Cullen/Frost Bankers, Inc.: Form 10-Q for the period ended Sep 30, 2024

Financial Review

The following discussion should be read in conjunction with our consolidated financial statements, and notes thereto, for the year ended December 31, 2023, and the other information included in the 2023 Form 10-K. Operating results for the three and nine months ended September 30, 2024 are not necessarily indicative of the results for the year ending December 31, 2024 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 global wars/military conflicts, terrorism, 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 2023 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 $144.8 million, or $2.24 per diluted common share, and $422.7 million, or $6.51 per diluted common share, for the three and nine months ended September 30, 2024, compared to $154.0 million, or $2.38 per diluted common share, and $490.4 million, or $7.54 per diluted common share for the three and nine months ended September 30, 2023.

Selected data for the comparable periods was as follows:

Net income available to common shareholders decreased $9.2 million, or 5.9%, for the three months ended September 30, 2024 and decreased $67.7 million, or 13.8%, for the nine months ended September 30, 2024, compared to the same periods in 2023. The decrease during the three months ended September 30, 2024 was primarily the result of a $30.2 million increase in non-interest expense and an $8.2 million increase in credit loss expense partly offset by an $18.9 million increase in net interest income, a $7.7 million increase in non-interest income, and a $2.6 million decrease in income tax expense. The decrease during the nine months ended September 30, 2024 was primarily the result of a $103.2 million increase in non-interest expense, which included $9.0 million related to a special Federal Deposit Insurance Corporation (“FDIC”) deposit insurance assessment discussed below, and an $18.6 million increase in credit loss expense partly offset by a $21.5 million increase in non-interest income, a $20.6 million increase in net interest income, and a $12.0 million decrease in income tax 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 78.0% of total revenue during the first nine months of 2024. 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 September 30, 2024, approximately 41.7% of our loans had a fixed interest rate, while the remaining loans had floating interest rates that were primarily tied to a benchmark developed by the American Financial Exchange, the Secured Overnight Financing Rate (“SOFR”) (approximately 31.1%); the prime interest rate (approximately 21.0%); or the American Interbank Offered Rate (“AMERIBOR”) (approximately 6.1%). Certain other loans are tied to other indices; however, such loans do not make up a significant portion of our loan portfolio as of September 30, 2024.

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

(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 September 30, 2024, the target range for the federal funds rate was 4.75% to 5.00%. In September 2024, the Federal Reserve released projections whereby the midpoint of the projected appropriate target range for the federal funds rate would fall to 4.4% by the end of 2024 and subsequently decrease to 3.4% by the end of 2025. 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 50 basis point decrease in the federal funds rate during the remainder of 2024, followed by a 100 basis point decrease in 2025.

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, particularly in rising or high interest rate environments. Nonetheless, our access to and pricing of 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. During this most recent, higher interest rate cycle, we have seen a decrease in our non-interest-bearing deposits, although as market interest rates for deposits decreased in the latter part of the third quarter of 2024, period-end non-interest bearing deposits increased $468.1 million compared to the end of the second quarter. See Item 3. Quantitative and Qualitative Disclosures About Market Risk elsewhere in this report for information about our sensitivity to increases and decreases in 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.

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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. The comparison between the quarters includes an additional change factor that shows the effect of the difference in the number of days in each period for assets and liabilities that accrue interest based upon the actual number of days in the period, as further discussed below.

Taxable-equivalent net interest income for the three months ended September 30, 2024 increased $17.8 million, or 4.4%, while taxable-equivalent net interest income for the nine months ended September 30, 2024 increased $12.4 million, or 1.0%, compared to the same periods in 2023. Taxable-equivalent net interest income for the nine months ended September 30, 2024 included 274 days compared to 273 for the same period in 2023 as a result of the leap year. The additional day added approximately $3.0 million to taxable-equivalent net interest income during the nine months ended September 30, 2024. Excluding the impact of the additional day results in an effective increase in taxable-equivalent net interest income of approximately $9.4 million during the nine months ended September 30, 2024.

