Cullen/Frost (CFR) Aided by High Interest Rates Amid Cost Woes

Cullen/Frost Bankers, Inc.’s CFR growth is aided by high interest rates, a rise in net interest income (NII), solid loan balances and steady capital deployment plans. Efforts to boost presence in Texas augur well for long-term growth. However, mounting costs due to expansion moves will likely impede the bottom-line growth. Also, deterioration in credit quality and an undiversified loan portfolio are concerning.

Cullen/Frost exhibits a strong balance sheet position. Its deposit balance witnessed a three-year compound annual growth rate (CAGR) of 12% (2020-2022), while loans (excluding Paycheck Protection Program) recorded a CAGR of 6.7% in the same time frame. The rising trend for loans continued in the first quarter of 2023, whereas deposits declined. Management expects loan growth in the high single digits in 2023.

Organic growth remains a key strength at Cullen/Frost, as reflected by its impressive growth in NII. The metric witnessed a CAGR of 8% over the last four years (2019-2022). The rising trend continued in the first quarter of 2023. Decent loan growth, exposure to non-interest-bearing deposits, and a high interest rate regime will continue to boost NII and margins in the upcoming period. We estimate NII (FTE basis) to increase to $1.65 billion in the current year.

Cullen/Frost’s steady capital deployment activities have been encouraging. On Jan 25, 2023, the company authorized a stock repurchase program worth $100 million for one year. However, no repurchases have been made under said authorization.

Nonetheless, in July 2022, the company hiked its quarterly dividend by 16%. With the debt/equity ratio comparing favorably with that of the broader industry and improving earnings, the company is expected to sustain capital deployment activities in the future.

The company continues to enhance its presence in Texas. In the second quarter of 2021, Cullen/Frost completed its 25-branch expansion program in the Houston region. It has planned a similar 28-branch expansion in Dallas.

Also, management expects to begin limited production of 1-4 family mortgage loans for its customers in the second quarter of 2023. Given the pro-business and a low-tax scenario, along with compelling demographics in the region, such efforts are apt and will likely drive deposit and loan growth for the company.

However, Cullen/Frost’s flaring cost base exposes it to operational risks. Non-interest expenses witnessed a CAGR of 7.1% over the last four years (2019-2022). The rising trend continued in first-quarter 2023, primarily due to a rise in compensation-related expenses. Going forward, expenses are likely to inflate on Houston and Dallas expansion moves. Management expects expense growth in the mid-teens for 2023.

Cullen/Frost’s credit quality seems to have worsened over the years. The allowance for credit losses on loans as a percentage of total loans increased to 1.33% in 2022 from 1.28% in 2016. Though the ratio declined to 1.32% in first-quarter 2023, it remains high.

Also, the ratio of net charge-offs to total average loans increased year over year in 2022 and reached 0.21% as of Mar 31, 2023. The worsening economic outlook amid recessionary fears is expected to affect credit quality and keep provisions high in the near term.

The majority of Cullen/Frost's loan portfolio comprises total commercial (C&I as well as commercial real estate or CRE lending). The current rapidly changing macroeconomic backdrop may put some strain on commercial lending. Moreover, in case of any economic downturn, the asset quality of the loan category might deteriorate.

In the past month, shares of this Zacks Rank #3 (Hold) company have gained 12.8% compared with the industry's rise of 12.9%.