Earnings Call Transcript - CFR Q2 2022

Operator, Operator

Greetings. Welcome to the Cullen/Frost Bankers Inc. Second Quarter Earnings Conference Call. At this time, all participants are in a listen-only mode. A question-and-answer session will follow the formal presentation. Please note, this conference is being recorded. I will now turn the conference over to your host, Director of Investor Relations, A.B. Mendez. Thank you. You may begin.

A.B. Mendez, Director of Investor Relations

Thanks, Alex. Our conference call today 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.

Phil Green, Chairman and CEO

Thanks, A.B. Good afternoon, everybody, and thanks for joining us today. I’ll review the second quarter results for Cullen/Frost and our Chief Financial Officer, Jerry Salinas, will provide additional comments, and then we’ll open it up to your questions. In the second quarter, Cullen/Frost earned $117.4 million or $1.81 a share compared with earnings of $116.4 million or $1.80 a share reported in the same quarter last year and $97.4 million or $1.50 a share in the first quarter of this year. Our return on average assets and average common equity in the second quarter was 0.92% and 13.88% respectively. These results and our overall growth show that our company is well-positioned to succeed in what’s been an unusual and evolving environment. Our loan growth is strong. Average loans, excluding PPP, in the second quarter were $16.5 billion or 13.2% higher than the average loans of $14.6 billion in the second quarter of 2021. It was good to see our growth exceeded our typical goal of high single-digit increases. In the second quarter, we booked 28% more loan commitments than in the same period last year. All segments were strong with C&I up 25%, CRE up 37%, and consumer up 31%. In addition, we saw new loan opportunities continue to increase. They increased 10% from a year ago and increased an unannualized 9% on a linked quarter basis. So the overall flow is good. Looking at our weighted 90-day pipeline, it was up 9% from a year ago. On a linked quarter basis, it’s fairly flat, down 2% as increases in commercial and consumer segments offset a reduction in the near-term pipeline for commercial real estate. Average deposits in the second quarter were $44.7 billion, an increase of 16.9% compared with the second quarter of last year. As much as we focus on loan growth, we were very pleased with our growth in deposits because it’s through deposits that we build long-term relationships as we offer attractive value propositions that customers can trust. Growth in our consumer business continues to be strong. Our net addition of 7,242 consumer households in the second quarter was an all-time high for us and represented an 8% increase on the same period a year ago. Consumer loan growth was also strong on a linked quarter annualized basis; average consumer loans grew by 20.6% led by increases in consumer real estate. Our success here was driven by our HELOC, home equity and home improvement products. Also, our pipeline for these loans continues at record levels. Now regarding our expansion efforts in Houston, we see the momentum continuing as newly opened branches mature. At the end of the second quarter, we stood at 109% of deposit goal, 122% of new household goal, and 185% of our loan goal. Our Dallas expansion is admittedly in its very early innings. However, I’m encouraged that the preliminary results are similar to our Houston success with 165% of deposit goal, 220% of loan goal, and 235% of new household goal. We’re making excellent progress towards launching our mortgage product, and we expect to begin a pilot program toward the end of this year. As you know, we are designing the entire process from start to finish to originate and service mortgage loans, keeping with the great Frost customer experience. Despite uncertainty about the broader economy, we have seen no signs of increasing loan delinquency. Our overall credit quality remains good. The June 30 total for delinquencies, excluding PPP, was $61.4 million or 37 basis points of total loans. Total problem loans, which we define as risk grade tenant or higher, totaled $429 million at the end of the second quarter, and that was down from $447 million at the end of the previous quarter. Once again, we did not report a credit loss expense in the second quarter, and net charge-offs for the second quarter were $2.8 million, compared with $6.3 million in the first quarter. Annualized net charge-offs for the second quarter were 7 basis points of average loans and below our typical long-term level. Non-accrual loans were $35.1 million at the end of the second quarter, a decrease from $49 million at the end of the first quarter. I was glad to see the great work of our energy team rationalizing our concentration in our energy portfolio. Energy loans represented 5.9% of loans at the end of the second quarter, and I’m happy to declare that we’ve reached mid-single digits. Finally, after more than two years of working with over 32,000 PPP borrowers, we’ve helped better than 98% of them with forgiveness. Our teams worked on the last few hundred PPP borrowers who haven’t yet begun the process, and we’re committed to helping every one of them get across the finish line. I couldn’t be more proud of our team and the efforts that they made in helping our customers in their businesses. You may remember that I’ve described our efforts in this area as historic and heroic, and I hope we don’t ever encounter another historic challenge like that anytime soon. We’ve got strategies and systems in place to allow us to succeed in all economic environments. I should point out that Frost employees do heroic deeds every day. I continue to hear from customers who get help from our bankers in sorting out their finances after a spouse passed away or who received financial planning that enabled their kids to attend college, or who simply had a pleasant interaction with a banker when they were having an otherwise lousy day. For us, those interactions are just doing our jobs in accordance with Frost. To our customers, those are heroic acts. I’d like to thank our people for being a force for good in people’s everyday lives. Now, I’ll turn the call over to our Chief Financial Officer, Jerry Salinas, for some additional comments.