The increase in taxable-equivalent net interest income during the three months ended September 30, 2024 was primarily related to increases in the average volume of and yield on loans; increases in the average yields on taxable and tax-exempt securities; and an increase in the average volume of interest-bearing deposits (primarily amounts held in an interest-bearing account at the Federal Reserve), among other things. The impact of these items was partly offset by an increase in the average volume of higher-yielding time deposit accounts; decreases in the average volumes of taxable and tax-exempt securities; increases in the average costs of interest-bearing deposit accounts; and an increase in the average volume of repurchase agreements, among other things.

The increase in taxable-equivalent net interest income during the nine months ended September 30, 2024 was primarily related to increases in the average volume of and yield on loans and increases in the average yields on interest-bearing deposits (primarily amounts held in an interest-bearing account at the Federal Reserve) and taxable securities, and to a lesser extent, tax-exempt securities, among other things. The impact of these items was partly offset by an increase in the average volume of higher-yielding time deposit accounts combined with increases in the average costs of interest-bearing deposit accounts and repurchase agreements and decreases in the average volumes of tax-exempt securities, taxable securities, and interest-bearing deposits (primarily amounts held in an interest-bearing account at the Federal Reserve), among other things.

As a result of the aforementioned fluctuations, the taxable-equivalent net interest margin increased 12 basis points from 3.44% during the three months ended September 30, 2023 to 3.56% during the three months ended September 30, 2024 while the taxable-equivalent net interest margin increased 7 basis points from 3.45% during the nine months ended September 30, 2023 to 3.52% during the nine months ended September 30, 2024.

The average volume of interest-earning assets for the three months ended September 30, 2024 increased $734.2 million while the average volume of interest-earning assets for the nine months ended September 30, 2024 decreased $552.8 million compared to the same periods in 2023. The increase in the average volume of interest-earning assets during the three months ended September 30, 2024 was primarily related to a $2.1 billion increase in average loans and a $326.4 million increase in average interest-bearing deposits (primarily amounts held in an interest-bearing account at the Federal Reserve) partly offset by a $1.3 billion decrease in average taxable securities and an $375.2 million decrease in average tax-exempt securities. The average taxable-equivalent yield on interest-earning assets increased 34 basis points from 4.92% during the three months ended September 30, 2023 to 5.26% during the three months ended September 30, 2024.

The decrease in the average volume of interest-earning assets during the nine months ended September 30, 2024 was primarily related to a $1.3 billion decrease in average taxable securities, a $947.0 million decrease in average tax-exempt securities, and a $236.3 million decrease in average interest-bearing deposits (primarily amounts held in an interest-bearing account at the Federal Reserve) partly offset by a $2.0 billion increase in average loans. The average taxable-equivalent yield on interest-earning assets increased 46 basis points from 4.75 during the nine months ended September 30, 2023 to 5.21% during the nine months ended September 30, 2024. The average taxable-equivalent yields on interest-earning assets during the comparable periods was impacted by changes in market interest rates (as noted in the table above) and changes in the volume and relative mix of interest-earning assets.

The average taxable-equivalent yield on loans increased 29 basis points from 6.83% during the three months ended September 30, 2023 to 7.12% during the three months ended September 30, 2024 while the average taxable-equivalent yield on loans increased 45 basis points from 6.62% during the nine months ended September 30, 2023 to 7.07% during the nine months ended September 30, 2024. The average taxable-equivalent yields on loans during the three and nine months ended September 30, 2024 were partly impacted by changes in market interest rates (as noted in the table above). The average volume of loans for the three months ended September 30, 2024 increased $2.1 billion, or 11.8%, while the average volume of loans for the nine months ended September 30, 2024 increased $2.0 billion, or 11.1%, compared to the same periods in 2023. Loans made up approximately 43.6% and 42.8% of average interest-earning assets during the three and nine months ended September 30, 2024, compared to 39.6% and 38.1% during the same respective periods in 2023. The increases were primarily related to the use of available funds to originate loans.

