Earnings Call Transcript - CFR Q1 2024

Operator, Operator

Greetings. Welcome to Cullen/Frost Bankers Inc. First Quarter 2024 Earnings Conference Call. 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.

A.B. Mendez, Senior Vice President and Director of Investor Relations

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

Phillip Green, Chairman and CEO

Thanks, A.B., and good afternoon, everyone. Thanks for joining us. Today, I'll review the first quarter results for Cullen/Frost and our Chief Financial Officer, Jerry Salinas, will provide additional comments before we open it up to your questions. In the first quarter, Cullen/Frost earned $134 million or $2.06 per share compared with earnings of $176 million or $2.70 a share reported in the same quarter last year. The first quarter results were affected by an additional FDIC insurance surcharge accrual of $7.7 million or $0.09 a share associated with the bank failures that happened in early 2023. Our return on average assets and average common equity in the first quarter were 1.09% and 15.22%, respectively, and that compared with 1.39% and 22.59% for the same period last year. Solid earnings from the first quarter demonstrate the success of our organic growth strategy and the hard work of our bankers. Our strength and stability, combined with our core values and strong corporate culture allow us to continue providing world-class service to our customers which results in sustained long-term growth. Our balance sheet and our liquidity levels remain consistently strong. Also, as was the case in previous quarters, we did not take on any Federal Home Loan Bank advances, participate in any special liquidity facility or government borrowing, access any broker deposits, or utilize reciprocal deposit arrangements to build uninsured deposit percentages. Additionally, our available-for-sale securities represent more than 80% of our portfolio at quarter end. Average deposits in the first quarter were $40.7 billion, down 4.8% from the $42.8 million in the first quarter of last year. Average loans grew 10.4% to $19.1 billion in the first quarter compared with $17.3 billion in the quarter a year ago. We continue to see excellent results in our organic growth program. For example, we combined our Houston locations and for the expansion, we stand at 104% of our deposit goal, 164% of our loan goal, and 122% of our new household goal. For the Dallas market expansion, we stand at 174% of our deposit goal, 212% of our loan goal, and 185% of our new household goal. Just after the first quarter close, we opened the second new location on our 17-site Austin expansion project. Our next new Austin region location will open just after Memorial Day. At the end of the first quarter, our overall expansion efforts had generated $2 billion in deposits, $1.5 billion in loans, and added over 46,000 new households. And it helps me to put this in perspective when I remember that the largest acquisition in our history was a company with $1.4 billion in deposits. Our consumer banking business continues to build momentum from the record net new household growth in 2023, and we added 6,600 net new checking accounts for households in the quarter, with an annual growth rate there of 6.5%, which we believe continues to put us among the top growing banks in the country. Average consumer loans saw steady growth in the first quarter, increasing an annualized 13% on a linked-quarter basis and hitting a milestone of $3 billion in average balances outstanding. We remain excited about the prospects for our new mortgage product, which is approaching 200 loans with about half coming in the first quarter. Looking at our commercial business, on a linked-quarter basis, average loan balances increased an annualized 10.5% for C&I and a 13.4% increase for CRE. Our new commitments booked in the first quarter were 24% less than the level booked in the first quarter of 2023. However, our new commercial relationships were up 10% year-over-year, standing at 825, representing our highest level of first quarter relationships ever. This coincided with us achieving our highest level ever for calling activity in the first quarter. New loan opportunities in our pipeline were up 15% year-over-year and were second only to last year's spike after SBD's failure. Our weighted average pipeline stood at $1.46 billion, up by 24% from the fourth