# Cullen/Frost Bankers, Inc.: Form 10-Q for the period ended Mar 31, 2023

- Company: [Cullen/Frost Bankers, Inc.](/companies/cfr.md) (CIK 39263)
- Form: 10-Q
- Filed: 2023-04-27
- Accepted by EDGAR: Apr 27, 2023, 15:10 ET
- Period: 2023-03-31
- Accession: 0000039263-23-000043
- Inline XBRL: yes
- Main document: https://www.sec.gov/Archives/edgar/data/39263/000003926323000043/cfr-20230331.htm
- All documents and exhibits: https://www.sec.gov/Archives/edgar/data/39263/000003926323000043/

## Figures reported in this filing

Standardized XBRL line items for the period ended 2023-03-31.

| Line item | Period | Value | XBRL concept |
| --- | --- | ---: | --- |
| Revenue | 3 months, 2023-01-01 to 2023-03-31 | $21.9m | us-gaap:RevenueFromContractWithCustomerExcludingAssessedTax |
| Interest expense | 3 months, 2023-01-01 to 2023-03-31 | $135.4m | us-gaap:InterestExpense |
| Income tax | 3 months, 2023-01-01 to 2023-03-31 | $33.2m | us-gaap:IncomeTaxExpenseBenefit |
| Net income | 3 months, 2023-01-01 to 2023-03-31 | $177.7m | us-gaap:NetIncomeLoss |
| Diluted EPS | 3 months, 2023-01-01 to 2023-03-31 | $2.70 | us-gaap:EarningsPerShareDiluted |
| Basic EPS | 3 months, 2023-01-01 to 2023-03-31 | $2.71 | us-gaap:EarningsPerShareBasic |
| Diluted shares (weighted) | 3 months, 2023-01-01 to 2023-03-31 | 64,632,076 shares | us-gaap:WeightedAverageNumberOfDilutedSharesOutstanding |
| Operating cash flow | 3 months, 2023-01-01 to 2023-03-31 | $168.3m | us-gaap:NetCashProvidedByUsedInOperatingActivities |
| Capital expenditure | 3 months, 2023-01-01 to 2023-03-31 | $46.1m | us-gaap:PaymentsToAcquirePropertyPlantAndEquipment |
| Dividends paid | 3 months, 2023-01-01 to 2023-03-31 | $56.6m | us-gaap:PaymentsOfDividendsCommonStock |
| Share repurchases | 3 months, 2023-01-01 to 2023-03-31 | $1.2m | us-gaap:PaymentsForRepurchaseOfCommonStock |
| Total assets | at 2023-03-31 | $51.25bn | us-gaap:Assets |
| Total liabilities | at 2023-03-31 | $47.78bn | us-gaap:Liabilities |
| Shareholders' equity | at 2023-03-31 | $3.47bn | us-gaap:StockholdersEquity |

## Management's discussion and analysis

As filed, 104,957 characters.

### Financial Review

The following discussion should be read in conjunction with our consolidated financial statements, and notes thereto, for the year ended December 31, 2022, and the other information included in the 2022 Form 10-K. Operating results for the three months ended March 31, 2023 are not necessarily indicative of the results for the year ending December 31, 2023 or any future period.

Dollar amounts in tables are stated in thousands, except for per share amounts.

### Forward-Looking Statements and Factors that Could Affect Future Results

Certain statements contained in this Quarterly Report on Form 10-Q that are not statements of historical fact constitute forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995 (the “Act”), notwithstanding that such statements are not specifically identified as such. In addition, certain statements may be contained in our future filings with the SEC, in press releases, and in oral and written statements made by us or with our approval that are not statements of historical fact and constitute forward-looking statements within the meaning of the Act. Examples of forward-looking statements include, but are not limited to: (i) projections of revenues, expenses, income or loss, earnings or loss per share, the payment or nonpayment of dividends, capital structure and other financial items; (ii) statements of plans, objectives and expectations of Cullen/Frost or its management or Board of Directors, including those relating to products, services or operations; (iii) statements of future economic performance; and (iv) statements of assumptions underlying such statements. Words such as “believes”, “anticipates”, “expects”, “intends”, “targeted”, “continue”, “remain”, “will”, “should”, “may” and other similar expressions are intended to identify forward-looking statements but are not the exclusive means of identifying such statements.

Forward-looking statements involve risks and uncertainties that may cause actual results to differ materially from those in such statements. Factors that could cause actual results to differ from those discussed in the forward-looking statements include, but are not limited to:

- The effects of and changes in trade and monetary and fiscal policies and laws, including the interest rate policies of the Federal Reserve Board.
- Inflation, interest rate, securities market and monetary fluctuations.
- Local, regional, national and international economic conditions and the impact they may have on us and our customers and our assessment of that impact.
- Changes in the financial performance and/or condition of our borrowers.
- Changes in the mix of loan geographies, sectors and types or the level of non-performing assets and charge-offs.
- Changes in estimates of future credit loss reserve requirements based upon the periodic review thereof under relevant regulatory and accounting requirements.
- Changes in our liquidity position.
- Impairment of our goodwill or other intangible assets.
- The timely development and acceptance of new products and services and perceived overall value of these products and services by users.
- Changes in consumer spending, borrowing and saving habits.
- Greater than expected costs or difficulties related to the integration of new products and lines of business.
- Technological changes.
- The cost and effects of cyber incidents or other failures, interruptions or security breaches of our systems or those of our customers or third-party providers.
- Acquisitions and integration of acquired businesses.
- Changes in the reliability of our vendors, internal control systems or information systems.
- Our ability to increase market share and control expenses.
- Our ability to attract and retain qualified employees.
- Changes in our organization, compensation and benefit plans.
- The soundness of other financial institutions.
- Volatility and disruption in national and international financial and commodity markets.
- Changes in the competitive environment in our markets and among banking organizations and other financial service providers.
- Government intervention in the U.S. financial system.
- Political or economic instability.
- Acts of God or of war or terrorism.
- The potential impact of climate change.
- The impact of pandemics, epidemics or any other health-related crisis.
- The costs and effects of legal and regulatory developments, the resolution of legal proceedings or regulatory or other governmental inquiries, the results of regulatory examinations or reviews and the ability to obtain required regulatory approvals.
- The effect of changes in laws and regulations (including laws and regulations concerning taxes, banking, securities and insurance) and their application with which we and our subsidiaries must comply.
- The effect of changes in accounting policies and practices, as may be adopted by the regulatory agencies, as well as the Public Company Accounting Oversight Board, the Financial Accounting Standards Board and other accounting standard setters.
- Our success at managing the risks involved in the foregoing items.

In addition, financial markets and global supply chains may continue to be adversely affected by the current or anticipated impact of military conflict, including the current Russian invasion of Ukraine or other geopolitical events.

Forward-looking statements speak only as of the date on which such statements are made. We do not undertake any obligation to update any forward-looking statement to reflect events or circumstances after the date on which such statement is made, or to reflect the occurrence of unanticipated events.

### Application of Critical Accounting Policies and Accounting Estimates

We follow accounting and reporting policies that conform, in all material respects, to accounting principles generally accepted in the United States and to general practices within the financial services industry. The preparation of financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. While we base estimates on historical experience, current information and other factors deemed to be relevant, actual results could differ from those estimates.

We consider accounting estimates to be critical to reported financial results if (i) the accounting estimate requires management to make assumptions about matters that are highly uncertain and (ii) different estimates that management reasonably could have used for the accounting estimate in the current period, or changes in the accounting estimate that are reasonably likely to occur from period to period, could have a material impact on our financial statements.

Accounting policies related to the allowance for credit losses on financial instruments including loans and off-balance-sheet credit exposures are considered to be critical as these policies involve considerable subjective judgment and estimation by management. In the case of loans, the allowance for credit losses is a contra-asset valuation account, calculated in accordance with Accounting Standards Codification (“ASC”) Topic 326 (“ASC 326”) Financial Instruments - Credit Losses, that is deducted from the amortized cost basis of loans to present the net amount expected to be collected. In the case of off-balance-sheet credit exposures, the allowance for credit losses is a liability account, calculated in accordance with ASC 326, reported as a component of accrued interest payable and other liabilities in our consolidated balance sheets. The amount of each allowance account represents management's best estimate of current expected credit losses on these financial instruments considering available information, from internal and external sources, relevant to assessing exposure to credit loss over the contractual term of the instrument. Relevant available information includes historical credit loss experience, current conditions and reasonable and supportable forecasts. While historical credit loss experience provides the basis for the estimation of expected credit losses, adjustments to historical loss information may be made for differences in current portfolio-specific risk characteristics, environmental conditions or other relevant factors. While management utilizes its best judgment and information available, the ultimate adequacy of our allowance accounts is dependent upon a variety of factors beyond our control, including the performance of our portfolios, the economy, changes in interest rates and the view of the regulatory authorities toward classification of assets. Refer to the 2022 Form 10-K for additional information regarding critical accounting policies.

### Overview

A discussion of our results of operations is presented below. Certain reclassifications have been made to make prior periods comparable. Taxable-equivalent adjustments are the result of increasing income from tax-free loans and investments by an amount equal to the taxes that would be paid if the income were fully taxable based on a 21% federal tax rate, thus making tax-exempt yields comparable to taxable asset yields.

### Results of Operations

Net income available to common shareholders totaled $176.0 million, or $2.70 per diluted common share, for the three months ended March 31, 2023 compared to $97.4 million, or $1.50 per diluted common share, for the three months ended March 31, 2022.

Selected data for the comparable periods was as follows:

|  | Three Months Ended March 31, 2023 | 2022 |
| --- | ---: | ---: |
| Taxable-equivalent net interest income | $425,844 | $272,194 |
| Taxable-equivalent adjustment | 26,024 | 23,123 |
| Net interest income | 399,820 | 249,071 |
| Credit loss expense | 9,104 | — |
| Net interest income after credit loss expense | 390,716 | 249,071 |
| Non-interest income | 105,265 | 101,390 |
| Non-interest expense | 285,142 | 238,732 |
| Income before income taxes | 210,839 | 111,729 |
| Income taxes | 33,186 | 12,627 |
| Net income | 177,653 | 99,102 |
| Preferred stock dividends | 1,669 | 1,669 |
| Net income available to common shareholders | $175,984 | $97,433 |
| Earnings per common share – basic | $2.71 | $1.51 |
| Earnings per common share – diluted | 2.70 | 1.50 |
| Dividends per common share | 0.87 | 0.75 |
| Return on average assets | 1.39% | 0.79% |
| Return on average common equity | 22.59 | 9.58 |
| Average shareholders’ equity to average assets | 6.44 | 8.48 |

Net income available to common shareholders increased $78.6 million, or 80.6%, for the three months ended March 31, 2023 compared to the same period in 2022. The increase during the three months ended March 31, 2023 was primarily the result of a $150.7 million increase in net interest income and a $3.9 million increase in non-interest income partly offset by a $46.4 million increase in non-interest expense, a $20.6 million increase in income tax expense and a $9.1 million increase in credit loss expense. Details of the changes in the various components of net income are further discussed below.

### Net Interest Income

Net interest income is the difference between interest income on earning assets, such as loans and securities, and interest expense on liabilities, such as deposits and borrowings, which are used to fund those assets. Net interest income is our largest source of revenue, representing 79.2% of total revenue during the first three months of 2023. Net interest margin is the ratio of taxable-equivalent net interest income to average earning assets for the period. The level of interest rates and the volume and mix of earning assets and interest-bearing liabilities impact net interest income and net interest margin.

