Cullen/Frost Bankers, Inc. (CFR) Earnings Call Transcript & Summary

Welcome to Cullen/Frost Bankers Inc. Second Quarter 2026 Earnings Conference Call. [Operator Instructions] Please note, this conference is being recorded. I will now turn the conference over to A.B. Mendez, Senior Vice President and Director of Investor Relations. Thank you. You may begin.

Thanks, Jerry. This afternoon's conference call will be led by Phil Green, Chairman and CEO; and Dan Geddes, Group Executive Vice President and CFO. Before I turn the call over to Phil and Dan, I need to take a moment to address the safe harbor provisions. Some of the remarks made today will constitute forward-looking statements as defined in the Private Securities Litigation Reform Act of 1995 as amended. We intend such statements to be covered by the safe harbor provisions for forward-looking statements contained in the Private Securities Litigation Reform Act of 1995 as amended. Please see the last page of text in this morning's earnings release for additional information about the risk factors associated with these forward-looking statements. If needed, a copy of the release is available on our website or by calling the Investor Relations department at (210) 220-5234. As a reminder, this call is being webcast and a webcast replay of the call will be available on our Investor Relations website at investor.frostbank.com. At this time, I'll turn the call over to Phil.

Thanks, A.B. Good afternoon, everyone, and thanks for joining us. Today, we'll review second quarter 2026 results for Cullen/Frost and our Chief Financial Officer, Dan Geddes will provide additional commentary and guidance before we take your questions. In the second quarter of 2026 Cullen/Frost earned $170.4 million, an increase of 9.7% compared to the $155.3 million earned in the second quarter last year. Per share earnings for the second quarter were $2.70 an increase of 13% from $2.39 in the second quarter of last year. Our return on average assets and average common equity in the second quarter, were 1.3%, 15.41%, respectively. That compares with 1.22% and 15.64% in the second quarter last year. Average deposits in the second quarter were $42.6 billion, an increase from $41.8 billion in the same quarter last year. Average loans grew to $22.6 billion in the second quarter, up from $21.1 billion in the second quarter last year. Frost's Consumer Bank continues to stand out as an industry leader in both customer experience and organic growth. Even as competition from new entrants to the Texas markets intensifies. Year-over-year, consumer checking account household growth accelerated from 5.3% reported last year to 5.7% this quarter, driven by our strongest quarter of customer growth since second quarter 2023. We believe this continues to be some of the best if not the best organic growth in the industry. This high customer growth is also driving strong increases in noninterest income. Year-over-year, noninterest income for consumer is up $2.8 million and 11% year-over-year increase. We've demonstrated remarkable consistency in organic growth since our expansion began in late 2018. Our success over the last 7.5 years of organic expansion, which had a profound effect. During the expansion, consumer checking accounts have grown 47%. Said another way, 1/3 of our customers are new to Frost since the expansion began. These results are further evidence that as I've said before, our organic growth strategy is both dual and scaling. We also see consistent above-average growth