Greetings and welcome to Cullen/Frost Bankers’ Fourth Quarter 2021 Earnings Conference Call. [Operator Instructions] I’d now like to turn the call over to A.B. Mendez, Senior Vice President and Director of Investor Relations. Thank you. You may begin.

Thanks, Joel. 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.

Thanks, A.B. Good afternoon, everyone, and thanks for joining us. Today, I’ll review fourth quarter and full year results for Cullen/Frost and our Chief Financial Officer, Jerry Salinas, will also provide additional comments before we open it up to your questions. In the fourth quarter, Cullen/Frost earned $99.4 million or $1.54 a share compared with earnings of $88.3 million or $1.38 a share reported in the same quarter of last year and a $106.3 million or $1.65 a share in the third quarter of 2021. For the full year of 2021, Cullen/Frost earned $435.9 million or $6.76 a share compared to earnings of $323.6 million or $5.10 a share reported for 2020. Our return on average assets and average common equity in the fourth quarter were 0.81% and 9.26% respectively. I’m very pleased with our company’s results and I’m optimistic about the prospects for our organic growth strategy. Average deposits in the fourth quarter were $41 billion, an increase of more than 20% compared with $34.1 billion in the fourth quarter of last year. This continued outstanding deposit growth reflects our success in developing new relationships and expanding current growth. It reflects well on our expansion efforts, our value proposition enhancements and our world-class level of customer service. Jerry will talk more about our deposit growth in a few moments. I was very pleased with our success in our commercial lending segment where we booked $2.4 billion in new commitments in the fourth quarter, up 64% from the first quarter last year and up an un-annualized 37% on a linked quarter basis, and morally certain at our highest level ever. The growth was geographically diverse compared to last year fourth quarter C&I commitments were up 73% while CRE was up 121%. On a linked quarter on annualized basis C&I commitments…

Thank you, Phil. Looking first at our net interest margin, our net interest margin percentage for the fourth quarter was 2.31%, down 16 basis points from the 2.47% reported last quarter. The decrease was primarily the result of the impact of lower PPP loan volumes and their related yields compared to the prior quarter. Excluding the impact of PPP loans, our net interest margin percentage would have been 2.25% in the fourth quarter, down two basis points from an adjusted 2.27% from the third quarter, with a decrease resulting primarily from lower yields in the investment portfolio, partially offset by higher volumes of investment securities and non PPP loans. The taxable equivalent loan yield for the fourth quarter was 3.89%, down 27 basis points from the previous quarter, but excluding the impact of PPP loans, the taxable equivalent loan yield would have been 3.79%, up five basis points from the prior quarter, with about three basis points of the increase resulting from non recurring fees. To add some additional color on our PPP loans, our total PPP loans at the end of December were $429 million, down almost $400 million from the $828 million at the end of September. At the end of the fourth quarter, we had only about $2.8 million in net deferred fees remaining to be recognized and as such, we don’t expect PPP to have any material impact on our 2022 results. Looking at our investment portfolio, the total investment portfolio average $14.4 billion during the fourth quarter, up about $1.9 billion from the third quarter average as we deployed some of our excess liquidity during the fourth quarter. We made investment purchases during the quarter of approximately $2.9 billion consisting of about $1.7 billion in agency MBS securities, with a yield of about 2.05%, about…

Thanks Jerry. We will now open the call up for questions.

Thank you. We will now be conducting a question-and-answer session. [Operator Instructions] Our first question is come from the line of Brady Gailey with KBW. Please proceed with your questions.

Good morning guys. If I back out the PPP loan shrinkage, I see period end loan growth just in the fourth quarter of over 20% linked quarter, I know it’s a nice are very, very strong level, maybe just some commentary about where you saw a lot of that loan growth happen?

Yes. It’s really across the board Brady, to be quite honest with you. We’re seeing good growth, both in C&I, CRE is good. Really all categories are good. We did see some increase in energy as well, that’s impacting it. So if I looked at that annualized growth, energy added about 1%, but not material to that annualized number that you mentioned, but it’s pretty much across the board.

