CULLEN quarterly report, Q3 FY2023

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Cullen/Frost Bankers, Inc. — Q3 2023 Form 10-Q

Business context and reporting period. Cullen/Frost is a Texas-based financial holding company providing banking, wealth management, insurance and related services. This unaudited quarterly report covers the three and nine months ended September 30, 2023; financial statements are consolidated.

Financial performance and condition

  • Q3 earnings: Net income was $155.7 million and diluted EPS was $2.38, compared with $169.8 million and $2.59 in Q3 2022. Net income available to common shareholders was $154.0 million, down 8.4% year over year.
  • Nine-month earnings: Net income was $495.4 million and diluted EPS was $7.54, versus $388.0 million and $5.90 in 2022; common earnings increased 28.1%.
  • Revenue and margins: Q3 net interest income was $385.4 million, up 8.4%, and non-interest income was $106.0 million, up 6.2%. Taxable-equivalent net interest margin was 3.44%, versus 3.01%. For the first nine months, net interest income was $1.171 billion, up 31.1%, and non-interest income was $314.8 million, up 5.2%; taxable-equivalent margin was 3.45%, versus 2.64%.
  • Expenses and credit costs: Q3 non-interest expense rose 13.7% to $293.3 million; credit loss expense was $11.2 million, compared with none in the prior-year quarter. Nine-month non-interest expense rose 16.2% to $863.4 million, and credit loss expense was $30.2 million. The nine-month effective tax rate was 16.3%, versus 13.6%.
  • Loans and credit quality: Loans were $18.40 billion, up 7.3% from year-end 2022. The allowance for loan losses was $242.2 million, or 1.32% of loans, versus $227.6 million, or 1.33%, at year-end. Non-accrual loans increased to $67.2 million from $37.8 million. Commercial real estate allowance allocations rose to $126.5 million from $90.3 million, reflecting higher qualitative adjustments.
  • Deposits, liquidity and funding: Deposits were $40.99 billion, down 6.7% from December 31, 2022; non-interest-bearing deposits declined to $14.63 billion from $17.60 billion. Cash and cash equivalents were $7.62 billion, versus $12.03 billion. The company reported about $7.0 billion at the Federal Reserve, $5.4 billion of available FHLB borrowing capacity and $14.1 billion of unencumbered securities. Repurchase agreements totaled $3.72 billion.
  • Capital and securities: Shareholders’ equity was $3.00 billion, down from $3.14 billion. Accumulated other comprehensive loss widened to $1.78 billion, primarily from declines in available-for-sale securities’ fair value. Regulatory capital remained above well-capitalized thresholds: Cullen/Frost CET1 was 13.32% and total capital was 15.28%; Frost Bank CET1 was 13.46% and total capital was 14.33%.
  • Cash flow: Nine-month operating cash flow was $561.8 million; investing cash flow was negative $830.8 million and financing cash flow was negative $4.14 billion. Cash and cash equivalents declined $4.41 billion during the period.

Material changes versus comparable periods

  • Q3 common earnings declined despite higher net interest income, as expense, credit-loss provision and tax increases more than offset higher interest and non-interest income. Nine-month earnings benefited from strong net interest income growth.
  • Higher market rates lifted loan and investment yields, but increased deposit and repurchase-agreement costs. Average deposits were lower year over year, particularly non-interest-bearing balances; time deposits increased substantially from year-end.
  • Loans expanded, particularly commercial real estate and consumer real estate. Non-accrual loans rose, including a commercial real estate increase largely related to one credit relationship.
  • Available-for-sale securities had $2.21 billion of gross unrealized losses at September 30. Management attributed these losses to higher market rates, stated it did not intend to sell the securities, and judged a forced sale before recovery to be unlikely. The filing records no credit-loss allowance on these securities.
  • The company sold $1.9 billion of available-for-sale securities during the first nine months, recognizing a net gain of $66 thousand; management said proceeds enhanced liquidity and future reinvestment flexibility.

Outlook, commentary and risks

  • The filing provides no formal earnings or revenue guidance. Management cautions that interim results are not necessarily indicative of full-year or future results.
  • Management’s interest-rate simulations estimate that, over 12 months, a 100- or 200-basis-point increase would raise net interest income by 1.7% or 3.3% versus a flat-rate case; equivalent decreases would reduce it by 1.2% or 2.8%. Results depend on assumptions, including deposit pricing; the model assumes no interest paid on certain commercial demand deposits.
  • The FDIC had proposed a special assessment to recover losses related to recent bank failures. If finalized as proposed, the company estimated an expense of approximately $47.9 million pre-tax ($37.9 million after tax); the proposal and timing remained uncertain in the filing.
  • Management cited risks including interest-rate and deposit competition, economic conditions, borrower performance, credit concentrations and commercial real estate refinancing and office-property concerns, as well as technology, cybersecurity, staffing, regulatory and geopolitical risks. It reported no material change to risk factors from the 2022 Form 10-K.
  • Allowance estimates involve significant judgment. First-quarter 2023 model updates reduced modeled expected losses, with qualitative adjustments largely offsetting the reduction; management also maintained overlays for commercial real estate, office buildings, downside scenarios, credit concentrations and consumer loans.
  • Management said pending litigation was not expected to have a material adverse financial impact. Disclosure controls were assessed as effective, with no material change in internal control over financial reporting during the quarter.

Important facts for investors to verify

  1. Whether deposit balances and mix stabilize, and how deposit pricing affects funding costs and net interest margin.
  2. Trends in non-accrual and classified loans, particularly commercial real estate exposures, and whether reserve overlays remain adequate.
  3. The size and timing of any FDIC special assessment and its effect on reported expenses and earnings.
  4. Whether unrealized securities losses, liquidity resources and capital ratios change materially as rates and funding conditions evolve.
  5. Whether rising operating expenses, including staffing, technology, deposit insurance and expansion costs, continue to outpace revenue growth.