Jerry Salinas, CFO

Thank you, Phil. Looking first at our net interest margin. Our net interest margin percentage for the second quarter was 2.56%, up 23 basis points from the 2.33% reported last quarter. Higher yields on both loans and balances held at the Fed had the largest positive impact on our net interest margin percentage. The increase was also positively impacted, to a lesser extent, by higher volumes of investment securities and loans and a lower relative percentage of earning assets invested in balances at the Fed compared to the prior quarter. These positive impacts were partially offset by higher deposit costs. Looking at our investment portfolio, the total investment portfolio averaged $18.1 billion during the second quarter, up $964 million from the first quarter average as we continue to deploy some of our excess liquidity during the quarter. We made investment purchases during the quarter of approximately $1.8 billion, which included about $1 billion in treasury, yielding about 3%, $400 million in agency MBS securities with a yield of about 4% and about $400 million in municipal securities with a taxable equivalent yield of about 4.7%. Our current expectation is that we would invest an additional $3.2 billion of our excess liquidity into investment purchases through the remainder of the year. The taxable equivalent yield on the total investment portfolio was 2.87% in the second quarter, down 1 basis point from the first quarter. The taxable portfolio, which averaged $10.3 billion, was up $1.3 billion from the prior quarter at a yield of 2.04%, up 14 basis points from the first quarter. Our tax-exempt municipal portfolio averaged about $7.8 billion during the second quarter, down about $363 million from the first quarter and had a taxable yield of 4.04%, up 1 basis point from the prior quarter. At the end of the second quarter, 76% of the municipal portfolio was pre-refunded or PSF insured. The duration of the investment portfolio at the end of the second quarter was 5.6 years, up from 5.2 years at the end of the first quarter, primarily related to the extended duration on lower coupon mortgage-backed securities. Looking at loans, average loans for the quarter were $16.7 billion, up $288 million from the first quarter or 1.8%. Excluding the impact of PPP loans, the average growth in the prior quarter would have been $446 million or 2.8%. The taxable equivalent loan yield for the second quarter was 4.04%, up 30 basis points from the previous quarter. Looking at deposits, on a linked-quarter basis, average deposits were up $1.8 billion or 4.1%. Public fund balances, which can be seasonal, had a negative effect on the linked quarter growth as those average balances were down $400 million. The linked quarter growth has come primarily from growth in average interest-bearing deposits, which were up $1.4 billion or 5.5%. The cost of interest-bearing deposits for the quarter was 22 basis points, up 14 basis points from the first quarter. Regarding total non-interest expenses, we continue to expect total non-interest expense for the full year 2022 to increase at a percentage rate in the low double digits over 2021 reported levels. Increasing our minimum wage to $20 per hour in December of last year, combined with continued market salary pressures, our expansion efforts in Dallas and Houston, and expenses associated with the rollout of our announced residential mortgage product are the primary drivers of the growth in non-interest expenses. The effective tax rate for the second quarter was 14.8%, and our current expectation is that our full year effective tax rate should be in the range of about 13% to 14%, but that can be affected by discrete items during the year. Regarding the estimates for full year 2022 earnings, our current projections include a 50 basis point Fed rate increase in September, followed by a 25 basis point increase in November. With those rate assumptions, we currently believe that the current mean of analyst estimates of $7.85 for 2022 is low. With that, I’ll now turn the call back over to Phil for questions.