and organic growth in consumer [indiscernible] Consumer loans ended the quarter with over $4.5 billion outstanding reflecting year-over-year growth of $751 million, a 20% annual growth rate. This growth was driven primarily by mortgage lending which has year-over-year growth of $533 million and second lien home equity products, which grew $198 million. Looking at consumer deposits, they were down 0.7% for the first quarter, reflecting primarily seasonal trends. Our commercial line of business is also showing impressive growth. As an example, our 90-day weighted loan pipeline increased 11% from the first quarter to the highest level in our history at $2.17 billion. It demonstrates good balance with about half representing C&I and half representing CRE. About 62% of our pipeline represents customer deals versus prospect yields of 38%. Looking at new loan commitments booked, second quarter was up 23% from Q1 and marked the second highest quarterly total in 2 years. Four commitments booked, remember that core relationships are defined as those under $10 million made up 58% of the dollar amount of our commitments in the second quarter. In addition, growth from the previous quarter was good in all segments. C&I, up 15%, CRE up 33%, energy up 47% and personnel up 13%. Now let's look at new relationships. New relationships were down 1% from the first quarter, but this was the fifth consecutive quarter over 1,000. The expansion continues to be a significant driver of commercial relationships and accounted for 33% of Houston's new relationships, 39% of Dallas and 24% Austin. Overall, the expansion accounted for 22% of commercial relationships. Finally, market disruption continues to be a tailwind for us. Year-to-date, new relationships from this source are up 65% compared to the same period last year. Our overall credit quality remains good by historical standards, total criticized problem loans, which we define as those risk rated [indiscernible] worse totaled $917 million at the end of the second quarter, down from $989 million last quarter and $989 million a year ago. Decrease in the quarter was a result of several successful resolutions that had been anticipated in the prior quarters. Nonperforming assets totaled $114 million at the end of the second quarter, up from $73 million last quarter and $64 million a year ago. The quarter end nonperforming asset figure represents 49 basis points of period-end loans and 21 basis points of total assets as compared to 33 and 14 basis points last quarter. The increase in nonperformers mainly relates to $154 million multifamily commercial real estate loan that is working through a sale of a property with an expected resolution in either the third or the fourth quarter. This was partly offset by a $20 million paydown on our nonperforming loan identified in the fourth quarter for 2025. Net charge-offs for the second quarter were $9.5 million compared to $5.7 million last quarter and $11.1 million a year ago. Annualized net charge-offs for the second quarter represented 17 basis points of average loans compared to 11 basis points last quarter and 21 basis points a year ago. In addition to our success in commercial and consumer business lines, I'm also optimistic about our efforts around expanding our wealth management and insurance brokerage businesses. I'll end by thanking our amazing staff for these outstanding results that we're achieving and recognizing that they make it all happen. And with that, I'll turn it over to Dan for some additional insights.