quarter and by 17.5% from the first quarter last year. Regarding those 825 new relationships in the first quarter that I mentioned, about half continue to come from the two large failed banks. We continue to use discretion as we look at our new loan opportunities. For example, I'd point out that in the first quarter, our deals lost were up by 24% year-over-year, and 82% of those deals lost were due to structure. Credit quality is good by historical standards with net charge-offs and new nonaccrual loans at healthy levels. We're seeing some normalization in credit risk ratings as we come off the historic lows and problems experienced in the years immediately following the pandemic. Looking at some of the details, net charge-offs for the first quarter were $7.4 million compared to $10.9 million last quarter and $8.8 million a year ago. Annualized net charge-offs for the first quarter represented 15 basis points of period-end loans. Nonperforming assets totaled $72 million at the end of the first quarter compared to $62 million last quarter and $39 million a year ago. The quarter-end figure represents 37 basis points of period-end loans and 15 basis points of total assets. Problem loans, which we define as risk grade 10 or OAEM, totaled $809 million at the end of the first quarter. That's up from $571 million at the end of the fourth quarter and $347 million at the same time last year. Three-quarters of the increase was due to company-specific C&I loans, with the remainder being CRE credits of various types. The growth in the first quarter was fairly evenly split between loans and the OAEM or risk grade 10 and classified risk grade 11 categories and was mainly attributable to a few larger credits, some of which we expect a relatively quick resolution for. Less than 20% of our problem loans overall are tied to investor commercial real estate. About 50% are related to C&I credits, with most of the balance in owner-occupied real estate, which are closely related to C&I loans. Regarding commercial real estate lending, our overall portfolio remains stable with steady operating performance across all asset types and acceptable debt service coverage ratios and loan-to-values. Within this portfolio, what we consider to be the major categories of investor CRE—office, multifamily, retail, and industrial—for example, totaled about $4 billion or 46% of total CRE loans outstanding. Our investor CRE portfolio has held up well with average performance metrics stable quarter-over-quarter, exhibiting an overall average loan-to-value and underwriting of about 53% and average weighted debt service coverage ratio of about 1.47. The investor office portfolio specifically had a balance of $983 million at quarter-end, and that portfolio exhibited an average loan-to-value of 53% and healthy occupancy levels with an average debt service coverage ratio of 1.53, which has slightly improved for the second consecutive quarter. Our comfort level with the office portfolio continues to be based on the charter experience of our borrowers and sponsors and the predominantly Class A nature of our office building projects. In our last conference call, I mentioned that we had just introduced the new Frost Bank marketing campaign and brand refresh designed to emphasize our great customer experiences. We saw proof points of that in the first quarter when Frost achieved the highest scores nationwide in the Greenwich Excellence Award for the eighth consecutive year and the highest ranking for banking customer satisfaction in Texas in J.D. Power's retail banking satisfaction study for the 15th consecutive year. These are unprecedented achievements. No other bank can say those things, and I hope that no other bank ever will. But when you think about it, that level of service is why our customers have come to expect from Frost. That's what we deliver on a daily basis, and it's what we mean when we talk in the new campaign about realized examples of extraordinary customer service, which is exactly what you expect. None of this is possible without the dedication of our employees across Texas. Their commitment to our culture and their optimistic experience makes all of our success possible, and I'm proud of everything that our Frost teams are accomplishing across all our communities. Now I'll turn the call over to our Chief Financial Officer, Jerry Salinas, for some additional comments.

