Cullen/Frost Bankers Inc (CFR) 2020 Q2 法說會逐字稿

_Ladies and gentlemen, thank you for standing by and welcome to the Cullen/Frost second quarter earning conference call. (Operator Instructions) Please be advised that today's call is being recorded. (Operator Instructions)

I would now like to hand the conference over to your speaker today, A. B. Mendez, Senior Vice President and Director of Investor Relations. Thank you. Please go ahead, sir.

Thanks, Janika. This morning's conference call will be led by Phil Green, Chairman and CEO; and Jerry Salinas, Group Executive Vice President and CFO.

Before I turn the call over to Phil and Jerry, I need to take a moment to address the safe harbor provisions. Some of the remarks made today will constitute forward-looking statements as defined in the Private Securities Litigation Reform Act of 1995 as amended. We intend to 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 is available on our website or by calling Investor Relations at (210) 220-5234.

At this time, I'll turn the call over to Phil.

Thanks, A.B., and good morning, everybody. Thanks for joining us.

Today, I'll review second quarter results for Cullen/Frost. And our Chief Financial Officer, Jerry Salinas, will also provide additional comments, and then we'll open it up for questions.

In the second quarter, Cullen/Frost earned $93.1 million or $1.47 per share compared with earnings of $109.6 million or $1.72 per share in the same quarter of last year and $47.2 million or $0.75 a share in the first quarter of this year.

Beyond the financials, the second quarter was an extraordinary one for Frost. Throughout our response to the COVID-19 pandemic, we've been continuing serving customers with appointments in our bank lobbies through our motor banks, with our online and mobile banking service, through around-the-clock telephone customer service and at our network of more than 1,200 ATMs.

I'll talk in more detail about our Houston expansion and our Paycheck Protection Program loans. But for now, I'd like to point out that we have been completing our organic growth initiatives and still achieving the same award-winning level of customer service that Frost is known for despite having more than 2/3 of our employees working remotely.

In fact, during the second quarter, we learned that Frost had achieved its highest ever Net Promoter Score with a jump from 82 to 87. And that's a score that would be the envy of many well-known brands, and it's a testament to our core values and our ability to consistently take care of our customers' needs, especially during trying times.

More recently, we learned that Frost is among the banks that Greenwich and Associates has identified as standouts in their response to the pandemic based on customer surveys. In fact, Frost was 1 of only 2 banks to be named a standout in both the small business banking and middle market banking categories.

I mentioned the Paycheck Protection Program. As of June 30, when PPP loan applications were initially scheduled to end, we had helped nearly 18,300 of our customers get PPP loans, totaling more than 3.2 billion. In the state of Texas, Frost was #3 in PPP lending with 5% of the loans. In San Antonio, Fort Worth and Corpus Christi, Frost was #1 in terms of PPP loans approved. And in San Antonio, we had more PPP loans than Bank of America, Chase and Wells Fargo combined.

We did well helping businesses of all sizes, but I'm particularly pleased that more than 3/4 of our PPP loans were for $150,000 or less, and close to 90% were for $350,000 or less.

PPP applications have been extended into August, and we're still taking anywhere from a few to 50 applications per day.

Through July, we've taken an additional 500 applications for over $22 million or an average size of about $45,000.

Meanwhile, we're setting up processes to help borrowers get their loans forgiven. We've heard many, many messages of thanks from our customers whose businesses were aided by PPP and the efforts of Frost Bankers have helped save hundreds of thousands of jobs.

Those results are more reflective of our culture and our philosophy than even the numbers we're reporting today for the second quarter.

Average deposits in the second quarter were $31.3 billion, up by more than 20% from the $26 billion in the second quarter of last year and the highest quarterly average deposits in our history.

We're grateful for the confidence our customers have placed in us during these times.

Average loans in the second quarter were $17.5 billion, up by more than 20% from the $14.4 billion in the second quarter of last year. And that includes our strong showing in PPP loans, but our loan total would have been up approximately 5% even without PPP.

In the second quarter, our return on average assets was 0.99% compared to 1.4% in the second quarter of last year.

Our credit loss expense was $32 million in the second quarter compared to $175.2 million in the first quarter of 2020 and $6.4 million in the second quarter of 2019.

That first quarter provision was significantly influenced by our energy portfolio stress scenario of oil at $9 per barrel for the remainder of 2020.

Oil prices since stabilized at levels well above that assumption and the energy borrowing base redeterminations are 95% complete.

Net charge-offs for the second quarter were $41 million compared with $38.6 million in the first quarter and $7.8 million in the second quarter of last year.

Annualized net charge-offs for the second quarter were 0.94% of average loans.

Second quarter charge-offs were related to energy borrowers that have been discussed for several quarters.

Nonperforming assets were $85.2 million at the end of the second quarter compared to $67.5 million at the end of the first quarter and $76.4 million at the end of the second quarter last year.

At their current level, nonperforming assets represent only 22 basis points of assets, which is well within our tolerance level and are a level lower than our average nonperforming assets over the past 9 quarters.

Overall, delinquencies for accruing loans at the end of the second quarter were $91 million or 51 basis points of period-end loans.

Those numbers remain within our standards and comparable to what we've experienced in the last past several years.

The payment deferrals we have extended to customers due to the pandemic-related slowdown have had some impact on delinquencies.

Through the end of the second quarter, we granted 90-day deferrals totaling $2.2 billion. Of the loans whose deferral periods has now ended, which is about $1.1 billion, only $72 million worth have requested a second deferral.

Total problem loans, which we define as risk grade 10 and higher, were $674 million at the end of the second quarter compared to $582 million at the end of the first quarter, which happened to be a multiyear low.

A subset of total problem loans, those loans graded 11 and worse, which is synonymous with the regulatory definition of classified, totaled $355 million or only 12% of Tier 1 capital.

Energy-related problem loans were $176.8 million at the end of the second quarter compared to $141.7 million for the previous quarter and $93.6 million in the first quarter last year.

