Cullen/Frost Bankers, Inc. (CFR) Q3 2022 Earnings Conference Call October 27, 2022 2:00 PM ET
Company Participants
A.B. Mendez – Senior Vice President and Director-Investor Relations
Phil Green – Chairman and Chief Executive Officer
Jerry Salinas – Group Executive Vice President and Chief Financial Officer
Conference Call Participants
Steven Alexopoulos – JPMorgan
Dave Rochester – Compass Point
John Pancari – Evercore ISI
Brady Gailey – KBW
Jennifer Demba – Truist Securities
Ebrahim Poonawala – Bank of America
Operator
Greetings. Welcome to Cullen/Frost Bankers Inc. Third Quarter Earnings Conference Call. At this time all participants are in a listen-only mode. [Operator Instructions] Please note this conference is being recorded.
I would now like to turn the conference over to A.B. Mendez, Senior Vice President and Director of Investor Relations. Thank you. You may begin.
A.B. Mendez
Thanks, Sherry. Our conference call today will be led by Phil Green, Chairman and CEO; and Jerry Salinas, Group Executive Vice President and CFO.
Before I turn the call over to Phil and Jerry, I need to take a moment to address the Safe Harbor provisions. Some of the remarks made today will constitute forward-looking statements as defined in the Private Securities Litigation Reform Act of 1995 as amended. We intend such statements to be covered by the Safe Harbor provisions for forward-looking statements contained in the Private Securities Litigation Reform Act of 1995 as amended.
Please see the last page of text in this morning’s earnings release for additional information about the risk factors associated with these forward-looking statements. If needed, a copy of the release is available on our website or by calling the Investor Relations department at 210-220-5234.
At this time, I’ll turn the call over to Phil.
Phil Green
Thanks, A.B, and good afternoon, everyone, and thanks for joining us. Today, I’ll review third quarter results for Cullen/Frost and our Chief Financial Officer, Jerry Salinas, who is going to provide additional comments before we open it up to your questions.
In the third quarter, Cullen/Frost earned $168.1 million or $2.59 a share and that compared with earnings of $106.3 million or $1.65 a share reported in the same quarter last year and $117.4 million or $1.81 a share in the second quarter of this year.
Our return on average assets and average common equity in the third quarter or 1.27% and 20.13%, respectively. These results and our overall growth show that our investments in our strategy of sustainable organic growth are paying off and that our company is well positioned to succeed. Loan growth continued to be strong and above our long-term expectation of high single-digit annual growth.
Average loans, excluding PPP, in the third quarter, were $16.75 billion or a 13% higher level than the average loans of $14.82 billion in the third quarter of 2021. On an annualized linked-quarter basis, loans, excluding PPP, increased by a little over 5%. Year-over-year growth in the portfolio was broad-based with about a third coming from our C&I component, about half coming from commercial real estate and the remainder coming from consumer real estate.
We booked about $2.04 billion in new commercial commitments in the third quarter, and this was up 12% from a year ago and down 7% from the second quarter. The drop was mainly from larger deals as core commitments were more in line with the previous quarter. Looking at our pipeline, gross pipeline is basically flat from the last quarter, down 0.9%. And on a weighted basis, it’s down 15%.
Overall, deposit growth was strong, and we invested in our depositor relationships by doing the right thing and allowing increased interest rates to flow through to our customers. Average deposits in the third quarter were $45.8 billion, an increase of 17% compared to the third quarter of last year and up 9.6% on an annualized basis over the previous quarter.
We continue to see great growth in our consumer banking business. Average consumer loans were $2.1 billion in the third quarter, up by 15.9% over the third quarter last year and up an un-annualized 6.9% compared to the previous quarter. This is primarily from our consumer real estate products of HELOC, home equity and home improvement. The outlook for these loans continues to be good and credit strong.
Growth in new households continues, in the third quarter, we put on 6,773 new households. That was 4% higher than the same quarter a year ago. Our total household count of over 405,000 in the third quarter was 7.1% over the record level in 2021, all organic. Regarding our branch expansion efforts, our Houston expansion branches have produced right at $1 billion of deposits with loans of $765 million and over 18,000 new households, and they continue to exceed pro forma.
In Dallas, we opened the sixth of our planned new locations earlier this month, and we expect to open four more new locations before the end of this year. We are very encouraged by the preliminary results of the new sites, which have achieved 356% of deposit goals, 290% of loan goals and 250% of new household goals. Now before anyone asked, yes, we did set meaningful goals for our new locations.