Thank you, Phil. Let me start off by discussing our branch expansion growth. As a reminder, this performance now includes 11 additional branches opened in trade areas outside of our announced expansions in Houston, Dallas and Austin. During the second quarter, our branch expansion delivered $0.16 or 5.8% of EPS accretion and $0.30 year-to-date or 5.9% of EPS accretion. We continue to be pleased with the volumes we've been able to achieve. On a year-over-year basis, average loans grew 38%, representing 13.4% of total loans, up from 10.5% a year ago and contributed 53% of the growth, while average deposits grew 20%, representing 8.7% of deposits versus 7.4% in the same period last year and contributed 72% of the growth. The expansion branches have now grown to $3 billion in loans, $3.7 billion in deposits and have added over 100,000 new households. We have opened 5 new locations since our last call, 1 in the Austin region, 1 in the Dallas region, 1 in the San Antonio region and 2 in the Fort Worth region. Our current plan is to open an additional 5 branches over the balance of 2026. Now moving to second quarter financial performance for the company. Our net interest margin percentage was 3.75% for the quarter, up 1 basis point from the 3.74% reported last quarter. Net interest margin was positively impacted by a volume shift of earning assets from lower yielding balances held at the Fed into both loans and investment securities. These were somewhat offset by both increased volumes of interest-bearing deposits and higher overall cost of deposits. Looking at our investment portfolio. The total investment portfolio averaged $20.6 billion during the second quarter, up $796 million from the previous quarter. Investment purchases during the quarter totaled $2.2 billion, consisting of $1.95 billion of agency MBS securities, yielding 5.32% and $259 million of municipals yielding 5.57% on a tax equivalent basis. Maturities during the quarter included $375 million of treasuries with an average yield of 3.35% and $211 million of municipals at an average tax equivalent yield of 5.46% and $427 million of Agency MBS paydowns. The net unrealized loss on the available-for-sale portfolio at the end of the quarter was $1.15 billion compared with the $1.04 billion reported at the end of the previous quarter. The taxable equivalent yield on the total investment portfolio during the quarter was 3.96%, up 11 basis points from the previous quarter. The taxable portfolio averaged $13.6 billion, up $840 million from the prior quarter and had a yield of 3.51%, up 12 basis points from the 3.39% in the prior quarter. Our tax-exempt municipal portfolio averaged $7.1 billion, flat with the prior quarter and had a taxable equivalent yield of 4.87%, up 14 basis points from the prior quarter. At the end of the second quarter, approximately 68% of the municipal portfolio was pre-refunded or PSF insured. As the duration of the investment portfolio at the end of the second quarter was 4.9 years, down from 5.2 years at the end of the first quarter. Looking at our funding sources. On a linked quarter basis, average total deposits of $42.6 billion were up $394 million from the previous quarter. The increase was approximately 80% in interest-bearing and 20% in noninterest-bearing deposits. Phil mentioned the consumer deposits seasonal second quarter behavior. I wanted to give some additional color on how commercial deposits performed as the second quarter ended and how overall deposits are looking thus far in July. Average commercial deposits for the month of June increased about $770 million or 3.6% compared to the average for the month of March, with even growth in checking accounts, money market accounts and CDs. Thus far in July, we are seeing continued trends of deposits firming with average July deposits up an annualized 3.9%. The cost of interest-bearing deposits in the second quarter was 1.61%, up 6 basis points from 1.55% in the first quarter. Customer repos for the second quarter averaged $4.4 billion, up $219 million from the first quarter. The cost of customer repos for the quarter was 2.65%, down 5 basis points from the first quarter. Looking at noninterest income and expense. I'll point out a couple of seasonal items impacting the linked quarter results. Regarding noninterest income, insurance commissions and fees were down $7.9 million. Recall that the first quarter is a seasonally strong quarter for annual renewals. Salaries and wages were up $6.8 million compared to the linked quarter primarily impacted by our annual merit increases starting in May and higher head count related to branch expansion. Our benefits expense was down $9.5 million impacted by lower payroll taxes and 401(k) expense a normal trend as the first quarter is normally higher due to payment of annual incentive payments. Regarding our guidance for full year 2026, our current outlook includes 125 basis point hike for the Fed funds rate in the third quarter. We expect net interest income growth for the full year to fall in the range of 4.75% to 5.25%. This reflects both an increase in narrowing of our prior guidance range of 3.5% to 5%. For net interest margin, we expect an improvement of about 10 to 13 basis points compared to our full year 2025 net interest margin of 3.66%. This narrows the range compared to the 10 to 15 basis point improvement last quarter. We expect full year average loan growth to be in the range of 7% to 8%. This increases the prior guidance of 6% to 7%. Regarding deposits, we expect full year average growth to be in the range of 2% to 3%, unchanged from prior guidance. Based on current projections, we expect noninterest income growth of 7.5% to 8.5%, up from the prior guidance range of 4% to 5%. Regarding noninterest expense, we expect growth to be in the range of 4.5% to 5% year-over-year, down from the prior guidance of 5% to 6%. Regarding net charge-offs, we expect full year 2026 to be in the range of 15 to 20 basis points of average loans. Our effective tax rate expectation for full year 2026 is in the range of 15.5% to 16%, lowering the upper end from 16.5% in the prior quarter. Regarding stock purchases, I want to mention that during the second quarter, we utilized $90 million of our $300 million approved share repurchase plan to buy back approximately 655,000 shares. And with that, I'll now turn the call back over to Phil for questions.