Phil Green, Chairman and CEO

Okay, Jerry. Thanks so much. We’ll open the call up for questions now.

Operator, Operator

Thank you. At this time, we will be conducting a question-and-answer session. Our first question comes from the line of Steven Alexopoulos with JPMorgan. Please proceed with your question.

Steven Alexopoulos, Analyst

Hi, everybody.

Phil Green, Chairman and CEO

Hey, Steve.

Jerry Salinas, CFO

Hey, Steve.

Steven Alexopoulos, Analyst

I wanted to start by asking, given such a low loan-to-deposit ratio and plenty of liquidity to fund loan growth, what was the thought behind driving such strong growth in interest-bearing deposits in the quarter? Were these primarily just coming from new markets?

Phil Green, Chairman and CEO

Steven, it’s as much as anything, this is a cultural decision, and it’s one that’s based on experience. A big part of our value proposition really rests on three things that everyone identifies with significant Frost: we will give a square deal, we will provide excellence at a fair price, and we create a sound place to do business for employees and customers. As corny as it sounds, we’re just giving our customers a square deal. As we’ve seen interest rates move up, it just makes sense for us to recognize that if we’re going to have a value proposition that customers can trust, like I mentioned earlier in my comments, and we saw this happen back in 2017, where we saw the Fed raise rates 100 basis points back then. We were focused on the too-big-to-fail pricing because that’s who we compete with more than anybody else; they haven’t moved at all, and we just got behind. We started to see some movement in deposits at that time. Interestingly, that was kind of when we sort of cracked the code on more consistent core loan growth, and it just wasn’t the right time, number one, for our balance sheet to show that. Another thing is that I really felt like we were losing trust in the industry when they just sat there as people read that interest rates were going up all the time. So I’m not saying we couldn’t have a lower rate and get away with it, but it’s just not the way to do business. It’s really just focusing on being fair with customers. We feel like the value of those deposits is continuing to increase, and certainly, the relationships are going to make you money on a long-term basis. Jerry, any thoughts there on your pricing?

Jerry Salinas, CFO

No, I think you got it, Phil. I mean that’s exactly what we’re doing. I think you’re right—we don’t have to increase, and I’ll put that in air quotes—but I think we certainly believe that it’s the right thing from a culture standpoint to be increasing these deposits. As Phil said, back in 2017, we were a little slow in raising rates. We kind of fell behind and certainly felt like by mid-July when the Fed raised rates 100 basis points, we were behind. We were starting to see some of our deposits leaving the bank. As we all know, it’s a lot more expensive to bring new deposits on, so we just felt like this time we would be a little more ratable as we move along as rates increase.

Phil Green, Chairman and CEO

Steven, the thing is too that, I mean, look, you can read the newspaper, and we can believe we know what’s happening because that’s what everyone is saying. But we don’t know where rates are going; we don’t know where inflation is headed or what the Fed’s going to do. None of us do either. But if we just tend to our business, and do it the right way as we go along, we’re not going to have to go into any big dislocations like we did in 2017, and that was pretty tough for our shareholders. We don’t want to have to choke all that down at one time. It’s about just the disciplines as we move along.

Steven Alexopoulos, Analyst

It’s interesting because many peers are allowing deposits to run off this quarter, and their loan-to-deposit ratios are going up fairly materially. So here, you’re holding it pretty steady—so if we follow that strategy forward, how should we think about deposit betas through the cycle versus where you were the last time rates were moving higher?

Jerry Salinas, CFO

Steven, I think what we said last quarter, and I would say the same thing today. Going back to the last cycle, say 2016 through 2018, our betas were about 30% on interest-bearing deposits and say 20% on total deposits. That’s sort of what we’re assuming right now for full year 2022. We’ve got that same sort of beta; we don’t have that today. Given the increases, we’re a little bit lighter than that. But in our projections, that’s what we’ve built in.

Steven Alexopoulos, Analyst

Okay. Then my final question. It’s good to hear the new markets continue to trend well above goal, particularly for loans in new households in Dallas. Was the goal too low? I’m curious why you’re coming in so far ahead of the goal?