As we’ve said before, those goals are based on the average of what we had achieved with the 40 locations that we had opened in the eight years prior to our Houston expansion strategy. As I mentioned, the new Houston locations are above goal and the new Dallas branches are performing even better than that.
Our team that is building our new mortgage loan process is preparing to launch its pilot program with an eye on rolling out our new mortgage loans on a wider basis in stages beginning late this year and early next year. It has been exciting to watch as we create an entire process to originate and service mortgage loans in keeping with the Frost philosophy and our core values of integrity, caring and excellence.
Overall, credit quality remains good. The September 30 number for total delinquencies, excluding PPP, was $80.5 million or 48 basis points of total loans. The total problem loan level, which we define as risk grade 10 and higher, totaled $387 million at the end of the third quarter, down from $429 million at the end of the second quarter. The favorable rate of problem resolutions that we began seeing late last year via payoffs, payments and upgrades continued through the third quarter totaling $381 million to date.
Once again, we did not report a credit loss expense in the third quarter, and net charge-offs for the quarter were $2.9 million, which compares favorably with the $2.8 million in the second quarter. Annualized net charge-offs for the third quarter remained at 7 basis points of average loans, which is below our typical long-term level. Nonaccrual loans were $29.9 million at the end of the third quarter, and that represented a decrease from $35.1 million at the end of the second quarter.
You may remember that in our second quarter conference call, I reported that we had achieved our goal of mid-single-digit concentration level in the energy portfolio, and I’m happy to report that we stuck to our goal with energy loans excluding PPP, representing 5.4% of loans at the end of the third quarter. And speaking of PPP loans, we knew that when that process began helping our customers get their loans forgiven would be as important as helping them get their applications approved and our team has done a magnificent job on both ends of the process, and more than 99% of our borrowers are through the process now and the way that we help borrowers get emergency loans and stay in business and then get through the PPP forgiveness process is going to pay dividends for our customer relationship for many, many years.
All this together demonstrates that we have strategies and systems in place to allow us to succeed in all economic environments. We believe in doing the right thing for our customers, and it isn’t just words. It’s backed up by the investments in time, resources and personnel that we make with things like our industry-leading rates on deposit accounts, building a world-class mortgage loan process from start to finish, providing overdraft grace, early payday, 24-hour customer assistance seven days a week and expanding our presence so that we can extend the Frost value proposition to people across Texas.
All that takes hard work, and I’d like to thank our people for being a force for good and everyday lives.
And now I’ll turn the call over to our CFO, Jerry Salinas, for some additional comments.
Jerry Salinas
Thank you, Phil. Looking first at our net interest margin. Our net interest margin percentage for the third quarter was 3.01%, up 45 basis points from the 2.56% reported last quarter. Higher yields on both balances held at the Fed and loans had the largest positive impact on our net interest margin percentage. The increase was also positively impacted to a much lesser extent by a higher yield on investment securities and by higher volumes of both investment securities and loans. These positive impacts were partially offset by higher costs on deposits and repurchase agreements.
Looking at our investment portfolio. The total investment portfolio averaged $19.4 billion during the third quarter, up $1.3 billion from the second quarter average as we continue to deploy some of our excess liquidity during the quarter. We made investment purchases during the quarter of approximately $2.2 billion, which included about $790 million in treasuries, yielding about 3.15%, $840 million in agency MBS securities with a yield of about 4.62%, and about $520 million in municipal securities with a taxable equivalent yield of about 4.85%.
Our current expectation is that we would invest an additional $1.2 billion of our excess liquidity into investment purchases in the fourth quarter or about $1 billion net of projected inflows. The taxable equivalent yield on the total investment portfolio was 2.94% in the third quarter, up 7 basis points from the second quarter. The taxable portfolio, which averaged $11.5 billion, up $1.2 billion from the prior quarter had a yield of 2.20%, up 16 basis points from the prior quarter.
Our tax-exempt municipal portfolio averaged about $7.9 billion during the third quarter up about $113 million from the second quarter and had a taxable equivalent yield of 4.09%, up 5 basis points from the prior quarter. At the end of the third quarter, approximately 76% of the municipal portfolio was pre-refunded or PSF insured. The duration of the investment portfolio at the end of the third quarter was 5.3 years, down from 5.6 years at the end of the second quarter.
