Cullen/Frost Bankers, Inc. (CFR) — Q2 2023 Form 10-Q
Business and period: Unaudited results for the three and six months ended June 30, 2023. Cullen/Frost is a Texas-based financial holding company providing banking, wealth management, insurance and related services, principally in Texas.
Financial performance and position
- Q2 earnings: Net income was $162.1 million, up 36.1% from $119.1 million in Q2 2022. Net income available to common shareholders was $160.4 million; diluted EPS was $2.47, versus $1.81.
- First-half earnings: Net income was $339.8 million, up from $218.2 million; diluted EPS was $5.17, versus $3.31.
- Net interest income: Q2 GAAP net interest income rose to $385.3 million from $288.2 million. Taxable-equivalent net interest margin was 3.45%, up 89 basis points year over year. For the first half, GAAP net interest income was $785.1 million and taxable-equivalent margin was 3.46%, up 101 basis points.
- Revenue and expenses: Q2 non-interest income increased 5.7% to $103.5 million, while non-interest expense rose 15.7% to $285.0 million. First-half non-interest income increased 4.8% to $208.8 million and expense rose 17.5% to $570.2 million. Higher compensation, benefits, technology, occupancy and other costs contributed to expense growth.
- Credit costs and asset quality: Q2 credit loss expense was $9.9 million; first-half expense was $19.0 million, compared with none in the corresponding 2022 periods. The loan-loss allowance was $233.6 million, or 1.32% of loans, at June 30. Non-accrual loans increased to $67.8 million from $37.8 million at year-end 2022, primarily reflecting a commercial real estate relationship. Management increased qualitative reserves, particularly for commercial real estate.
- Balance sheet: Total assets were $48.6 billion, down from $52.9 billion at December 31, 2022. Loans were $17.7 billion, up 3.4%; deposits were $40.7 billion, down from $44.0 billion. Non-interest-bearing deposits were $14.9 billion, versus $17.6 billion at year-end.
- Cash flow and liquidity: First-half operating cash flow was $323.2 million; investing cash flow was negative $718.6 million and financing cash flow was negative $4.5 billion. Cash and cash equivalents fell to $7.1 billion from $12.0 billion, largely alongside deposit and short-term borrowing outflows. Management reported $6.3 billion at the Federal Reserve, $5.2 billion of FHLB borrowing capacity and approximately $14.8 billion in unencumbered securities available to support borrowing.
- Securities and equity: Available-for-sale securities had $1.62 billion of gross unrealized losses at June 30, attributed by management to market interest rates rather than credit quality; no credit-loss allowance was recorded. Shareholders’ equity was $3.39 billion, up from $3.14 billion at year-end, while accumulated other comprehensive loss remained $1.31 billion.
- Capital and shareholder returns: At June 30, Cullen/Frost reported CET1 of 13.42%, total capital of 15.39% and a leverage ratio of 8.11%; Frost Bank’s respective ratios were 13.55%, 14.41% and 7.88%. Both exceeded regulatory minimums and well-capitalized thresholds. The company paid $0.87 per common share quarterly and repurchased approximately $28.0 million of stock during Q2 under its $100 million authorization.
Material changes and management commentary
- Higher market rates lifted loan and securities yields, driving net interest income growth. Deposit and repurchase-agreement costs also rose substantially; average interest-bearing deposit cost reached 1.87% in Q2, compared with 0.22% a year earlier.
- Deposits declined, including a notable reduction in non-interest-bearing balances. Management cited competition for deposits and customers’ alternative investment options as potential pressures on funding costs and liquidity.
- Commercial real estate allowance allocations increased to $120.9 million from $90.3 million at year-end, reflecting larger qualitative adjustments, including overlays for office properties and construction/non-owner-occupied CRE. Management also cited refinancing and capital-market access risks amid higher rates.
- The company sold $1.5 billion of available-for-sale securities in the first half, generating a $54,000 net gain; management said the sales enhanced liquidity and allowed flexibility to reinvest.
- The FDIC had proposed a special assessment to recover losses associated with recent bank failures. If finalized as proposed, Cullen/Frost estimated an approximately $47.1 million pretax charge ($37.2 million after tax), potentially recognized when the rule becomes final; the proposal and timing remained uncertain.
Outlook, risks and contingencies
- The filing gives no company earnings or revenue guidance. Management noted the Federal Reserve’s June projections implied a possible rate increase during the remainder of 2023 and reductions in 2024; these were Federal Reserve projections, not company guidance. The policy rate subsequently increased on July 27, 2023.
- Interest-rate simulations at June 30 indicated projected 12-month net interest income would rise 1.5% or 2.9% under parallel rate increases of 100 or 200 basis points, and fall 1.2% or 2.6% under corresponding decreases. The model assumed no interest payments on a significant portion of commercial demand deposits.
- Key stated risks include rate and market volatility, deposit competition, borrower performance and credit-loss estimates, Texas economic conditions, CRE refinancing and office-space trends, cyber and technology disruption, regulatory changes and potential FDIC assessments. Management reported no material change to the risk factors in its 2022 Form 10-K.
- Management did not expect pending claims and legal actions to have a material adverse impact. Disclosure controls were assessed as effective, with no material quarterly change in internal control over financial reporting.
Important facts for investors to verify
- Whether deposit levels stabilize and how deposit pricing affects funding costs and net interest margin.
- Developments in non-accrual loans, classified CRE credits, office and construction exposures, and the adequacy of credit-loss overlays.
- The final FDIC special-assessment rule, estimated charge and recognition timing.
- Realized or potential effects of securities sales, unrealized losses and liquidity needs if funding conditions change.
- Whether strong earnings growth persists as expenses rise and interest rates, loan growth and deposit mix evolve.