And then, I think last quarter, you guys had about $13 million of PPP fees left. You’re now saying it’s three. So is it safe to assume that in the fourth quarter you realized PPP fees of about $10 million in 4Q?

Yes. Let me grab that real quick here. Yes, I’m seeing a number just on the fee side, it’s about $8 million. So if you included the interest on it, it’s probably in that 9 million range, but I’m showing about 8 million for in the quarter related to those fees.

And then, we saw the bond portfolio expand in the fourth quarter. If you look at the 10 year bond yield is now 180 basis points, so it’s even higher than where it was then. How should we think about the possibility of Frost continuing to grow the bond book this year in 2022?

Yes, what we’ve said Brady all along is that it was our intent continue to invest. We’d like to be opportunistic, I’m going to be honest with the deposit growth that we saw, I mean, it just really been incredible. I kind of expected that the fourth quarter might be a little bit softer. I probably said that in the third quarter as well. And so, we’ve been able to make a lot of these investment purchases that we made in 2021 without really having a significant impact on our balances at the Fed. This morning, I think when I got an update, I think we’re north of 14 billion still today, after the purchases that I talked about. So still pretty strong, I think from a projection standpoint, we’re assuming that we probably have purchases in the neighborhood of half of that 14, if you will. Again, we’re going to be opportunistic, but that’s a current thought.

And those are just purchases, you’ll have obviously bonds that are rolling off. So that’s just on the purchase side is what you’re saying?

That’s right.

Yes. I think on the -- I was going to see if I had the maturity here. I think what I’m seeing is that we’ve got about $2 billion scheduled in maturities and assumptions on prepayments for the year.

So that half of 14 billion is 7, you take away 2 billion that’s going to be rolling off. So maybe think about the bond book growing roughly 5 billion in 2022. Does that seem fair?

Yes, I don’t think you’re off base. Again what we’ve said is, we’re going to look at what’s going on in the market. And we’ll take a look at what’s going on in deposits as these deposits continue to stick, we could be more opportunistic, but that’s kind of where I’m thinking right now. We’re early in the year. Obviously, the ALCO group meets monthly. So we’ll just decide from there, but I don’t think you’re too far off base with that.

Thank you. Our next question comes from the line of Jennifer Demba with Truist. Please proceed with your questions.

Hi, good afternoon. How much of your loan growth this year do you think is going to come from the expansion in Houston and Dallas? And do you think the Dallas branch expansion could be, you’ve raised the Houston branch count more than I think originally projected? Do you think you could do the same for Dallas at some point?

Well, let’s see. Jerry might have a feel on loan growth from the Houston. I mean, I think I gave the numbers and I may be able to pull up in a second where we stood at the end of the year. I think loans were just a little under 500 million, deposits were a little under 700 million really round numbers. But, I think I think Dallas is going to be solid. I don’t have any reason to believe verse branch there. I should say we opened up a location before we had begun working on, before we announced the strategy we call it Redbird locations. In the southern sector, Dallas has been really successful. And so that’s the first example I have of boots on the ground there and how we do with the new locations. So that’s been really good. I just think the character of Dallas is such that it is a very much of a business centric market. I think once upon a time someone told me they were 10,000 corporate headquarters there. It’s not nearly as energy centric as the Houston market. That can be a good thing or a bad thing. But it is, I think it is just a more diverse market in many ways. And so, I’ve always been excited about the prospects for Frost Bank in Dallas because middle market small business commercial is our wheelhouse. And man that is a target rich environment. So if we just do the right things. Learn the lessons that we learned from Houston. I have no reason to believe we won’t be successful in the Dallas market.

Jennifer, I can quantify some sort of numbers just to give you perspective, fourth quarter to fourth quarter, I don’t have the link in front of me, but so Houston expansion. So again, they’re starting from small numbers. But if they’re contributing that sort of growth on the change, if you will, they were responsible for a significant part of the growth.

Thank you. Our next questions come from the line of Dave Rochester with Compass Point. Please proceed with your questions.

