Executive Summary / Key Takeaways

• Cullen/Frost Bankers, a venerable Texas institution, is leveraging its deep regional roots and relationship-focused model to drive robust organic growth, significantly outpacing peers in key metrics like consumer checking households and new commercial relationships.
• The company's strategic expansion across major Texas markets (Houston, Dallas, Austin) is yielding substantial gains in loans and deposits, with earlier phases now funding current efforts and the overall program poised for earnings accretion starting in 2026.
• Recent financial performance reflects strategic success, with strong net interest income growth driven by lower funding costs and asset repricing, alongside solid non-interest income gains from expanding customer volumes and wealth management activities.
• While credit quality remains sound by historical standards, management is prudently adjusting allowance levels through qualitative overlays to account for potential macroeconomic headwinds like tariffs and recession risk, particularly in commercial real estate and C&I portfolios.
• CFR maintains a strong capital and liquidity position, providing flexibility for continued investment in growth initiatives, technology enhancements, and shareholder returns, including a commitment to dividend increases.

A Foundation Built on Texas Soil

Cullen/Frost Bankers, Inc. stands as a financial bedrock in Texas, its history stretching back to 1868. This long tenure has imbued the institution with a deep understanding of the state's dynamic economy and a resilient operating philosophy, enabling it to weather numerous economic cycles, interest rate fluctuations, and market shifts. More than just a historical artifact, this legacy informs a core strategy centered on relationship banking, localized expertise, and a commitment to high-quality customer service – a stark contrast to the scale-driven models of national giants.

The company operates primarily through two segments: Banking and Frost Wealth Advisors. The Banking segment encompasses traditional commercial and consumer lending and deposit-taking, forming the bulk of the business. Frost Wealth Advisors provides a suite of fee-based services including trust, investment management, and insurance. This structure, overlaid by a regional reporting model across Texas's key metropolitan areas, allows CFR to maintain a community-focused approach while scaling its offerings.

A pivotal strategic shift began in late 2018 with a focused organic expansion initiative. Starting with 131 financial centers, the company embarked on a plan to significantly increase its physical presence in high-growth Texas markets like Houston, Dallas, and Austin. This effort is nearing a significant milestone, with the 200th location expected to open around mid-2025, marking a more than 50% increase in its footprint. This expansion is not merely about adding branches; it's a deliberate strategy to plant roots in new communities, cultivate relationships, and capture market share through direct engagement.

Fueling Growth Through Strategic Investment and Operational Excellence

The organic growth strategy is yielding tangible results, particularly in customer acquisition. As of the first quarter of 2025, the overall expansion efforts launched in late 2018 had generated $2.64 billion in deposits, $1.9 billion in loans, and brought in 64,000 new households. Notably, loan generation has significantly exceeded initial goals, demonstrating strong market penetration. The success of earlier expansion locations, particularly in Houston, has been crucial, with their performance now providing the capital to fund the ongoing build-out in newer markets like Austin. Management anticipates the entire expansion program will turn accretive to earnings beginning in 2026, signaling a transition from investment phase to harvest phase.

Operational execution underpins this growth. The first quarter of 2025 saw record levels of calling activity by the company's officers, leading to a record number of new opportunities entering the pipeline. This proactive approach is translating into new relationships, with 972 new commercial relationships added in Q1 2025, an 18% increase year-over-year and the largest first quarter total on record. A significant portion of this new business, half of the new commercial relationships in Q1 2025, is being captured from larger "too big to fail banks," highlighting CFR's ability to attract customers seeking a different banking experience.

The consumer business is a particular bright spot, consistently delivering strong growth. Average consumer loan balances grew by over 20% year-over-year in Q1 2025, marking the eleventh consecutive quarter of this robust performance. This is largely driven by the popularity of the company's second lien home equity products and its relatively new mortgage offering, which is gaining momentum and has received national recognition for customer experience. Consumer checking household growth, a key metric for core deposit acquisition, remains industry-leading at 5.7% year-over-year, achieved without resorting to the direct cash incentives often used by competitors. This success is attributed to the company's reputation for outstanding service, recognized by JD Power for 16 consecutive years, and investments in its physical network, marketing, and technology.

