Cullen/Frost Bankers, Inc. ’s ( CFR Quick Quote CFR - Free Report) solid loan balances, rise in net interest income (NII), and steady capital distribution activities are positives. Also, efforts to expand its presence in Texas bode well for long-term growth. However, the company is affected by mounting costs and an undiversified loan portfolio.
Cullen/Frost exhibits a strong balance sheet position, with its deposits and loan balances growing over the years. Moreover, the company’s solid deposit balances will help generate better liquidity to offer loans and meet other general business purposes in the upcoming period. We estimate loans and deposits to witness a compound annual growth rate of 4.3% and 0.7% over the next three years.
Organic growth remains a key strength at Cullen/Frost, reflected by its impressive rise in NII over the years. This was backed by high interest rates and solid loan balances.
A high interest rate regime, decent loan demand and exposure to non-interest-bearing deposits (a low-cost funding source) will continue to boost NII, though rising deposit costs will weigh on it. We estimate NII to increase 16.4% this year, then decline marginally in 2024 and rebound and grow 3.3% in 2025.
Cullen/Frost continues to enhance its presence in the lucrative Texas markets. In June, the company announced plans to double its financial centers to 34 in the Austin region by 2026. The region is the third-largest deposit market in Texas, where the company ranks fourth in market share, having more than $5 billion in deposits.
Also, in 2021, Cullen/Frost completed its 25-branch expansion program in the Houston region. Further, it planned a similar 28 branch expansion in Dallas. In April 2023, the Dallas branch expansion reached its halfway mark. 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 Cullen/Frost.
We remain encouraged by Cullen/Frost’s steady capital distribution activities, which are likely to stoke investors’ confidence in the stock. In July 2023, the company announced a 5.7% hike in quarterly dividend to 92 cents per share. Further, as of Jun 30, 2023, almost $72 million worth of authorization remained available under its current stock repurchase program.
However, Cullen/Frost’s elevating cost base exposes it to operational risks. Non-interest expenses have been rising over the years, primarily due to a rise in compensation-related expenditures.
Going forward, costs are likely to remain elevated on expansion moves in the Texas region. Management expects expenses to rise in mid-teens for 2023. We estimate non-interest expenses to jump 13.7% this year.
The credit quality of Cullen/Frost seems to have worsened over the years. Though allowance for credit losses on loans as a percentage of total loans declined to 1.32% in the first half of 2023, it remains high. Further, the ratio of net charge-offs to total average loans increased in 2022 and reached 0.21% in the first half of 2023.
The worsening economic outlook is expected to adversely impact its credit quality. Our estimate for provision indicates a substantial surge this year.
CFR's loan portfolio comprises majorly of commercial loans (C&I as well as commercial real estate or CRE lending). In fact, its loan mix underpinned nearly 80% of CRE and C&I loans as of Jun 30, 2023.
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. Thus, the lack of loan portfolio diversification is likely to hurt the company’s financials if the economic situation worsens.
In the past three months, shares of this Zacks Rank #3 (Hold) company have lost 13.7% compared with the
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