Hey good afternoon, guys. Just wanted to start on NII, you talked about a lot of moving parts with rate hikes and you’ve got cash deployment and securities that you’re expecting and that sounds like that’s going to be pretty meaningful this year. Can you just remind us first maybe what is the impact on NIM or NII from each 25 basis point rate hike that you’re looking at this year and then just bigger picture what you’re thinking on the total NII trends versus 21? That would be great.

Sure. So maybe an easy way to say it is the impact of the net interest of the rate hike each 25 basis point rate hike is about 1,000,004 a month for the first 25. And so because of some of the floors, they’ll come into play, they don’t come, they’re impacting that growth in the first hike. By the second hike that number, most of them are eliminated and so I would say that number is closer to 1,000,007 say a month. That’ll give you some perspective there.

And then just overall for NII growth in 22 versus 21?

Yes. I mean we’re projecting. Obviously, we’ve got a lot of positive things going for us. You got to take out PPP, of course, because if you include PPP, we’re going to find some pressure there. I’d say with let me hold on, grab my notes here real quick. Yes, it is going to be, it could be pretty substantial just given, as you said, the assumptions that we’re talking about and some of its going to be impacted by the timing. As you heard, I said, our first assumption for rate hike is in May. If it happens sooner, that’ll help us. But we’re talking certainly a double digit, sort of mid teen potential growth for us on a TE basis, year-over-year.

And that’s factoring out again, that net 5 billion in growth and securities and then what you are expecting on the loan side?

That’s everything. Yes, exactly.

That’s all in. Good. And what do you guys factoring in for deposit growth for this year? Because that I guess, will drive, but maybe won’t drive that much, because you’ve got enough cash to the point securities was just curious, what’s your thinking on the deposit growth side?

Yes, to be honest, it’s been interesting. I’ve kind of expected that deposits might slow down some of their growth as I’ve said. It’s been pretty solid in the last couple of quarters. Our growth assumptions are that that’s somewhat softer in 2022. I can’t envision that. And again, I might be eating my words a year from now. But at this point, I don’t envision that we’ll be seeing a 20% or we’re not assuming we’ll see a 20% year-over-year average growth in deposits. If we do it, it’ll be great. And as Phil mentioned we’re doing a lot to enhance new customer relationships. The one thing I was really happy to see on the deposit side, continue to be happy to see is, we do our 12-month look back on deposit growth. And for the last 12 months, about one-third of our growth is coming from new relationships with two-thirds of that then coming from customer augmentation. That number is really the split between new and existing augmentation is really skewing slowly more and more to the new relationship. So we continue to be happy about that and that could impact the growth. But at this point on a full year average, I’m thinking, we’re going to be much softer than where we were in 2022.

Yes, that makes sense. And maybe just one last one on the non-interest income side. You had some good growth in 2021; I was just curious what your thoughts are if you’re expecting sort of a similar pace of growth on a core basis or if it should accelerate for any reason?

Yes, I think the pressure that I’ll go through the pressures first. The pressure we’re having is on the deposit service charge. We put in the overdraft grace product as we’ve talked about quite a bit, really happy with that product. There continues to be obviously things that we’re doing to continue to look at OD fees and what makes sense and what doesn’t make sense. So I don’t expect that we’ll see a potential for a lot of growth there, so some pressure there. On the insurance side, I think the pressures that I see there are more on the contingent income side. So we have a pretty big and you can see in our numbers, I don’t have them in front of me, but a good piece of our business there is contingent income associated with how those policies perform. Let me see if I can grab it here in front of me, but I’m expecting that that’s going to be softer. So we had about looks like 3.2 million in 2021. If you recall, we had a freeze here in Texas in February that was pretty much stopped the state for a few days. So there were quite a few claims there. So I’m expecting there will be quite a bit of pressure on that contingent income line item in 2022. But we are excited about our trust area. They had good growth there. Obviously, the markets have helped us. We had good growth in oil and gas fees, which are dependent on what happens in oil prices. But we’re optimistic, especially as we add new customers. I think there’s a good potential there. I don’t think, it’d be great if the market expectations or the market returns in 2022, look like 21. But that’s kind of not making sense right now. So might be a little bit pressure there as well.