Phil Green, Chairman and CEO

Yes. When we started the program, we discussed this with our Board, and we talked to each other about it. Our goal was based upon what we had achieved for the 40 locations that we had opened prior to starting that strategy. We went back eight years, and we said, look, this is what we’ve done on average. We said that if we can do that, that would be a successful strategy that would result in a great return for our shareholders. So we set that up as that’s what we want to do. I kind of wanted to keep it the same as we move into Dallas because I think it gives context for the performance in those markets. Could we use a different number? Yes, we could, but we know what this one means. We know where it came from is, and we’re going to go there. I will say, Steven, honestly, I don’t think there’s any reason why Dallas shouldn’t be better than Houston in terms of its success because, as you know, two-thirds to 70% of this business and the business in the pro forma is commercial business, and Dallas has as good a commercial market; it’s really well diversified and full of middle market and small business with a little bit less energy concentration than Houston. As great as Houston is, I think the business demographics around Dallas could be even better.

Steven Alexopoulos, Analyst

Okay. I appreciate all the color. Thanks.

Jerry Salinas, CFO

Thank you.

Operator, Operator

Our next question comes from the line of Michael Rose with Raymond James. Please proceed with your question.

Michael Rose, Analyst

Hey, good afternoon, and thanks for taking my questions. Just wanted to touch on expenses. I think if I’m doing the math right, if I annualize the first half of the year, it looks like you’ve grown at about 10%. So would imply a deceleration in the back half of the year. Understanding that a lot of expenses related to Dallas have been incurred, and obviously wage inflation, stuff like that. But is that kind of the right way to think about it, that the expense growth should kind of slow as we move into the back half of the year?

Jerry Salinas, CFO

I think that’s right. A lot of the dollars that we put in are built into the base. We moved our increases for most of the organization to May, so really, even in the second quarter, you don’t have the full effect of all of our increases. The fourth quarter is typically the highest, and it’s unusually high given we pay a lot of our incentives in that quarter. There’s a lot of true-up going on. Obviously, the volumes we’re seeing this year have been pretty strong, and I envision that as we go through the year, we’re continuing to increase those incentives. So, if I were you, I’d stick with my full year guidance and then just kind of take the next two quarters, but really don’t want the slide to be too thin. I’ll just speak to that full year guidance—it says just look at 2021 and grow that on a low double-digit growth, and I think that’ll kind of be what we’re projecting currently based on what we’re seeing.

Michael Rose, Analyst

Very helpful. And then maybe just as a follow-up, I think at the outset, you mentioned that the pipelines were down about 2% sequentially. It looks like the period-end ex-PPP growth slowed a little bit this quarter versus last quarter. Any rationale to that? Is it a function of paydowns? Is it customers being a little less active, or a combination of both? I think you had previously talked about a high single-digit ex-PPP average growth for the year. Is that still kind of in the realm of expectations? Thanks.

Phil Green, Chairman and CEO

Yes. Well, I don’t—we don’t want to read too much into the weighted pipeline number that was fairly flat, down 2% because if you look at the C&I piece of that, this is on a non-annualized basis, it was up 4% on a linked quarter basis. We’re seeing positives. The consumer weighted pipeline is up a non-annualized 62%. The fact is that it was commercial real estate that was down a non-annualized 13%. We closed so many commitments; our commitments were up 27% on a linked quarter basis, non-annualized. That’s putting a lot through the pipeline, and so if it goes down, somewhere it’s a little weaker in the commercial real estate; I’d like to believe it’s more because we’re reloading. As I look at the opportunities, I think I talked about them being up like 9%. That’s unannualized on a linked quarter basis, and we’re up 10% year-over-year. That tells me that we’re still on a gross basis seeing deals and we’re seeing growth in that. We’ll keep our eye on it, but the tone that I get from our officers is that it’s still good, and we’re seeing lots of opportunities. There are some, I’d say—I want to be careful with the words I use—real estate, particularly some kinds of real estate with the higher rates and uncertainty in some areas, you can see still good deal flow, but some beginning to slow. Office for sure, we’re seeing maybe a little bit of industrial on the investor side. I think single-family housing, it’s not slowing really much, but I think we expect it to. I think our borrowers expect it to. They’re also saying that’s probably good because they cannot keep up with the pace today, but you’re still seeing really good growth in multifamily for really good economic reasons. We’re seeing good growth in retail, just for example, you’re seeing some good growth in owner-occupied areas. The tone is still good. But, the other thing I’ll say is that things are changing, and the Fed’s trying to slow things down. I think in Texas we are a little different in terms of the activity we’re seeing in terms of in-migration with individuals and businesses. I’d like to believe we can be a little bit better than the general economy. But anyway, I’ve rambled too much on that; that’s kind of what we’re seeing.