The average taxable-equivalent yield on securities was 3.40% during the three months ended September 30, 2024, increasing 16 basis points from 3.24% during the three months ended September 30, 2023 while the average taxable-equivalent yield on securities was 3.36% during the nine months ended September 30, 2024, increasing 12 basis points from 3.24% during the nine months ended September 30, 2023. The average yield on taxable securities was 2.94% during the three months ended September 30, 2024, increasing 18 basis points from 2.76% during the same period in 2023 while the average yield on taxable securities was 2.90% during the nine months ended September 30, 2024, increasing 19 basis points from 2.71% during the same period in 2023. The average taxable-equivalent yield on tax-exempt securities was 4.32% during the three months ended September 30, 2024, increasing 6 basis points from 4.26% during the same period in 2023 while the average taxable-equivalent yield on tax-exempt securities was 4.30% during the nine months ended September 30, 2024, increasing 4 basis points from 4.26% during the same period in 2023.

Tax-exempt securities made up approximately 35.0% and 35.2% of total average securities during the three and nine months ended September 30, 2024, compared to 34.0% and 36.0% during the same respective periods in 2023. The average volume of total securities during the three months ended September 30, 2024 decreased $1.7 billion, or 8.1%, compared to the same period in 2023 while the average volume of total securities during the nine months ended September 30, 2024 decreased $2.2 billion, or 10.6%, compared to the same period in 2023. Securities made up approximately 41.0% and 41.3% of average interest-earning assets during the three and nine months ended September 30, 2024, compared to 45.3% and 45.6% during the same respective periods in 2023. The decreases during the three and nine months ended September 30, 2024 were primarily related to the use of funds provided by maturities, calls and principal repayments of these securities to support the origination of loans and to provide liquidity to offset the decrease in non-interest-bearing deposits.

Average interest-bearing deposits (primarily amounts held in an interest-bearing account at the Federal Reserve) for the three months ended September 30, 2024 increased $326.4 million, or 4.8%, compared to the same period in 2023 while average interest-bearing deposits (primarily amounts held in an interest-bearing account at the Federal Reserve) for the nine months ended September 30, 2024 decreased $236.3 million, or 3.2%, compared to the same period in 2023. The increase during the three months ended September 30, 2024 was partly related to funds provided from maturities of taxable and tax-exempt securities combined with an increase in the funds provided from an increase in the average balance of repurchase agreements. The decrease during the nine months ended September 30, 2024 was partly related to the reinvestment of amounts held in an interest-bearing account at the Federal Reserve into loans. Balances held at the Federal Reserve were also impacted by a decrease in customer deposits (primarily non-interest-bearing). Interest-bearing deposits (primarily amounts held in an interest-bearing account at the Federal Reserve) made up approximately 15.3% and 15.7% of average interest-earning assets during the three and nine months ended September 30, 2024, compared to 14.9% and 16.0% during the same respective periods in 2023. The average yields on interest-bearing deposits (primarily amounts held in an interest-bearing account at the Federal Reserve) were 5.32% and 5.37% during the three and nine months ended September 30, 2024, respectively, compared to 5.33% and 4.95% during the three and nine months ended September 30, 2023, respectively. The average yield on interest-bearing deposits during the nine months ended September 30, 2024 were impacted by a higher average interest rate paid on reserves held at the Federal Reserve, compared to the same period in 2023.