To put that into perspective, the year-end 2016 total problem energy loans totaled nearly $600 million.

Energy loans in general represented 9.6% of our non-PPP portfolio at the end of the second quarter.

If you include PPP loans, energy loans were 7.9%.

As a reminder, the peak was 16% back in 2015. And we continue to diversify our loan portfolio and to moderate our company's exposure to the energy segment.

As expected and as we discussed in the first quarter call, the pandemic economic impacts on our portfolio have been negative, but manageable.

During our last conference call, we discussed portfolio segments that have had increased impact from economic dislocations brought on by the pandemic. Besides energy, we've narrowed these down to restaurants, hotels, aviation, entertainment and sports and retail.

The total of these portfolio segments, excluding PPP loans, represented almost $1.6 billion at the end of the second quarter.

Like the energy portfolio, we continually review these specific segments, and we have frequent conversations with those borrowers to assess how they're handling current issues.

Combined with our risk assessments, these conversations influence our loan loss reserve for these segments, which is 2.52% at the end of the second quarter.

Overall, our focus for commercial loans continues to be on consistent, balanced growth, including both core loan component, which we define as lending relationships under $10 million in size; as well as larger relationships while maintaining our quality standards.

We're hearing from customers in all segments of that economic impact of the pandemic as well as the uncertainty ahead, and those factors have had an impact on our results.

New relationships are up by about 28% compared with this time last year largely because of our strong efforts in helping small businesses get PPP loans.

When we ask these businesses why they came to Frost, 340 of them told us that PPP was a key factor.

The dollar amount of new loan commitments booked through June dropped by about 3% compared to the prior year.

Regarding new loan commitments booked, the balance between these relationships went from 57% larger and 43% core at the end of the first quarter to 53% larger and 47% core so far in 2020, and that's about where it was this time last year.

The market remains competitive. For instance, the percentage of deals lost to structure increased from 61% this time last year to 75% this year.

Our weighted current active loan pipeline in the second quarter was up 24% compared with the end of the first quarter.

The first quarter numbers were low and reflected the uncertainty about the pandemic's effect.

On the consumer side, we continue to see solid growth in deposits and loans despite the impact from the pandemic and the reduction in customer visits to our financial centers.

Overall, net new consumer customer growth rate for the second quarter was 2.2% compared to the second quarter of 2019.

Same-store sales, however, is measured by -- account openings were down by 30% through the end of the second quarter as lobbies were opened only by appointment only and through drive-in tellers.

In the second quarter, 59% of our account openings came from our online channel, which includes our Frost Bank mobile app.

Online account openings in total were 72% higher compared to the second quarter of 2019.

The consumer loan portfolio was $1.8 billion at the end of the second quarter, and it increased by 4.3% compared to last year.

Overall, Frost Bankers have risen to the unique challenges presented by the pandemic and its resulting shutdowns with the mix of keeping our standards and sticking to our strategies, along with a truly remarkable amount of flexibility and adaptability.

Our Houston expansion continues on pace, with 4 new financial centers opened in the second quarter and 2 more opened already in the third quarter for a total of 17 of the 25 planned new financial centers.

Those new financial centers include our location in the Third Ward where customer response has been enthusiastic, even though our lobbies are open for appointment only.

Our employees manage those new financial center openings while most of them are working remotely due to the pandemic, and also working nonstop to help our business customers stay afloat with PPP loans.

And that commitment and dedication is what Frost philosophy and culture is all about.

As I mentioned earlier, we've gained a lot of new business relationships through our PPP efforts. The customers that are new to us are learning what a long-time customer has always known that Frost is a source of strength for customers and our communities, and also a source and force for good in people's everyday lives.

I've told our team that their efforts are historic and heroic, and I'm extraordinarily proud of our company that we've been able to help so many small businesses get through these extraordinary times.

It's clear that many pandemic challenges remain, particularly here in Texas. We're seeing the spirit and dedication of Frost employees who live our philosophy and culture every day gives me optimism that we will help our customers find a way through this situation and come out stronger.

And now I'll turn the call over to our Chief Financial Officer, Jerry Salinas, for some additional comments.

Thank you, Phil. I wanted to start out by giving some additional financial information on our PPP loan portfolio.

As Phil mentioned, we generated over $3.2 billion in PPP loans during the quarter.

Our average fee on that portfolio was about 3.2% and translates into about $104 million.

Our direct origination costs associated with these loans totaled about $7.4 million, resulting in net deferred fees of about $97 million.

About 20% of the net fees were accreted into interest income during the second quarter.

Looking at our net interest margin. Our net interest margin percentage for the second quarter was 3.13%, down 43 basis points from the 3.56% reported last quarter.

Excluding the impact of our PPP loans, the net interest margin would have been 3.05%.

The 43-basis-point decrease in our reported net interest margin percentage primarily resulted from lower yields on loans and balances at the Fed as well as an increase in the proportion of balances at the Fed as a percentage of earning assets, partially offset by lower funding costs.

The taxable equivalent loan yield for the second quarter was 3.95%, down 70 basis points from the previous quarter, impacted by the lower rate environment with the March Fed rate cuts and decreases in LIBOR during the quarter.

The yield on the PPP loan portfolio during the quarter was 4.13% and had a favorable 3-basis-point impact on the overall loan yields for the quarter.

Looking at our investment portfolio. The total investment portfolio averaged $12.5 billion during the second quarter, down about $463 million from the first quarter average of $13 billion.

The taxable equivalent yield on the investment portfolio was 3.53% in the second quarter, up 7 basis points from the first quarter.

Our municipal portfolio averaged about $8.5 billion during the second quarter, flat with the first quarter, with the taxable equivalent yield also flat at the first quarter at 4.07%.

At the end of the second quarter, over 70% of the municipal portfolio was pre-refunded or PSF insured.

The duration of the investment portfolio at the end of the second quarter was 4.4 years compared to 4.6 years last quarter.

Looking at our funding sources. The cost of total cost for the second quarter was 8 basis points, down 16 basis points from the first quarter.