Looking at deposits. On a linked quarter basis, average deposits were up $1.1 billion or 9.6% on an annualized basis. Average total noninterest-bearing deposits were up $156 million or 3.4% on an annualized basis from the second quarter. Excluding public funds, those deposits would have been up $250 million or 5.6% on an annualized basis. The linked quarter growth in deposits has come primarily from growth in average interest-bearing deposits, which were up $921 million or 14% on an annualized basis.
The cost of interest-bearing deposits for the quarter was 62 basis points up 40 basis points from the second quarter. Looking at noninterest income on a linked quarter basis. Service charges on deposit accounts were down $910,000 or 3.8% primarily as a result of lower commercial service charges, primarily resulting from a higher earnings credit rate on annualized balances.
Insurance commissions and fees were up $1.4 million or 11.7% from the second quarter as a result of higher life insurance commissions, which were up $600,000 and also impacted by our normal business cycle, which results in higher commissions on both P&C and Group Benefits in the third quarter versus the second.
Other charges, commissions and fees were up $1.2 million or 12.2% from the second quarter. Commitment fees on unused lines of credit and money market income were both up over $500,000 compared to the second quarter.
Regarding total noninterest expenses, total noninterest expense was up $11.6 million or 4.7% and compared to the second quarter. The primary driver was salaries and wages, up $10.3 million or 8.8%, primarily impacted by higher accrued incentives and an increase in the number of employees as we continue to grow our business and, to a lesser extent, the impact of merit market increases, which were effective in May.
Looking at our projection of full year total noninterest expenses, we now expect total noninterest expense for the full year 2022 and to increase at a percentage rate in the mid-teens over our 2021 reported levels. The effective tax rate for the third quarter was 14% and our current expectation is that our full year effective tax rate should be in the range of about 13% to 14%, but that can be affected by discrete items during the remainder of the year.
Regarding the estimates for the fourth quarter of 2022 earnings, our current projections include a 75 basis point Fed rate increase in November, followed by a 50 basis point increase in December. Given those rate assumptions, we currently believe that the current mean of analyst estimates for the fourth quarter of $2.50 is too low, and we believe that even the highest estimate that I see as $2.72 for the fourth quarter is low.
With that, I’ll now turn the call back over to Phil for questions.
Phil Green
Okay. Thank you, Jerry. We’ll open it up for questions now.
Question-and-Answer Session
Operator
Thank you. [Operator Instructions] Our first question is from Steven Alexopoulos with JPMorgan. Please proceed.
Steven Alexopoulos
Hi everybody.
Phil Green
Hey, Steven.
Steven Alexopoulos
I wanted to start. So Frost is one of the few banks that saw growth of noninterest-bearing deposits in the quarter. Can you give more color on what drove that? And are – you’re not seeing the same underlying trend most banks are seeing where they’re seeing outflows into higher-yielding alternatives?
Jerry Salinas
Yes, I think, Steven if you remember the last quarter, I said one of my concerns was that we might see some softness there. I’m going to say I continue to be somewhat concerned especially about the larger balances. We’re seeing some movement there, but so far, have been able to offset that sort of reduction in balances. So knock on wood, I think we – in our projections, part of our beat was that we had more liquidity than we expected, part of it being from deposits being stronger.
So, I think that we continue to analyze those. I think there is still a little bit of risk, especially on those higher balanced accounts. But I think as Phil mentioned, our goal is to try to continue to provide top-quality service. We continue to build new relationships. So, we’re obviously adding deposits there. When we look back at kind of the 12-month look back at what our deposits where that growth is coming from, about 55% of it is from augmentation of our existing customers, but 45% of the growth was coming from new customers. So, I think it’s a good place to be, but I continue to be concerned, especially like I said, about those higher-balance customers.
Steven Alexopoulos
Got you. Okay. I’m hoping we could drill a little bit. I got many questions on the AOCI mark and the TCE ratio falling below 4%. Can you talk about where do you see that bottoming? And when you look at the securities payoff schedule, what’s the timing of what we should start to see tangible book and TCE ratios start to turn up given the payoff schedule?
Jerry Salinas
I think, obviously, most of that is going to be driven by what happens with interest rates more than payoffs to be quite honest with you. If you believe kind of what the Fed is saying about interest rates starting to decline in the next year or two, if you will. I think you’ll see some of that come back. We’re aware of what’s out there from a TCE basis. We are moving our new muni purchases to the held-to-maturity category. We’re not doing a lot there, but we’re sensitive to it.