The Federal Reserve influences the general market rates of interest, including the deposit and loan rates offered by many financial institutions. As of March 31, 2023, approximately 42.8% of our loans had a fixed interest rate, while the remaining loans had floating interest rates that were primarily tied to the prime interest rate (approximately 26.3%); or the American Interbank Offered Rate (“AMERIBOR”); or a benchmark developed by the American Financial Exchange, the Secured Overnight Financing Rate (“SOFR”); or a benchmark developed by Bloomberg Index Services (“BSBY”) (together totaling approximately 27.2%). We discontinued originating loans based on the London Interbank Offered Rate (“LIBOR”) effective December 31, 2021 due to the fact that the most commonly used LIBOR settings will cease to be published on June 30, 2023. As of March 31, 2023, LIBOR-based loans totaled approximately 3.7% of our total loan portfolio. For our currently outstanding LIBOR-based loans, the timing and manner in which each customer’s contract transitions from LIBOR to another rate will vary on a case-by-case basis. We expect to complete all transitions by the applicable LIBOR cessation date.

Select average market rates for the periods indicated are presented in the table below.

|  | Three Months Ended March 31, 2023 | 2022 |
| --- | ---: | ---: |
| Federal funds target rate upper bound | 4.69% | 0.29% |
| Effective federal funds rate | 4.51 | 0.12 |
| Interest on reserve balances at the Federal Reserve | 4.59 | 0.19 |
| Prime | 7.69 | 3.29 |
| 1-Month LIBOR | 4.61 | 0.22 |
| 3-Month LIBOR | 4.91 | 0.51 |
| AMERIBOR Term-30(1) | 4.58 | 0.19 |
| AMERIBOR Term-90(1) | 4.88 | 0.51 |
| 1-Month Term SOFR(2) | 4.61 | 0.15 |
| 3-Month Term SOFR(2) | 4.78 | 0.33 |
| Bloomberg 1-Month Short-Term Bank Yield Index | 4.58 | 0.17 |
| Bloomberg 3-Month Short-Term Bank Yield Index | 4.82 | 0.46 |

(1) AMERIBOR Term-30 and AMERIBOR Term-90 are published by the American Financial Exchange.

(2) 1-Month Term SOFR and 3-Month Term SOFR market data are the property of Chicago Mercantile Exchange, Inc. or its licensors as applicable. All rights reserved, or otherwise licensed by Chicago Mercantile Exchange, Inc.

As of March 31, 2023, the target range for the federal funds rate was 4.75% to 5.0%. In March 2023, the Federal Reserve released projections whereby the midpoint of the projected appropriate target range for the federal funds rate would rise to 5.1% by the end of 2023 and subsequently decrease to 4.3% by the end of 2024. While there can be no such assurance that any increases or decreases in the federal funds rate will occur, these projections imply up to a 25 basis point increase in the federal funds rate during the remainder of 2023, followed by a 75 basis point decrease in 2024.

We are primarily funded by core deposits, with non-interest-bearing demand deposits historically being a significant source of funds. This lower-cost funding base is expected to have a positive impact on our net interest income and net interest margin in a rising interest rate environment. Nonetheless, our access to deposits may be negatively impacted by, among other factors, periods of higher interest rates which could promote increased competition for deposits, including from new financial technology competitors, or provide customers with alternative investment options. See Item 3. Quantitative and Qualitative Disclosures About Market Risk elsewhere in this report for information about our sensitivity to interest rates. Further analysis of the components of our net interest margin is presented below.

The following tables present an analysis of net interest income and net interest spread for the periods indicated, including average outstanding balances for each major category of interest-earning assets and interest-bearing liabilities, the interest earned or paid on such amounts, and the average rate earned or paid on such assets or liabilities, respectively. The tables also set forth the net interest margin on average total interest-earning assets for the same periods. For these computations: (i) average balances are presented on a daily average basis, (ii) information is shown on a taxable-equivalent basis assuming a 21% tax rate, (iii) average loans include loans on non-accrual status, and (iv) average securities include unrealized gains and losses on securities available for sale, while yields are based on average amortized cost.

| Assets: | Quarter To Date March 31, 2023 Average Balance | Interest Income/ Expense | Yield/ Cost | Quarter To Date March 31, 2022 Average Balance | Interest Income/ Expense | Yield/ Cost |
| --- | ---: | ---: | ---: | ---: | ---: | ---: |
| Interest-bearing deposits | $8,687,003 | $99,245 | 4.57% | $13,766,486 | $6,343 | 0.18% |
| Federal funds sold | 64,294 | 758 | 4.72 | 13,892 | 13 | 0.37 |
| Resell agreements | 89,573 | 1,068 | 4.77 | 5,835 | 4 | 0.27 |
| Securities: |  |  |  |  |  |  |
| Taxable | 13,342,207 | 97,775 | 2.67 | 9,000,677 | 43,058 | 1.90 |
| Tax-exempt | 8,401,401 | 90,692 | 4.23 | 8,165,462 | 78,898 | 4.03 |
| Total securities | 21,743,608 | 188,467 | 3.24 | 17,166,139 | 121,956 | 2.88 |
| Loans, net of unearned discounts | 17,319,061 | 271,681 | 6.36 | 16,386,458 | 151,068 | 3.74 |
| **Total Earning Assets and Average Rate Earned** | 47,903,539 | 561,219 | 4.57 | 47,338,810 | 279,384 | 2.39 |
| Cash and due from banks | 676,441 |  |  | 651,124 |  |  |
| Allowance for credit losses on loans and securities | (227,503) |  |  | (248,801) |  |  |
| Premises and equipment, net | 1,117,644 |  |  | 1,050,735 |  |  |
| Accrued interest and other assets | 1,836,957 |  |  | 1,531,609 |  |  |
| **Total Assets** | $51,307,078 |  |  | $50,323,477 |  |  |
| **Liabilities:** |  |  |  |  |  |  |
| Non-interest-bearing demand deposits | 16,636,298 |  |  | 17,961,221 |  |  |
| Interest-bearing deposits: |  |  |  |  |  |  |
| Savings and interest checking | 11,661,657 | 10,338 | 0.36 | 11,954,465 | 410 | 0.01 |
| Money market deposit accounts | 12,404,532 | 75,470 | 2.47 | 11,858,775 | 3,651 | 0.12 |
| Time accounts | 2,054,972 | 12,181 | 2.40 | 1,187,458 | 851 | 0.29 |
| Total interest-bearing deposits | 26,121,161 | 97,989 | 1.52 | 25,000,698 | 4,912 | 0.08 |
| Total deposits | 42,757,459 |  | 0.93 | 42,961,919 |  | 0.05 |
| Federal funds purchased | 51,263 | 583 | 4.55 | 27,759 | 12 | 0.17 |
| Repurchase agreements | 4,210,767 | 33,651 | 3.20 | 2,051,577 | 518 | 0.10 |
| Junior subordinated deferrable interest debentures | 123,078 | 1,988 | 6.46 | 123,020 | 584 | 1.90 |
| Subordinated notes | 99,359 | 1,164 | 4.69 | 99,203 | 1,164 | 4.69 |
| **Total Interest-Bearing Funds and Average Rate Paid** | 30,605,628 | 135,375 | 1.79 | 27,302,257 | 7,190 | 0.11 |
| Accrued interest and other liabilities | 760,304 |  |  | 790,092 |  |  |
| **Total Liabilities** | 48,002,230 |  |  | 46,053,570 |  |  |
| **Shareholders’ Equity** | 3,304,848 |  |  | 4,269,907 |  |  |
| **Total Liabilities and Shareholders’ Equity** | $51,307,078 |  |  | $50,323,477 |  |  |
| Net interest income |  | $425,844 |  |  | $272,194 |  |
| Net interest spread |  |  | 2.78% |  |  | 2.28% |
| Net interest income to total average earning assets |  |  | 3.47% |  |  | 2.33% |

39

The following table presents the changes in taxable-equivalent net interest income and identifies the changes due to differences in the average volume of earning assets and interest-bearing liabilities and the changes due to changes in the average interest rate on those assets and liabilities. The changes in net interest income due to changes in both average volume and average interest rate have been allocated to the average volume change or the average interest rate change in proportion to the absolute amounts of the change in each.

|  | Three Months Ended March 31, 2023 vs. March 31, 2022 Increase (Decrease) Due to Change in Rate | Volume | Total |
| --- | ---: | ---: | ---: |
| Interest-bearing deposits | $96,021 | $(3,119) | $92,902 |
| Federal funds sold | 568 | 177 | 745 |
| Resell agreements | 571 | 493 | 1,064 |
| Securities: |  |  |  |
| Taxable | 21,698 | 33,019 | 54,717 |
| Tax-exempt | 4,091 | 7,703 | 11,794 |
| Loans, net of unearned discounts | 111,550 | 9,063 | 120,613 |
| Total earning assets | 234,499 | 47,336 | 281,835 |
| Savings and interest checking | 9,935 | (7) | 9,928 |
| Money market deposit accounts | 71,650 | 169 | 71,819 |
| Time accounts | 10,296 | 1,034 | 11,330 |
| Federal funds purchased | 553 | 18 | 571 |
| Repurchase agreements | 32,045 | 1,088 | 33,133 |
| Junior subordinated deferrable interest debentures | 1,404 | — | 1,404 |
| Subordinated notes | — | — | — |
| Total interest-bearing liabilities | 125,883 | 2,302 | 128,185 |
| Net change | $108,616 | $45,034 | $153,650 |

Taxable-equivalent net interest income for the three months ended March 31, 2023 increased $153.7 million, or 56.4%, compared to the same period in 2022. The increase in taxable-equivalent net interest income during the three months ended March 31, 2023 was primarily related to increases in the average yield on loans and, to a lesser extent, the average volume of loans; an increase in the average yield on interest-bearing deposits (primarily amounts held in an interest-bearing account at the Federal Reserve); and increases in the average volumes of and the average taxable-equivalent yields on taxable and tax-exempt securities, among other things. The impact of these items was partly offset by increases in the average costs of interest-bearing deposit accounts and repurchase agreements, among other things, combined with a decrease in the average volume of interest-bearing deposits (primarily amounts held in an interest-bearing account at the Federal Reserve). As a result of the aforementioned fluctuations, the taxable-equivalent net interest margin increased 114 basis points from 2.33% during the three months ended March 31, 2022 to 3.47% during the three months ended March 31, 2023.

The average volume of interest-earning assets for the three months ended March 31, 2023 increased $564.7 million compared to the same period in 2022. The increase in the average volume of interest-earning assets was primarily related to a $4.3 billion increase in average taxable securities, a $932.6 million increase in average loans and a $235.9 million increase in average tax-exempt securities partly offset by a $5.1 billion decrease in average interest-bearing deposits (primarily amounts held in an interest-bearing account at the Federal Reserve). The average taxable-equivalent yield on interest-earning assets increased 218 basis points from 2.39% during the three months ended March 31, 2022 to 4.57% during the three months ended March 31, 2023. The average taxable-equivalent yield on interest-earning assets during the comparable periods was impacted by the aforementioned changes in market interest rates and changes in the volume and relative mix of interest-earning assets.

The average taxable-equivalent yield on loans increased 262 basis points from 3.74% during the three months ended March 31, 2022 to 6.36% during the three months ended March 31, 2023. The average taxable-equivalent yield on loans during the three months ended March 31, 2023 was positively impacted by recent increases in market interest rates. The average volume of loans for the three months ended March 31, 2023 increased $932.6 million, or 5.7% compared to the same period in 2022. Loans made up approximately 36.1% of average interest-earning assets during the three months ended March 31, 2023, compared to 34.6% during the same period in 2022.

The average taxable-equivalent yield on securities was 3.24% during the three months ended March 31, 2023, increasing 36 basis points from 2.88% during the three months ended March 31, 2022. The average yield on taxable securities was 2.67% during the three months ended March 31, 2023, increasing 77 basis points from 1.90% during the same period in 2022. The average taxable-equivalent yield on tax-exempt securities was 4.23% during the three months ended March 31, 2023, increasing 20 basis points from 4.03% during the same period in 2022.