The cost of combined Fed funds purchased and repurchase agreements, which consists primarily of customer repos, decreased 80 basis points to 0.15% for the second quarter from 0.95% in the previous quarter.

Those balances averaged about $1.3 billion during the second quarter, up about $36 million from the previous quarter.

Moving to noninterest expense. Total noninterest expense for the second quarter decreased approximately $3.5 million or 1.7% compared to the second quarter last year.

The expense decrease was impacted by the $7.4 million in PPP loan origination costs that were deferred and netted against the PPP processing fee, which are amortized into interest income as a yield adjustment over the life of those PPP loans.

Excluding the favorable impact of deferring those origination fees related to PPP loans, total noninterest expenses would have been up $3.8 million or 1.9% compared to the second quarter last year.

In addition to the reduced expense run rate during the second quarter due to the pandemic's effect on the business environment, we continue to focus on managing our discretionary spending and looking for ways to operate more efficiently.

As we look out for the full year, adding back the $7.4 million in deferred expenses related to the PPP loans I mentioned previously, we currently expect annual expense growth of something around 6%, which is down 2.5 percentage points from the 8.5% growth guidance we gave last quarter.

Regarding income tax expense, we did recognize a $2.6 million onetime discrete tax benefit during the quarter related to an asset contribution to a charitable trust during the second quarter.

Excluding the impact of that item, our effective tax rate on our year-to-date earnings would have been about 3.1%.

With that, I'll turn the call over -- back over to Phil for questions.

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

(Operator Instructions) Your first question comes from the line of Brady Gailey of KBW.

It's Brady Gailey. So I was a little surprised to hear that 20% of the PPP fees were captured in the second quarter. That seems a little higher than what some of the other banks have disclosed.

Any color around how you're able to capture that amount of fees before any sort of forgiveness?

Really what we're assuming, we look at those loans, Brady, on a pool basis. And so we're really just looking at it over the expected term of those loans. We expect a big portion of those to pay off later this year.

So when I look out, I think our current expectations is that we'll earn about 60% of that fee in 2020 and about 40% of it in '21.

Okay. And then I heard your comments on some of the issues with the tax rate coming in lower. It was actually negative for the quarter. But can you just go over that again? Is there anything else that's driving this tax rate to be lower than it normally is?

Well, unfortunately, earnings are lower, and we've got a pretty big municipal portfolio. And obviously, that higher tax-exempt income drives down that -- the tax rate. And we would have had a low effective tax rate for the quarter had we not had that $2.6 million credit, but it would have been a tax expense. But with that, that brought us into the negative territory. So no, there's nothing unusual other than a $2.6 million discrete item that's going through the second quarter.

Okay. And then finally for me, I know on last quarter's call, we talked about the full year net interest margin for you guys being a little above 3%. I mean now that we're 1 more quarter into the year. I mean, does that still feel like the right NIM level?

And I think the guidance we gave, Brady, was ex-PPP. That's the guidance you guys asked for. And yes, I'm still comfortable with that.

Your next question comes from the line of Dave Rochester of Compass Point.

Definitely appreciated the reserve on the more at risk book you guys gave. I was just wondering what your energy reserve was following the charge-offs this quarter.

Let's see.

Our energy reserve is about $40.8 million. So that's about a 2.86% coverage. That's down from the 6.58% that we had in the second quarter.

Phil mentioned we had about $35 million in charge-offs related to energy in the quarter. And then also, obviously, with the CECL allowance calculation that we did, if you recall, and Phil mentioned in his comments, when we did this the allowance calculation last quarter, we were looking at oil at $9. And obviously, we've got a huge improvement during the quarter.

Right. So I guess I had that at a little over $100 million last quarter. So with the $35 million charge-offs, you effectively released, I guess, what, $28 million roughly. Is that right?

That's -- right. Yes, exactly.

Okay. Got you. I appreciate that. And then what are you guys seeing for new loan yields overall and securities purchase yields at this point in the quarter just with lower rates and everything? I was just curious where you're seeing those yields come in.

Yes. Unfortunately, on the security side, there's not a whole lot out there. I think we did purchase about $200 million during the quarter of mortgage-backed, I think, and we were about a [1.51].

So, nothing great, but certainly better than the 10 basis points we were earning at the Fed.

And our loan yields have been pretty consistent with previous quarters. So we're seeing less usage of LIBOR, which is good, given it's going away. But -- and we've seen a little bit of an increase in the fixed component with people taking advantage of the current rate environment. But I'd say they're fairly consistent.

Okay. So if I back out the PPP fee from this quarter, I'd probably be closer to where the average is going forward effectively. I mean are you looking for any more loan yield pressure ex-PPP just given what you're seeing in the market, the pricing?

You -- I'm sorry, what did you ask about PPP? I couldn't hear it.

Oh, sure. I was just saying, excluding PPP, given loan yields this quarter and what you're seeing currently in the market, are you expecting any more loan yield pressure going forward? Are you expecting the loan yields to be relatively stable from here, excluding PPP?

Yes. I think it depends on what you have in maturities versus on the fixed side versus what is being put back on that. I don't -- it's not a topic that we're talking about a lot. I don't expect to see a lot of compression there. I think the interesting thing is going to be what we're seeing as the replacement for LIBOR as we continue to move forward through '21. But that's interesting.

Okay. And then maybe just one last one on the fee side. Just curious how much fee waivers impacted service charges and the other charge lines, and what the outlook on that is going forward.

The fee waivers actually weren't a huge part of the second quarter run rate. Really, they were in the tail end of the first quarter. And maybe the first month of the second quarter, we did see higher levels. But really, what we saw in the quarter was just really a lower run rate.

What I will say is that we looked at those on a monthly basis. I will say that June and into July are stronger than we had seen in April and May.

So I'm feeling a little bit positive there. The uncertainty, of course, is everything that's going on with the pandemic. It seems to be more pressure with the mask and the stay at home. But for what we saw in June, it was certainly stronger than April and May and early into July, even a little bit better there.