We don’t spend a lot of time to be quite honest with you, worrying about it with liquidity. I think this morning, we were still north of $12 billion. I’ve got – we’ve got a loan-to-deposit ratio that’s pretty low. So, we’re not in the same situation as other banks are. So it’s something that we’re aware of, but don’t really spend a lot of time worrying about it. We may do some things within – with new purchases. But to the extent of what we’re discussing, that’s really about it.
Phil Green
Steven, from a business point of view, again, notwithstanding a situation where somebody would have to monetize those unrealized losses, and that would really be a situation, I think, where you had a liquidity issue or something like that. And that’s not on our radar. Obviously, in terms of – because of so much liquidity we have. Now, I am a Frost banker and liquidity is always on my radar. So, I will say that. But the economic reality is we run a business to me. And I think this is one of the things that the Fed considered when they changed those rules several years ago about this mark-to-market is there are tremendous natural hedges that exist in the balance sheets of regional banks.
With their non maturity deposit bases. And the accounting industry doesn’t even try to recognize those values. And I think as you look at as you look at how balances and net interest margins operate where banks have these natural hedges. I think from an economic standpoint, it’s not something that is of concern to us. That said, I recognize that if a bank doesn’t have liquidity to hold these things than there might be in a different situation, but it’s not keeping us up at night.
Jerry Salinas
Steven, just to give you a little bit of color to answer your question specifically, on 2023 right now, I’m projecting about $1.4 billion in maturities and payoffs. And as you go into 2024 and such, the munis really start to accelerate. We are only expecting about $400 million next year. But after that, you’re probably in the range of $1 billion [indiscernible] for the next couple of years.
Steven Alexopoulos
Got you. Okay. Thanks. And if I could sneak one more in. So in the backdrop of what we’re hearing this quarter is most banks are only raising the rates on deposits basically when they’re forced to fund loan growth. What’s been the customer reception in your markets like at the ground level to you guys offering higher rates? Are you seeing a material acceleration of client acquisition because of that? Thanks.
Phil Green
What I would say about client acquisition that has continued to stay. I was looking at our retail numbers recently and our – I think I might have said that our retail numbers were up by 7.1% in terms of total customer numbers. And then we also saw an increase of 4% from the third quarter of 2021 in terms of the net new customers that we had. So those were really record numbers in 2021. I don’t know if you remember, but we were – I think we beat our all-time high before that year by 210%. So that’s kept up. And I think we’ve continued to see growth, as you said earlier, in deposits. And I believe we’re seeing some more growth in interest-bearing deposits as opposed to noninterest-bearing, would – Jerry?
Jerry Salinas
Yes, correct.
Phil Green
Total. So, I think it’s reflecting in those numbers and the character of the deposits that we’re raising. I think it’s been understood by people in the marketplace. We’re trying to make it better understood by improving our marketing. I think we could do a better job there, and we’re hard at work trying to do that, and we will do that.
And Steven, it’s – I don’t think we’ve been defensive in these raises. I think what – our attitude to spend, it’s more offensive than it is defensive. And so if you see increases in our deposit betas, it’s because we’ve got the ability to do it. We’ve got the operating leverage to do it. We’re making that investment in those customers and I think it just makes our franchise stronger and the trust factor greater. So that’s what you’re seeing today when you see those betas. It’s not really a factor of we’re worried. It’s that this is kind of our time, and we really want to be – we don’t want to be a sleep of the switch. We want to continue to be putting on the pressure and increasing market share.
Jerry Salinas
Yes. The one last thing I’ll say, and it’s really tough to analyze, but it’s not like we’re seeing from the work that we’ve done, significant percentages of those deposits if you’re looking at the growth in MMA, for example, it’s not that money is coming out of our DDA or IOC accounts. So maybe 10% or 15% of the increases, some disintermediation between our own noninterest-bearing to our interest bearing. So it’s not like we’re seeing big percentages of movements there.
Steven Alexopoulos
Got it. Got it. Thanks for all the color.
Jerry Salinas
Sure.
Operator
Our next question is from Dave Rochester with Compass Point. Please proceed.
Dave Rochester
Hey good afternoon guys, nice quarter.
Jerry Salinas
Thank you, Dave.