The average rate paid on interest-bearing liabilities was 2.60% during the three months ended September 30, 2024, increasing 27 basis points from 2.33% during the same period in 2023 while the average rate paid on interest-bearing liabilities was 2.58% during the nine months ended September 30, 2024, increasing 50 basis points from 2.08% during the same period in 2023. Average deposits decreased $94.7 million, or 0.2%, during the three months ended September 30, 2024, compared to the same period in 2023 and included a $1.2 billion decrease in average non-interest-bearing deposits partly offset by a $1.1 billion increase in average interest-bearing deposits. Average deposits decreased $867.5 million, or 2.1%, during the nine months ended September 30, 2024, compared to the same period in 2023 and included a $1.8 billion decrease in average non-interest-bearing deposits partly offset by a $918.4 million increase in average interest-bearing deposits. The ratio of average interest-bearing deposits to total average deposits was 66.5% and 66.1% during the three and nine months ended September 30, 2024, compared to 63.7% and 62.5% during the same respective periods in 2023. 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 2.41% and 1.60%, respectively, during the three months ended September 30, 2024, compared to 2.12% and 1.35%, respectively, during the same period in 2023. The average cost of interest-bearing deposits and total deposits was 2.38% and 1.57%, respectively, during the nine months ended September 30, 2024, compared to 1.84% and 1.15%, respectively, during the same period in 2023. The average cost of deposits during the comparable periods were impacted by increases in the interest rates we pay on our interest-bearing deposit products as a result of an increase 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 2.66% and 2.63% during the three and nine months ended September 30, 2024, compared to 2.59% and 2.67% during the same respective periods in 2023. 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 7 - 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:

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 and nine months ended September 30, 2024 increased $7.7 million, or 7.3%, and increased $21.5 million, or 6.8%, respectively, compared to the same periods in 2023. 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 increased $3.4 million, or 9.0%, for the three months ended September 30, 2024 and increased $8.4 million, or 7.4%, for the nine months ended September 30, 2024, compared to the same respective periods in 2023. Investment management fees are the most significant component of trust and investment management fees, making up approximately 81.4% and 79.5% of total trust and investment management fees for the first nine months of 2024 and 2023, respectively. The increases in trust and investment management fees during the three and nine months ended September 30, 2024 were primarily related to increases in investment management fees (up $3.4 million and $8.9 million, respectively) and oil and gas fees (up $333 thousand and $1.2 million, respectively), partly offset by decreases in estate fees (down $215 thousand and $1.1 million, respectively), and real estate fees (down $157 thousand and $940 thousand, respectively). 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 increases in investment management fees during the three and nine months ended September 30, 2024 were primarily related to increases in the average value of assets maintained in accounts. The increases in the average value of assets were partly related to higher equity valuations during 2024 relative to 2023. The increase in oil and gas fees was primarily related to higher average market prices in 2024, particularly in the second quarter, relative to 2023, which impacted the amount of royalties received, and increases in new lease bonuses. The decreases in estate fees and real estate fees were primarily related to decreased transaction volumes relative to 2023.

At September 30, 2024, trust assets, including both managed assets and custody assets, were primarily composed of equity securities (43.2% of assets), fixed income securities (32.9% of assets), alternative investments (9.5% of assets) and cash equivalents (8.3% of assets). The estimated fair value of these assets was $50.4 billion (including managed assets of $25.6 billion and custody assets of $24.9 billion) at September 30, 2024, compared to $47.2 billion (including managed assets of $23.8 billion and custody assets of $23.5 billion) at December 31, 2023 and $44.5 billion (including managed assets of $22.5 billion and custody assets of $22.0 billion) at September 30, 2023.

Service Charges on Deposit Accounts. Service charges on deposit accounts for the three and nine months ended September 30, 2024 increased $3.8 million, or 16.1%, and increased $9.4 million, or 13.6%, respectively, compared to the same periods in 2023. The increase during the three months ended September 30, 2024 was primarily related to increases in overdraft charges on consumer and commercial accounts (up $2.1 million and $745 thousand, respectively) and commercial service charges (up $1.3 million). The increase during the nine months ended September 30, 2024 was primarily related to increases in commercial service charges (up $4.0 million) and overdraft charges on consumer and commercial accounts (up $3.8 million and $1.5 million, respectively). The increases in commercial service charges during the three and nine months ended September 30,