Your next question comes from the line of Steven Alexopoulos of JPMorgan.

Just to follow up on the energy reserve. So you said you were assuming $9 in the prior quarter. What level you're assuming now?

What I was going to say was we did use -- so what happened, obviously, if you recall, the prices were changing so much at the end of the quarter. The first quarter, Moody's really couldn't keep up. And so we ended up doing our own internal stress test.

I think in the case of this quarter, what we did was we used -- the Moody's price was $26 a barrel for the second quarter of 2020 and then moving up to $32 for the -- through the fourth quarter of this year and then $42 on into '21.

Got you. Okay. I'm curious, so the reserve decline this quarter, it was you using some of the energy reserve and changing that. How did the economic forecast component of the reserve change in the quarter?

Well, obviously, the -- from the standpoint of what were the expectations, yes, I don't have the specific changes. I think that we used the Moody's consensus scenario. And so that one, if you recall, is one that talks about GDP going down 23.5% in the second quarter, rebounds in the third quarter; unemployment rate, about 16% in the second quarter, improving to about 10% by the fourth quarter.

And then I think Texas is a little bit better there. So really -- so if you want to go through the specifics of it, I guess the net decrease in the allowance of $9 million, I think a lot of it was an increase in the -- yes.

So that was kind of what was happening from an economic standpoint. I think the economy is better. I think one thing that was different this time for us was really on the commercial real estate portfolio. Because the commercial real estate portfolio for us really ended up being a lot more sensitive to the volatility in the forecasted technical unemployment rate and the forecasted U.S. GDP. And so the model rate for -- our commercial real estate portfolio is about 170% higher than the model rate for our C&I portfolio.

And we tend to believe that the loss rate for our owner-occupied commercial real estate and our C&I should be similar. Both are underwritten with the assumption that the primary repayment source is the cash flow from the operations of the borrower.

So that was probably the one area where the model in and of itself was requiring a higher reserve. And then based on the specifics of how our owner-occupied real estate portfolio performs, we did make a reduction there.

I don't know if that answers your question, but that's...

Yes. That's helpful. And then it looks like the COVID-sensitive loan exposures came down nicely quarter-over-quarter. I think you called out $1.6 billion. Last quarter, you gave us the breakout of that in terms of energy, restaurant, hotel, et cetera. Could you give us that breakdown of the $1.6 billion?

Yes. And $1.6 billion does not include energy. But what I'm showing is retail is about $783 million; hotels and lodging, about $261 million; restaurants, $225 million; aviation, $194 million; and entertainment, $120 million.

They have a combined allocated allowance of 2.52% at the end of June.

I'll just give you a little more detail on allowance by sector. So the reserve for the restaurant component was at 4.34%. On the hotels, it's 1.21%. The reserve on sports and entertainment is 4.58%. Reserve on aviation was 2.8%. And then the reserve on total retail combined was 2.06%.

Okay. That's actually really helpful. If I could squeeze one more in. Just following up on the tax rate. What's your outlook for the tax rate for the second half?

Sure. I think that adjusted 3.1% that I gave that would have been the year-to-date rate without that discrete item in the quarter.

I think it's something in that range. Obviously, it's pretty low now. I don't expect it to go any lower. So I'd say in that 3% to 5% range.

Your next question or comment comes from the line of Jennifer Demba of SunTrust.

Your net charge-off levels have been more elevated than is typical for Cullen over the last couple of quarters. Are you anticipating that will remain the case over the next 2 or 3 quarters?

I'm not anticipating it. I mean the thing that drove the charge-off, 80% of it or so this quarter, was really a resolution of those loans I've been talking about that have been moving through the snake.

Actually, it's been a couple of years, maybe even 3 in 1 of the cases. Finally got them to where one was completely sold off. The other is down to a level that we feel pretty good about getting the remaining balance back and it's under $10 million.

So not pretty, but those have been resolved. The other credit that I've been talking about for the last several quarters is the largest one that -- other than the ones that were on nonaccrual at that time when I began talking about it.

And you might recall was a company that really needed to sell assets in order for its business model to work, and they will try to do that in a situation where capital had left the energy industry. So it's very difficult for them to do that.

And then whenever you layer on top of that, the impacts that happened with COVID, I think it was very, very difficult for them. So they ended up -- we ended up having a charge-off on that credit. But I believe down to levels that, again, are very manageable.

So I feel good about -- those were the 3 largest credits that we had to deal with, the most seriously impacted. So those have been taken care of. There are a couple of more that just as a result of the new environment in energy that are out there, but they're not that big a deal.

So I expect to see energy charge-offs not be the same level as they were in the second quarter. As I look forward on energy, I mean I think we're going to see increases in problem loans, which we define as risk grade 10 and higher. And I think the biggest impact of that in the second half is probably going to be in the service area.

Service isn't really a big area for us. It's about $200 million in round numbers. And so if you take those credits that are related more to the drilling component of it, that still hasn't come back even with the [low purchase price]. So I think that's where you'll probably see the increase in problem loans. And we just have to see with regard to -- if there are charge-offs there.

Good thing about it is that people that we've banked have generally been through multiple cycles. And I recall the service component of our -- our component the last downturn, '14 through '16, actually performed better than the production side, which was -- surprised me going in.

So anyway, that's a long way of saying I don't expect the charge-offs to be the same level based upon the fact that some of those were those legacy energy credits that we cleaned up.

But Jennifer, we're going to have to see what happens with the pandemic and see whether or not they close things down again. It's -- nobody really knows the answer going forward. But that's what I feel right now.

And of the $674 million in those greater at-risk sectors, how much of that $674 million is in that energy, restaurant, hotel, aviation, entertainment and retail?

I think the $674 million might be the [part of that fees]. The total of all the credits in those segments that we named, excluding energy, was, I think, $1.6 billion.

But I guess -- I'm sorry. I'm not being clear. So of your $674 million in problem loans, right, is the vast majority of those loans in those sectors you mentioned?