Jerry Salinas, Group Executive Vice President and CFO

Thank you, Phil. Let me start off by giving some additional color on our overall expansion results. As Phil mentioned, we continue to be very pleased with the volumes we've been able to achieve. Looking at the first quarter, growth in both average loans and deposits was approximately 9% when compared to the previous quarter. For the first quarter, the profitability of the Houston expansion offset the costs associated with the additional expansion efforts in Dallas and Austin. Now moving to our net interest margin. Our net interest margin percentage for the first quarter was 3.48%, up 7 basis points from the 3.41% reported last quarter. Some positives for the quarter include higher volumes of both loans and balances at the Fed and higher yields on loans and investment securities. These positives were partially offset by the higher cost of interest-bearing deposits compared to the fourth quarter. Looking at our investment portfolio, the total investment portfolio averaged $19.3 billion during the first quarter, down $510 million from the fourth quarter. During the first quarter, investment purchases totaled $187 million with $112 million of that being Agency MBS securities and $75 million in municipals. The net unrealized loss on the available-for-sale portfolio at the end of the quarter was $1.59 billion, an increase of $199 million from the $1.39 billion reported at the end of the fourth quarter. The taxable equivalent yield on the total investment portfolio in the first quarter was 3.32%, up 8 basis points from the fourth quarter. The taxable portfolio, which averaged $12.5 billion, down approximately $582 million from the prior quarter, had a yield of 2.83%, up 8 basis points from the prior quarter. Our tax-exempt municipal portfolio averaged about $6.8 billion during the first quarter, up about $73 million from the fourth quarter, and had a taxable equivalent yield of 4.27%, up 1 basis point from the prior quarter. At the end of the first quarter, approximately 70% of the municipal portfolio was pre-refunded or PSF insured. The duration of the investment portfolio at the end of the first quarter was 5.5 years, up from 5 years at the end of the fourth quarter. Looking at deposits, on a linked-quarter basis, average total deposits of $40.7 billion were down $459 million or 1.1% from the previous quarter. We did continue to see a shift in the mix during the first quarter as average noninterest-bearing demand deposits decreased by $720 million or 4.9%, while interest-bearing deposits increased by $261 million or 1% when compared to the previous quarter. Based on first quarter average balances, noninterest-bearing deposits as a percentage of total deposits were 34.3% compared to 35.7% in the fourth quarter. The cost of interest-bearing deposits in the first quarter was 2.3% and up 7 basis points from 2.27% in the fourth quarter. Looking at April month-to-date averages for total deposits through yesterday, they are up about $134 million from our first quarter average of $40.7 billion, with interest-bearing up $332 million and noninterest-bearing down $198 million month-to-date. Regarding noninterest income and expense on a linked-quarter basis, I'll point out a couple of items. Trust and investment management fees were down $1.1 million or 2.7%, impacted by lower estate fees down $1.5 million. Estate fees can be lumpy as they are based on the value and number of estates settled. Insurance commissions and fees were up $5.6 million or 44%. Property and casualty and benefit company bonuses, which are typically received in the first quarter, contributed $3.4 million to the increase. Benefit commissions were up $2.1 million as the first quarter is typically the strongest quarter for those commissions. As a reminder, the second quarter is typically the weakest quarter for insurance commissions and fees, given our typical yearly renewal cycle. The other noninterest income category was down $6.9 million primarily related to $4.4 million in card-related incentives, as those incentives are received in the fourth quarter each year and a $3.5 million fourth quarter recovery of a previous loss accrual. Salaries and wages were up $1.4 million, as increased salaries and higher incentive accruals were mostly offset by stock compensation expense, which was lower by $8.2 million. As a reminder, our stock awards are granted in October of each year, and some awards by their nature require immediate expense recognition. Benefits expense was up $7.9 million, impacted by higher payroll taxes and 401(k) expenses related to annual bonuses paid during the first quarter and impacted by the normal trend for FICA taxes and 401(k) limits reset at the beginning of the year. Other noninterest expense was down $6.4 million or 9.6%. The decrease was driven primarily by donations expense, which was down $3.5 million, and professional services down $2.9 million. Regarding our guidance for the full year of 2024, our current projections include two 25 basis point cuts for the Fed funds rate over the remainder of 2024, with one cut in September and another one in November. This is down from five cuts in our January guidance. For the full year of 2024, we currently expect full-year average loan growth in the high single digits. That's up from our previous guidance of growth in the mid- to high single digits. Full-year average deposit growth is projected to be flat to 2%, that's down from our previous guidance of growth in the range of 1% to 3%. Net interest income growth is estimated in the range of 2% to 4%, that has not changed from our previous guidance, with the net interest margin percentage expected to trend slightly upward each quarter for the remainder of the year. Noninterest income could be flat to up 1%, impacted by the pressure facing the industry on interchange revenues and OD fees and also impacted by our high level of sundry income in 2023. That represents a slight improvement from our previous guidance of basically flat. Noninterest expense growth is projected in the range of 6% to 8% on a reported basis; this has not changed from our previous guidance. Regarding net charge-offs, we still expect those to go up to a more normalized historical level of 25 to 30 basis points of average loans. Regarding taxes, our effective tax rate for the full year of 2023 was 16.1%, and we currently expect a comparable effective rate in 2024. With that, I'll now turn the call back over to Phil for questions.