Dave Rochester
I was wondering if you could just give an update on your NII expectations following the stronger trends this quarter? And then if you could just talk about how you’re thinking about the NIM trajectory into 4Q and the beginning of next year, if you think you’ll still have some solid expansion opportunity to go there, that would be great.
Jerry Salinas
Yes, Dave, I’ll speak in generalities. As I said, we’re still assuming that the next – whatever it is, five days or such, the Fed is going to raise rates 75 basis points and then again, 50 in December. So with that sort of a trajectory, I certainly would expect that our NIM and our net interest income will both increase in the – in the fourth quarter. We don’t give guidance on 2023 until January. But I’ll say that given what we’re seeing, I don’t see without some dramatic change in reduction in rates, if you will, I don’t see the fourth quarter being the peak on the NIM. I don’t expect the same sort of growth in the NIM percentage of dollars that we had between third and fourth – excuse me, second and third to occur third and fourth and going forward. But I do expect, from a trend standpoint that those will continue to improve.
Dave Rochester
Yes. That makes sense. I think you talked about at least being up over the low 20s in NII this year. It seems like that should go decently higher. What are you guys thinking there now?
Jerry Salinas
Yes, I would say so. I think that you’ll just see that if you guys kind of put that out there trajectory-wise, you’re going to see that if I’m giving you guidance that I would expect the fourth quarter to increase, it really blows that low 20% growth out of the water.
Dave Rochester
Yes. That sounds good. And how are you guys thinking about deposit beta through the cycle at this point? I think you mentioned getting a 20% total deposit beta through 2022; you’re expecting 75 and 50 coming up here. How are you just thinking about that through the cycle now?
Jerry Salinas
We really haven’t changed our thought process is very much there. I mean, I think we’re kind of on the same place. We might be a little bit light right now, not much. But as I look at 2022 right now, that’s kind of what we’re expecting that we’ll be doing through the rest of the year.
Dave Rochester
Yes. Okay. Maybe just switching to deposits. Great growth this quarter. It’s great to see really about the trend for the industry as you guys talked about before. I was curious what the contribution was from Houston and Dallas. I know you mentioned the $1 billion mark for Houston. Congrats on that. I was just curious if you had the starting and finishing balances for both of those markets. That would be great.
Jerry Salinas
Yes. The one thing I do remember top of mind, I’ll just close that right now because I think Phil mentioned the year-over-year growth in deposits. So I think the – if you look at – I think we reported 17% growth year-over-year. And I think without the expansion, we would have been at 16%. And then if you look at the loan side, I think that they actually provided loans had grown.
Let me see if I’ve got it here, they had provided 2% of the growth in that category. So I think we were up and this is excluding PPP, obviously, if you exclude PPP, we were up 13%. And I think the expansion provide a little over 2% of that growth. So we would have been in the 11% range without. As far as the numbers period end, I don’t think I’ve got those well I can give it to you here pretty quickly. From a deposit standpoint, we’re close to $1 billion, as Phil said. Both combined, right. And our loan balances would be about $700 million, both combined.
Operator
And our next question is from John Pancari with Evercore ISI. Please proceed.
John Pancari
Good afternoon.
Jerry Salinas
Hi, John.
John Pancari
On the – back on the deposit side, deposit growth overall came in better than expected this quarter, and I know you gave some good color on the noninterest-bearing dynamics. As you look at fourth quarter and into 2023. How are you thinking about deposit growth trajectory from here? Do you think – what level of growth do you think is achievable as you’re looking into 2023 specifically?
Jerry Salinas
Well, I guess what I would say is that if I looked at the linked quarter growth, if I remember correctly here, and I’ll just grab that I think that we’ve been saying that we expect it to get softer, and it has gotten softer.
The linked quarter growth was an annualized 10% if I look at year ago quarter, or closer to 17%. So we are seeing softness, obviously, compared to where we had been historically. I think the expansion is obviously helping I think that our deposit rates are obviously contributing to that as well.
But I’ll continue to say that, especially for larger customers, there’s just going to be more options out there for customers with higher balances that we won’t be able to compete with and may not want to compete with, right? Because there are going to be some rates that don’t make sense for us to pay.
So I would think that if I was looking at it, I would think that I’d leave a little bit more towards the linked quarter growth and maybe even a little softer there. But again, we were wrong in the third quarter, as you know, we saw a lot stronger than we expected. But I think the fourth – the second and third linked quarter growth is kind of would be my starting point. All things being equal.