Tax-exempt securities made up approximately 38.6% of total average securities during the three months ended March 31, 2023, compared to 47.6% during the same period in 2022. The average volume of total securities during the three months ended March 31, 2023 increased $4.6 billion, or 26.7%, compared to the same period in 2022. Securities made up approximately 45.4% of average interest-earning assets during the three months ended March 31, 2023 compared to 36.3% during the same period in 2022. The increase was primarily related to the investment of available funds (primarily from the reinvestment of amounts held in an interest-bearing account at the Federal Reserve) into taxable securities, and to a lesser extent, tax-exempt securities.

Average interest-bearing deposits (primarily amounts held in an interest-bearing account at the Federal Reserve) for the three months ended March 31, 2023 decreased $5.1 billion, or 36.9%, compared to the same period in 2022. Interest-bearing deposits (primarily amounts held in an interest-bearing account at the Federal Reserve) made up approximately 18.1% of average interest-earning assets during the three months ended March 31, 2023 compared to 29.1% during the same period in 2022. The decrease during the three months ended March 31, 2023 was primarily related to the reinvestment of amounts held in an interest-bearing account at the Federal Reserve into taxable securities, and to a lesser extent, loans and tax-exempt securities. The average yield on interest-bearing deposits (primarily amounts held in an interest-bearing account at the Federal Reserve) was 4.57% during the three months ended March 31, 2023, compared to 0.18% during the same period in 2022. The average yield on interest-bearing deposits during the three months ended March 31, 2023 was impacted by higher interest rates paid on reserves held at the Federal Reserve, compared to the same period in 2022.

The average rate paid on interest-bearing liabilities was 1.79% during the three months ended March 31, 2023, increasing 168 basis points from 0.11% during the same period in 2022. Average deposits decreased $204.5 million, or 0.5%, during the three months ended March 31, 2023 compared to the same period in 2022 and included a $1.3 billion decrease in average non-interest-bearing deposits partly offset by a $1.1 billion increase in average interest-bearing deposits. The ratio of average interest-bearing deposits to total average deposits was 61.1% during the three months ended March 31, 2023 compared to 58.2% during the same period in 2022. The average cost of deposits is primarily impacted by changes in market interest rates as well as changes in the volume and relative mix of interest-bearing deposits. The average cost of interest-bearing deposits and total deposits was 1.52% and 0.93%, respectively, during the three months ended March 31, 2023 compared to 0.08% and 0.05%, respectively, during the same period in 2022. The average cost of deposits during the comparable periods was impacted by increases in the interest rates we pay on our interest-bearing deposit products as a result of the aforementioned increases in market interest rates.

Our net interest spread, which represents the difference between the average rate earned on earning assets and the average rate paid on interest-bearing liabilities, was 2.78% during the three months ended March 31, 2023 compared to 2.28% during the same period in 2022. The net interest spread, as well as the net interest margin, will be impacted by future changes in short-term and long-term interest rate levels, as well as the impact from the competitive environment, including from new financial technology competitors, and the availability of alternative investment options. A discussion of the effects of changing interest rates on net interest income is set forth in Item 3. Quantitative and Qualitative Disclosures About Market Risk included elsewhere in this report.

Our hedging policies permit the use of various derivative financial instruments, including interest rate swaps, swaptions, caps and floors, to manage exposure to changes in interest rates. Details of our derivatives and hedging activities are set forth in Note 8 - Derivative Financial Instruments in the accompanying notes to consolidated financial statements included elsewhere in this report. Information regarding the impact of fluctuations in interest rates on our derivative financial instruments is set forth in Item 3. Quantitative and Qualitative Disclosures About Market Risk included elsewhere in this report.

### Credit Loss Expense

Credit loss expense is determined by management as the amount to be added to the allowance for credit loss accounts for various types of financial instruments including loans, securities and off-balance-sheet credit exposures after net charge-offs have been deducted to bring the allowances to a level which, in management’s best estimate, is necessary to absorb expected credit losses over the lives of the respective financial instruments. The components of credit loss expense were as follows:

| Credit loss expense (benefit) related to: | Three Months Ended March 31, 2023 | 2022 |
| --- | ---: | ---: |
| Loans | $12,675 | $4,464 |
| Off-balance-sheet credit exposures | (3,675) | (4,464) |
| Securities held to maturity | 104 | — |
| Total | $9,104 | $— |

See the section captioned “Allowance for Credit Losses” elsewhere in this discussion for further analysis of credit loss expense related to loans and off-balance-sheet credit exposures.

### Non-Interest Income

Total non-interest income for the three months ended March 31, 2023 increased $3.9 million, or 3.8%, compared to the same period in 2022. Changes in the various components of non-interest income are discussed in more detail below.

*Trust and Investment Management Fees.* Trust and investment management fees for the three months ended March 31, 2023 decreased $2.5 million, or 6.5%, compared to the same period in 2022. Investment management fees are the most significant component of trust and investment management fees, making up approximately 81.4% and 81.6% of total trust and investment management fees for the first three months of 2023 and 2022, respectively. The decrease in trust and investment management fees during the three months ended March 31, 2023 was primarily due to a decrease in investment management fees (down $2.1 million) and, to a lesser extent, decreases in estate fees (down $174 thousand) and real estate fees (down $169 thousand). Investment management fees are generally based on the market value of assets within an account and are thus impacted by volatility in the equity and bond markets. The decrease in investment management fees during the three months ended March 31, 2023 was primarily related to lower average equity valuations, in part related to the sharp decline in equity valuations that began during the second quarter of 2022. The decreases in estate fees and real estate fees were primarily related to decreases in transaction volumes.

At March 31, 2023, trust assets, including both managed assets and custody assets, were primarily composed of equity securities (40.7% of assets), fixed income securities (34.4% of assets), alternative investments (8.6% of assets) and cash equivalents (9.9% of assets). The estimated fair value of these assets was $44.7 billion (including managed assets of $21.9 billion and custody assets of $22.7 billion) at March 31, 2023, compared to $43.6 billion (including managed assets of $21.4 billion and custody assets of $22.2 billion) at December 31, 2022 and $42.4 billion (including managed assets of $20.8 billion and custody assets of $21.6 billion) at March 31, 2022.

*Service Charges on Deposit Accounts.* Service charges on deposit accounts for the three months ended March 31, 2023 decreased $861 thousand, or 3.8%, compared to the same period in 2022. The decrease during the three months ended March 31, 2023 was primarily related to a decrease in commercial service charges (down $3.1 million), partly offset by increases in overdraft charges on consumer and commercial accounts (up $1.2 million and $664 thousand, respectively) and consumer service charges (up $294 thousand). The decrease in commercial service charges during the three months ended March 31, 2023 primarily resulted from a higher average earnings credit rate applied to deposits maintained by treasury management customers. Because average market interest rates were higher during 2023 compared to 2022, deposit balances were more valuable and yielded a higher average earnings credit rate. As a result, customers paid for less of their services through fees rather than with earnings credits applied to their deposit balances. Overdraft charges totaled $10.6 million ($7.9 million consumer and $2.7 million commercial) during the three months ended March 31, 2023 compared to $8.7 million ($6.7 million consumer and $2.0 million commercial) during the same period in 2022. The increases in overdraft charges during the three months ended March 31, 2023 were impacted by increases in the volumes of fee assessed overdrafts relative to 2022, in part due to growth in the number of accounts.

*Insurance Commissions and Fees*. Insurance commissions and fees for the three months ended March 31, 2023 increased $2.3 million, or 14.1%, compared to the same period in 2022. The increase during the three months ended March 31, 2023 was primarily the result of increases in contingent income (up $1.4 million) and commission income (up $971 thousand).

Contingent income totaled $3.8 million during the three months ended March 31, 2023, compared to $2.4 million during the same period in 2022. Contingent income primarily consists of amounts received from various property and casualty insurance carriers related to portfolio growth and the loss performance of insurance policies previously placed. These performance related contingent payments are seasonal in nature and are mostly received during the first quarter of each year. This performance related contingent income totaled $3.2 million and $1.6 million during the three months ended March 31, 2023 and 2022, respectively. The increase in performance related contingent income was primarily related to growth within the portfolio and improvement in the loss performance of insurance policies previously placed. Performance related contingent income in 2022 was impacted by a severe weather event in Texas during 2021 that resulted in significant property and casualty claims and losses. Contingent income also includes amounts received from various benefit plan insurance companies related to the volume of business generated and/or the subsequent retention of such business. This benefit plan related contingent income totaled $665 thousand during the three months ended March 31, 2023, compared to $813 thousand during the same period in 2022. The increase in commission income was primarily related to an increase in life insurance commissions due to increased business volumes.

*Interchange and Card Transaction Fees*. Interchange fees, or “swipe” fees, are charges that merchants pay to us and other card-issuing banks for processing electronic payment transactions. Interchange and card transaction fees consist of income from debit and credit card usage, point of sale income from PIN-based card transactions and ATM service fees. Interchange and card transaction fees are reported net of related network costs.

Net interchange and card transaction fees for the three months ended March 31, 2023 increased $663 thousand, or 15.7%, compared to the same period in 2022 primarily due to increases in transaction volumes partly offset by an increase in network costs. A comparison of gross and net interchange and card transaction fees for the reported periods is presented in the table below.

|  | Three Months Ended March 31, 2023 | 2022 |
| --- | ---: | ---: |
| Income from card transactions | $8,802 | $7,481 |
| ATM service fees | 844 | 764 |
| Gross interchange and card transaction fees | 9,646 | 8,245 |
| Network costs | 4,757 | 4,019 |
| Net interchange and card transaction fees | $4,889 | $4,226 |

Federal Reserve rules applicable to financial institutions that have assets of $10 billion or more provide that the maximum permissible interchange fee for an electronic debit transaction is the sum of 21 cents per transaction and 5 basis points multiplied by the value of the transaction. An upward adjustment of no more than 1 cent to an issuer's debit card interchange fee is allowed if the card issuer develops and implements policies and procedures reasonably designed to achieve certain fraud-prevention standards. The Federal Reserve also has rules governing routing and exclusivity that require issuers to offer two unaffiliated networks for routing transactions on each debit or prepaid product.

*Other Charges, Commissions and Fees*. Other charges, commissions and fees for the three months ended March 31, 2023 increased $2.1 million, or 21.6%, compared to the same period in 2022. The increase was primarily related to increases in income from the placement of money market accounts (up $1.5 million), other service charges (up $609 thousand), commitment fees on unused lines of credit (up $337 thousand), capital markets advisory fees (up $245 thousand), letter of credit fees (up $186 thousand) and merchant services rebates/bonuses (up $169 thousand), among other things, partly offset by a decrease in income from the sale of mutual funds (down $862 thousand), among other things.

*Net Gain/Loss on Securities Transactions*. During the three months ended March 31, 2023, we sold certain available-for-sale securities with amortized costs totaling $1.2 billion (of which $298.6 million remained unsettled as of March 31, 2023) and realized a net gain of $21 thousand. Market conditions provided us an opportunity to sell certain lower-yielding securities. The proceeds from these sales enhanced our current liquidity position and will provide us the flexibility to be more opportunistic with the reinvestment of these funds in the future. There were no sales of securities during 2022.

*Other Non-Interest Income.* Other non-interest income for the three months ended March 31, 2023 increased $2.1 million, or 22.5%, compared to the same period in 2022. The increase was primarily related to increases in sundry and other miscellaneous income (up $1.3 million), income from customer derivative and securities trading transactions (up $482 thousand), gains on the sale of foreclosed and other assets (up $334 thousand) and income from customer foreign exchange transactions (up $247 thousand), among other things, partly offset by a decrease in public finance underwriting fees (down $927 thousand), among other things. Sundry income during the three months ended March 31, 2023 included $1.2 million related to a distribution received from a Small Business Investment Company (“SBIC”) fund investment and $575 thousand related to a partnership interest, among other things, while sundry income during the three months ended March 31, 2022 included

$458 thousand related to a contract fee, among other things. The fluctuations in income from public finance underwriting fees; income from customer derivative and securities trading transactions; and income from customer foreign exchange transactions were primarily related to fluctuations in transaction volumes. The increase in gains on the sale of foreclosed and other assets was primarily related to the sale of foreclosed real estate property.