Phillip Green, Chairman and CEO

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

Operator, Operator

Our first question is from Casey Haire with Jefferies.

Casey Haire, Analyst

Starting with the NII guide, it seems you are leaving it unchanged despite fewer rate cuts. The loan growth appears to be slightly stronger than your revised high single-digit guidance. Is the higher pressure from funding costs the reason for keeping it the same? Could you provide more detail on the NII dynamics?

Jerry Salinas, Group Executive Vice President and CFO

Yes. That's certainly some of that. And also, we're talking about higher for longer rates. As we've discussed, the competitive field for deposits continues to put pressure on us. I think the higher that risk, the longer that rates stay elevated, we will continue to see more pressure on deposits. We've been talking for a while now about customers looking for higher yields, and I think that pressure will continue. We continue to see that especially on the noninterest-bearing side, where people are continuing to move their deposits. We are observing a downward trend there. I think just the uncertainty will make us maintain our original guidance, despite the reduction of a couple of basis points.

Casey Haire, Analyst

Okay. Great. And maybe just following up on that. What does your NII guidance assume regarding the DDA mix, which I believe has decreased to 34%? Also, what are your expectations for betas moving forward?

Jerry Salinas, Group Executive Vice President and CFO

Yes. The betas are really, at this point, we're not assuming any significant movement in the betas. Our cumulative beta moved up from 42% to 43%. I'd expect that we'd have some pressure there. We're not seeing much movement in the interest-bearing, non-time accounts. We slightly tweaked some downward actually. So, at this point, you may see a same sort of increase of 1% quarter-over-quarter, but I don't expect that to change drastically. Of course, we'll continue to keep an eye on what's happening in the market. I don't hear nearly as much extreme CD pricing as we've heard a few months ago, but some activity is still ongoing. I expect some pressure on the beta, but I wouldn't expect it to change significantly.

Casey Haire, Analyst

Okay. And the DDA mix at 34%, it sounds like there's more pressure. Just wondering how much more...

Jerry Salinas, Group Executive Vice President and CFO

Yes, I expect there will continue to be pressure. I don't expect it to drastically change at this point. You kind of heard the movement that we have in that category was down a couple of hundred million year-to-date. And as a reminder, the first half of the year, historically, is softer for us on DDA. So that's not unusual to us.

Operator, Operator

Our next question is from Steven Alexopoulos with JPMorgan.

Steven Alexopoulos, Analyst

Maybe to start, so to follow up on Casey's question on NII. Jerry, last quarter, I thought you said that NII could increase by 2% to 4%. I was assuming five rate cuts. But if we didn't get any cuts, we would add about 1.5% to that increase. Is it still the same? If we get no cuts, are you thinking 1.5% above? Or has that potential improvement lessened now?

Jerry Salinas, Group Executive Vice President and CFO

It probably lessens a little bit now. A part of it again is when we're primarily discussing the noninterest-bearing deposits. This is a significant impact on that number. Given what the pressure that we saw there— a little bit more than we expected in the first quarter— I am not really ready to increase our guidance. It’s really more related to what happens there. I think that will drive a lot of it. The month of April doesn't look unusually bad; it is a tough assessment to make because this time of year tends to be a little softer for us. Yes, at this point, we just have to see where it plays out.

Steven Alexopoulos, Analyst

Got it. Okay. And then on the loan growth side, you guys had solid loan growth in a quarter where the industry has not much loan growth to speak of. How much of the loan growth is coming from current customers borrowing more—a sign of the health of the markets—versus just pure market share gains, like new customers to the bank?

