Cullen/Frost: Texas' Organic Growth Powerhouse Reaps Accretion (NYSE:CFR) - CFR Stock Research Report

## Executive Summary / Key Takeaways * Cullen/Frost Bankers, Inc. has validated its long-term organic expansion strategy, with the overall effort becoming accretive to earnings in the third quarter of 2025, ahead of prior expectations. * The company delivered strong financial performance in Q3 2025, marked by significant increases in net income, net interest income, and non-interest income, reflecting effective balance sheet management and robust customer acquisition. * CFR maintains a disciplined approach to credit quality, with nonperforming assets declining and problem loans showing improvement, supported by proactive risk management and qualitative adjustments. * Strategic investments in technology and a growing branch network in high-growth Texas markets are foundational to its competitive differentiation and future growth trajectory. * Despite increasing competition and evolving macroeconomic conditions, Cullen/Frost's customer-centric model and low funding costs position it favorably to capture market share and drive sustained value. ## A Legacy of Growth and a Vision for Texas Cullen/Frost Bankers, Inc. (NYSE:CFR), founded in 1868, stands as a testament to enduring financial strength and adaptability within the dynamic Texas market. The company's long history demonstrates its ability to grow and prosper through diverse economic cycles, including periods of fluctuating interest rates, employment levels, recessions, and expansions. This deep institutional experience underpins its current strategic approach, which is firmly rooted in organic expansion and a steadfast commitment to customer service. CFR's overarching strategy centers on extending its value proposition across Texas, a state characterized by robust economic growth. A pivotal shift occurred in late 2018 with the launch of an aggressive organic expansion strategy. Starting with 131 financial centers, the company reached a significant milestone in the second quarter of 2025, opening its 200th location in Austin, representing a more than 50% increase in its physical footprint. This expansion, particularly in high-growth metropolitan areas like Houston, Dallas, and Austin, is designed to capture new households, deposits, and loans. The success of earlier expansion locations, such as Houston 1.0 (now with an average branch age of 5.5 years), is now funding newer endeavors, a testament to the strategy's durability and scalability. Crucially, this overall expansion effort achieved accretion to earnings in the third quarter of 2025, earlier than the previously projected 2026. ## Competitive Edge and Technological Foundation Cullen/Frost operates in a highly competitive financial services landscape, facing both direct and indirect rivals. Direct competitors, such as Regions Financial Corporation (TICKER:RF), Comerica Incorporated (TICKER:CMA), Zions Bancorporation (TICKER:ZION), and Huntington Bancshares Incorporated (TICKER:HBAN), offer similar commercial and consumer banking services across Texas and surrounding regions. CFR differentiates itself through a deeply ingrained relationship-based banking model, a strong regional brand, and an extensive branch network. This approach fosters exceptional customer loyalty, evidenced by 16 consecutive years of being ranked number one in Texas for consumer banking satisfaction by J.D. Power. This strong brand and localized expertise allow CFR to command pricing power and maintain stable revenue streams, even as competitors may offer more aggressive terms or structures. The company's competitive positioning is further bolstered by its low funding costs, which enable it to compete effectively on price when necessary, while maintaining strict underwriting standards on loan structure. Management notes that approximately half of its new commercial relationships originate from larger, "too big to fail" banks, highlighting CFR's ability to attract customers seeking a more personalized and responsive banking experience. Furthermore, CFR explicitly favors organic growth over mergers and acquisitions, viewing competitor M&A activity as a source of market dislocation that creates opportunities to attract new customers and bankers. While CFR's core competitive advantages are rooted in its service model and physical presence, the company also makes substantial investments in technology. These investments are critical for modernizing legacy systems, enhancing cybersecurity, and improving the digital customer experience. Despite lacking proprietary, quantifiable technology differentiators, the strategic intent behind these investments is clear: to reduce risk, improve operational efficiency, and support growth initiatives. For instance, enhanced internal procedures were implemented in mid-2023 to identify fraudulent activity more accurately and rapidly, leading to direct write-offs to fraud expense rather than through the allowance for credit losses. These ongoing technological upgrades are essential for maintaining competitiveness against digitally advanced rivals and fintech companies, which represent a growing indirect competitive threat by offering alternative lending platforms, mobile banking, and automated investment tools. ## Operational Excellence and Financial Performance Cullen/Frost's strategic initiatives translated into robust financial performance in the third quarter of 2025. Net income available to common shareholders rose to $172.7 million, or $2.67 per diluted common share, marking a 19.2% increase from the same period in 2024. For the nine months ended September 30, 2025, net income available to common shareholders increased by 12.9% to $477.3 million. This growth was primarily driven by a $37.3 million increase in net interest income and an $11.9 million increase in non-interest income for the quarter, alongside a $12.6 million decrease in credit loss expense.