2024 were partly related to increases in billable services related to analyzed treasury management accounts partly offset by the effect of a higher average earnings credit rate applied to deposits maintained by treasury management customers which resulted in customers paying for less of their services through fees rather than with earnings credits applied to their deposit balances. The increases in commercial service charges were also partly related, to a lesser extent, to increases in service fees on non-analyzed accounts. Overdraft charges totaled $13.8 million ($10.4 million consumer and $3.4 million commercial) during the three months ended September 30, 2024, compared to $11.0 million ($8.3 million consumer and $2.6 million commercial) during the same period in 2023. Overdraft charges totaled $37.8 million ($28.4 million consumer and $9.4 million commercial) during the nine months ended September 30, 2024, compared to $32.5 million ($24.6 million consumer and $7.9 million commercial) during the same period in 2023. The increases in overdraft charges during the three and nine months ended September 30, 2024 were impacted by increases in the volumes of fee assessed overdrafts relative to 2023, in part due to growth in the number of accounts.

In January 2024, the Consumer Financial Protection Bureau (“CFPB”) proposed to update and narrow certain regulatory exceptions for overdraft credit provided by financial institutions with assets in excess of $10 billion. Unless eligible for these narrowed exceptions, extensions of overdraft credit must adhere to certain regulatory requirements that generally apply to consumer credit products, unless the overdraft fee is a small amount, below a to-be-determined benchmark or that only recovers applicable costs and losses. The comment period for this proposal ended in April 2024. The extent to which any such proposed changes will impact our future overdraft fee revenues is currently uncertain.

Insurance Commissions and Fees. Insurance commissions and fees for the three and nine months ended September 30, 2024 increased $1.2 million, or 8.8%, and increased $1.5 million, or 3.4%, respectively, compared to the same periods in 2023. The increase during the three months ended September 30, 2024 was primarily the result of an increase in commercial lines property and casualty commissions (up $944 thousand). The increase during the nine months ended September 30, 2024 was primarily the result of an increases in both commercial lines and personal lines property and casualty commissions (up $2.7 million and $327 thousand, respectively), partly offset by decreases in life insurance commissions (down $1.3 million) and benefit plan commissions (down $321 thousand). The increases in commercial lines property and casualty commissions during the three and nine months ended September 30, 2024 and personal lines property and casualty commissions during the nine months ended September 30, 2024 were related to increases in the underlying exposure bases and increases in rates, and, in the case of commercial lines, increased business volumes. The decrease in life insurance commissions during the nine months ended September 30, 2024 was primarily due to a decrease in business volumes mostly due to a significant transaction in the first quarter of 2023. The decrease in benefit plan commissions during the nine months ended September 30, 2024 was primarily related to a decrease in business volumes as well as premium and exposure rate decreases within the existing customer base.

Contingent income totaled $413 thousand and $4.5 million during the three and nine months ended September 30, 2024, respectively, compared to $210 thousand and $4.5 million during the same respective periods in 2023. 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 during the nine months ended September 30, 2024 and $3.2 million during the nine months ended September 30, 2023. While total performance related contingent income remained flat during the respective nine month periods in 2024 and 2023, performance related contingent income related to commercial lines insurance policies decreased due to a deterioration of the loss performance of commercial lines insurance policies previously placed and lower growth within the commercial lines portfolio, partly due to a tightening of underwriting standards. This decrease was offset by an increase in performance related contingent income related to our personal lines portfolio due to improved loss performance. 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 $252 thousand and $1.4 million during the three and nine months ended September 30, 2024, respectively, compared to $135 thousand and $1.2 million during the same respective periods in 2023.

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 and nine months ended September 30, 2024 increased $756 thousand, or 16.2%, and increased $442 thousand, or 3.0%, respectively, compared to the same periods in 2023. A comparison of gross and net interchange and card transaction fees for the reported periods is presented in the table below.