Phillip Green, Chairman and CEO

Steven, I don't have that number at hand. I can tell you that some of the new customers have contributed to loan growth, Jerry can help me out with that. Just to talk a little bit about the interesting activity we saw in pipeline increasing is customer-related, as opposed to prospects. I thought that was interesting. I think also the core loan growth was under $10 million relationships, which reflects our expansion growth. So, it’s pretty broadly based.

Jerry Salinas, Group Executive Vice President and CFO

Yes. From the numbers that I'm looking at, it looks like about a quarter of the period-end growth between December and March is related to new customers.

Steven Alexopoulos, Analyst

Got it. Okay. And while—go ahead.

Phillip Green, Chairman and CEO

In the first quarter, we added $145 million in new loan balances and $100 million in deposits from new relationships over the last 12 months.

Jerry Salinas, Group Executive Vice President and CFO

That's about a quarter of them.

Steven Alexopoulos, Analyst

About a quarter. Yes, part of the reason I asked, considering the industry has fairly modest growth this quarter, quite a few banks are coming out pretty bullish, seeing pipelines build and you guys are already experiencing low double-digit growth year-over-year on loan growth. Jerry, I know you said high single-digit, but if you’re seeing the same pipeline build, it would seem that puts you in a good position to potentially exceed the high single-digit growth. Do you just want to be conservative here?

Jerry Salinas, Group Executive Vice President and CFO

If you're asking if it could move up to the low double digits, I think we could, but there is a little bit of slowness out there. Some of this growth is coming from commitments that were originated last year. Could we get up to 10% or 10.5%? Certainly, but I do hear some caution from some of our team.

Phillip Green, Chairman and CEO

There's a bifurcation in the market; high-end customers are doing really well, while some lower-end customers are under pressure. Overall, activity is good, but we're careful with the structure; we did lose 82% of deals due to that. The aggressive behavior of some banks could limit us if the market heats up. However, our outlook is still strong, supported by solid pipeline information. The linked-quarter growth in the pipeline was robust, and new relationships were strong, so we're doing well competitively.

Operator, Operator

Our next question is from Dave Rochester with Compass Point.

David Rochester, Analyst

Back on the NII guide, I was just wondering what your assumptions are for liquidity trends you're baking into that? It sounds like you made some securities purchases this quarter. Is the plan to grow that book somewhat from here to reduce some of that cash and take some of the asset sensitivity off the table? And if you have those purchase yields on those different segments, that would be great.

Jerry Salinas, Group Executive Vice President and CFO

Sure. Let me give you those purchase yields first: we bought at a weighted average yield of 549 basis points in the agencies and 518 basis points in the municipals. Right now, I don’t see liquidity moving much during the year. Loan growth has been better than we expected. We have been targeting investment purchases of about $1.6 billion; however, we are talking about scaling that back somewhat. We want to continue to be opportunistic in this environment.

David Rochester, Analyst

Okay. And then just on your comment of less NII upside and a higher for longer type of scenario. I was just curious where that NII sensitivity is now on delaying a cut. I think last quarter, you mentioned roughly $1 million of benefit each month. What is that now roughly?

Jerry Salinas, Group Executive Vice President and CFO

Yes. I think that number is probably at about $1.4 million a month in the event that cuts happen later in the year.

David Rochester, Analyst

Okay. And maybe...

Jerry Salinas, Group Executive Vice President and CFO

On our credit quality, I mentioned a few larger credits are impacting the problem loan trends this quarter. I was just hoping to get some detail on those, and then where are you on your office reserve ratio at this point?

Phillip Green, Chairman and CEO

Okay. Well, let me take the question regarding the increased problem loans due to the company-specific matters. There was a large construction company that missed some bids, and we recognized it at risk grade 10. There was a factoring company that we increased risk grade 10 on due to borrowing base concerns. Additionally, a truck company we saw had volume issues along with a company that moved into a significant new facility. These issues are mostly company-specific and not significantly related to interest rates except for a few issues with auto dealer financing.

David Rochester, Analyst

And then just on the office reserve ratio at this point, if there's any update there?