### Non-Interest Expense

Total non-interest expense for the three months ended March 31, 2023 increased $46.4 million, or 19.4%, compared to the same period in 2022. Changes in the various components of non-interest expense are discussed below.

*Salaries and Wages*. Salaries and wages for the three months ended March 31, 2023 increased $19.0 million, or 17.1%, compared to the same period in 2022. The increase in salaries and wages was primarily related to an increase in salaries, due to annual merit and market increases, and an increase in the number of employees. The increase in the number of employees was partly related to our investments in organic expansion in the Houston and Dallas markets as well as preparations for our mortgage loan product offering. Salaries and wages were also impacted, to a lesser extent, by increases in stock-based compensation and incentive compensation. We are experiencing a competitive labor market which has resulted in and could continue to result in an increase in our staffing costs.

*Employee Benefits*. Employee benefits expense for the three months ended March 31, 2023 increased $9.7 million, or 40.1%, compared to the same period in 2022. The increase was primarily related to increases in 401(k) plan expense, payroll taxes and medical benefits expense, and a decrease in the net periodic benefit related to our defined benefit retirement plan, among other things.

Our defined benefit retirement and restoration plans were frozen in 2001 which has helped to reduce the volatility in retirement plan expense. We nonetheless still have funding obligations related to these plans and could recognize expense related to these plans in future years, which would be dependent on the return earned on plan assets, the level of interest rates and employee turnover. See Note 12 - Defined Benefit Plans for additional information related to our net periodic pension benefit/cost.

*Net Occupancy*. Net occupancy expense for the three months ended March 31, 2023 increased $2.9 million, or 10.7%, compared to the same period in 2022. The increase during the three months ended March 31, 2023 was primarily related to increases in lease expense (up $841 thousand), depreciation on buildings and leasehold improvements (together up $683 thousand), utilities expense (up $633 thousand) and repairs and maintenance/service contracts expense (up $399 thousand), among other things. The increases in the aforementioned components of net occupancy expense were impacted, in part, by our expansion within the Houston and Dallas market areas.

*Technology, Furniture and Equipment.* Technology, furniture and equipment expense for the three months ended March 31, 2023 increased $3.3 million, or 11.4%, compared to the same period in 2022. The increase during the three months ended March 31, 2023 was primarily related to increases in cloud services expense (up $1.6 million), service contracts expense (up $989 thousand) and software amortization (up $340 thousand), among other things.

*Deposit Insurance*. Deposit insurance expense totaled $6.2 million for the three months ended March 31, 2023, up $2.6 million, or 71.9%, compared to $3.6 million for the three months ended March 31, 2022. The increase was primarily related to an increase in the assessment rate. In October 2022, the Federal Deposit Insurance Corporation (“FDIC”) adopted a final rule to increase the initial base deposit insurance assessment rate schedules uniformly by 2 basis points beginning with the first quarterly assessment period of 2023. During the second quarter of 2023, the FDIC is expected to issue a proposed rulemaking for public comment for a special assessment to replenish the deposit insurance fund after recent bank failures. The extent to which any such assessment will impact our future deposit insurance expense is currently uncertain.

*Other Non-Interest Expense*. Other non-interest expense for the three months ended March 31, 2023 increased $8.9 million, or 20.7%, compared to the same period in 2022. The increase during the three months ended March 31, 2023 included increases in professional services expense (up $2.3 million), primarily related to information technology services; travel, meals and entertainment (up $1.4 million); sundry and other miscellaneous expenses (up $1.4 million), advertising/promotions expense (up $1.2 million); check card expense (up $903 thousand); business development expense (up $719 thousand) and communications expense (up $582 thousand), among other things. Sundry and other miscellaneous expense included $997 thousand related to an operational loss and $323 thousand related to a write-off of premises and equipment.

### Results of Segment Operations

We are managed under a matrix organizational structure whereby our two primary operating segments, Banking and Frost Wealth Advisors, overlap a regional reporting structure. A third operating segment, Non-Banks, is for the most part the parent holding company, as well as certain other insignificant non-bank subsidiaries of the parent that, for the most part, have little or no activity. A description of each segment, the methodologies used to measure segment financial performance and summarized operating results by segment are described in Note 15 - Operating Segments in the accompanying notes to consolidated financial statements included elsewhere in this report. Segment operating results are discussed in more detail below.

#### Banking

Net income for the three months ended March 31, 2023 increased $82.4 million, or 90.2%, compared to the same period in 2022. The increase during the three months ended March 31, 2023 was primarily the result of a $151.2 million increase in net interest income and a $4.9 million increase in non-interest income partly offset by a $43.3 million increase in non-interest expense, a $21.4 million increase in income tax expense and a $9.1 million increase in credit loss expense.

Net interest income for the three months ended March 31, 2023 increased $151.2 million, or 60.5%, compared to the same period in 2022. The increase during the three months ended March 31, 2023 was primarily related to increases in the average yield on loans and, to a lesser extent, the average volume of loans; an increase in the average yield on interest-bearing deposits (primarily amounts held in an interest-bearing account at the Federal Reserve); and increases in the average volumes of and the average taxable-equivalent yields on taxable and tax-exempt securities, among other things. The impact of these items was partly offset by increases in the average costs of interest-bearing deposit accounts and repurchase agreements, among other things, combined with a decrease in the average volume of interest-bearing deposits (primarily amounts held in an interest-bearing account at the Federal Reserve). See the analysis of net interest income included in the section captioned “Net Interest Income” included elsewhere in this discussion.

Credit loss expense/benefit was not significant for the Banking segment during the reported periods. See the sections captioned “Credit Loss Expense” and “Allowance for Credit Losses” elsewhere in this discussion for further analysis of credit loss expense related to loans and off-balance-sheet commitments.

Non-interest income for the three months ended March 31, 2023 increased $4.9 million, or 8.4%, compared to the same period in 2022. The increase during the three months ended March 31, 2023 was primarily due to increases in insurance commissions and fees; other non-interest income; other charges, commissions and fees and interchange and card transactions fees partly offset by a decrease in service charges on deposit accounts. The increase in insurance commissions and fees was primarily related to increases in contingent income and commission income, which is further discussed below in relation to Frost Insurance Agency. The increase in other non-interest income was primarily due to increases in sundry and other miscellaneous income, income from customer derivative and securities trading transactions, gains on the sale of foreclosed and other assets and income from customer foreign exchange transactions, among other things, partly offset by a decrease in public finance underwriting fees, among other things. Sundry income during the three months ended March 31, 2023 was impacted by the receipt of distributions from an SBIC fund investment and a partnership interest, among other things. The fluctuations in income from public finance underwriting fees; income from customer derivative and securities trading transactions; and income from customer foreign exchange transactions were primarily related to fluctuations in transaction volumes. The increase in gains on the sale of foreclosed and other assets was primarily related to the sale of foreclosed real estate property. The increase in other charges, commissions and fees was primarily related to increases other service charges, commitment fees on unused lines of credit, capital markets advisory fees, letter of credit fees and merchant services rebates/bonuses, among other things. The increase in interchange and card transactions fees was primarily due to increases in transaction volumes partly offset by an increase in network costs. The decrease in service charges on deposit accounts was primarily related to a decrease in commercial service charges, largely due to a higher average earnings credit rate applied to deposits maintained by treasury management customers, partly offset by increases in overdraft charges on consumer and commercial accounts and consumer service charges due to increases in the volumes of fee assessed overdrafts relative to 2022, in part due to growth in the number of accounts. See the analysis of these categories of non-interest income included in the section captioned “Non-Interest Income” included elsewhere in this discussion.

Non-interest expense for three months ended March 31, 2023 increased $43.3 million, or 21.0%, compared to the same period in 2022. The increase was primarily due to increases in salaries and wages; employee benefit expense; other non-interest expense; technology, furniture and equipment expense; net occupancy expense and deposit insurance. The increase in salaries and wages was primarily related to an increase in salaries, due to annual merit and market increases. Salaries and wages were also impacted by an increase in the number of employees as well as increases in stock-based compensation and incentive compensation. The increase in the number of employees was partly related to our investments in organic expansion in the Houston and Dallas markets as well as preparations for our mortgage loan product offering. The increase in employee benefits expense was primarily related to increases in 401(k) plan expense, payroll taxes and medical benefits expense, and a decrease in the net periodic benefit related to our defined benefit retirement plan, among other things. The increase in other non-interest expense was primarily related to increases in professional services expense; travel, meals and entertainment; sundry and other miscellaneous expenses, advertising/promotions expense; check card expense; business development expense and communications expense, among other things. The increase in technology, furniture and equipment expense was primarily related to increases in cloud services expense, service contracts expense and software amortization, among other things. The increase in net occupancy was primarily related to increases in lease expense, depreciation on buildings and leasehold improvements, utilities expense and repairs and maintenance/service contracts expense, among other things. The increases in the aforementioned components of net occupancy expense were impacted, in part, by our expansion within the Houston and Dallas market areas. The increase in deposit insurance was primarily related to an increase in the assessment rate. See the analysis of these categories of non-interest expense included in the section captioned “Non-Interest Expense” included elsewhere in this discussion.

Frost Insurance Agency, which is included in the Banking operating segment, had gross commission revenues of $19.0 million during the three months ended March 31, 2023, compared to $16.7 million during the same period in 2022. The increase was primarily related to increases in contingent income and commission income. The increase in contingent income was primarily related to an increase in performance related contingent payments due to growth within the portfolio and improvement in the loss performance of insurance policies previously placed. The increase in gross commission income was primarily related to an increase in life insurance commissions due to increased business volumes. See the analysis of insurance commissions and fees included in the section captioned “Non-Interest Income” included elsewhere in this discussion.

#### Frost Wealth Advisors

Net income for the three months ended March 31, 2023 decreased $2.6 million, or 25.2%, compared to the same period in 2022. The decrease was primarily the result of a $3.0 million increase in non-interest expense and a $1.2 million decrease in non-interest income partly offset by a $954 thousand increase in net interest income and a $688 thousand decrease in income tax expense.

Net interest income for the three months ended March 31, 2023 increased $954 thousand, or 136.3%, compared to the same period in 2022. The increase was primarily due to an increase in the average funds transfer prices allocated to funds provided by Frost Wealth Advisors. See the analysis of net interest income included in the section captioned “Net Interest Income” included elsewhere in this discussion.

Non-interest income for the three months ended March 31, 2023 decreased $1.2 million, or 2.8%, compared to the same period in 2022. The decrease was primarily due to a decrease in trust and investment management fees partly offset by increases in other charges, commissions and fees and other non-interest income. Trust and investment management fee income is the most significant income component for Frost Wealth Advisors. Investment management fees are the most significant component of trust and investment management fees, making up approximately 81.4% of total trust and investment management fees for the first three months of 2023. The decrease in trust and investment management fees during the three months ended March 31, 2023 was primarily due to a decrease in investment management fees and, to a lesser extent, decreases in estate fees and real estate fees. The decrease in investment management fees was primarily related to lower average equity valuations, in part related to the sharp decline in equity valuations that began during the second quarter of 2022. The decreases in estate fees and real estate fees were primarily related to decreases in transaction volumes. The increase in other charges, commissions and fees was primarily related to an increase in income from the placement of money market accounts and, to a lesser extent, an increase in annuity income, partly offset by a decrease in income from the sale of mutual funds, among other things. The increase in other non-interest income was primarily related to an increase in income from customer securities trading transactions. See the analysis of trust and investment management fees and other charges, commissions and fees included in the section captioned “Non-Interest Income” included elsewhere in this discussion.