Thanks, Dan. Okay. We'll open it up for questions now.

[Operator Instructions] Our first question is from Dave Rochester with Cantor Fitzgerald.

I wanted to start on the NII guide. The improvement there. I was curious what the impact was of the addition of the rate hike which I think you said was in the third quarter. Which month was that in?

In September.

Okay. And so it's just 1 quarter impact. So probably not much of an impact on the overall.

Not on the overall, but I think you -- we typically have said it's around $2 million a month impact, and that's still the case. So you get the impact of the last quarter.

Great. And then just, I guess, on the competitive front, we've just heard from some of the Texas banks that competition is really heating up for larger loans, and it sounds like some of that pressure is being driven by banks entering the market. It doesn't really sound like you're having a real issue with that just given the pipeline you talked about earlier, but are you seeing any pickup in those pressures? And if you could just comment on the deposit side as well on that front, that would be great.

Yes. I would say we are seeing a pickup on competition on the lending side. And it's mainly around structure and when we are losing deals of the commerce of those our structure. We're competing on price, we've said we're going to do that, particularly for good relationships, good prospects that are out there, and you have to. You have to find out what the market is and you have to engage at a market price. And so we're doing that. And I was looking at some numbers on the C&I side, we're really not losing much to price this last quarter. I was proud of our people for finding out what the clearing price was and being able to get deals done on that basis. The place where I've seen more deals that we were unsuccessful on and you're right, we are being successful. But when we've seen deals that we've lost, it's mainly been CRE and that's been some price but a whole lot of structure. And it just seems like the market is continuing a bit of a race to the bottom on some of these structures. So you got to be really careful and make sure you're doing business with the right people. And varying on what you would like to do in some cases, because you always do that for the best quality people, you're going to do the best you can on structuring terms. And as you said, again, we're being successful. But yes, talking to our people, we hear clearly that there is more competition as it relates to loans. So I'll let Dan talk about finances.

I think the deposit environment seems to be where we're seeing some competition. And generally, it's for large balance opportunities where you'll see some just really competitive rates out there for either CDs or money markets, some come with it, some, I guess, urgency, if there's not an action within a certain time period, that rate will go away. That's really not the way we handle our customers or opportunities. We want to be transparent. And when we put out a rate unless the market changes, we're going to live by that rate. So I'd say that that's where you're seeing a lot of the competition. And you saw kind of an increase in our deposit costs. And some is just the natural shift, I would say, just with the market indicating likely higher rates, you're price seeing some just behavior defined yield. And so we've seen that. But others, it's our decision to not lose business. And so we're making that decision on sometimes on deposit price. And so we're being competitive.

Okay. And then maybe just a big picture question on the guidance shifts. NII got better. Your outlook for fees got better. Your outlook for expenses got better. And I guess I'm trying to dig into what was it in the expense side? Was it just the better result this quarter that gives you a lower starting point for the second half? What was it that allows you to tweak that expense guide lower while revenue expectations are increasing?

So some of it is just the second quarter performance, and now we have half a year versus just looking at it with a quarter. So we just have more information so we can have a better sight into how we expect to perform for the full year. We also just are seeing opportunities in the marketplace to higher and so if that comes to fruition, it may be on the higher end, if we see more opportunities to hire bankers that are displaced. But I would say, in general, it's just having more more line of sight and feeling like for the first half of the year, we just we had expense growth 4%, 4.5%, 4.6% and feel like for the back half, we're going to have some -- our seasonal fourth quarter likely increase in expenses on salaries and wages, and that's kind of typical when we have award our stock awards. Some of those, by their nature, are vested immediately. And so you'll likely see fourth quarter exhibit what it generally has. But all in all, I feel like we've -- that everybody here has done a really excellent job of managing expense growth and in a lot of areas, it's like I've mentioned in the prior calls, are just a higher base in terms of expansion growth. When you're growing 10 to 15 branches at 130 branches at the beginning, that's going to be a higher percentage than 13 to 15 branch growth at 210 branches. And so some of it is just scale that we've now reached that we feel better about the rate of growth.

Appreciate it. Maybe if I could sneak in 1 last 1 on the purchases of securities $2.2 billion this quarter. You talked about accelerating that to offset some of the deposit cost pressures. What are you targeting for purchases in the back half? And then given any runoff that you're expecting, what kind of net growth are you expecting for securities in the back half?

Sure. So our plan, we're going to increase this about $750 million with that pull forward that we did last quarter to protect the NIM and so just looking at our investments for the back half, we have about $1 billion more to spend in the back half of the year. And the difference -- those will likely be split up roughly half and half between agencies and municipals. We're leaning likely a little bit more towards municipal purchases or if the market were to give us an opportunity, we hold the we reserve the rights that makes us to shift that to either one way or the other. But that's kind of where the -- where that -- with our purchase plan is headed. And did I answer all your components to that question?

Yes. I think that's good.

Our next question is from Jared Shaw with Barclays.

Maybe on the deposits, as we go into a likely rising rate environment, what's the expectation around beta there with some of the mix shift that you've had over the last few quarters and looking at the expansion market impact?