Jerry Salinas, Group Executive Vice President and CFO

Sure. In the 10-Q, we don’t provide a detailed view, but commercial real estate reserve coverages like at 148. For non-owner occupied and construction office buildings, higher-risk tenants receive a 5% reserve, while anything worse than that gets a 10% reserve. The combined reserve for our investor office and any office buildings under construction would be at a 372-production level.

Operator, Operator

Our next question is from Peter Winter with D.A. Davidson.

Peter Winter, Analyst

Thanks. Good afternoon. I just wanted to, Phil, if I could follow up on the problem loan discussion. Just if we're in this higher-for-longer rate environment? Because I heard your comments that these aren't interest rate-related yet, but the longer we remain in this higher-for-longer rate environment, do you see more pressure on C&I loans and continued increases in the problem loans sector?

Phillip Green, Chairman and CEO

I don't see anything significant or a trend for the higher-for-longer on the C&I piece. With the exception of some of the auto dealers running portfolios, I don't see issues. The main impact will be on commercial real estate and what they were financing before and where they are today. Those situations will need support from borrowers and sponsors as they mature. We’ve had great experience and performance from our borrowers, but we could see scenarios where higher interest rates create more pressure. Right now, we aren't experiencing further significant issues.

Peter Winter, Analyst

Okay. And then just separately, the insurance commissions had really nice growth in ’23, but in the first quarter year-over-year, it was down 3.5%. Is there anything unusual this quarter, or how are you looking at that on a full-year basis?

Jerry Salinas, Group Executive Vice President and CFO

Well, the first quarter last year had a strong life insurance commission. So we were probably unfavorable this quarter in that comparison by about $1.1 million. The commissions on those policies are one-time fees, unlike benefit commissions that tend to be more consistent. That was the biggest factor affecting us negatively compared to the first quarter last year, although benefits commissions were also softer than I expected.

Operator, Operator

Our next question is from Catherine Miller with KBW.

Unknown Analyst, Analyst

Thanks. Good afternoon. A question on expenses. I know that you left your expense guidance unchanged at a 6% to 8% growth rate year-over-year. Curious—I know you mentioned that FICA taxes and some 1Q seasonality drove the higher expenses this quarter. Should we assume that we will fall back from this first quarter level, or do you still think you will grow from this run rate into next quarter?

Jerry Salinas, Group Executive Vice President and CFO

Sure. We did get the additional FDIC surcharge of $7.7 million that we didn't anticipate when we gave guidance in January. We have also been keeping a tight ship on expenses. We saw almost $80 million in expenses that we hadn't expected. I think benefits will trend down during the year as a lot of it relates to 401(k) matches. If employees reach the limit early, our matches stop. Benefits will go down as the year continues. So I expect you'll see slight growth quarter-over-quarter in expenses based on today’s performance.

Unknown Analyst, Analyst

Yes, that's helpful. To be clear, that 6% to 8% includes the $7 million FDIC assessment?

Jerry Salinas, Group Executive Vice President and CFO

Exactly. Yes, we just included it as operating expenses for those purposes.

Unknown Analyst, Analyst

Okay. Great. And then next question on fees, service charges, I mean, seasonally also lower in the first quarter, but I know you've talked about interchange and some other things being softer in the first quarter. Would you expect that to also increase as we go into the next couple of quarters? Or is this also a good lower run rate for service charges?

Jerry Salinas, Group Executive Vice President and CFO

Yes. The upside to service charges has been the commercial service charges. In some cases, it may work against you because customers may choose to pay hard dollar charges rather than keeping balances. We've done a lot for the consumer side, especially regarding OD fees. Overall, I don't expect significant growth in service charges from current levels, and I see continued pressure in that category for the rest of 2024.

Operator, Operator

Our next question is from Manan Gosalia with Morgan Stanley.

Manan Gosalia, Analyst

Good afternoon. I wanted to ask about deposit pressure. Most banks spoke about how deposit pressure eased in the first quarter. Do you think there's something related to your specific customer mix or the fact that you are accelerating growth in new markets? What do you think is driving that incremental pressure on deposit costs for you guys relative to what we're seeing in the broader market?