Non-interest expense for the three months ended March 31, 2023 increased $3.0 million, or 9.8%, compared to the same period in 2022. The increase was primarily due to increases in other non-interest expense, salaries and wages and employee benefits expense. The increase in other non-interest expense was primarily related to an increase in the corporate overhead expense allocation and, to a lesser extent, an increase in meals and entertainment, among other things, partly offset by a decrease in research and platform fees, among other things. The increase in salaries and wages was primarily due to an increase in salaries, due to annual merit and market increases, as well as an increase in commission expense. The increase in employee benefits was primarily related to an increase in 401(k) plan expense, medical benefits expense and payroll taxes.

#### Non-Banks

The Non-Banks operating segment had a net loss of $3.7 million during the three months ended March 31, 2023, compared to a net loss of $2.5 million during the same period in 2022. The increase in the net loss was primarily due to an increase in net interest expense due to an increase in the average rates paid on our long-term borrowings.

### Income Taxes

During the three months ended March 31, 2023, we recognized income tax expense of $33.2 million, for an effective tax rate of 15.7%, compared to $12.6 million, for an effective tax rate of 11.3%, for the same period in 2022. The effective income tax rates differed from the U.S. statutory federal income tax rate of 21% during 2023 and 2022 primarily due to the effect of tax-exempt income from securities, loans and life insurance policies and the income tax effects associated with stock-based compensation, among other things, and their relative proportion to total pre-tax net income. The increase in the effective tax rates during 2023 was primarily related to an increase in projected pre-tax net income and, to a lesser extent, an increases in disallowed deposit interest expense and deposit insurance premiums and a decrease in discrete tax benefits associated with stock-based compensation, among other things.

### Average Balance Sheet

Average assets totaled $51.3 billion for the three months ended March 31, 2023 representing an increase of $983.6 million, or 2.0%, compared to average assets for the same period in 2022. Earning assets increased $564.7 million, or 1.2%, during the three months ended March 31, 2023 compared to the same period in 2022. The increase in earning assets was primarily related to a $4.3 billion increase in average taxable securities, a $932.6 million increase in average loans and a $235.9 million increase in tax-exempt securities partly offset by a $5.1 billion decrease in average interest-bearing deposits (primarily amounts held in an interest-bearing account at the Federal Reserve). Average deposits decreased $204.5 million, or 0.5%, during three months ended March 31, 2023 compared to the same period in 2022. The decrease included a $1.3 billion decrease in non-interest-bearing deposits partly offset by a $1.1 billion increase in interest-bearing deposit accounts. Average non-interest-bearing deposits made up 38.9% and 41.8% of average total deposits during the three months ended March 31, 2023 and 2022, respectively.

### Loans

Details of our loan portfolio are presented in Note 3 - Loans in the accompanying notes to consolidated financial statements included elsewhere in this report. Loans increased $331.1 million, or 1.9%, from $17.2 billion at December 31, 2022 to $17.5 billion at March 31, 2023. The majority of our loan portfolio is comprised of commercial and industrial loans, energy loans, and real estate loans. Real estate loans include both commercial and consumer balances. Selected details related to our loan portfolio segments are presented below. Refer to our 2022 Form 10-K for a more detailed discussion of our loan origination and risk management processes.

*Commercial and Industrial.* Commercial and industrial loans totaled $5.7 billion at both March 31, 2023 and December 31, 2022. Our commercial and industrial loans are a diverse group of loans to small, medium and large businesses. The purpose of these loans varies from supporting seasonal working capital needs to term financing of equipment. While some short-term loans may be made on an unsecured basis, most are secured by the assets being financed with collateral margins that are consistent with our loan policy guidelines. The commercial and industrial loan portfolio also includes commercial leases and purchased shared national credits ("SNC"s).

*Energy*. Energy loans include loans to entities and individuals that are engaged in various energy-related activities including (i) the development and production of oil or natural gas, (ii) providing oil and gas field servicing, (iii) providing energy-related transportation services, (iv) providing equipment to support oil and gas drilling, (v) refining petrochemicals, or (vi) trading oil, gas and related commodities. Energy loans increased $140.7 million, or 15.2%, from $925.7 million at December 31, 2022 to $1.1 billion at March 31, 2023. While we have recently made efforts to reduce our exposure to energy loans, such loans nonetheless remain our largest industry concentration totaling 6.1% of total loans at March 31, 2023, up from 5.4% of total loans at December 31, 2022. The average loan size, the significance of the portfolio and the specialized nature of the energy industry requires a highly prescriptive underwriting policy. Exceptions to this policy are rarely granted. Due to the large borrowing requirements of this customer base, the energy loan portfolio includes participations and SNCs.

*Purchased Shared National Credits.* Purchased shared national credits are participations purchased from upstream financial organizations and tend to be larger in size than our originated portfolio. Our purchased SNC portfolio totaled $773.6 million at March 31, 2023, decreasing $16.9 million, or 2.1%, from $790.5 million at December 31, 2022. At March 31, 2023, 32.0% of outstanding purchased SNCs were related to the construction industry while 21.5% were related to the energy industry, 12.2% were related to the financial services industry and 12.1% were related to the real estate management industry. The remaining purchased SNCs were diversified throughout various other industries, with no other single industry exceeding 10% of the total purchased SNC portfolio. Additionally, almost all of the outstanding balance of purchased SNCs was included in the energy and commercial and industrial portfolio, with the remainder included in the real estate categories. SNC participations are originated in the normal course of business to meet the needs of our customers. As a matter of policy, we generally only participate in SNCs for companies headquartered in or which have significant operations within our market areas. In addition, we must have direct access to the company’s management, an existing banking relationship or the expectation of broadening the relationship with other banking products and services within the following 12 to 24 months. SNCs are reviewed at least quarterly for credit quality and business development successes.

*Commercial Real Estate.* Commercial real estate loans increased $89.0 million, or 1.1%, from $8.2 billion at December 31, 2022 to $8.3 billion at March 31, 2023. Commercial real estate loans represented 80.6% of total real estate loans at March 31, 2023 compared to 81.6% at December 31, 2022. The majority of our commercial real estate loan portfolio consists of commercial real estate mortgages, which includes both permanent and intermediate term loans. These loans are viewed primarily as cash flow loans and secondarily as loans secured by real estate. Consequently, these loans must undergo the analysis and underwriting process of a commercial and industrial loan, as well as that of a real estate loan. At March 31, 2023, approximately 51.3% of the outstanding principal balance of our commercial real estate loans were secured by owner-occupied properties.

*Consumer Real Estate and Other Consumer Loans.* The consumer real estate loan portfolio increased $143.3 million, or 7.8%, from $1.8 billion at December 31, 2022 to $2.0 billion at March 31, 2023. Combined, home equity loans and lines of credit made up 61.5% and 61.9% of the consumer real estate loan total at March 31, 2023 and December 31, 2022, respectively. We offer home equity loans up to 80% of the estimated value of the personal residence of the borrower, less the value of existing mortgages and home improvement loans. Prior to 2023, we did not generally originate 1-4 family mortgage loans; however, from time to time, we did invest in such loans to meet the needs of our customers or for other regulatory compliance purposes. During the first quarter of 2023, we began offering 1-4 family mortgage loans to our employees. We expect to begin limited production of 1-4 family mortgage loans for customers in the second quarter of 2023. Our 1-4 family mortgage loan production is intended to be for portfolio investment purposes. Nonetheless, 1-4 family mortgage loans are not a significant component of our consumer real estate portfolio. Consumer and other loans decreased $29.4 million, or 6.0%, from December 31, 2022. The consumer and other loan portfolio primarily consists of automobile loans, overdrafts, unsecured revolving credit products, personal loans secured by cash and cash equivalents and other similar types of credit facilities.

*Paycheck Protection Program*. We have originated loans to qualified small businesses under the PPP administered by the SBA under the provisions of the CARES Act. Loans covered by the PPP may be eligible for loan forgiveness for certain costs incurred related to payroll, group health care benefit costs and qualifying mortgage, rent and utility payments. The remaining loan balance after forgiveness of any amounts is still fully guaranteed by the SBA. Refer to the 2022 Form 10-K for additional details.

*Accruing Past Due Loans.* Accruing past due loans are presented in the following tables. Also see Note 3 - Loans in the accompanying notes to consolidated financial statements included elsewhere in this report.

| March 31, 2023 | Total Loans | Accruing Loans 30-89 Days Past Due Amount | Percent of Loans in Category | Accruing Loans 90 or More Days Past Due Amount | Percent of Loans in Category | Total Accruing Past Due Loans Amount | Percent of Loans in Category |
| --- | ---: | ---: | ---: | ---: | ---: | ---: | ---: |
| Commercial and industrial | $5,668,697 | $27,524 | 0.49% | $1,876 | 0.03% | $29,400 | 0.52% |
| Energy | 1,066,388 | 2,561 | 0.24 | — | — | 2,561 | 0.24 |
| Paycheck Protection Program | 28,497 | 484 | 1.70 | 5,748 | 20.17 | 6,232 | 21.87 |
| Commercial real estate: |  |  |  |  |  |  |  |
| Buildings, land and other | 6,789,838 | 38,751 | 0.57 | 112 | — | 38,863 | 0.57 |
| Construction | 1,482,458 | 1,647 | 0.11 | 118 | 0.01 | 1,765 | 0.12 |
| Consumer real estate | 1,986,859 | 13,790 | 0.69 | 2,013 | 0.10 | 15,803 | 0.79 |
| Consumer and other | 463,283 | 4,430 | 0.96 | 98 | 0.02 | 4,528 | 0.98 |
| Total | $17,486,020 | $89,187 | 0.51 | $9,965 | 0.06 | $99,152 | 0.57 |
| Excluding PPP loans | $17,457,523 | $88,703 | 0.51 | $4,217 | 0.02 | $92,920 | 0.53 |

48

| December 31, 2022 | Total Loans | Accruing Loans 30-89 Days Past Due Amount | Percent of Loans in Category | Accruing Loans 90 or More Days Past Due Amount | Percent of Loans in Category | Total Accruing Past Due Loans Amount | Percent of Loans in Category |
| --- | ---: | ---: | ---: | ---: | ---: | ---: | ---: |
| Commercial and industrial | $5,674,798 | $30,769 | 0.54% | $5,560 | 0.10% | $36,329 | 0.64% |
| Energy | 925,729 | 1,472 | 0.16 | — | — | 1,472 | 0.16 |
| Paycheck Protection Program | 34,852 | 5,321 | 15.27 | 13,867 | 39.79 | 19,188 | 55.06 |
| Commercial real estate: |  |  |  |  |  |  |  |
| Buildings, land and other | 6,706,078 | 23,561 | 0.35 | 5,664 | 0.08 | 29,225 | 0.43 |
| Construction | 1,477,247 | — | — | — | — | — | — |
| Consumer real estate | 1,843,539 | 7,856 | 0.43 | 2,398 | 0.13 | 10,254 | 0.56 |
| Consumer and other | 492,726 | 5,155 | 1.05 | 311 | 0.06 | 5,466 | 1.11 |
| Total | $17,154,969 | $74,134 | 0.43 | $27,800 | 0.16 | $101,934 | 0.59 |
| Excluding PPP loans | $17,120,117 | $68,813 | 0.40 | $13,933 | 0.08 | $82,746 | 0.48 |

Accruing past due loans at March 31, 2023 decreased $2.8 million compared to December 31, 2022. The decrease was primarily related to decreases in past due PPP loans (down $13.0 million) and past due commercial and industrial loans (down $6.9 million) mostly offset by increases in past due commercial real estate loans (up $11.4 million) and past due consumer real estate loans (up $5.5 million). PPP loans are fully guaranteed by the SBA and we expect to collect all amounts due related to these loans. Excluding PPP loans, accruing past due loans increased $10.2 million.