Michael Rose, Analyst

All right. Appreciate all the colors. Thanks.

Phil Green, Chairman and CEO

Thanks.

Operator, Operator

Our next question comes from the line of Ebrahim Poonawala with Bank of America. Please proceed with your questions.

Ebrahim Poonawala, Analyst

Good afternoon.

Phil Green, Chairman and CEO

Hey, Ebrahim.

Ebrahim Poonawala, Analyst

First question maybe around credit. Credit is obviously not an issue, but just wanted to get a sense of how far down you think the loan loss reserve can go before you begin provisioning, and just give us a perspective of where you think the steady-state reserve ratio looks like if we start seeing some signs of a slowdown or even a potential recession over the next year?

Jerry Salinas, CFO

What I’d say is that we had this last quarter, we have it again this quarter, and there’s quite a bit of color in the 10-Q. Part of our assumption as we work in our CECL model is the probability of a recession. Included in our overlays is a 30% assumption that there might be a recession, so we stress our portfolio accordingly. That’s kind of where we’re at with a 144 reserve coverage right now, which I think is pretty strong. Looking at that discussion in the 10-Q, you’ll see what we’re alluding to. There are many nuances going on in the economy right now, a lot of uncertainty. But what’s happening in our case is we’re giving some probability to a recession. Where can it go? I guess with CECL, when it was adopted, we were probably at 1%. I don’t foresee that we bring our reserve coverage all things being equal and credit quality being great. I don’t see the reserve ending at 1%, but I think for now, we feel extremely comfortable with where we’re at from a reserve level. Should the economy improve, we could see that reserve coverage continuing to decrease.

Ebrahim Poonawala, Analyst

Got it. And I guess just a separate question, Jerry. I wanted to confirm that the $3.2 billion number for securities was a net number as opposed to gross. Also, talk us through, with the 10-year yield at 269, how are you thinking about protecting the margin if we do get into a period of Fed rate cuts next year?

Jerry Salinas, CFO

What I’ll say for now is that what we’re looking at is something we visit all the time. Right now, we’re staying pretty consistent. Our purchases, we said would be 70% treasuries and 15% municipals and MBS securities. We’ve been pretty consistent with that and moved around a little bit. We might accelerate things. It’s something we continually talk about. We’re buying in the three to five year area; that’s really where we’re looking, and we’ve made the bulk of our purchases. We’ll continue to have those conversations. We’ll look at risk and reward and see what makes sense if it makes sense to add duration. It’s something we continue to think about, and I think we’ve been pretty transparent. We still have plenty of liquidity. This morning, we were close to $13 billion, even after all the purchases we’ve made. We’ll just have to see. I will say given the conversation earlier about deposit rates, our deposit rates are much higher than most. In an environment where you see rates going down, we’ve proven that we can bring rates down as well. We’ve been through a long rate cycle, and we’ve proven that we can take our rates down. Given our value proposition to our customers, we really haven’t lost deposits during that time.

Ebrahim Poonawala, Analyst

That’s fair. Thank you.

Phil Green, Chairman and CEO

Thank you.

Operator, Operator

Our next question comes from the line of Brady Gailey with KBW. Please proceed with your question.

Brady Gailey, Analyst

Thank you. Good afternoon.

Phil Green, Chairman and CEO

Hey Brady.

Brady Gailey, Analyst

If you look at cash to average earning assets, it finished the quarter at about 27%. If you put another $3.2 billion of cash into bonds, it feels like by the end of the year, it could be closer to 20% or so. Longer-term, where would you like to run cash to assets? Does that get down to 5%, or is that too low longer-term? What level of cash would you like to have on the balance sheet?

