Cullen/Frost Bankers, Inc. — Q1 2023 Form 10-Q
Reporting period: Three months ended March 31, 2023. Unaudited consolidated results. Cullen/Frost is a Texas-based financial holding company offering banking, wealth management, insurance, and related services.
Key financial results
| Metric | Q1 2023 | Q1 2022 / comparison |
|---|---|---|
| Net interest income | $399.8 million | $249.1 million |
| Taxable-equivalent net interest margin | 3.47% | 2.33% |
| Credit loss expense | $9.1 million | Nil |
| Non-interest income | $105.3 million | $101.4 million |
| Non-interest expense | $285.1 million | $238.7 million |
| Net income | $177.7 million | $99.1 million |
| Net income available to common shareholders | $176.0 million | $97.4 million |
| Diluted EPS | $2.70 | $1.50 |
| Common dividend per share | $0.87 | $0.75 |
Net income available to common shareholders rose 80.6% year over year, principally reflecting a $150.7 million increase in net interest income. The higher income was partly offset by increased expenses, taxes, and credit loss expense. Return on average assets was 1.39% versus 0.79%; return on average common equity was 22.59% versus 9.58%.
Balance sheet, funding, and capital
- Assets: $51.25 billion at March 31, down from $52.89 billion at year-end 2022. Loans were $17.49 billion, up 1.9% from year-end.
- Deposits: $42.18 billion, down $1.77 billion from December 31. Non-interest-bearing demand deposits fell to $16.00 billion from $17.60 billion.
- Cash and cash equivalents: $9.30 billion, down from $12.03 billion at year-end. Management reported $8.6 billion held in an interest-bearing account at the Federal Reserve.
- Securities: Available-for-sale securities had a $17.98 billion fair value. Their gross unrealized losses were $1.43 billion; management attributed these losses to higher market rates, recorded no credit-loss allowance, and said it did not intend to sell the securities and expected not to need to sell them before recovery.
- Debt and borrowings: Repurchase agreements totaled $4.24 billion, all overnight or continuous; federal funds purchased were $57.5 million. Junior subordinated debentures and subordinated notes totaled $123.1 million and $99.4 million, respectively.
- Liquidity sources: Management cited approximately $3.5 billion of FHLB borrowing capacity and $14.3 billion of unencumbered securities available to support additional borrowing. Cullen/Frost, the holding company, reported $331.1 million of liquid assets.
- Regulatory capital: Cullen/Frost CET1, Tier 1, total capital, and leverage ratios were 13.24%, 13.74%, 15.22%, and 7.69%. Frost Bank’s corresponding ratios were 13.33%, 13.33%, 14.19%, and 7.45%. The filing states both exceeded applicable well-capitalized levels.
Material changes and credit quality
- Higher market rates drove the improvement in net interest income: the average yield on earning assets increased to 4.57% from 2.39%, while the average rate paid on interest-bearing liabilities rose to 1.79% from 0.11%. Average deposit costs also increased; the average cost of total deposits was 0.93% versus 0.05%.
- Non-interest expense increased 19.4%, led by salaries and benefits, technology, occupancy, and other expenses. Deposit insurance expense increased 71.9% to $6.2 million following an FDIC assessment-rate increase.
- Loan allowance was $231.5 million, or 1.32% of loans, versus $227.6 million, or 1.33%, at year-end. Non-accrual loans were $38.4 million, or 0.22% of loans; total past-due loans were $117.1 million. Net charge-offs were $8.8 million.
- Commercial real estate allowance increased to $115.7 million from $90.3 million, reflecting larger qualitative adjustments and overlays. Management described concerns around office-property use, borrower access to capital, refinancing, rising rates, and construction-loan risks.
- Management recalibrated credit models in Q1. The changes reduced modeled expected loan losses by approximately $45 million, largely offset by qualitative adjustments; off-balance-sheet modeled losses fell approximately $19 million, also largely offset. Management noted that parts of the recalibration relied on historical data from a relatively low-loss period.
- Energy loans increased 15.2% sequentially to $1.07 billion, or 6.1% of loans. Non-accrual energy loans rose to $22.3 million from $15.2 million at year-end.
Cash flow, outlook, and risks
Operating cash flow was $168.3 million, compared with $332.8 million a year earlier. Investing activities used $649.3 million, while financing activities used $2.25 billion, including a $1.77 billion net decrease in deposits. Cash and cash equivalents decreased $2.73 billion during the quarter. The cash movements included substantial securities purchases and maturities, as well as deposit and short-term borrowing outflows.
The filing provides no company earnings or revenue guidance. Management described the balance sheet as more asset-sensitive than at year-end: its model estimated that a 100- or 200-basis-point rate increase would raise next-12-month net interest income by 1.4% or 3.0% relative to a flat-rate scenario; equivalent decreases would reduce it by 1.4% or 2.9%. These estimates depend on assumptions, including deposit pricing, and the model did not assume interest payments on certain commercial demand deposits.
- Management identified deposit competition, higher rates, alternative customer investments, liquidity changes, borrower performance, economic conditions, and interest-rate and securities-market movements as risks.
- The FDIC was expected to propose a special assessment after recent bank failures; the effect on future deposit insurance expense was uncertain.
- A $100 million stock repurchase authorization was approved in January 2023; no shares were repurchased under the plan during the quarter. Share purchases reported were related to vesting of stock awards.
- Management reported no material change in the risk factors from the 2022 Form 10-K, no material adverse expected impact from pending legal matters, and effective disclosure controls.
Investor verification priorities
- Track deposit balances and mix, funding costs, and liquidity outflows, including the effect of continued rate competition.
- Assess whether net interest margin and earnings remain resilient if rates fall or deposit pricing rises faster than modeled.
- Review unrealized securities losses, available liquidity, and whether securities could need to be sold before recovering value.
- Monitor commercial real estate and energy credit trends, non-accruals, charge-offs, and the adequacy of qualitative allowance overlays after model changes.
- Verify the potential cost of any FDIC special assessment and the timing or use of the authorized repurchase program.