Yes. Okay, all right. Thanks, guys, I appreciate it.

Thank you. Our next question is come from the line of Peter Winter with Wedbush Securities. Please proceed with the question.

Great, thank you. I was curious if the rates come in higher than what you’re expecting so for instance, if we get a rate hike in March and that would lead to higher net interest income. The question is, would you let most of the benefit fall to the bottom line or would there be any type of plan to maybe accelerate some of your branch expansion investments as kind of like a partial offset?

No, not really. The timing of the branches, there’s a lot involved in that right, because we need to make sure that we find the locations. You’ve got to hire the right people that’s such an important part of the success as we know. And so in some ways, we really wouldn’t be able to accelerate that expansion. What I would say is that regarding our deposit betas, we’re pretty conservative I’ll say in our assumptions on deposit betas, on the interest bearing side. I think the last numbers I saw, we had deposit betas of say 50% in our assumptions. Historically, when we went back and looked at cycles in 17 to 19, for example, we were probably closer to 30%, 35%. So it’ll be interesting to see what happens. What we’ve said is that we always want to make sure that we’re offering a square deal to our customers. We’ll be looking at market rates not only against too big to fail, but who our competitors are. And so we’ll react on the deposit side. If the industry as a whole doesn’t raise rates, we could have bigger benefits then, but over time we’re going to see increases in deposits just given where the market takes deposit costs.

Just on that point, if I think back to the last cycle, you guys actually moved ahead of peers in terms of raising deposit rates. I’m just curious just given so much deposits that you have today, what’s the thought of that type of strategy this time around?

Peter, I guess, I think you know us as well, I mean, we’re really all about the customer relationship, we want to make sure that we provide our customers with a square deal. So we want to make sure that the rates that we’re offering are competitive and to the extent that there are rates that we feel we need to move, even with a loan to deposit ratio under 40 where we’re going to raise those rates, because we think it’s fair to, it’s important for us to try to continue to build those relationships and make sure that we’re offering our customers a square deal.

Peter, last time in 17, you saw the Fed move up in rates 100 basis points. And the thing that happened to us is, we focus so much on competing with the too big to fail here in these markets that our eyes were squarely on what they were doing competitively and they really didn’t move at all at that point. And so, we sort of started to break away from that time, also this time around, we have learned from that experience and Jerry and his team and our deposit teams have really been very diligent, I think in paying attention to what rates are regardless of what some of the larger competitors might be doing. And I think we’ve done a nice job. I know we have on the CD rates, for example, and there really has been much movement in the non maturity portfolio rates, but we’ve moved some on that I feel really good about where we are. I think we’ve got a much better start going into this rate cycle moving up than we had in 2017. So we’re not really playing from behind the curve right now. And so, I feel pretty good about it. Like I say, I think we learn from our experience back in 17.

If I could just two quick housekeeping questions. Just other income, if I take out the branch sale game, it was still pretty elevated relative to third quarter. I’m just wondering anything unusual in other income?

Compared to which quarter I’m sorry, Peter?

The third quarter?

Yes. We did have some incentives related to our debit card that were paid to us in the fourth quarter and usually arrive in the fourth quarter and are recognized in the fourth quarter and that’s really the only other major item affecting the linked quarter comparison.

Got it. And just the tax rate that we should use for 2022?

I think on a discreet basis we’re probably around 9% would be my guess at this point.

Our next question comes from the line of Steven Alexopoulos with JP Morgan, please proceed with your question.

I wanted to start, Jerry to follow up on the high single digit expense, growth guide for 2022, just given where wage pressure and inflations been trending for everyone, you think at least at this stage it looks like that would be maybe at the upper end of a high single digit range?