Jerry Salinas, CFO

I’m looking at Phil. I’m kind of laughing because every time our balance is at the Fed and it decreases from $13 billion to $12.5 billion or something, he’s calling me and asking me what’s going on. In all seriousness, you’ve followed us for a while. We’ve tended to be more conservative on our levels of cash, but we’ve been all over the board. Obviously, we feel very comfortable and confident in alternative sources available to us. Off the cuff, I’d say 5% feels kind of low to us right now. So I would say something in that 5% to 10% range where we think about it.

Brady Gailey, Analyst

Okay. And then in the last quarter, we talked about spread income ex-PPP potentially growing on a high-teens basis. After looking at the increase in margin and spread income that you guys enjoyed in the second quarter, it feels like that’s too low. It feels like they’ll easily be percent plus; any refresh on how you’re thinking about spread income year-over-year?

Phil Green, Chairman and CEO

Yeah, what I would say is the environment today is different than where we were a quarter ago. I think our assumption at that point—the rates we have now, given the rate hikes we’ve seen in June and July—are end up the year at 125 basis points higher. So, certainly, given that sort of environment, a mid-teen growth in net interest income would be too low.

Brady Gailey, Analyst

Yeah. And finally, on deposit balances, you’ve seen a lot of deposits shrink this quarter for some of your peers, but you all saw some nice growth. I know you increased deposit rates, but do you think you’ll see any sort of deposit outflows in the next year or so, or are you really just hoping to keep growing the core deposit base?

Phil Green, Chairman and CEO

I hope to keep growing. I mean, that’s really what we’ve been focused on. I was just thinking about the question that Jerry answered and got asked about interest rates and protection against interest rates. I mean, I think we’ve done a pretty decent job of coming up with ways to manage that, but we really don’t want to be defined by that. What we’re more and more defining ourselves as is a company that is focused on growth. If we’re accessing great markets and making the investments to grow in those markets, we get any kind of rates at all. First, could cut rates, but maybe they cut them to zero; maybe not. But we think our job is clear: continue to grow the business. That’s growing deposits and what’s really where the value of any banking franchise is—growing asset classes. We’ve got the opportunity to do that with the products we’ve got. We’ve got the new mortgage product we’re bringing out at the end of the year. The direction of rates is important, but as Jerry said, we’ve got flexibility because we’ve been diligent in moving rates along with move ups. I think the more important thing for us to focus on is continuing to show this organic growth by accessing these markets and proving that we can take share.

Brady Gailey, Analyst

Yep. That makes sense. Thanks, guys.

Phil Green, Chairman and CEO

Thank you.

Operator, Operator

Our next question comes from the line of Dave Rochester with Compass Point. Please proceed with your question.

Dave Rochester, Analyst

Hey, good afternoon, guys.

Phil Green, Chairman and CEO

Hello. Hey, Dave.

Dave Rochester, Analyst

Just wanted to go back on to the NII guide. Are you guys thinking high teens now or possibly low twenties in terms of growth year-over-year?

Jerry Salinas, CFO

Yeah, I would definitely be in the 22%. I wouldn’t guide you more to the twenties than the low, the high teens.

Dave Rochester, Analyst

Low twenties. Okay, perfect. And then do you have a spot rate for interest-bearing deposit costs at quarter end?

Phil Green, Chairman and CEO

I don’t have it on me right now. I think A.B. is on, so we’ll have him reach out to you today with that number. I don’t have it on.

Dave Rochester, Analyst

Yeah. That’s all right. That’s totally fine. I appreciate that. And then just a clarifying point, the $3.2 billion in securities purchase that you have for the rest of the year; that’s gross purchases, so growth would be somewhere in the $2 billion, $2.5 billion if you haven’t had the majorities for the back half. That’d be great.

Jerry Salinas, CFO

We probably got, yeah, we probably got another $700 million that would be falling back to us. So that number’s gross. So yeah, you’re somewhere in the $2.5 billion range.