Let me take a quick look and see if I can -- actually, Jennifer, at this point, no. I mean I'm just looking at the problem loans. These would be on commitments for those sectors.

So if you look at problems in restaurants, the -- and these are round numbers, around $23 million; problems on hotels are $8 million; problems on sports and entertainment, around $7 million; problems on aviation, $44 million -- excuse me, about $6 million, sorry; problems on retail, all total look like around, say, just under $40 million; problems on -- and that's pretty much it.

So the problems are spread around in different areas in there.

Yes. I think we said that the energy problem loans are about $177 million.

Yes, yes. So you add all that together compared to $600 million, I mean you're going to get a good portion of it, but I wouldn't call it the vast majority to use your term.

And the other thing I want to give a little clarity on was our management overlay on energy. So our price deck, just to get that out there, for 2020 oil is $30, for '21 is $36, for '22 is $40 and then for '23 is $45. And then we stressed that at 75% is how we came up with our management overlay in energy.

Jennifer, just to be clear, I think problems are going to increase I mean just as things -- if we go deeper into this pandemic. And -- but problems don't necessarily equal loss. It doesn't mean problem means you get your risk rate 10. For example, take hotels. I expect to see some increases in hotel problems, mainly because there are a couple of those -- if you look at that segment, I think we've got in round numbers 21, as I recall, 21 different properties and 7 were construction, let's say, 1/3 were construction. And a couple of them moved out from construction into operations. And we'll move those to problems until we see how they go. And they're probably not going to open until you can be confident, say, a 15% occupancy number. That's when we're finding that hotels are opening. They could cover overhead around 35%, again producing some cash flow at 50%. And so as those come into -- out of construction, we're going to immediately move those to problem status. That doesn't necessarily mean there will be issues, but they're -- in our view, they should be considered problems as we look at how they're doing in the early part of their operating status. So that's just one example.

Restaurants, we're going to have to see how that continues to go. I think the -- [about what] Jerry said, I think that the problems there are going to be ones which are fine-dining where you have to sit down, the premium, casual and then probably the other -- the small places, we've probably got $100 million of that kind of thing. Again, restaurant problems haven't been that large. But we continue to see those problems continue to increase as the pandemic goes longer and longer. So I don’t want to be Pollyanna about any of this. We do expect problems to increase. We really do think they're manageable. As I've said many times, it's kind of important what you do to in a crisis, but it's not nearly as important as what you do before the crisis. And I feel good about the disciplines that we've had in place. Not that we won't make mistakes. I mean you see the energy numbers that we reported. That kind of mistakes will happen. But I feel really good about the way that we've done our business going into this cycle. Because it's really hard to get your way out of it, if you -- than you were going into it.

The next question comes from the line of Ken Zerbe of Morgan Stanley.

Just want to ask about the PPP fees. They end at 20%. I think most banks that we look at basically would expect to accelerate the PPP fees when they actually get paid off, which I agree with you, likely in fourth quarter, it's a good chunk of them. But if you're recognizing 20% of the fees this quarter and presumably 20% over the next 2 quarters to your 60%, does that imply that when the loan is forgiven, that you would see 0 accelerated amortization of those PPP fees?

Yes. It would have to be pretty significant to affect that because it's going to be pretty ratable. We kind of assume an average life of 24 months kind of essential. We'll be looking at it monthly to see if that is really accelerating. But we do expect a big chunk of it to pay off in the third -- late third and into the fourth quarter of this year. So we expect those balances to go down quite a bit.

But yes, I think that we wouldn't necessarily see a huge peak in the recognition because of a huge amount of forgiveness, if you will. But it could be accelerated, if they -- if all of a sudden, the average life, we're assuming, which is 24 months, that were a lot shorter, yes, then that could be accelerated. I currently don't expect that to happen. There's a lot of unknowns, obviously out there associated with the portfolio. We do expect that a big part of the forgiveness will happen after that 24-week period.

But again, as Phil mentioned in his comments, I mean, we are working on helping the customers through that forgiveness process. But I have to be honest, some of the things that I've seen for others, to me, it's been all across the board on how people are recognizing those fees up. In my mind, ours really wasn't more aggressive than others. And in fact, it's less aggressive than some of the ones I saw. But obviously, we feel good about where we're at.

Got it. And then is it right to assume that you'll recognize another 20% in each of 3Q and 4Q?

Yes. I think our current assumption is something close to that, yes. Because I think what I mentioned was, yes, our expectation is 60% this year. So yes, that's an easy way to get there.

Okay. And haven't forbid, but if those loans actually don't get forgiven and they get pushed out, what happens to the fees? Because it seems like you would have recognized all the revenues upfront or beforehand?

Yes, haven't forbid, as you said, yes. I mean, yes, we are recognizing the fees as we go along.

Okay. Maybe it was a slightly different question. In terms of expenses, the 6% new growth rate year-over-year, it's -- just doing back of the envelope numbers, it looks like that puts your expenses, I think, back in the -- if I got my numbers right, call it the 2 20 range. Let me make sure I got this, yes, like the 2 25, 2 30 range, is that kind of what you're thinking about for the next couple of quarters?

I think that -- again, yes, it's pretty simple math. You wouldn't be too far off from that number, given the guidance we've given.

Your next question comes from the line of Ebrahim Poonawala of Bank of America.

I guess, first, Jerry, just very quickly, I had a follow-up on the margin. Sorry, I guess I heard you say you expect the full year margin to be slightly over 3% ex all things PPP. But could you tell us the amount of securities that are coming up for maturity over the back half of the year?

And I'm assuming that the yields on the maturing cash flows are about 3%. And what I'm trying to get to is, it seems like the margin will be somewhere in the 2.90s by the time we exit 2020 with additional pressure beyond that. So just want to make sure we capture that correctly.

Yes. I think that we've got -- I think a big part of it is here in the third quarter. If we look at our cash flow from, we had some agencies that were maturing in July. So I'm thinking we're around $600 million, $750 million between now and the end of the year.