*Non-Accrual Loans.* Non-accrual loans are presented in the table below. Also see in Note 3 - Loans in the accompanying notes to consolidated financial statements included elsewhere in this report.

|  | March 31, 2023 Total Loans | Non-Accrual Loans Amount | Percent of Loans in Category | December 31, 2022 Total Loans | Non-Accrual Loans Amount | Percent of Loans in Category |
| --- | ---: | ---: | ---: | ---: | ---: | ---: |
| Commercial and industrial | $5,668,697 | $10,494 | 0.19% | $5,674,798 | $18,130 | 0.32% |
| Energy | 1,066,388 | 22,349 | 2.10 | 925,729 | 15,224 | 1.64 |
| Paycheck Protection Program | 28,497 | — | — | 34,852 | — | — |
| Commercial real estate: |  |  |  |  |  |  |
| Buildings, land and other | 6,789,838 | 4,604 | 0.07 | 6,706,078 | 3,552 | 0.05 |
| Construction | 1,482,458 | — | — | 1,477,247 | — | — |
| Consumer real estate | 1,986,859 | 963 | 0.05 | 1,843,539 | 927 | 0.05 |
| Consumer and other | 463,283 | — | — | 492,726 | — | — |
| Total | $17,486,020 | $38,410 | 0.22 | $17,154,969 | $37,833 | 0.22 |
| Allowance for credit losses on loans |  | $231,514 |  |  | $227,621 |  |
| Ratio of allowance for credit losses on loans to non-accrual loans |  | 602.74% |  |  | 601.65% |  |

Non-accrual loans at March 31, 2023 increased $577 thousand from December 31, 2022 primarily due to increases in non-accrual energy and commercial real estate loans mostly offset by a decrease in non-accrual commercial and industrial loans. The decrease in commercial and industrial was primarily related to principal payments, loans returning to accrual and charge offs.

Generally, loans are placed on non-accrual status if principal or interest payments become 90 days past due and/or management deems the collectibility of the principal and/or interest to be in question, as well as when required by regulatory requirements. Once interest accruals are discontinued, accrued but uncollected interest is charged to current year operations. Subsequent receipts on non-accrual loans are recorded as a reduction of principal, and interest income is recorded only after principal recovery is reasonably assured. Classification of a loan as non-accrual does not preclude the ultimate collection of loan principal or interest. There were no non-accrual commercial and industrial loans in excess of $5.0 million at March 31, 2023 or December 31, 2022. Non-accrual energy loans included three credit relationships in excess of $5.0 million totaling $18.1 million at March 31, 2023. Two of these credit relationships, which totaled $10.3 million at March 31, 2023, were previously reported as non-accrual with an aggregate balance of $11.1 million at December 31, 2022. The decreases in the aggregate balance of these credit relationship were related to principal payments made by these borrowers. Non-accrual real estate loans primarily consist of land development, 1-4 family residential construction credit relationships and loans secured by office buildings and religious facilities. There were no non-accrual commercial real estate loans in excess of $5.0 million at March 31, 2023 or December 31, 2022.

### Allowance for Credit Losses

In the case of loans and securities, allowances for credit losses are contra-asset valuation accounts, calculated in accordance with Accounting Standards Codification (“ASC”) Topic 326 (“ASC 326”) Financial Instruments - Credit Losses, that are deducted from the amortized cost basis of these assets to present the net amount expected to be collected. In the case of off-balance-sheet credit exposures, the allowance for credit losses is a liability account, calculated in accordance with ASC 326, reported as a component of accrued interest payable and other liabilities in our consolidated balance sheets. The amount of each allowance account represents management's best estimate of current expected credit losses (“CECL”) on these financial instruments considering available information, from internal and external sources, relevant to assessing exposure to credit loss over the contractual term of the instrument. Relevant available information includes historical credit loss experience, current conditions and reasonable and supportable forecasts. While historical credit loss experience provides the basis for the estimation of expected credit losses, adjustments to historical loss information may be made for differences in current portfolio-specific risk characteristics, environmental conditions or other relevant factors. While management utilizes its best judgment and information available, the ultimate adequacy of our allowance accounts is dependent upon a variety of factors beyond our control, including the performance of our portfolios, the economy, changes in interest rates and the view of the regulatory authorities toward classification of assets. See our 2022 Form 10-K for additional information regarding our accounting policies related to credit losses. Also see Note 3 - Loans in the accompanying notes consolidated financial statements for information related to model updates during the first quarter of 2023.

*Allowance for Credit Losses - Loans.* The table below provides, as of the dates indicated, an allocation of the allowance for loan losses by loan portfolio segment; however, allocation of a portion of the allowance to one segment does not preclude its availability to absorb losses in other segments.

| March 31, 2023 | Amount of Allowance Allocated | Percent of Loans in Each Category to Total Loans | Total Loans | Ratio of Allowance Allocated to Loans in Each Category |
| --- | ---: | ---: | ---: | ---: |
| Commercial and industrial | $78,465 | 32.4% | $5,668,697 | 1.38% |
| Energy | 19,191 | 6.1 | 1,066,388 | 1.80 |
| Paycheck Protection Program | — | 0.2 | 28,497 | — |
| Commercial real estate | 115,693 | 47.3 | 8,272,296 | 1.40 |
| Consumer real estate | 9,708 | 11.4 | 1,986,859 | 0.49 |
| Consumer and other | 8,457 | 2.6 | 463,283 | 1.83 |
| Total | $231,514 | 100.0% | $17,486,020 | 1.32 |
| **December 31, 2022** |  |  |  |  |
| Commercial and industrial | $104,237 | 33.1% | $5,674,798 | 1.84% |
| Energy | 18,062 | 5.4 | 925,729 | 1.95 |
| Paycheck Protection Program | — | 0.2 | 34,852 | — |
| Commercial real estate | 90,301 | 47.7 | 8,183,325 | 1.10 |
| Consumer real estate | 8,004 | 10.7 | 1,843,539 | 0.43 |
| Consumer and other | 7,017 | 2.9 | 492,726 | 1.42 |
| Total | $227,621 | 100.0% | $17,154,969 | 1.33 |

The allowance allocated to commercial and industrial loans totaled $78.5 million, or 1.38% of total commercial and industrial loans, at March 31, 2023 decreasing $25.8 million, or 24.7%, compared to $104.2 million, or 1.84% of total commercial and industrial loans, at December 31, 2022. Modeled expected credit losses decreased $19.5 million while qualitative factor (“Q-Factor”) and other qualitative adjustments related to commercial and industrial loans decreased $3.4 million. Specific allocations for commercial and industrial loans that were evaluated for expected credit losses on an individual basis decreased $2.9 million from $6.1 million at December 31, 2022 to $3.2 million at March 31, 2023. The decrease in specific allocations for commercial and industrial loans was primarily related to the recognition of charge-offs.

The allowance allocated to energy loans totaled $19.2 million, or 1.80% of total energy loans, at March 31, 2023 increasing $1.1 million, or 6.3%, compared to $18.1 million, or 1.95% of total energy loans, at December 31, 2022. Modeled expected credit losses related to energy loans decreased $3.5 million while Q-Factor and other qualitative adjustments related to energy loans increased $4.2 million. Specific allocations for energy loans that were evaluated for expected credit losses on an individual basis totaled $4.8 million at March 31, 2023 increasing $431 thousand compared to $4.4 million on December 31, 2022.

The allowance allocated to commercial real estate loans totaled $115.7 million, or 1.40% of total commercial real estate loans, at March 31, 2023 increasing $25.4 million, or 28.1%, compared to $90.3 million, or 1.10% of total commercial real estate loans, at December 31, 2022. Modeled expected credit losses related to commercial real estate loans decreased $12.3 million while Q-Factor and other qualitative adjustments related to commercial real estate loans increased $39.3 million. Specific allocations for commercial real estate loans that were evaluated for expected credit losses on an individual basis decreased from $1.7 million at December 31, 2022 to $126 thousand at March 31, 2023. The decrease in specific allocations for commercial real estate loans was related to principal payments received and a loan no longer requiring a specific allocation.

The allowance allocated to consumer real estate loans totaled $9.7 million, or 0.49% of total consumer real estate loans, at March 31, 2023 increasing $1.7 million, or 21.3%, compared to $8.0 million, or 0.43% of total consumer real estate loans, at December 31, 2022. Modeled expected credit losses related to consumer real estate loans increased $1.5 million while Q-Factor and other qualitative adjustments related to consumer real estate loans increased $171 thousand.

The allowance allocated to consumer loans totaled $8.5 million, or 1.83% of total consumer loans, at March 31, 2023 increasing $1.4 million, or 20.5%, compared to $7.0 million, or 1.42% of total consumer loans, at December 31, 2022. Modeled expected credit losses related to consumer loans decreased $570 thousand while Q-Factor and other qualitative adjustments increased $2.0 million, which was primarily due to an increase in the consumer overlay, which is further discussed below.

As more fully described in our 2022 Form 10-K, we measure expected credit losses over the life of each loan utilizing a combination of models which measure probability of default and loss given default, among other things. The measurement of expected credit losses is impacted by loan/borrower attributes and certain macroeconomic variables. Models are adjusted to reflect the current impact of certain macroeconomic variables as well as their expected changes over a reasonable and supportable forecast period.

In estimating expected credit losses as of March 31, 2023, we utilized the Moody’s Analytics March 2023 Consensus Scenario (the “March 2023 Consensus Scenario”) to forecast the macroeconomic variables used in our models. The March 2023 Consensus Scenario was based on the review of a variety of surveys of baseline forecasts of the U.S. economy. The March 2023 Consensus Scenario projections included, among other things, (i) U.S. Nominal Gross Domestic Product annualized quarterly growth rate of 2.83% during the remainder of 2023 followed by average annualized quarterly growth rates of 3.85% in 2024 and 4.80% through the end of the forecast period in the first quarter of 2025; (ii) average U.S. unemployment rate of 4.38% during the remainder of 2023 followed by average annualized quarterly rates of 4.70% in 2024 and 4.46% through the end of the forecast period in the first quarter of 2025; (iii) average Texas unemployment rate of 4.45% during the remainder of 2023 followed by average annualized quarterly rates of 4.50% in 2024 and 4.27% through the end of the forecast period in the first quarter of 2025; (iv) projected average 10 year Treasury rate of 3.77% during the remainder of 2023, decreasing to 3.41% during 2024 and 3.32% by the end of the forecast period in the first quarter of 2025 and (v) average oil price of $87 per barrel during the remainder of 2023 decreasing to $83 per barrel in 2024 and $78 per barrel by the end of the forecast period in the first quarter of 2025.

In estimating expected credit losses as of December 31, 2022, we utilized the Moody’s Analytics December 2022 Baseline Scenario (the “December 2022 Baseline Scenario”) to forecast the macroeconomic variables used in our models. The December 2022 Baseline Scenario was based on the most likely outcome based on prevailing economic conditions and Moody's forecast of the U.S. economy. The December 2022 Baseline Scenario projections included, among other things, (i) U.S. Nominal Gross Domestic Product annualized quarterly growth rate of 2.65% in the first quarter of 2023, followed by annualized quarterly growth rates in the range of 3.62% to 4.50% during the remainder of 2023 and an average annualized growth rate of 4.79% through the end of the forecast period in the fourth quarter of 2024; (ii) U.S. unemployment rate of 3.80% in the first quarter of 2023 and an average quarterly U.S. unemployment rate of 4.06% through the end of the forecast period in the fourth quarter of 2024; (iii) Texas unemployment rate of 4.10% in the first quarter of 2023 and an average quarterly Texas unemployment rate of 4.04% through the end of the forecast period in the fourth quarter of 2024; (iv) projected average 10 year Treasury rate of 4.03% in the first quarter of 2023 and average projected rates of 4.25% during the remainder of 2023 and 3.96% in 2024; and (v) average oil price of $93 per barrel in the first quarter of 2023 decreasing to $67 per barrel by the end of the forecast period in the fourth quarter of 2024.