Does that help if I say, hope it is. No. Let me say, I’m going to say that just to be clear, we continue to see salary pressure. We are out to get and keep and attract and keep the best people that we can and so we’re going to do what we need to do to be competitive, so it probably would be a little bit pretty mature for me to say that. But I’ll say that I don’t want to mislead you. We continue to feel salary pressure, we are having conversations all the time to be quite honest with you. So yes, I would be flippant to say, yes, we’ve taken care of the problem, because it’s something that we’re facing every day.

Yes. That’s fair. And then on the loan side, with every bank, right, sitting on a ton of liquidity, just like you guys, everybody’s focused on loans. Can you give us a sense how competitive is a lending environment today? Are you walking away from even more loan opportunities over structure? And what is the loan outlook for 2022?

I wouldn’t say Steven, it’s more competitive. It’s really competitive and has been I think that we, if you look at what was lost to structure I am trying to look here three months ago versus now. So we lost 64% of the deals this quarter, the fourth quarter of the structure. And the prior quarter, we lost 68% of the deals to structure those, so it’s actually been fairly consistent. If you look a year ago, though, we lost 56% of the deals to structure, 44% to rate. So we’re competing aggressively on price and I think that’s the right thing for us to do by the time someone passes, our credit criteria and relationship and character and all those elements that go into underwriting and given the cost of good soul related deposits, which I’ll argue for us are as low as anybody I know about. There’s no reason for us to be losing business over a few basis points. So I want us to be competitive on that. And let’s engage with somebody and have a long term relationship. I think it works out for us very well. But it’s managed, been competitive and continues to be I saw, I was asking our people about in the real estate markets what’s going on, you see an interest rates go up some. You look at cap rates, they haven’t moved in some cases for some credits say they’re going down. There’s tons of capital still available looking for high quality low risk deals. And so it’s not been great. But it’s the same. I’m proud of the way that our people are competing and the kind of customer relationships we have and the kind of deal flow that we’re bringing in. So I think we’re doing a good job competing. But we’re also, I’ve said a million times, there’s no green pasture on the other side of the fence of great credit quality. It might look good, but it is a wasteland out there. And so we’re still focused on maintaining our disciplines. And we will be competitive, but we’re not going to be, I can say, we’re not going to, we’ll try not to be stupid about that.

So when you think about 2022, is this a high single digit year for loan growth? Is that what you’re thinking? I don’t put words in your mouth.

No, I think those are my words. I feel good about high single digit growth this year. We’ll have everybody’s fighting this thing, Steven, on commercial real estate payoffs, right? Because with rates beginning move up, you’re seeing some people accessing long term markets maybe sooner than they would. I talked about cap rates that people worried about, and going up and that be taking advantage of prices out there. So you could see some deals payoffs more than you’ve seen, but the other thing is our advanced rates on liquidity lines, working capital lines, is up a little bit. It’s up a little bit from the previous quarter, I think we’re like around 32.5% this year, excuse me this quarter. And it used to be around a little over 38. So there’s room there. If supply chain things, clear up some and maybe that offset some of that. So, but we’re just competing well and we’re seeing relationships grow. And we’ve got what’s going on in Houston and Dallas to take a little while to move the needle, but it’s going to. So I’m just optimistic about how it’s going.

Thanks. Maybe just one final question, even though many in our industry think the branch is dead. How important has it been having a physical branch in your new markets to those growth metrics and consumer checking accounts you mentioned? And could you have pulled that off without a physical branches with direct digital advertising, etc? Thanks.

Yes. I’ll give you a number Steven. 87% of the account growth or the relationship growth we’ve had in Houston has come within five miles of a branch. I’d say it matters.

Thank you. Our next questions come from the line of Jon Arfstrom with RBC. Please proceed with your questions.

Thanks. Good afternoon, everyone. Just one quick follow up on expenses. You gave us the components of Houston, Dallas residential and then minimum wage. Is the rest of it just compensation or is there anything else in there to call out in terms of the increases?

I would say that really it’s related to the base in 2021. So some of the things that we’re doing as it relates to, starting to meet more with customers, so I’m seeing increases and things that you would expect like meals, travel and entertainment as we start continuing to do some of that prospecting face to face. I saw some good size increases in advertising, marketing as well as we continue to make sure that we’re doing what we need to be doing there. And then, yes, we’re obviously going to feel as you’re saying, some continued salary pressure. So I would say those in my mind are the major components.