Got it. And is there any component of the deposits that came in 2Q that you expect to leave the bank, which may be beneficial to the margin in terms of excess liquidity leaving?

Yes. Obviously, we're a little bit of in an unprecedented time here. Some of it we do expect -- some of the increase we do think is associated with those PPP loans. And although it appears, some of it's getting parked. You would expect that some of that will get spent out. Our modeling assumptions indicate that we do see some of it going on. We're not comfortable disclosing how much at this point. But really, to be honest with you, it's tough to tell that continue to grow.

When we look at the 12-month look back on deposits, really about 85% of our growth, both on the consumer side and the commercial side, is really from our own customer augmentation. And we continue to have good growth from new customers about 15%. But at this point, it's really just tough. So I think there's just a lot of uncertainty. People are being obviously more careful with their money. And we haven't really -- didn't really see a big decrease related to tax payments or anything that I've seen at this point. But obviously, with the pushback, we've expected some movement down in July. So I think it's a little bit hard to tell. I think we're all kind of trying to grapple with what's going to go on with deposits.

We've never been one to shy away from accepting deposits. Obviously, like the fact that a lot of the new relationships that Phil mentioned, I mean, in some cases, we're going to start with deposits. But I think our growth from a standpoint compared to the second quarter last year, about -- if I remember correctly, 70% of it is really commercial DDA, which we're not paying any interest on.

Got it. And I guess, if I could ask one question, Phil, just in terms of -- I guess, it's tied to credit, but when you look at the environment today across your markets in Texas, just talk to us around like do you have a sense of confidence that things get better? Like did you see things deteriorate into a quarter as like some of the COVID cases increase in Texas?

And how do you see this playing out vis-à-vis (inaudible) when Texas actually outperformed quite nicely given what we're seeing with COVID, given what we're seeing with the energy sector? Just give us a big picture view of how to think about how the economy might play out over the next 12 months?

Well, I think the view of the economy over the last 12, I kind of say that it's the economy -- on the other hand economy, there are some parts of it that are doing well. You talk to boat dealers. We talk to the customers there. We've got a large boat dealer who's been around since the 70s, had their best month for their history in May. Automobile dealer who's been around for generations, best month in history in May. Diamond distributors up 25% in May year-over-year.

There are a number of areas like that. If you look at the heavy equipment dealer that has -- if you look at the parts of their business that are not related to energy, they're still positive. There's lots of roadwork going on. There's lots of construction going on. On the other hand, you've got anything related to the energy piece is pretty much dead because that relates to sort of the service fracking piece. So you've got good pipelines from our customers as we talk to them on the construction side through November.

On the other hand, there's concern that with the municipal and business situations at, say, local levels that you may see reductions in construction and road work and those kind of things because of the focus on basic services.

So the pipeline is going into '21, there's some concern on that. You're seeing -- you've got the energy piece, which we've been talking about, which has improved greatly to $40-ish or so, north of that. On the other hand, you're really not seeing any drilling right now. Service side is going to be weak so. And it's going to depend on being -- just being a participant in Texas right now, sort of how the authorities decide to handle the situation with cases increasing.

I think there's a lot of activity. People are using masks. I mean you go into a grocery store 4 -- I'd say 3, 4 weeks ago, maybe 2/3 of people have mask on. If you go to a place today, it is you almost never see anyone without one. And so some of the local authorities that I've talked to here realized that our hand has been dealt over the last 3 weeks or so and then also past Memorial Day because of what happened with infections without a mandatory mask situation, but now people have been more careful. There's hope that, that's going to help the situation going forward.

So I think that the next 6 months are going to be probably the heavy lifting on just grinding through the general economic impacts on the portfolio. And hopefully, we won't be sitting here in the same situation at the end of the first quarter having done this because I think some of these businesses, these smaller businesses, et cetera, are going to run out of steam without some kind of continued fiscal stimulus.

So I know that's not definitive. Truth is nobody knows. But there are some positive things going on. But on the other hand, there are negative things that we're all dealing with. And I think at the end of the day, this really relates to some kind of medical solution either through really effective therapeutics or through some kind of vaccine, and that's what we're all looking for.

Your next question comes from the line of Peter Winter of Wedbush Securities.

I was wondering on the Houston branch expansion. In the past, you said it takes about 27 months for breakeven. You lose about $1.5 million before breakeven. But I'm just wondering in this type of environment that we're in, how that impacts those 2 metrics?

Well, the -- those are average numbers as we went into the program. I'll tell you, maybe the best thing for me to do is just give you an update on how the Houston expansion is going. With regard to our pro forma, which we would have based those numbers on, we're 143% ahead on relationships, 150% ahead of target on relationships. We're slightly below target on total deposits. We're about 83% of target on deposits today, but the momentum is positive going forward.

And then on loans, we're 200% plus of our target on the lending side. So I think we're ahead of those numbers that we were assuming that we gave when we entered into the program, and things have been going better than we expected. One thing I'll point out is that half of the new relationships that we're experiencing in the Houston market are related to the expansion effort and new relationship growth in Houston year-over-year is up 40%.

I also think that Houston is the only market we have for loan opportunities are positive versus a year ago. And so not only are the branches performing better. But I think there's some overall impact in the entire market that's benefiting from the efforts. So I say sometimes in the heat of battle and fog of war, it's hard to focus on what are we doing right for the long term. I'm very excited and pleased with the expansion strategy, and I think these numbers have shown that we're going to reach those breakeven numbers faster, and the impact is going to be less than what we anticipated.

That's really helpful. On the expenses, you keep lowering that expense guidance. And last quarter, you put more focus on discretionary expenses and hiring and then the benefit with this stay-at-home restrictions. What are some of the drivers that you're able to lower that expense growth target again this quarter?