Technology as an Enabler of Service and Efficiency

While not defined by a single, proprietary "core technology" in the manufacturing sense, CFR leverages technology strategically to enhance its service model and operational efficiency. Key technological differentiators lie in its customer-facing digital platforms and internal systems supporting relationship management and risk assessment.

The company's mobile banking application is a notable strength, having been rated highly in app stores. This provides a seamless digital channel for customers, complementing the physical branch network and contributing to the overall customer experience that drives checking household growth. On the internal side, investments in technology, furniture, and equipment are significant, increasing by 14.6% in Q1 2025, driven by higher cloud services expense and software maintenance costs. These investments are aimed at modernizing legacy systems, enhancing cybersecurity, and improving risk management capabilities.

Management also highlighted the implementation of new tools and enhanced internal procedures in 2025 designed to identify fraudulent activity more accurately and rapidly. This operational improvement has a direct financial impact, leading to deposit overdrafts resulting from fraud being written off directly to fraud expense rather than impacting loan charge-offs, improving the clarity of credit quality metrics. While specific quantitative metrics on the efficiency gains or cost savings from these technology investments are not detailed, the strategic intent is clearly to support growth, improve customer experience, and strengthen risk controls, contributing to the company's competitive positioning.

Financial Performance Reflecting Strategic Momentum

CFR's recent financial results underscore the effectiveness of its strategy. Net income available to common shareholders increased by 11.4% in the first quarter of 2025 compared to the prior year period, reaching $149.3 million or $2.30 per diluted common share. This improvement was largely fueled by a 6.6% increase in net interest income, which rose to $416.2 million.

The expansion in net interest income was primarily driven by a favorable shift in funding costs and asset yields. The average cost of interest-bearing deposits decreased significantly, falling 40 basis points year-over-year to 1.94% in Q1 2025, reflecting the company's ability to manage deposit pricing effectively even as market rates remained elevated. This, combined with an increase in the average volume of higher-yielding loans and taxable securities, more than offset a decrease in average yields on loans and balances held at the Federal Reserve. Consequently, the taxable-equivalent net interest margin expanded by 12 basis points to 3.60% in Q1 2025.

Non-interest income also contributed meaningfully to the bottom line, increasing by 11.3% to $124.0 million. This growth was broad-based across fee categories. Trust and investment management fees rose by 9.8%, benefiting from higher average asset values and increased transaction volumes. Service charges on deposit accounts saw a substantial 15.4% increase, driven by higher overdraft charges and commercial service fees linked to growing account volumes and treasury management activity. Insurance commissions and fees were particularly strong, up 14.9%, with management noting that 80% of this growth was attributable to net new business or market share gains, reflecting successful cross-selling and market penetration efforts.

Operating expenses increased by 6.7% in Q1 2025, primarily due to investments in personnel (salaries and benefits), technology, and the ongoing branch expansion. This high single-digit expense growth is consistent with the company's stated strategy of investing for future growth and is expected to continue in the near term before potentially moderating as the expansion matures and operational efficiencies from technology investments are realized.

Prudent Credit Management Amidst Economic Crosscurrents

CFR maintains a conservative approach to credit risk, which is a cornerstone of its long-term stability. Credit quality remains sound by historical standards, with net charge-offs at 19 basis points of average loans in Q1 2025, within management's expected range of 20-25 basis points for the full year. Non-performing assets and problem loans saw a slight decrease in Q1 2025 compared to year-end 2024, totaling $85 million and $890 million, respectively.

The allowance for credit losses on loans stood at 1.32% of total loans at March 31, 2025. Management utilizes a comprehensive methodology, including modeled expected credit losses based on macroeconomic forecasts (like Moody's scenarios) and qualitative adjustments (Q-Factors and overlays). These qualitative adjustments are crucial for capturing risks not fully reflected in models, such as the potential impact of tariffs, recession risk, specific portfolio attributes, and credit concentrations. Overlays are also applied to commercial real estate portfolios to address concerns related to capital markets access for refinancing, slower lease-up, and the impact of higher rates on floating-rate loans, as well as longer-term uncertainties in the office sector. While management acknowledges these potential headwinds and prudently adjusts reserves, they emphasize that current problem loan activity appears to be isolated incidents rather than systemic issues.