John Pancari
Got it. Okay, thanks. Jerry, that’s helpful. And then on the efficiency side, your efficiency ratio clearly, given some of your top line trends given better than expected this quarter as well, I guess, in the 34% [ph] range on a core basis. How do you see that trending as you look at 2023, what do you think is a reasonable longer-term level or particularly for 2023? And then – and then separately, top expense came in a little higher this quarter. How much of that was revenue driven versus head count or branch investment?
Phil Green
Well, I would say with regard to efficiency, and I know Jerry gets uncomfortable providing guidance to 2023 because we just don’t do it until our January call. So you guys are getting a little bit more than you would have normally got anyway. But I will say that. Look, earnings are good. I mean, a certain amount of this is arithmetic, okay?
And it’s – you guys can guess earning assets, you see the NIM, you can see the impact that the increase in rates has, I mean that’s not hard to figure out. And you guys have been doing it. John, I know you’ve been doing it for a long, long time. So we expect to see the revenue piece increase. I think that bodes well for efficiency ratios. At the same time, the reason I jumped in is that we’re going to continue to invest in the business. And I’m not – and we aren’t obsessing over that ratio. We’re going to continue to invest.
And I’d say at least three things. I’d say four really right now. One, we’re going to invest in our people. And we been doing that, and you’ve seen the numbers on salaries we reported them, they’re pretty dramatic and they’re necessary in order to keep the best group of people here and bring new ones in. So there’s that.
We’re going to invest in technology. We’ve been doing a lot of that. We’ve been getting better in our technology is improving all the time and the customer experience related to it is great. We’re going to continue to invest in our physical footprint in the markets that we’ve decided and that we’ve disclosed, and we’ll look at other markets as we continue to move forward.
And the other thing that we’re going to do is we’re going to invest in our marketing. I think we need to have with the value propositions we’ve got, we make sure our voice is as loud as it should be in the marketplace. And so those things are going to continue to be investments and that will be on top of just any inflationary pressure. So what we’re really looking to do as Jerry and I look at the business is expand it, grow it profitably and make it stronger. And so – and so the efficiency ratio will be, I think, a derivative of all that together.
John Pancari
Thanks. That’s helpful. And thanks for the reminder that I’m going to old.
Jerry Salinas
We’re there together.
Operator
Our next question is from Brady Gailey with KBW. Please proceed.
Brady Gailey
Yes, it’s Brady. Good afternoon guys.
Jerry Salinas
Hi, Brady.
Brady Gailey
It looks like the last three quarters, you’ve been growing bonds on a net basis pretty consistently a little around like $1 billion, maybe a little on top of $1 billion per quarter. Sounds like, that’s going to be the same in the fourth quarter.
Frost still has a lot of cash as a percentage of average earning assets. So does it seem like as we look to next year, the bond addition should be potentially about the same where you add about $1.5 billion next year?
Jerry Salinas
I think, Brady, it’s kind of funny, Phil says, I was giving it Bill over here because he said that I was giving more sort of 2023 sort of visual, if you will, forward looking. I said, yes, more than the former CFO you said that, what I would say is that that’s a good starting point. That’s what I would do if I were you.
Part of our sensitivity obviously, about giving too much guidance is we’re still in that planning process. Communications we’re still having internally. You heard us talking a little bit about our liquidity when we got asked the question about tangible capital. So we want to think about all those things and take a look also again to make sure that we’re comfortable with what sort of prepayment and maturity assumptions we’ve got included in there.
But I think that’s a really good place to start. And what I would say is in the fourth quarter, one thing that’s a little bit different. We have been buying treasury securities. And right now, we’re more focused on mortgage backs and municipals. We feel like the – that’s a better place for us right now from a risk/reward standpoint. I mean those yields are in the third quarter of what we purchased was a little bit better than the yields we’d assumed.
Obviously, that helped part of our beat as well. And so we’re seeing yields in the fourth quarter north of 5% in those products. So that’s kind of what we’re thinking about. And as we go into 2023 then, we’ll revisit what sort of investment program we put together. But I think that you start at $1 billion is a good place to be.
Brady Gailey
Okay. And then I wanted to circle back on the tangible common equity ratio of $3.85. It seems like you guys are not concerned about it at that level. Is there a level TCE that would be concerning to you guys. I think the FHLB has some restrictions if you go below a certain level. I know some public funds accounts also had some restrictions if you trip a certain level.