Dave Rochester, Analyst

Perfect. And I guess for the deposit trends, those were very solid this quarter. I was very impressed. Was just curious if you had the component of that growth that came from Houston and Dallas versus the rest of the franchise. And then I know you’d mentioned expecting high single digit deposit growth for 2022. Are you still thinking in that range or do you think that maybe you could do a little bit better just given the better first half results?

Jerry Salinas, CFO

I’m still there. I think, Phil, you heard Phil talk. I think we’re optimistic that it can be better given continued new growth. As rates go up, there’ll be more and more pressure on us, especially on some of those larger deposit balances. So yeah, I mean, that’s what we’re projecting; if it can be higher than that, we’ll all definitely be happy. But I do think it’s riskier the higher rates go, especially on those larger accounts. With regard to the expansion, one thing that I’ll give you year-over-year, I’ll say they contributed 1% of the growth in average deposits.

Dave Rochester, Analyst

And about loans?

Jerry Salinas, CFO

And 2% on loans. Yeah, I’ll say that as well. So they are starting to move the needle, especially on that loan side.

Dave Rochester, Analyst

Great. Awesome. Maybe just one last one on credit. Given you guys aren’t seeing any signs of anything, it kind of feels like a zero provision is still good, at least at the end of this year. Is that kind of how you’re thinking about it?

Jerry Salinas, CFO

Everything that I’m seeing—I’ll let Phil talk to, but everything I’m seeing and hearing and sitting in our CECL meetings, that’s really where I’m at right now. Obviously, it’s something we can’t project that far out. We’re talking to our people in the credit area all the time, but at this point, I’m not hearing anything that gives me cause for concern.

Phil Green, Chairman and CEO

Yeah, I mean, CECL is hard to envision a need right now based on everything we know.

Dave Rochester, Analyst

Yeah, that makes sense. All right, guys. Thanks. I appreciate it.

Phil Green, Chairman and CEO

Thank you.

Jerry Salinas, CFO

Thank you.

Operator, Operator

Our next question comes as a follow-up from Ebrahim Poonawala with Bank of America. Please proceed with your question.

Ebrahim Poonawala, Analyst

Thanks. Just one follow-up question, Phil, I guess outside of things that you are doing and then the strength in the market, how are you seeing competitors behave? One in terms of just the risk appetite; are you seeing competitors losing the underwriting box? You mentioned, you obviously go head-to-head with the largest banks in your markets. Have you seen the bigger banks pull back a little bit, given some of the capital constraints they’re facing?

Phil Green, Chairman and CEO

Ebrahim, you know, in talking with our people in preparation for the call, there may be some marginal improvement in structural competition—not much, but I did hear one of our teams mention how they had won a deal on our traditional underwriting, which they seemed surprised to do. I mean, we do that all the time, but in this particular instance, it seemed like they were pleased to see that. I’d say it’s beginning to be a little bit more structurally sound, but that’s not pervasive. I probably hear as many stories or more stories where you’re seeing competition continue to increase. Maybe beginning to see a little bit more competition on the C&I side as opposed to just the commercial real estate side, but it’s still competitive, but things are slowing a bit in real estate. I remember some conversations we had with builders who are expecting to see a 10% price change or reduction by the end of the year in certain residential markets. And the point they made is that’s fine; it may be a slowing that will help us catch our breath. We’ve had build times go from 120 days to 210 or something like that, and they’ve got such wide margins historically high margins. They’ve got plenty of room to fade that. I don’t think it would be unwelcome in some ways to see a little bit moderation in that market, but we’ve heard that as well.

Ebrahim Poonawala, Analyst

Got it. Thanks for the color. Thank you.

Phil Green, Chairman and CEO

Thank you.

Operator, Operator

Our next question comes from the line of Jon Arfstrom with RBC Capital Markets. Please proceed with your question.

Jon Arfstrom, Analyst

Hey, thanks. Good afternoon.

Phil Green, Chairman and CEO

Hey, Jon.

Jon Arfstrom, Analyst

Jerry, can you give us a little bit of help on the trust and investment management and deposit service charges? What you’re thinking there? They’re a little better than I thought they would be, but just give us some insight into the outlook.