Jerry Salinas, Group Executive Vice President and CFO

From a cost standpoint, I will say that we're really not feeling much pressure on the deposit cost side from a market perspective. We need to be competitive and we are. We’ve decided to compete primarily on the 90-day CD. The pressure mainly comes on the noninterest-bearing side. Rates at higher levels continue to pressure both commercial and consumer customers looking for balances. We have seen increases in interest-bearing side balances from February to March and then March to April.

Manan Gosalia, Analyst

Got it. And then maybe on the loan side, you spoke about the deals lost being up due to structure. Where are you seeing this competition coming from? Is it private credit? Is it other banks? And is part of the reason for the weakness in NIM due to skewing towards higher quality and lower yielding loans right now?

Phillip Green, Chairman and CEO

Well, primarily, it’s coming from banks that are seeing changes in structures— guarantees, loan values, and terms. Some of that may come from private credit, although they offer lower yields at higher risk. Our loan yields are slightly lower but still competitive. The constraints you noted about credit quality and terms do influence our risk-adjusted strategy.

Manan Gosalia, Analyst

Got it. Okay. And if I could just have a clarification on one of your comments regarding the security side. I think you said duration of that book was up about half a year to 5.5 years. Is that a result of the move up in rates, or are you taking on more duration to lock in the benefits of higher rates?

Jerry Salinas, Group Executive Vice President and CFO

No, we didn't do a lot of purchases in the first quarter. What happened is we had about $1 billion in treasuries mature early in January. That affected our total duration. There might be a slight increase in duration related to mortgage-backed securities, but we have not aggressively lengthened our duration in the first quarter.

Operator, Operator

Our next question is from Jon Arfstrom with RBC Capital Markets.

Jon Arfstrom, Analyst

A couple of questions. Phil, should we expect that potential problem loans will continue to migrate higher, or is that not necessarily true?

Phillip Green, Chairman and CEO

Yes, Jon, first of all, I’d refer to loans, the old potential problem loans category we no longer use. Risk grade 10 and higher could increase. The reason is we were at unsustainably low levels previously, especially in the industry following the pandemic for credit quality. We are experiencing a reversion to normal levels, so I would say yes, we might expect to see an increase. However, we’re looking for swift resolutions on some of these new ratings, so that provides some balance as we navigate this.

Jon Arfstrom, Analyst

Okay. Yes. It doesn’t seem like you feel the need to build reserves from here? I mean, I hear your charge-off guidance and I respect that, but it doesn't seem like you have more pressure coming, at least in your mind, in terms of credit.

Phillip Green, Chairman and CEO

I don't feel that we do. Can we see it worsen? Sure, that is possible. Jerry can speak to our formulas, but I believe our reserves are in a strong place. We built reserves considerably during the COVID period, and we never took them down.

Jerry Salinas, Group Executive Vice President and CFO

Yes, our reserve coverage percentage hasn’t fluctuated significantly. I do not predict that we will see any noteworthy increases unless credit quality significantly deteriorates.

Jon Arfstrom, Analyst

Yes. Okay. Jerry, while you have the mic, you changed the presentation of the expansion contribution for the quarter. What kind of contribution did Houston 1.0 have this quarter?

Jerry Salinas, Group Executive Vice President and CFO

Last time we rounded it to $0.07; this quarter it was rounded to $0.06.

Jon Arfstrom, Analyst

Okay. And the—when you say Houston is funding Dallas and Austin, that's 1.0 and 2.0, is that right together?

Jerry Salinas, Group Executive Vice President and CFO

Correct, yes. I just simplified the presentation. Houston together funds the other expansions, and that was how we planned it, and it’s been successful.

Operator, Operator

We have reached the end of our question and answer session. I would like to turn the conference back over to Phil for closing remarks.

Phillip Green, Chairman and CEO

Okay. Well, thank you, everyone, for their interest. We appreciate your participation.

Operator, Operator

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