Well, I think this quarter, some of what we're dealing with -- and you hit the nail on the head. A big part of it, obviously, the run rate is much lower. And without knowing how that turns around or when it turns around, we just thought it made sense to lower our guidance. But I think if I looked at travel, meals, entertainment, that sort of stuff, compared to the second quarter last year, it was probably down $3 million. Marketing expenses, this quarter, were down quite a bit. We do expect that those will go up in the second quarter. We kind of slowed down some of the things we're doing, but we want to continue to have our name out there. Phil talked a little bit about our Net Promoter Scores, and we're very sensitive to what's going on in Houston. So I envision we'll spend some dollars there. There's some discretionary stuff that we can do associated with performance. Obviously, it's not a great year. So that's coming into the reduction that we're projecting here. And I'm really just looking for ways to be efficient. There's a lot of things that we learned. Phil talked about our success on the PPP program. A lot of that, we couldn't have done without really improving some of our back-office processes. And that team really through IT and through our operations area, put a lot of processes in place to automate a lot of things. So our expectations are that we'll be able to do -- continue to do some improvements there. But we're really being careful. I mean I think the team overall is really sensitive to the revenue challenge that we're in. So we're trying to look at every position. If somebody leaves or retires, we're asking ourselves whether that position needs to be replaced. And really just asking everybody to question every dollar that they spend, to be quite honest with you. And -- but again, there are some discretionary incentive sort of type costs in there that are also affecting those dollars.

Your next question comes from the line of Michael Rose, Raymond James.

Just as we think about loan growth as we move forward with the energy reduction strategy and kind of the -- obviously, you have some momentum in Houston. But how should we think about loan growth as we move forward?

Mark, that's hard to say on loan growth. We've -- we are -- it seems like we've just been in the PPP business for the last 2 months, although we have seen some growth. And I think our pipeline, as I mentioned, was up somewhat in the third quarter, going into the third quarter, although that's -- some of that is deals that would -- were pushed forward into that quarter. If you look at the -- let me just one second. Yes, I think that we could see some growth in the third, but it's really hard to get visibility on what it's going to be after that because we just don't know what kind of activity businesses are going to undertake until they get some more visibility on the health issue. So I think high single digits has always been our goal for loan growth. I'm going to expect it's going to be lower than that until we get some visibility on what's going to happen medically and what's going on in the economy. Hope, we had a better answer for you, but we're still working on.

Completely understand. We're in challenging times. If we think about the reserve at this point, we've had a lot of banks talk about the heavy reserve being done. How do you guys think about that? It looks like the reserve was down ex PPP a couple basis points. How should we think about reserve at this point?

Michael, we -- I think what we did, which doesn't surprise me is -- it's been my experience. This is what we do. We did it really hard really early. So if you look at the first quarter, I mean, we had $175 million reserve, we built the numbers up. We added a much smaller amount in second quarter really because of it. But if you look at the first half of the year and look at the numbers that we provided, I think that we were representative of people who are doing their business the right way. I feel good about that. The question is going to be what happens going forward. And that's just going to depend on the health situation, I think. And I think we're going to see some increases in problems, but how pretty big, I don't know how the CECL thing is going to play out. I mean it's -- it is what it is. That also creates uncertainty what the model going to say, what are the complications going to be. I feel pretty good about where we are and about where our situation is with the reserve. I'm not going to say it won't increase if things get worse. And it also could -- we can see provisions go way down if the models and the situation indicates that things are continuing to improve. So it's kind of like longer. I wish I had a better answer, but there's just so much uncertainty right now.

Jerry, any thoughts on the CECL?

No. I mean I think you hit the nail on the head. I think right now, obviously, we feel good about where we're at. It just depends on what the second half of the year looks like. I think if things were to turn for -- take a turn for the worse, obviously, we did have expectations that, that thing would increase that, that reserve would increase. But Right now, we feel good about it. A lot of work is done both on the commercial real estate side. We've got the credit guys meeting with our relationship managers weekly, just like they do on the energy portfolio. So we're trying to stay ahead of all of that. But we can't really control what happens to the economy related to the pandemic effect. If something happens there, we could see some challenges.

Yes. I think Jerry made a really good point there that we've established -- I mean, again, it's not our first rodeo. So we put in place counsel, an energy counsel that reviews. I think we're reviewing all, basically 90% of all the energy relationships on the production side, 85% to 90%, probably higher now on the service side, meets every week, used to meet for 3 hours. It's down to where it's probably half that time now. We've established a commercial real estate counsel as well that's doing the same thing on a weekly basis, going through the credits. The relationship managers are responsible for communicating with customers, communicating back in terms of what they're seeing.

We need to understand the sustainability of their cash flow. We need to understand their plans and the effectiveness there, having on executing those plans. There's just a tremendous amount of work that's being done, communicating with customers and understanding our situation. I'll tell you that I sit in on those. I'd like to monitor those as much as I can. And I'm always encouraged going away from it just as the ability of our customers to execute and their willingness to and our relationship managers their ability to understand and have deep relationships with customers.

I'll tell you the other thing that I feel good about just anecdotally is as you talk to people about credits and listen to people to explain what's going on with our credits, I'm sure and glad that we put as much focus as we do on guarantees and on structures on those deals. It makes a big difference when you're reading it right, when you get to the end and it's guaranteed and the people that are supporting it. That's what I mean by. It's really important the decision to make going into the crisis more so than what you do during the crisis because now we're in it. But I feel good about the way we're handling the credits where our people are operating and feel good about how our customers perform. Again, not that we won't have problems and not that they won't increase, but I feel that we did a good job of handling things across that way going into this.

I appreciate the color. Just one last question. So if I look at pretax, preprovision earnings, with a lower margin, I mean when do you guys think that you will stabilize? I know you didn't give the typical EPS guidance because the range are very wide at this point. But I mean on a pretax preprovision basis, I mean, when do you think we kind of bottom? Is it the next quarter or 2? And then you grow -- obviously, I understand the investments in Houston and everything that's going on at this point. But just from a guide perspective, I mean, when do you think we hit the bottom?

I think we're at the bottom. We got to handle the situation, you know, and businesses are able to move forward. I mean that's real. I mean there's some political uncertainty because it's an election year. So we can't forget about that. But I mean, the big deal is COVID, and it's -- the impact on the economy and on people, and that's it. That's all I can tell you. So I don't know the answer to your question.