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Net interest income (NII) for the third quarter of 2025 increased by $37.3 million, or 9.2%, compared to the prior year, reaching $441.6 million. The taxable-equivalent net interest margin expanded by 13 basis points to 3.69% in Q3 2025, up from 3.56% in Q3 2024. This improvement was largely due to decreases in the average costs of interest-bearing deposit accounts and repurchase agreements, coupled with increased yields and volumes in taxable and tax-exempt securities, and a higher average volume of loans. The average rate paid on interest-bearing liabilities decreased by 47 basis points to 2.13% in Q3 2025 compared to Q3 2024, reflecting effective deposit cost management. Non-interest income also demonstrated strong growth, increasing by 10.5% to $125.6 million in Q3 2025. Trust and investment management fees, a significant component, grew by 9.3% for the quarter and 8.2% year-to-date, driven by increases in investment management fees and estate fees, partly due to higher average equity valuations and growth in account numbers. Service charges on deposit accounts increased by 14.7% for the quarter, primarily from commercial service charges and overdraft charges on consumer accounts, reflecting growth in customer volumes. Insurance commissions and fees also saw a 3.9% increase for the quarter and 6.9% year-to-date. Operating expenses, however, remain a focus area. Non-interest expense increased by 9% for the quarter and 8.4% year-to-date, primarily due to higher salaries and wages, employee benefits, net occupancy, and technology-related costs. Management acknowledges this elevated expense growth but views it as necessary investment in the company's long-term growth, risk reduction, and competitive capabilities, with expectations for moderation towards mid-single digits in 2026 or 2027 as these investments mature.

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## Balance Sheet Strength and Credit Quality Cullen/Frost maintains a robust balance sheet and strong liquidity. Total assets stood at $52.53 billion as of September 30, 2025, with total loans (net of unearned discounts) at $21.45 billion. Average deposits in Q3 2025 were $42.1 billion, an increase of 3.3% year-over-year. The company prides itself on not relying on FHLB advances or brokered deposits for funding or liquidity, emphasizing that "what you see is what you get" on its balance sheet. As of September 30, 2025, liquid assets, primarily cash on deposit at Frost Bank, totaled $314 million, complemented by a $6.8 billion borrowing capacity with the FHLB and $12.8 billion in pledgeable securities.

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Credit quality remains strong by historical standards. Nonperforming assets declined significantly to $47 million at the end of Q3 2025, down from $64 million last quarter and $106 million a year ago. This figure represents a mere 22 basis points of period-end loans and 9 basis points of total assets. Net charge-offs for the third quarter were $6.6 million, or an annualized 12 basis points of average loans, reflecting a healthy credit environment. Total problem loans (risk grade 10 or higher) decreased to $828 million from $989 million last quarter, largely due to the successful resolution of several multifamily loans. The allowance for credit losses on loans totaled $280.2 million at September 30, 2025, representing 1.31% of total loans. Management employs a comprehensive methodology, including qualitative (Q-Factor) adjustments and model overlays, to account for risks not fully captured by models, such as economic recession, credit concentrations, and specific commercial real estate market dynamics (e.g., office building utilization, capital market access for refinancing). The company also proactively managed its exposure to the "Buy Here Pay Here" used car segment by reducing approximately $50 million from that asset class in mid-2023, demonstrating a forward-looking approach to risk. ## Outlook and Strategic Trajectory Cullen/Frost's guidance for the full year 2025 reflects continued optimism, albeit with a cautious eye on macroeconomic factors. The company anticipates one 25 basis point Fed funds rate cut in December 2025. Despite this, net interest income growth is projected to be in the range of 7% to 8%, an increase from prior guidance, with net interest margin expected to improve by 12 to 15 basis points over 2024's 3.53%. This NII and NIM strength is supported by strategic investment portfolio purchases and lower deposit costs. Average loan growth is expected to be in the range of 6.5% to 7.5%, driven by robust consumer lending (with a year-end goal of $0.5 billion in mortgages outstanding) and commercial activity, despite anticipated commercial real estate paydowns. Average deposit growth is projected between 2.5% and 3.5%, benefiting from new customer acquisition and potential shifts from off-balance sheet funds in a lower rate environment. Non-interest income growth is now guided higher, in the range of 6.5% to 7.5%, reflecting strong broad-based growth. Non-interest expense growth is expected to be in the high single digits, consistent with ongoing strategic investments. Net charge-offs are anticipated to improve to 15 to 20 basis points of average loans, and the effective tax rate is expected to be between 16% and 17%. The organic expansion strategy remains a cornerstone of the long-term outlook. Management foresees continued significant room for growth within Texas, particularly in Houston and Dallas, where market shares remain relatively low despite substantial branch expansion. The accretion from these maturing expansion markets is expected to be a growing contributor to earnings in 2026 and beyond. ## Conclusion Cullen/Frost Bankers, Inc. presents a compelling investment thesis grounded in its proven organic growth strategy, deeply embedded customer-centric culture, and disciplined financial management. The recent achievement of accretion from its multi-year expansion efforts validates its long-term vision and operational execution. Despite a competitive landscape and evolving interest rate environment, CFR's strong regional brand, low funding costs, and strategic investments in its branch network and technology provide a robust competitive moat. The company's consistent financial performance, healthy credit quality, and clear guidance for continued growth underscore its resilience and potential for sustained shareholder value creation. Investors should recognize CFR's unique positioning as a Texas-focused powerhouse, poised to capitalize on the state's economic dynamism through its methodical and relationship-driven approach, with technological enhancements supporting its core strengths.