Jerry Salinas, CFO

Sure. I guess yes for the quarter, I’ll be honest on the trust and investment management fees. I was pleasantly surprised that we ended up where we did. We had a good month and a good quarter in oil and gas fees; they were up about $1.8 million quarter-over-quarter. Compared to the second quarter last year, they really were able to offset a decrease that we saw in investment fees, which were down $1 million. Our state fee was down another $1 million. I don’t expect that given all the volatility and what’s going on in the markets, we’ll see some pressure on that investment line item. We have continued to grow our managed accounts in that business. I think we’re up 5% in the number of accounts compared to the second quarter last year. I know there’s a lot of focus on trying to grow the business, but we will feel some pressure given the market volatility. On deposit service charges, we’ve made, in my opinion, some changes that have really made a lot of sense for us and our customers, particularly concerning overdraft fees when we instituted overdraft grace. Recently, in June, we changed the requirement to receive that free $100 overdraft. Previously, you had to have a direct deposit of at least $500 a month, which we felt was punitive to some of our customers, given not every employer pays via direct deposit. We lifted that in June, and we’re saying that’s probably going to cost us $2 million. So we haven’t seen the impact of that change yet. We’ve also eliminated our NSF fees, which were about $1.5 million. That line item is going to see some pressure going forward. A lot of our growth is from the number of new accounts, where we’ve expected some pressure on that line item. We’ve been able to bring on new customers, which has led to an increase in the number of transactions.

Jon Arfstrom, Analyst

That kind of segues to my next question. Just the 7,200 new households—that’s an all-time high. How are you doing in your legacy markets on that? How much of that is driven by the new markets?

Phil Green, Chairman and CEO

One thing I’d offer up is if you look at account openings from traditional branches, which is mostly legacy right, account growth year-over-year from traditional branches was 9.2%. I think we’re doing pretty good. A lot of things are working for us. Our value proposition is solid; we give people a square deal and great service. You don’t always have to be looking over your shoulder at who’s paying me this or that for my deposits. We’ve put in a lot of work every week; Jerry is looking at the market where we’re talking to our lines of business. We’re trying to figure out what’s fair. A lot is working for us. Our branch experience is unparalleled in terms of how we treat people, the facilities are beautiful, creating a great experience. I talked last time about the location we opened in the west part of San Antonio; that’s a legacy market. We’ve been here 154 years, and in the first six months, the growth we’ve seen in that particular location was literally multiples of what we did in our best Houston location. It’s already at $24 million in deposits in six or seven months. That’s just in a legacy market. So there’s something going on that I hope we can continue to leverage, and I feel good about how the business is operating and how we move forward.

Jon Arfstrom, Analyst

Okay. This is my last earnings call in the quarter, and I think I might be last in the queue, so maybe I’ll end the quarter. You used the terms unusual and evolving in your opening comments. I’ve asked this on other calls, but there seems to be a disconnect between credit quality that we’re seeing from the banks and what we see on the street or read about every day. What’s your take on where we’re evolving to? Are you worried about it? Is Texas different? It sounds like you’re not seeing erosion in your loan book. Just any big picture thoughts on whether the market is right or you’re right or where are we going?

Phil Green, Chairman and CEO

I think it’s a great question, Jon. The disconnect we’re seeing is when we talk to customers on Main Street; there’s not a lot of talk about slowing. There’s not a lot of talk about recession. There’s talk about where am I going to get the next person to hire, what I’m going to have to pay them and issues with the supply chain, like how can I get capacity to warehouse what I can so that I’m ready to move forward when I can get the other parts of the supply chain that I need. The economy is strong here, and I’m not too worried about its direction right now. It is unusual and evolving; hedge funds are increasing rates by 75 basis points at a time, and we’ll see what impact that has.

Jon Arfstrom, Analyst

All right. Thanks, guys. Appreciate it.

Phil Green, Chairman and CEO

Okay, Jon. Thank you.

Operator, Operator

Thank you, ladies and gentlemen. We have reached the end of the question-and-answer session. I will now turn the call back over to Phil Green for closing remarks.

Phil Green, Chairman and CEO

Okay. Thanks, everybody, for your participation today, and we’ll be adjourned.

Operator, Operator

Thank you. This concludes today’s conference, and you may disconnect your lines at this time. We thank you for your participation.