Capital Strength and Liquidity Flexibility

CFR maintains a robust capital position, comfortably exceeding all regulatory requirements under Basel III and the minimum levels to be considered well-capitalized. Shareholders' equity increased to $4.10 billion at March 31, 2025, supported by net income and other comprehensive income gains related to the increase in fair value of available-for-sale securities. The company's capital management priorities include a strong commitment to its dividend, which has seen 32 consecutive years of increases, and opportunistic share repurchases under a recently authorized $150 million program.

Liquidity remains a significant strength. As of March 31, 2025, the company held approximately $7.10 billion in an interest-bearing account at the Federal Reserve. This substantial cash position, combined with significant borrowing capacity at the FHLB ($6.50 billion) and a large portfolio of pledgeable securities ($9.70 billion), provides ample flexibility to fund loan growth, manage deposit fluctuations, and navigate potential market volatility without relying on more volatile funding sources like brokered deposits.

Competing in a Dynamic Texas Market

CFR operates in a highly competitive Texas market, facing off against a diverse set of players ranging from national banks like Bank of America (BAC) and Truist Financial (TFC) to regional institutions like PNC Financial Services Group (PNC) and Citizens Financial Group (CFG), as well as a growing presence of fintech firms and private credit providers.

National banks like BAC and TFC possess significant scale, vast resources, and extensive digital capabilities that allow them to compete aggressively on pricing and offer a wide array of products. Their larger size often translates to lower operating costs per unit and greater capacity for large-scale technology investments. However, CFR differentiates itself through its deep-rooted Texas brand, localized decision-making, and a relationship-centric model that resonates with many businesses and consumers, particularly those seeking personalized service. This allows CFR to capture new commercial relationships, including a significant number from larger banks, and maintain industry-leading consumer checking growth without resorting to cash incentives.

Regional peers like PNC and CFG also compete in overlapping segments and are investing in digital platforms and expanding their footprints. While they may have advantages in operational efficiency due to scale, CFR's specific expertise in Texas industries like energy and healthcare, coupled with its established branch network, provides a competitive edge in these niche markets. The company's discipline on loan structure, even if it means losing deals on terms, is a key differentiator against competitors willing to offer less stringent terms, particularly in commercial real estate.

The rise of fintech and private credit introduces new competitive dynamics. Fintech firms challenge traditional banking models with lower-cost digital-only services, impacting areas like payments and consumer lending. Private credit is increasingly active in providing alternative financing, particularly for commercial real estate projects that may not currently meet traditional bank underwriting criteria. CFR acknowledges these players and adapts by enhancing its own digital offerings and focusing on areas where its relationship model and local knowledge provide a distinct advantage.

Overall, CFR's competitive positioning is defined by its ability to leverage its regional strengths and service model to capture organic growth in a competitive landscape. While facing challenges from larger, more efficient players and disruptive new entrants, its focus on relationship banking, prudent risk management, and strategic investment in its network and technology provides a durable foundation for continued success in the attractive Texas market.

Conclusion

Cullen/Frost Bankers continues to execute effectively on its organic growth strategy, demonstrating the power of a relationship-focused model in the vibrant Texas economy. The ongoing expansion is successfully driving new customer acquisition and balance sheet growth, setting the stage for future earnings accretion. Strong financial performance in the first quarter of 2025, marked by expanding net interest income and robust fee income growth, reflects the benefits of strategic investments and favorable funding dynamics. While macroeconomic uncertainties and competitive pressures necessitate prudent risk management and ongoing investment, CFR's solid capital base, ample liquidity, and commitment to its core values position it well to capitalize on future opportunities. For investors, CFR represents a high-quality regional bank with a clear growth trajectory, underpinned by a resilient business model and a commitment to shareholder returns, making it a compelling consideration in the current environment.