So is there any TCE ratio that would be concerning? Or do you just not care? And you had almost 13% common equity Tier 1, so TCE just doesn’t matter.
Phil Green
I don’t think there’s any operational concern over that number, Brady.
Brady Gailey
Okay. All right. And then my last question is just on the provision. I think you guys have had coming up on two years of a zero provision. The reserve ratio or percentage has been coming down with the economic uncertainty out there; do you think we start to see some provisioning costs in the near term? Or do you think that, that reserve has room to potentially go lower and the zero provision can continue?
Jerry Salinas
Yes. Brady, I think that’s a great question. I mean that’s the sort of conversations we’re having right now. You’re right. We haven’t booked a provision for a while. I think if we found ourselves in a situation where we thought couple of things.
If we thought – we saw actual loan growth quite a bit higher than maybe we had this quarter. And if you combine that with maybe a more concerning sort of a rate environment, and a more concerning sort of lending environment, we could find ourselves with provisions. I don’t think we’re – I think it’s a sort of conversation that we’ll be having throughout the quarter.
I don’t think it’s a slam dunk either way. All things being equal, if we did record a provision and need a provision in the fourth quarter, I couldn’t see that it would be anything that really material. But you’re right; I think that the conversations are – continue to be good with the CECL execution committee. We’re having a lot of good conversations and I wouldn’t be completely surprised either way, to be honest with you, if we recorded zero or if we recorded some small provision of a couple of million, I wouldn’t be surprised. And a lot of it is going to depend on how we see the environment over the next quarter.
Brady Gailey
Okay. Great. Thanks guys.
Operator
Our next question is from Jennifer Demba with Truist Securities. Please proceed. Jennifer, please check if the line is muted.
Jennifer Demba
Thank you. Good afternoon. Just curious about what you’re seeing within your asset quality trends. Are you seeing any weakness underneath the covers in any areas that are worth noting at this point?
Phil Green
Jennifer, the short answer is really no – we talk about what are we seeing? I mean, their inflation is – a lot of people haven’t gone through that. I kidded John that some of the analysts have been doing this a long time, obviously, so have I and we’ve been through – we’ve been doing inflationary cycles before.
A lot of people haven’t that are in business today, and we’re careful to make sure that we’re asking the right questions and our loan officers are particularly ones that have not lived in an increasing rate environment, an inflationary environment, understand what to ask and the things that can be happening to businesses. I think the things to watch are commercial real estate deals and probably not so much credit. Existential credit issues as opposed to are they going to be able to meet certain covenants if you’ve got covenants in there where you have to be able to cash flow X times debt service and you assume some kind of phantom debt service number.
I mean those numbers are getting pretty high, and I don’t think that they’ll really have much like I say, existential impact on things, but you could see some risk rates move as a result of that. I think we’re seeing – you’re seeing cap rates beginning to rise, particularly on deals that have – don’t have the opportunity to increase rents. Like seen you’re not seeing cap rates move so much on multifamily, where we get an opportunity to change those rents in relation to inflation, whereas you might see – you might see an industrial deal with a single tenant, very high credit quality tenant, but those are long-term leases.
You’re not going to get the opportunity to increase those cash flows from rental rate increases. So you’re seeing cap rates move up on those. You can ask yourself, is that going to affect these deals at all? So – but you look at us, we saw problem loans decline. This quarter, we saw nonperformers decline this quarter. So it’s still hard to see it anywhere.
But if you look at the real estate area, you look at deals being more – they’re pausing certain deals are going back to drawing board on certain deals. And so things are slowing somewhat. I think interest rates are a factor there. That’s trying to slow things down. I think they’re being somewhat successful there. And I think usually, anytime you have a large election, I think business owners tend to pause a little bit and see what happens, see if there’s any great change that might occur one way or the other.
And I think we’re probably feeling a little bit of that. So no cracks right now. Credit still looks really good, and we’ll just have to see what the economy does from here.
Jennifer Demba
Thanks, Phil.
Phil Green
You’re welcome.
Operator
And our final question is from Ebrahim Poonawala with Bank of America. Please proceed.
Ebrahim Poonawala
Good afternoon. Just had a couple of quick follow-up questions. One, in terms of the branch expansion, could you remind us, after the end of the year, how many more branches you have remaining in terms of – as you think about opening in 2023?