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. In October 2023, the Federal Reserve issued a proposal under which the maximum permissible interchange fee for an electronic debit transaction would be the sum of 14.4 cents per transaction and 4 basis points multiplied by the value of the transaction. Furthermore, the fraud-prevention adjustment would increase from a maximum of 1 cent to 1.3 cents. The proposal would adopt an approach for future adjustments to the interchange fee cap, which would occur every other year based on issuer cost data gathered by the Federal Reserve from large debit card issuers. Had the proposed maximum interchange fees been in effect during the reported periods, interchange and debit card transaction fees would have been approximately 30% lower. The comment period for this proposal ended in May 2024. The extent to which any such proposed changes in permissible interchange fees will impact our future revenues is currently uncertain.

Other Charges, Commissions, and Fees. Other charges, commissions, and fees for the three months ended September 30, 2024 decreased $68 thousand, or 0.5%, compared to the same period in 2023. The decrease was primarily related to decreases in capital markets advisory fees (down $419 thousand), other service charges (down $284 thousand), and income from the placement of mutual funds (down $187 thousand), among other things, mostly offset by increases in income from the placement of annuities (up $338 thousand) and money market accounts (up $188 thousand); letter of credit fees (up $174); and merchant services rebates/bonuses (up $126 thousand), among other things. Other charges, commissions, and fees for the nine months ended September 30, 2024 increased $1.2 million, or 3.3%, compared to the same period in 2023. The increase was primarily related to increases in income from the placement of money market accounts (up $1.2 million); letter of credit fees (up $711 thousand); merchant services rebates/bonuses (up $657 thousand); and income from the placement of annuities (up $587 thousand); among other things, partly offset by decreases in capital markets advisory fees (down $1.2 million), other service charges (down $853 thousand), and commitment fees on unused lines of credit (down $658 thousand), among other things.

Net Gain/Loss on Securities Transactions. During the nine months ended September 30, 2024, we sold certain available-for-sale securities with amortized costs totaling $145.4 million and realized a net gain of $16 thousand.

During the nine months ended September 30, 2023, we sold certain available-for-sale securities with amortized costs totaling $1.9 billion and realized a net gain of $66 thousand. Prevailing market conditions in 2023 provided us an opportunity to sell certain lower-yielding securities to enhance our liquidity position and provide us the flexibility to be more opportunistic with the subsequent reinvestment of these funds.

Other Non-Interest Income. Other non-interest income for the three months ended September 30, 2024 decreased $1.4 million, or 10.5%, compared to the same period in 2023. The decrease was primarily related to decreases in sundry and other miscellaneous income (down $1.4 million) and income from customer derivative and foreign exchange transactions (down $1.1 million) partly offset by increases in gains on the sale of foreclosed and other assets (up $449 thousand) and public finance underwriting fees (up $397 thousand), among other things. Other non-interest income for the nine months ended September 30, 2024 increased $642 thousand, or 1.8%, compared to the same period in 2023. The increase was primarily related to increases in public finance underwriting fees (up $4.1 million), income from customer securities trading activities (up $635 thousand), and earnings on the cash surrender value of life insurance (up $622 thousand), among other things, partly offset by a decrease in sundry and other miscellaneous income (down $3.8 million), among other things. The fluctuations in public finance underwriting fees and income from customer derivative, foreign exchange and securities trading transactions were primarily related to variations in transaction volumes. Sundry and other miscellaneous income during the nine months ended September 30, 2024 included, among other things, $535 thousand related to the recovery of prior write-offs; $379 thousand related to a volume bonus received from a clearing broker; $184 thousand related to distributions received from a Small Business Investment Company (“SBIC”) investment; and $162 thousand related to merchant services performance and revenue milestone bonuses. Sundry and other miscellaneous income during the same period in 2023 included, among other things, $1.5 million related to distributions received from a Small Business Investment Company (“SBIC”) investment; $1.3 million related to the recovery of prior write-offs; $950 thousand related to merchant services performance and revenue milestone bonuses; $839 thousand related to a volume bonus received from a clearing broker; and $575 thousand related to a partnership interest.