The overall loan portfolio as of March 31, 2023 increased $331.1 million, or 1.9%, compared to December 31, 2022. This increase included a $143.3 million, or 7.8%, increase in consumer real estate loans; a $140.7 million, or 15.2%, increase in energy loans; and an $89.0 million, or 1.1%, increase in commercial real estate loans; partly offset by a $29.4 million, or 6.0%, decrease in consumer and other loans and a $6.1 million, or 0.1%, decrease in commercial and industrial loans.

The weighted average risk grade for commercial and industrial loans was 6.39 at both March 31, 2023 and December 31, 2022 as the impact of an increase in the weighted-average risk grade of pass-grade commercial and industrial loans, which increased to 6.25 at March 31, 2023 from 6.24 at December 31, 2022, was offset by a decrease in the weighted-average risk grade of classified loans, which decreased to 11.22 at March 31, 2023 from 11.43 at December 31, 2022. Classified loans consist of loans having a risk grade of 11, 12 or 13. The weighted-average risk grade for energy loans increased to 5.99 at March 31, 2023 from 5.67 at December 31, 2022. The increase in the weighted average risk grade was partly related to a $27.2 million increase in energy loans graded “watch” and “special mention” (risk grades 9 and 10). Additionally, pass grade energy loans increased $114.4 million while the weighted-average risk grade of pass grade energy loans increased from 5.44 at December 31, 2022 to 5.71 at March 31, 2023. The weighted average risk grade for commercial real estate loans increased to 7.16 at March 31, 2023 from 7.10 at December 31, 2022. Pass grade commercial real estate loans increased $29.6 million while the weighted-average risk grade of such loans increased from 6.96 at December 31, 2022 to 7.00 March 31, 2023. Commercial real estate loans graded as “watch” and “special mention” decreased $20.2 million while classified commercial real estate loans increased $79.5 million.

As noted above, our credit loss models utilized the economic forecasts in the Moody's March 2023 Consensus Scenario for our estimated expected credit losses as of March 31, 2023 and the Moody’s Baseline Scenario for our estimate of expected credit losses as of December 31, 2022. We qualitatively adjusted the model results based on these scenarios for various risk factors that are not considered within our modeling processes but are nonetheless relevant in assessing the expected credit losses within our loan pools. These qualitative factor, or Q-Factor, adjustments are discussed below.

Q-Factor adjustments are based upon management's judgment and current assessment as to the impact of risks related to changes in lending policies and procedures; economic and business conditions; loan portfolio attributes and credit concentrations; and external factors, among other things, that are not already captured within the modeling inputs, assumptions and other processes. Management assesses the potential impact of such items within a range of severely negative impact to positive impact and adjusts the modeled expected credit loss by an aggregate adjustment percentage based upon the assessment. As a result of this assessment as of March 31, 2023, modeled expected credit losses were adjusted upwards by a weighted-average Q-Factor adjustment of approximately 4.2%, resulting in a $3.0 million total adjustment, compared to 2.3% at December 31, 2022, which resulted in a $2.3 million total adjustment. The increase in the Q-Factor adjustment percentage as of March 31, 2023 was largely related to a generally more negative outlook associated with national, regional and local economic and business conditions and developments that affect the collectability of loans; changes in loan portfolio concentrations; changes in the volumes and severity of loan delinquencies; changes in risk grades and adverse classifications; and the potential for deterioration of collateral values, among other things.

We have also provided additional qualitative adjustments, or management overlays, as of March 31, 2023 as management believes there are still significant risks impacting certain categories of our loan portfolio. Q-Factor and other qualitative adjustments as of March 31, 2023 are detailed in the table below.

|  | Q-Factor Adjustment | Model Overlays | Office Building Overlays | Down-Side Scenario Overlay | Credit Concentration Overlays | Consumer Overlay | Total |
| --- | ---: | ---: | ---: | ---: | ---: | ---: | ---: |
| Commercial and industrial | $1,486 | $— | $— | $28,233 | $3,086 | $— | $32,805 |
| Energy | 176 | — | — | — | 9,167 | — | 9,343 |
| Commercial real estate: |  |  |  |  |  |  |  |
| Owner occupied | 422 | 23,910 | — | — | 626 | — | 24,958 |
| Non-owner occupied | 197 | 29,028 | 13,371 | — | 949 | — | 43,545 |
| Construction | 385 | 28,564 | 2,935 | — | 441 | — | 32,325 |
| Consumer real estate | 328 | — | — | — | — | — | 328 |
| Consumer and other | 44 | — | — | — | — | 4,000 | 4,044 |
| Total | $3,038 | $81,502 | $16,306 | $28,233 | $14,269 | $4,000 | $147,348 |

52

Model overlays are qualitative adjustments to address the effects of risks not captured within our commercial real estate credit loss models. These adjustments are determined based upon minimum reserve ratios for our commercial real estate loans. In the case of our commercial real estate - owner occupied loan portfolio, we determined a minimum reserve ratio is appropriate to address the effect of the model's over-sensitivity to positive changes in certain economic variables. After analysis and benchmarking against peer bank data, we believe the modeled results may be overly optimistic and not appropriately capturing downside risk. As such, we determined that the appropriate forecasted loss rate for our owner-occupied commercial real estate loan portfolio should be more closely aligned with that of our commercial and industrial loan portfolio. In the case of our commercial real estate - non-owner occupied and commercial real estate - construction loan portfolios, we determined minimum reserve ratios are appropriate as we believe the modeled results are not appropriately capturing the downside risk associated with our borrowers' ability to access the capital markets for the sale or refinancing of investor real estate and assets currently under construction. We believe access to capital may be impaired for a significant amount of time. Accordingly, this would require secondary sources of liquidity and capital to support completed projects that may take considerably longer to stabilize than originally underwritten. Furthermore, rapidly rising interest rates have presented a new emerging risk as most non-owner occupied and construction loans are originated with floating interest rates.

Office building overlays are qualitative adjustments to address longer-term concerns over the utilization of commercial office space which could impact the long-term performance of some types of office properties within our commercial real estate loan portfolio. These adjustments are determined based upon minimum reserve ratios for loans within our commercial real estate - non-owner occupied and commercial real estate - construction loan portfolios that have risk grades of 8 or worse.

The down-side scenario overlay is a qualitative adjustment for our commercial and industrial loan portfolio to address the significant risk of economic recession as a result of inflation; rising interest rates; labor shortages; disruption in financial markets and global supply chains; further oil price volatility; and the current or anticipated impact of military conflict, including the current war between Russia and Ukraine, terrorism or other geopolitical events. Factors such as these are outside of our control but nonetheless affect customer income levels and could alter anticipated customer behavior, including borrowing, repayment, investment and deposit practices. To determine this qualitative adjustment, we use an alternative, more pessimistic economic scenario to forecast the macroeconomic variables used in our models. As of March 31, 2023, we used the Moody’s Analytics March S3 Alternative Scenario Downside - 90th Percentile (the “March 2023 S3 Scenario”). In modeling expected credit losses using this scenario, we also assume each loan within our modeled loan pools is downgraded by one risk grade level, with the exception of loans with risk grades of 8 or 9 for which we assume such loans are downgraded by two risk grade levels. The qualitative adjustment is based upon the amount by which the alternative scenario modeling results exceed those of the primary scenario used in estimating credit loss expense, adjusted based upon management's assessment of the probability that this more pessimistic economic scenario will occur.

Credit concentration overlays are qualitative adjustments based upon statistical analysis to address relationship exposure concentrations within our loan portfolio. Variations in loan portfolio concentrations over time cause expected credit losses within our existing portfolio to differ from historical loss experience. Given that the allowance for credit losses on loans reflects expected credit losses within our loan portfolio and the fact that these expected credit losses are uncertain as to nature, timing and amount, management believes that segments with higher concentration risk are more likely to experience a high loss event. Due to the fact that a significant portion of our loan portfolio is concentrated in large credit relationships and because of large, concentrated credit losses in recent years, management made the qualitative adjustments detailed in the table above to address the risk associated with such a relationship deteriorating to a loss event.

The consumer overlay is a qualitative adjustment for our consumer and other loan portfolio to address the risk associated with the level of unsecured loans within this portfolio and other risk factors. Unsecured consumer loans have an elevated risk of loss in times of economic stress as these loans lack a secondary source of repayment in the form of hard collateral. This adjustment was determined by analyzing our consumer loan charge-off trends as well as those of the general banking industry. Management deemed it appropriate to consider an additional overlay to the modeled forecasted losses for the unsecured consumer portfolio.

As of December 31, 2022, we provided qualitative adjustments, as detailed in the table below. Further information regarding these qualitative adjustments is provided in our 2022 Form 10-K.

|  | Q-Factor Adjustment | Model Overlays | Office Building Overlays | Down-Side Scenario Overlay | Credit Concentration Overlays | Consumer Overlay | Total |
| --- | ---: | ---: | ---: | ---: | ---: | ---: | ---: |
| Commercial and industrial | $929 | $— | $— | $29,632 | $5,676 | $— | $36,237 |
| Energy | 128 | — | — | — | 5,020 | — | 5,148 |
| Commercial real estate: |  |  |  |  |  |  |  |
| Owner occupied | 318 | 19,708 | — | — | 1,718 | — | 21,744 |
| Non-owner occupied | 95 | 10,472 | 16,557 | — | 487 | — | 27,611 |
| Construction | 660 | 7,905 | 3,122 | — | 530 | — | 12,217 |
| Consumer real estate | 157 | — | — | — | — | — | 157 |
| Consumer and other | 34 | — | — | — | — | 2,000 | 2,034 |
| Total | $2,321 | $38,085 | $19,679 | $29,632 | $13,431 | $2,000 | $105,148 |

Additional information related to credit loss expense and net (charge-offs) recoveries is presented in the tables below. Also see Note 3 - Loans in the accompanying notes to consolidated financial statements included elsewhere in this report.

| Three months ended: March 31, 2023 | Credit Loss Expense (Benefit) | Net (Charge-Offs) Recoveries | Average Loans | Ratio of Annualized Net (Charge-Offs) Recoveries to Average Loans |
| --- | ---: | ---: | ---: | ---: |
| Commercial and industrial | $(20,684) | $(5,088) | $5,653,233 | (0.37)% |
| Energy | 966 | 163 | 1,016,325 | 0.07 |
| Paycheck Protection Program | — | — | 31,601 | — |
| Commercial real estate | 25,361 | 31 | 8,223,698 | — |
| Consumer real estate | 1,283 | 421 | 1,911,249 | 0.09 |
| Consumer and other | 5,749 | (4,309) | 482,955 | (3.62) |
| Total | $12,675 | $(8,782) | $17,319,061 | (0.21) |
| **March 31, 2022** |  |  |  |  |
| Commercial and industrial | $17,561 | $(2,626) | $5,466,467 | (0.19)% |
| Energy | (2,044) | 249 | 1,055,021 | 0.10 |
| Paycheck Protection Program | — | — | 302,431 | — |
| Commercial real estate | (15,609) | (373) | 7,666,754 | (0.02) |
| Consumer real estate | (26) | (200) | 1,422,077 | (0.06) |
| Consumer and other | 4,582 | (3,345) | 473,708 | (2.86) |
| Total | $4,464 | $(6,295) | $16,386,458 | (0.16) |

We recorded a net credit loss expense related to loans totaling $12.7 million for the three months ended March 31, 2023 while we recorded a net credit loss expense totaling $4.5 million during the same period in 2022. Net credit loss expense/benefit for each portfolio segment reflects the amount needed to adjust the allowance for credit losses allocated to that segment to the level of expected credit losses determined under our allowance methodology after net charge-offs have been recognized.