Phil Green
I would guess in round numbers, we’ve got about 15 to do in Dallas and probably four-ish or so of five in Houston for our 2.0 expansion. So let’s say, in round number is around 20.
Ebrahim Poonawala
Got it. And anything just given the environment better or worse that would make you want to do accelerate additional – or maybe open more branches than these or what you had initially planned given the success that you’ve had in any new markets that you’re looking at fill in terms of where you might deploy the same strategy over the next year or two?
Phil Green
Yes. I think the thing that we’ll do is we’ll continue to look at attractive markets in the state. We’re not done with that. And we’ve talked about for years now about understanding the Austin market and how that may or may not be different from some of the larger strategies we’ve used in Dallas and Houston, and we’re continuing to do that.
I think if you’ve heard us talk on the calls the last couple of calls, we’ve had some new locations and what I’ll call a more consumer-oriented markets. There are more rooftops than they are, what I’ll call, premier businesses there. And that about two-thirds, 70% of the profitability, this strategy has been always based on the commercial middle market piece.
But some of the returns and some of the performance we’ve had in these, more consumer-centric now admittedly higher income consumer-centric markets have been pretty remarkable. And it results in two things. One is your mix of assets leans a little harder on the consumer side. If you look at our Dallas early numbers, again, Dallas is early in the game, but it’s interesting that half of our loans or consumer loans in the Dallas market and half commercial as opposed let’s say, take Houston which is like 80% commercial, 20% consumer.
And so the reason I mentioned that at is that I think it gives some opportunity in that market in those markets that might be more house top oriented. And the other thing about those markets, they tend to be a little bit smaller, so they don’t have to be as big and if it turns out that what we’re seeing in these markets has legs that I think it could open up some new opportunities for us in markets that we’ve already been in, which might have been – which might have screened a little bit more consumer centric.
And I think it also might help us as we evaluate some of these new markets that we might go into new geographies in the state that might be a little bit more consumer-centric then commercial, it could be that those might actually be viable markets for us as well. So I think what we’ve been seeing recently, to me, makes me a little bit more optimistic on our ability to continue to expand the strategy.
And like I say, and I’ve begun to say more and more, I think the strategy is – I used two words about it. I believe that it’s scalable, and I believe it’s durable. And I believe that we’ll be doing this a long time.
Ebrahim Poonawala
Got it. That’s helpful. Thanks, Phil. And I guess one follow-up for you, Jerry. If I heard you correctly, did you say you’re adding mostly mortgage-backed securities right now?
Jerry Salinas
Munis and mortgage backs.
Ebrahim Poonawala
And I guess the question is, as we think about the other banks who are trying to hedge their margins to prevent if rates begin to go lower at some point over the next few years. Anything that you are doing synthetically in terms of defending the margin against lower rates? And how do you think – and I guess the mortgage securities, it does increase prepayment risk, if and when rates go lower. So I just want to get your thought process around managing the margin against lower rates.
Jerry Salinas
Yes. So some – obviously, we continue to have those conversations. I think the part of the conversation, obviously, is all the liquidity that we have. Some of the analysis we do is, of course, if we thought rates were going down, we could make bigger bets, right, with all that liquidity in hand, which certainly would help to protect the margin during a period of decreasing rates. So I think that that’s one of the things that’s out there.
And I think the other thing that we’ve talked about, and this is outside of the investment portfolio, obviously, is that given our deposit rates, we’ve got a lot more room than most do. To bring deposit rates down. I mean we’ve proven that we will and we can in the low rate environment. We did it when we started raising rates in 2017 and when rates came down in 2019 and 2020, we were moving our rates down. So we’ve got that opportunity as well. I mean it’s not something that we would want to do, but we’re certainly not afraid to do it and could do it to protect the margin.
But again, also analyzing where those purchases could be, we could make, I’ll call them, bullet type purchases of significant amounts of liquidity if we decided we wanted to do that.
Ebrahim Poonawala
Noted. Thanks for taking my questions.
Operator
We have reached the end of our question-and-answer session. I would like to turn the conference back over to Phil for closing comments.
Phil Green
All right. Thank you. Well, we thank you for your participation on the call today and for your interest in our company. Thank you. We’ll be adjourned.
Operator
Thank you. This does conclude today’s conference. You may disconnect your lines at this time and thank you for your participation.
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