Your next question comes from the line of Jon Arfstrom of RBC Capital.

Just a couple of follow-ups. Deferral numbers that you gave, it sounds like you have $1.1 billion left. Any reason to think that the second deferral request will be any different, that second half of the --?

Jon, we don't have any indication that it will be right now. So no. I mean, I'm not saying it won't be, but that's not something that we've seen a sight of from where it was. I think it's sort of going the same way.

Pipeline comments, you made quite a few, but how does the pipeline compare, say, where you were at the end of the fourth quarter? It seems to me like it's an okay pipeline, but maybe a little narrower than normal. But just kind of thinking about where you were competing?

If you look versus a year ago, I happen to have that handy. The pipeline -- the gross pipeline was up 8%, and that's not weighted. But -- and as I've mentioned, it's up on a linked-quarter basis, 24%. But -- versus last year, it's up 23%.

And is it fair -- you talked about some construction projects just -- is it narrower? Or is it starting to broaden out a bit?

If you look at the pipeline, commercial industrial is weaker, and you'd expect that. It's flat to down 10%. The growth in the pipeline is in commercial real estate and also consumer -- in consumer real estate. I haven't really talked about much, but our consumer pipeline is up 58% on a linked-quarter basis. It's up 138% from last year. Now those are huge numbers. They're about -- that growth is about 10% of what you see in the commercial real estate side. So that's a positive. But -- so is it narrower? Probably. And right now, it's more oriented towards commercial real estate and in consumer real estate. And we're not going to see much pipeline in the energy space, right, because we're moderating our exposure there, as we've talked about for a long time.

Last one I have, maybe more big picture. But in an odd way, it seems like this environment is actually good for you in terms of market share and business development, maybe you're taking share. Just kind of curious what your approach is right now for calling on new business. What kind of plans you have in place for getting people back out in the field?

Right now, we're working on calls with Zoom. It's a little clumsy. As you know, I'd take 30 days out of the year and just call on customers. And I've had, I guess, 4, maybe 5 days of that.

Teams, I'm sorry.

Sorry?

Teams, you said Zoom. (inaudible)

Zoom is kind of a generic (inaudible) Microsoft Teams. That's right. And they're not terrible. They're a little awkward. Sometimes you have technology issues and all, but you're still getting to see people, but we're getting used to it. But we're kind of bumping our way along. I think the thing that really gave us the biggest push was just PPP. And you can say a bunch of your PPP loans for customers, how are you getting on customers if you didn't do their loans. People are so frustrated with some of the experiences that they have had.

And we've got a lot of good reputational word of mouth on the experience people have with us, and it's been great. I mean our numbers of new relationships, we report them every week. And we've seen them go from probably 30-ish to 100-ish a week for the last 7, 8 weeks. And that's really notable and a lot, and a big percentage of those are related to PPP. So that's good. It's -- I will say this. It's amazing to me how competitive it still is. Just to give you an example, take commercial real estate lending. We lost -- I gave you the total deals that we lost to structure. But if you looked at just CRE, so we lost in 2019 68% of the deals that we lost, we lost to structure. In '20, this year, 92% of the deals we've lost -- we've lost to structure. So it's amazing to me that you're still seeing some aggressiveness in structure in this market.

So as far as the competitive situation, it really hasn't cleared up yet. But I think that we are -- this is kind of the time that's good for us. We tend to be a stable force in terms of providing capital. We don't move in and out too much. We kind of stay in the middle. People know that about us. Our reputation on PPP has been great. I think it's really helped us out in Houston, where we've been growing. So that's been good. So I think there's some -- I agree with you, there's some positives in this market for us taking share, but there's a lot of work that we've got to do to get there. And I will say one other thing. We've talked about it. I think it's harder to move business over in this situation because people are just kind of hunkering down and so that, that may make that a little bit more difficult. But that's the [level we're in] right now competitively.

And your final question comes from Matt Olney at Stephens Inc.

Just wanted to follow-up on the investment securities portfolio. The yields ticked a little bit higher in 2Q. I was surprised. And given your commentary around the upcoming maturities, it sounds like you're saying that security yields should see a material decline, I think, in the back half of the year. Is that right? And then if so, how should we think about the magnitude of the decline in the securities yields?

Yes. I didn't really address the significance of the decline. I don't know that our current economy what's coming off of what rate. The improvement really between the first and the second quarter, some of it was really that we had some maturities of some taxable securities that were below, or I guess we had sales too of some securities that were below the average yield. So that kind of pumped up the yield in the second quarter compared to the first.

I think that, obviously, for anything that's maturing right now, yes, it's really difficult to find any sort of anything out there along the yield curve. So it's just going to be our guys just continuing to see what we can look at. We will spend some of our liquidity. I think I said we spend about $200 million of it in the second quarter, not a great rate there at 1.5%. But we're going to take a look at that, and we'll probably spend a little bit more in the latter half of the year.

Jerry, are there any large or chunky maturities that you see in the back half of the year?

No, I think that they're all pretty ratable. We did have a -- let's see if I've got the yield on this year. Hold off a second. Bear with me, let me get my notes here. So I guess we had -- in the first quarter, we had quite a bit of -- that we -- like we talked about maturity in sales of the treasuries portfolio. In the second quarter, really, there wasn't -- I don't have any sort of size associated with. I think we had -- we really matched our sales and our purchases pretty evenly.

I think we had $200 million maturing in the second quarter and replace it with $200 million. The yields I saw on the munis, for example, about $50 million of it was munis, and that was coming off at about $279 million. So yes, there's nowhere we can find anything like that right now. But that $279 million is really the only comparable I can give that matured in the second quarter.

And there are no further questions in queue. Do you have any closing remarks?

Thanks, everybody, for their participation today, and we'll be adjourned. Thank you.

Thank you for your participation. Ladies and gentlemen, you may now disconnect.