The net credit loss expense related to loans during the first three months of 2023 primarily reflects an increase in expected credit losses associated with commercial real estate loans, primarily related to increases in the minimum reserve ratios for our commercial real estate - non-owner occupied and construction portfolios. The net credit loss expense related to loans during the first three months of 2023 also reflects charge-off trends related to consumer and other loans and the additional expected credit losses associated with our consumer real estate; consumer and other; and energy loan portfolios. The impact of these items was partly offset by a decrease in expected credit losses associated with commercial and industrial loans, primarily related to a decrease in modeled expected losses and decreases in the credit concentration and down-side scenario overlays.

The ratio of the allowance for credit losses on loans to total loans was 1.32% at March 31, 2023 compared to 1.33% at December 31, 2022. Management believes the recorded amount of the allowance for credit losses on loans is appropriate based upon management’s best estimate of current expected credit losses within the existing portfolio of loans. Should any of the factors considered by management in making this estimate change, our estimate of current expected credit losses could also change, which could affect the level of future credit loss expense related to loans.

*Allowance for Credit Losses - Off-Balance-Sheet Credit Exposures.* The allowance for credit losses on off-balance-sheet credit exposures totaled approximately $54.9 million and $58.6 million at March 31, 2023 and December 31, 2022, respectively. The level of the allowance for credit losses on off-balance-sheet credit exposures depends upon the volume of outstanding commitments, underlying risk grades, the expected utilization of available funds and forecasted economic conditions impacting our loan portfolio. We recognized a net credit loss benefit related to off-balance-sheet credit exposures totaling $3.7 million during the three months ended March 31, 2023 compared to a net credit loss benefit of $4.5 million during the same period in 2022. Our policies and methodology used to estimate the allowance for credit losses on off-balance-sheet credit exposures are further described in our 2022 Form 10-K. This methodology was also impacted by the model updates described in Note 3 - Loans in the accompanying notes to consolidated financial statements elsewhere in this report. The overall approximate impact of the model updates was a $19.0 million decrease in modeled expected credit losses for off-balance-sheet credit exposures, though the impact of this decrease was largely offset with a qualitative adjustment similar to the model overlay described above for commercial real estate - construction loans.

### Capital and Liquidity

*Capital*. Shareholders’ equity totaled $3.5 billion and $3.1 billion at March 31, 2023 and December 31, 2022, respectively. The increase was partly related to the accumulated other comprehensive income/loss component of shareholders’ equity which decreased to a net, after-tax, unrealized loss of $1.1 billion at March 31, 2023 from a net, after-tax unrealized loss of $1.3 billion at December 31, 2022. This change was primarily due to a $205.6 million net, after-tax, increase in the fair value of securities available for sale. Other sources of capital during the three months ended March 31, 2023 included net income of $177.7 million, $4.7 million related to stock-based compensation and $1.5 million in proceeds from stock option exercises. Uses of capital during the three months ended March 31, 2023 included $58.3 million of dividends paid on preferred and common stock and $1.2 million of treasury stock purchases.

Under the Basel III Capital Rules, we have elected to opt-out of the requirement to include most components of accumulated other comprehensive income in regulatory capital. Accordingly, amounts reported as accumulated other comprehensive income/loss do not increase or reduce regulatory capital and are not included in the calculation of our regulatory capital ratios. In connection with the adoption of ASC 326 on January 1, 2020, we also elected to exclude, for a transitional period, the effects of credit loss accounting under CECL in the calculation of our regulatory capital and regulatory capital ratios. Regulatory agencies for banks and bank holding companies utilize capital guidelines designed to measure capital and take into consideration the risk inherent in both on-balance-sheet and off-balance-sheet items. See Note 7 - Capital and Regulatory Matters in the accompanying notes to consolidated financial statements included elsewhere in this report.

We paid a quarterly dividend of $0.87 per common share during the first quarter of 2023 and a quarterly dividend of $0.75 per common share during the first quarter of 2022. These dividend amounts equate to a common stock dividend payout ratio of 32.2% and 49.7% during the first three months of 2023 and 2022, respectively. Our ability to declare or pay dividends on, or purchase, redeem or otherwise acquire, shares of our capital stock may be impacted by certain restrictions described in Note 7 - Capital and Regulatory Matters in the accompanying notes to consolidated financial statements included elsewhere in this report.

*Stock Repurchase Plans.* From time to time, our board of directors has authorized stock repurchase plans. In general, stock repurchase plans allow us to proactively manage our capital position and return excess capital to shareholders. Shares purchased under such plans also provide us with shares of common stock necessary to satisfy obligations related to stock compensation awards. On January 25, 2023 our board of directors authorized a $100.0 million stock repurchase program, allowing us to repurchase shares of our common stock over a one-year period from time to time at various prices in the open market or through private transactions. No shares have been repurchased under this plan or under prior plans during the reported periods. See Note 7 - Capital and Regulatory Matters in the accompanying notes to consolidated financial statements and Part II, Item 2 - Unregistered Sales of Equity Securities and Use of Proceeds, each included elsewhere in this report.

In August 2022, the Inflation Reduction Act of 2022 (the “IRA”) was enacted. Among other things, the IRA imposes a new 1% excise tax on the fair market value of stock repurchased after December 31, 2022 by publicly traded U.S. corporations. With certain exceptions, the value of stock repurchased is determined net of stock issued in the year, including pursuant to compensatory arrangements.

*Liquidity*. As more fully discussed in our 2022 Form 10-K, our liquidity position is continuously monitored and adjustments are made to the balance between sources and uses of funds as deemed appropriate. Liquidity risk management is an important element in our asset/liability management process. We regularly model liquidity stress scenarios to assess potential liquidity outflows or funding problems resulting from economic disruptions, volatility in the financial markets, unexpected credit events or other significant occurrences deemed problematic by management. These scenarios are incorporated into our contingency funding plan, which provides the basis for the identification of our liquidity needs. Our principal source of funding has been our customer deposits, supplemented by our short-term and long-term borrowings as well as maturities of securities and loan amortization. As of March 31, 2023, we had approximately $8.6 billion held in an interest-bearing account at the Federal Reserve. We also have the ability to borrow funds as a member of the Federal Home Loan Bank (“FHLB”). As of March 31, 2023, based upon available, pledgeable collateral, our total borrowing capacity with the FHLB was approximately $3.5 billion. Furthermore, at March 31, 2023, we had approximately $14.3 billion in securities that were unencumbered by a pledge and could be used to support additional borrowings, as needed, through repurchase agreements, the Federal Reserve discount window or the Federal Reserve's new Bank Term Funding Program (“BTFP”). The BTFP is a new facility established in response to recent liquidity concerns within the banking industry in part due to recent deposit runs that resulted in a few large bank failures. The BTFP was designed to provide available additional funding to eligible depository institutions in order to help assure that banks have the ability to meet the needs of all their depositors. Under the program, eligible depository institutions can obtain loans of up to one year in length by pledging U.S. Treasuries, agency debt and mortgage-backed securities, and other qualifying assets as collateral. These assets will be valued at par. The BTFP is intended to eliminate the need for depository institutions to quickly sell their securities when they are experiencing stress on their liquidity.

Since Cullen/Frost is a holding company and does not conduct operations, its primary sources of liquidity are dividends upstreamed from Frost Bank and borrowings from outside sources. Banking regulations may limit the amount of dividends that may be paid by Frost Bank. See Note 7 - Capital and Regulatory Matters in the accompanying notes to consolidated financial statements included elsewhere in this report regarding such dividends. At March 31, 2023, Cullen/Frost had liquid assets, primarily consisting of cash on deposit at Frost Bank, totaling $331.1 million.

### Accounting Standards Updates

See Note 17 - Accounting Standards Updates in the accompanying notes to consolidated financial statements included elsewhere in this report for details of recently issued accounting pronouncements and their expected impact on our financial statements.

## Market risk

As filed, 4,494 characters.

*The disclosures set forth in this item are qualified by the section captioned “Forward-Looking Statements and Factors that Could Affect Future Results” included in Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations of this report and other cautionary statements set forth elsewhere in this report.*

Refer to the discussion of market risks included in Item 7A. Quantitative and Qualitative Disclosures About Market Risk in the 2022 Form 10-K. There has been no significant change in the types of market risks we face since December 31, 2022.

We utilize an earnings simulation model as the primary quantitative tool in measuring the amount of interest rate risk associated with changing market rates. The model quantifies the effects of various interest rate scenarios on projected net interest income and net income over the next 12 months. The model measures the impact on net interest income relative to a flat-rate case scenario of hypothetical fluctuations in interest rates over the next 12 months. These simulations incorporate assumptions regarding balance sheet growth and mix, pricing and the repricing and maturity characteristics of the existing and projected balance sheet. The impact of interest rate derivatives, such as interest rate swaps, caps and floors, is also included in the model. Other interest rate-related risks such as prepayment, basis and option risk are also considered.

For modeling purposes, as of March 31, 2023, the model simulations projected that 100 and 200 basis point ratable increases in interest rates would result in positive variances in net interest income of 1.4% and 3.0%, respectively, relative to the flat-rate case over the next 12 months, while 100 and 200 basis point ratable decreases in interest rates would result in a negative variances in net interest income of 1.4% and 2.9%, respectively, relative to the flat-rate case over the next 12 months. For modeling purposes, as of December 31, 2022, the model simulations projected that 100 and 200 basis point ratable increases in interest rates would result in positive variances in net interest income of 0.2% and 1.4%, respectively, relative to the flat-rate case over the next 12 months, while 100 and 200 basis point ratable decreases in interest rates would result in a negative variances in net interest income of 0.2% and 1.4%, respectively, relative to the flat-rate case over the next 12 months.

We do not currently pay interest on a significant portion of our commercial demand deposits. Any interest rate that would ultimately be paid on these commercial demand deposits would likely depend upon a variety of factors, some of which are beyond our control. Our March 31, 2023 and December 31, 2022 model simulations did not assume any payment of interest on commercial demand deposits (those not already receiving an earnings credit). Management believes, based on our experience during the last interest rate cycle, that it is less likely we will pay interest on these deposits as rates increase.

The model simulations as of March 31, 2023 indicate that our projected balance sheet is more asset sensitive in comparison to our balance sheet as of December 31, 2022. The increased asset sensitivity was primarily due to a decrease in the expected deposit pricing beta for rate increases on certain types of deposit accounts and an increase in the projected relative proportion of interest-bearing deposits (primarily amounts held in an interest-bearing account at the Federal Reserve) and federal funds sold to projected average interest-earning assets. The deposit pricing beta is a measure of how much deposit rates will reprice, up or down, given a defined change in market rates. Management believes that the deposit pricing betas used as of March 31, 2023 are more reflective of current expectations. Interest-bearing deposits and federal funds sold are more immediately impacted by changes in interest rates in comparison to our other categories of earning assets.

As of March 31, 2023, the effects of a 200 basis point increase and a 200 basis point decrease in interest rates on our derivative holdings would not result in a significant variance in our net interest income.

The effects of hypothetical fluctuations in interest rates on our securities classified as “trading” under ASC Topic 320, “Investments—Debt and Equity Securities,” are not significant, and, as such, separate quantitative disclosure is not presented.

## Controls and procedures

As filed, 835 characters.

As of the end of the period covered by this Quarterly Report on Form 10-Q, an evaluation was carried out by management, with the participation of its Chief Executive Officer and Chief Financial Officer, of the effectiveness of our disclosure controls and procedures (as defined in Rule 13a-15(e) under the Securities Exchange Act of 1934). Based upon that evaluation, the Chief Executive Officer and Chief Financial Officer concluded that the disclosure controls and procedures were effective as of the end of the period covered by this report. No change in our internal control over financial reporting (as defined in Rule 13a-15(f) under the Securities Exchange Act of 1934) occurred during the last fiscal quarter that materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

Filed Apr 27, 2023.
Source: SEC EDGAR, the filing index for accession 0000039263-23-000043. Last ingested by Listed: Nov 5, 2026, 13:53 ET. No prices; not investment advice.