And then kind of a follow up on Peter’s question. Are there areas where you would like to spend more in the business?

Yes. [Indiscernible] I guess we don’t like to spend more in there. But we do. We sure do. I’ll tell you the things that we’re doing. You’re going to, as relates to the legacy business we’re pretty careful in expenses. I mean, Jerry has pointed that out. And I think if you peel back all the PPP and you peel back expansion, you peel back our mortgages expansions, our number is pretty conservative there. So I wouldn’t say we’d like to spend money. That’s not exactly what you said. But I wouldn’t say we will spend money, and we will invest. We’re going to continue to do this, and one needs to know it. We will continue to invest in expanding our business. So if you look at things we will invest with, and we’re going to continue expanding on this organic growth strategy, there is a great payoff in it. And it comes closer and closer to that harvesting phase of these new locations every year. So we’re going to do that. We’re going to continue to invest in our people. Jerry talked about what we’ve been seeing there. I’ll talk to you about how we went to a $20 minimum wage. We’re investing our people. There’s a lot of other things like that. We’re paying a lot bigger share of our medical premiums than we were a year ago. And we’re going to continue to invest in technology. I really, I’m extremely proud of our technology and what we’re able to do and our strategy that we’ve employed there, if you look at our apps, rating is really high. As you know, we do our own web development. We do our own digital development. We have lots of flexibility and ability to have a great customer experience and a branded experience there. So and I don’t feel because we’ve been willing to do this, I don’t feel we’re playing from behind the curve and technology. Yes, it’s a ton of money. We spend more there seems like when we spin out a place, but we’re not playing from behind the curve. The things that we’re doing, I think are moving us forward and it’s really exciting to see.

One more thing, you mentioned Houston and energy a couple of times. Can you just touch on your appetite for energy lending in general?

We’ve got an appetite for it. But it’s kind of like that going on keto diet. You want to get down to that weight loss level. And then, once you get there you can normalize your diet. But we said we want to get down mid single digits, we are almost there. We are 6.6%. But what I want to point out is, that’s still a really big part of our portfolio. It’s one of the top segments of the portfolio. So we’re not moving out of that business. We’re just getting to where we need to be on a prudent level. The thing I’m really proud of our people for doing is that we’re on the deals that we are engaging in now and prospecting, we’re doing it on the basis that we’ve always underwritten things and we’re being disciplined about it. And that’s good. It doesn’t work for everyone but it works for the right kind of customer. The way I think about that business is, I’ve always thought about it kind of like the multifamily construction business. I mean, we can do as much multifamily construction lending as we wanted to. We could take that loan to deposit ratio and get it where ever you want it over the next year. But that’s not the right thing for us to do. It is a important asset class to us. But we do it a certain way. And we do it with people that we are familiar with and have had great relationships with or wanted to have great relationships with. And does it work for every deal for everyone? No, it doesn’t. But those customers that do business with us, they know what we’ll do. And they know what works with us. And they like to do business with us. We’re not going to do every deal for everybody. But we do a lot of deals for them. And I see that being the same thing and same approach we take in the energy business won’t work for everyone the way we do it. But we’re going to do it in such a way that when energy prices move down and they will, it’s a commodity business, we don’t want our shareholders losing sleep about it. I sure don’t want to lose sleep about it. And we’re going to be underwritten in a way that we feel good about it. And there are ways you can do that well, and that’s what we’re focused on. And it’s not going to be such a large level that Cullen Frost becomes the next easy short when energy prices start moving down.

Okay, thank you. Well, that makes sense.

Thank you. There are no further questions at this time. I would like to turn the call back over to Phillip Green for any closing comments.

Well, thanks everyone for your interest and we will be adjourned. Thank you.

Thank you. This does conclude today’s teleconference. We appreciate your participation. You may disconnect your lines at this time. Enjoy the rest of your day.