Sure. Right now, we are running like 46% beta on our interest-bearing deposits. And we expect that to go down slightly, I would say, to the low 40% range throughout the rest of the year. Just anticipating competitive pressures and our changes in our money market rates for the tiers that I mentioned last quarter, kind of the $100 to $250 and the $250 to $1 million on our consumer side. So given those changes in just the competitive environment, that's where we would expect it to the beta to kind of drift to.

And then looking at the buyback, increasing the amount this quarter. How should we -- is this sort of a good level that we should be thinking about going through the rest of the year? Or is there some opportunistic element of the buyback in 2Q?

There was some opportunistic, I think. And then just like we've mentioned, just our plan was to be consistent with our buyback a portion and then to hold back a portion for some opportunistic and then a third element to hold back some dry powder for that, I'll call it a macro event that the market just goes down that you want to hold back. So I would say that our plan would be to have 1/3 of that element kind of be in play and then the other 2/3 depending on what the opportunity is.

Okay. And just finally for me, when we look at the the NPL change and you called out the multifamily. Is there a specific reserve or charge-off that was taken in the quarter with that? Or once that's resolved later in the year there could be something that flows through?

Yes. I just can say, just to talk about the nonperformer kind of overall figure out, Mike, it's question on it. But the increase in nonperformers, it's basically a net of a pay down of an existing [indiscernible] the addition of the pay down of the existing one related to the Shared National Credit beverage distribution business that we talked about in January. In that case, we said we'd allocated a specific reserve that one in given recent events will only be 3, and so that's been true up [indiscernible] and that was [indiscernible]. The new nonperformance is a $55 million multifamily credit, as I mentioned. It's in the Austin region. The owners are negotiating a sale, it's one of the few remaining loans from the 2022 vintage that was underwritten back on rates and costs were much, much lower. For some time now, those loans have been taken out by private credit. But in this case, they've got a third-party equity partner that's unwilling to participate further to do what it takes to make that happen, so that precipitates the sale and without going in too much detail in situations like this one party can be hesitant to cover the expenses for the benefit of another party, which leaves the project in [indiscernible] until you get a sale that we sold to these issues. I think as I said, the expected to be little, if any, impact on bank. But until that sale occurs in this situation, we need to be classified as an [indiscernible] and that's what we've done. I can't recall if we have a specific result on it. If we do, it's very small, but we expect that it's got a guarantor on it. We expect to be taking have a little reserve on...

About $1.5 million.

$1.5 million pretty small. And range be seen if we will hopefully need to..

Our next question is from Casey Haire with Autonomous Research.

I wanted to touch on the NII guide again. So basically, the -- you guys are pointing to negative beta as the year progresses, but a little bit of NIM expansion. So I'm guessing that is fixed freight asset repricing and a rebound in loan yields to offset the deposit headwind pressure. Maybe just a little bit more color on that? And where are new money loan yields today versus that 617 and maybe spot loan yields at June 30?

So a lot of it is just fixed rate repricing, whether that be fixed rate loans or in our investment portfolio. So our fixed rate loans, what we're anticipating for the back half is a little bit over $0.5 billion, and we'll probably pick up somewhere north of $120, $125 in the spread between what's rolling off and what we're able to replace it with. When you look at our investments for the rest of the year. We're anticipating getting back about $1.5 billion in the, let's say, call it, 360, 365 range. And so we certainly have the ability to -- I think we're looking at yields in the 525, 540. So let's call it a pickup of 170 to 180 for reinvesting that part that's coming back. I would say, looking at really where we are on our loan yields. I think it just -- it depends on the mix. So I think what what I would expect is continued, depending on where we grow in the back half of the year, we're seeing some opportunities on the CRE. And generally, those get higher yields than what our average yields are overall. We are seeing growth on the mortgage product. And those are probably a little bit on the lower side of what our average yield is, and we're making that conscious decision to grow that portfolio. We feel like that's a strategic decision. And just to go off on a little bit of a tangent on the mortgage right now, the numbers that we got, we're able to -- our mortgage loans are attracting 45% new customers to the bank. And this -- as of this quarter, we've been able to convert those 45%, 35% of those. We've added a checking account or another account and the average balances on those accounts are around 22,500, which is pretty -- it's stronger than our what our average deposit for a consumer is. And so I feel like that's been a really strong product for customer acquisition. And just also keep in mind. Yes, just one more thing on just where you're getting the NII. There is a $250 million treasury that's maturing in August that's yielding at sub-1%. So we'll have a pickup in the fourth quarter with that repricing.

