still expect to see decent growth in our mortgage portfolio because of the purchase, home purchase.

Just some kind of additional data points. For the first quarter, 46% of our mortgages were refis. That percentage went down to 36% in the second quarter. Our average credit score in our mortgage is 769. So it's a good quality. And then in the second quarter, the average loan was around $640,000.

Okay, thanks for all the color. If I can just ask one more, maybe for you, Phil. Do you entertain the idea, or do you have any appetite to grow outside of Texas through de novo expansion? I know you're focused on organic, but I just wanted to see whether that's something that you would consider.

Yeah, it is something that I would consider. And just taking the long-term view of our business, we will do that. But it's not something that we're focused on right now. And the reason is that we have so much opportunity in Texas, and the state is just an amazing economy. And so we'll do that for the next, you know, I'll say foreseeable future. But at some point in time, there's no reason why what we do, which is providing this amazing service proposition and consistency and all the things that we do that people like. I don't think there's any reason why you couldn't go someplace else and do it one day. At least that's my opinion. But don't look for us to do that, you know, in any seeable time. But it's so important.

Our final question is from John Arstrom with RBC Capital Markets. Please proceed.

Good afternoon, guys. Hey, John. I think almost everything's been covered, but just two things. Phil, you mentioned the insurance business focus for growth, and I think maybe that's the one thing, Dan, you didn't comment on. So can you talk about what you're doing there?

I think the thing which gives us the most optimism about the insurance business is we are very focused on, in our organization, what we call teaming. But basically, it's making sure that we're providing that product to other lines of business, and most specifically, our commercial line of business. We haven't had sufficient penetration, and when I mean sufficient, we're not at what I would call an average penetration rate for commercial insurance, which is where we mainly operate. Personal lines is a small piece of it, and what's left is benefits, and then property and casualty. And I think as we increase that penetration and our leadership in that area is focused on it, we've got new leadership there in the last couple of years. In fact, it's being at the highest level run by our chief banking officer, commercial-oriented officer. So he's got great visibility into how our sales culture works, in the commercial line of business and how to translate that into the insurance business and make sure that we're getting an opportunity for this amazing commercial customer base to just get a chance to do the business. And I think as we've increased the way those parties work together, In some cases, we've encouraged licensing with some of our bankers so that they have the ability to share in a commission, if you will, that we earn, being an insurance broker. That's, on the margin, a positive thing, but I think, more importantly, it's an example of the new kinds of things we're willing to try in order to improve this cross-pollination and expand the relationships so that we're moving beyond even the deposit and lending and cash management function to where we're doing something and providing a product that everybody needs. Everybody has insurance. And so that's why I'm optimistic about it. It's mainly common sense. It's like, man, we should be better at this. And there's been that general recognition. They're working on how we can do that. And I have this saying, you've got to be careful what you ask a Frostbanker to do. because they're going to do it. And I have every confidence we're going to be much more successful in the insurance.

That's good. Helpful. And then back on credit, it's obviously not a huge deal, but any signs of changing credit conditions? And Dan, just curious on your thoughts on where the reserve could go over time. Should we just assume it stays steady over time or, or is there something I'm missing there?

I'd say with regard to the general credit question, we feel good about it. Let's take, for example, the non-forma we had in this quarter. As I look at it, there are probably three more credits of that vintage that was underwritten in 22, maybe early 23, before the Fed raised 500 basis points, we saw costs go up so much. A couple of them were in Austin. I'm not concerned about them. They may be like these other credits that we have had pay down through private credit, that type of thing. They could go to a risk rate 10 as they go through that process, but But they have very good financial sponsorship, people that are willing to stay and do the things that they need to do to get to that either sale or private credit alternative. So I don't see, even though we have some of those, that it could arguably look a little similar to what we have. remember we had a third party equity partner that, you know, just decided they didn't want to play anymore. And that's fine. You know, it's happened sometimes, but, but we don't have that in those other situations. So I'm not expecting a similar event like we have. And, and as I look at the The rest of the portfolio, it's very strong. Energy is very strong. You know, those people, you know, I had a customer tell me very recently that, Phil, we had our highest level of cash flow in our history, you know, in the previous month. And these people have a lot of cash flow, so that's really saying something. You know, and they're probably, and I'm looking at Dan, too, because he used to do this for years, but I'd say single-family builders have some pressure on them because, you know, even though the high end of the market's still pretty good, you know, the middle tier and the starter is really difficult when you've got mortgage rates. It's 6.25%. So they're under some pressure, particularly the independents. And they're going to have to, you know, they're going to have to figure that out. But their balance sheets are really very strong. And so they're just going to have to get through that cycle. But you may see some weakness here or there. I'm not expecting it, but we're seeing some risk-grade increases there. So, Matt, do you think you've made a mistake?

Yeah, I think for the builders, you know, you mentioned just they were making such great margins for, you know, kind of the post-pandemic. And so they've had to give some of that back by buying down the mortgage rates to get the buyer into the house. So I think you're seeing just, you know, kind of a normalization there. But our office portfolio, it had a payoff, an upgrade and a payoff from last quarter. And the rest of the portfolio, we were looking at it, it has the highest debt coverage test of all the real estate sectors. sectors. So that's really firmed up. You've already discussed the multifamily. Retail continues to be strong. And just to kind of look at our reserve, I would say steady. You might see a basis point or two increase or variance in the back half of the year. Some of it was just moving the allowance from the funded side to the unfunded. And if you took the funded and unfunded, over total loans, we're at 1.45%. So the first quarter is 1.49%. So improvement, and I would say it's stable.

Okay, that helps. And then, Phil, for the record, I would spot you $100 for an overdraft. No problem. No problem.

This will conclude our question and answer session. I would like to turn the conference back over to Phil for closing remarks.

Okay. Thanks, everybody, for your interest, and we'll be adjourned.

Thank you. This will conclude today's conference. You may disconnect at this time, and thank you for your participation.