Got you. Okay. And then just 1 follow-up. The -- just big picture question on the Texas marketplace. We're hearing from not just you, from everyone that's obviously very competitive with some new entrants. I just wanted to draw on -- you guys have been at this a long time. How do you like -- how do you expect this to play out? Like is this just the new dynamic will -- we'll see this last for a number of years? Or what -- based on your experience, how do you expect this to play out?

It's a good question. We've seen it a lot. And I think it will normalize after probably a couple of years. Some of these deals that are being made that are very structured light. You're never going to know if that's a good loan or bad loan for another couple of years. And then things soften up, they'll see some things they wish they hadn't done and it will change their perspective on what they'll do going forward. We see that a lot. You see people who are very aggressive in the market and then things turn a little bit and they disappear. And that's one of the things that is I think, well known about our company is that we're always in the game. I call it, we're in the fairway. We may boost the left fairway a little bit, maybe to the right but we're in the fairway, we're easy to find, right? We're going to be in the marketplace. So I think it takes a couple of years for some of these aggressive things to work their way through. And people try to buy market share, right? They try to come into a market, they're aggressive. They're not crazy. I mean it's a pretty standard playbook. I mean I'm doing it in mortgage, right? And we're being very price competitive in that because we want to be an element of the market that has to be accounted for others were being accounted for. And so we are being very successful. What we always see that same level of progressive pricing? No, we're not. We're getting near $1 billion there. And so our pricing will tighten up. So I'm doing it, and that's sort of my perspective on it. It's been a couple of years that I've been new in that market. So that's kind of what I would expect to see.

Our next question is from Catherine Mealor with KBW.

I had a follow-up question just on the loan yield discussion. Did the change in SOFR throughout the quarter had any impact on loan yields this quarter that may help boost the loan yield as we go into the third quarter. We saw that a few other competitors that have big floating rate [indiscernible] and was curious if that impacted you at all as well?

There was -- we there's about a 1 basis point impact of that SOFR index being, I think, around 3 basis points higher last quarter than this quarter. So the impact to our loan yield was about 1 basis point. Yes, I think the -- when we looked at kind of the loan yields, a lot of it was just it's not 1 thing, it's several -- and it's -- some of it is just mix is what's what ended up increasing. We did decide to refinance some commercial real estate and put them on longer-term longer terms. And part of that, we did lower the yield because at that point, the construction risk and the lease-up risk had been removed -- and so we were -- the choices were do we want to keep those loans on the books? Or do we want them to be refinanced into the permanent market and these -- this commercial mortgage program has grown, and it's around $700 million. And it's to our kind of choice developers that we have had a long relationship with and on properties that we feel like our, I'll call them legacy properties that they're very lowly leveraged and have high debt coverage ratios that we feel really good about putting some longer terms in what we typically would do in terms of being just a construction lender and then letting a permanent lender kind of take us out.

Okay. Very helpful. And then just a picture question on the outlook, you've increased the revenue guide for both season NII and then taking down expenses. So it feels like we're coming into this positive operating moment that we've been waiting for as we move to the back end of your branch expansion plan. And curious, as you look into '27 without giving specific guidance for '27, is that a trend that you would expect to continue?

Yes. I mean I think we're at around 140 basis points of positive operating leverage for this quarter, and I think even for year-to-date. And so that's that's a significant moment. And we recognize that and we see that '27, again, without giving guidance, I would say that with the the tailwinds that we have with loan growth and with these just overall, I would say, growth in funding sources and deposit growth end with just again, what I mentioned on our ability now to have just a higher base of expense to grow out that I feel good about '27 being a year that we can maintain positive operating leverage.

Our next question is from Peter Winter with D.A. Davidson.