Non-Interest Expense

Total non-interest expense for the three and nine months ended September 30, 2024 increased $30.2 million, or 10.3%, and increased $103.2 million, or 11.9%, respectively, compared to the same periods in 2023. Changes in the various components of non-interest expense are discussed below.

Salaries and Wages. Salaries and wages for the three and nine months ended September 30, 2024 increased $19.1 million, or 13.9%, and $54.8 million, or 13.7%, respectively, compared to the same periods in 2023. The increases in salaries and wages were primarily related to increases in salaries due to annual merit and market increases and increases in the number of employees. The increase in the number of employees was partly related to our investment in organic expansion in various markets. Salaries and wages during the three and nine months ended September 30, 2024 were also impacted, to a lesser extent, by increases in incentive compensation and commissions. We are continuing to experience 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 and nine months ended September 30, 2024 increased $2.5 million, or 9.5%, and increased $6.6 million, or 7.6%, respectively, compared to the same periods in 2023. The increases were primarily related to medical/dental benefits expense (up $1.3 million and $4.4 million during the three and nine months ended September 30, 2024, respectively) and payroll taxes (up $1.2 million and $3.8 million during the three and nine months ended September 30, 2024, respectively), among other things, partly offset, during the nine months ended September 30, 2024, by a decrease in 401(k)/profit sharing plan expense, primarily related to discretionary profit sharing contributions, (down $1.4 million) and increases in the net periodic benefit related to our defined benefit retirement plan (up $206 thousand and $621 thousand during the three and nine months ended September 30, 2024, respectively), 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 11 - Defined Benefit Plans for additional information related to our net periodic pension benefit/cost.

Net Occupancy. Net occupancy expense for the three and nine months ended September 30, 2024 increased $916 thousand, or 2.9%, and increased $3.0 million, or 3.2%, respectively, compared to the same periods in 2023. The increases during the three and nine months ended September 30, 2024 were primarily related to increases in depreciation on buildings and leasehold improvements (together up $814 thousand and $2.9 million, respectively), and repairs/maintenance/service contracts expense (up $1.1 million and $2.2 million, respectively), among other things, partly offset by decreases in property taxes (down $444 thousand and $1.2 million, respectively), and, during the nine months ended September 30, 2024, utilities expense (down $634 thousand), among other things. The increases in the aforementioned components of net occupancy expense were impacted, in part, by our expansion efforts.

Technology, Furniture, and Equipment. Technology, furniture, and equipment expense for the three and nine months ended September 30, 2024 increased $2.5 million, or 7.1%, and increased $7.9 million, or 7.8%, respectively, compared to the same periods in 2023. The increases during the three and nine months ended September 30, 2024 were primarily related to increases in cloud services expense (up $1.9 million and $6.4 million, respectively), service contracts expense (up $854 thousand and $2.3 million, respectively), software amortization (up $371 thousand and $767 thousand, respectively), and, during the nine months ended September 30, 2024, software maintenance (up $707 thousand), among other things. The increases from these items were partly offset by decreases in depreciation on furniture and equipment (down $612 thousand and $2.3 million, respectively), among other things.

Deposit Insurance. Deposit insurance expense totaled $7.2 million and $30.3 million for the three and nine months ended September 30, 2024, respectively, compared to $6.0 million and $18.5 million for the three and nine months ended September 30, 2023, respectively. The increase during the three months ended September 30, 2024 was primarily related to an increase in the assessment rate. The increase during the nine months ended September 30, 2024 was primarily related to additional accruals related to the special deposit insurance assessment discussed below and, to a lesser extent, an increase in the average assessment rate.

As more fully discussed in our 2023 Form 10-K, during the fourth quarter of 2023, we accrued $51.5 million ($40.7 million after tax) related to a special deposit insurance assessment to recover losses to the Deposit Insurance Fund ("DIF") incurred as a result of bank failures in 2023 and the FDIC's use of the systemic risk exception to cover certain deposits that were otherwise uninsured. This amount was based on our estimate of the full amount of the assessment at that time. In February 2024, the FDIC notified insured depository institutions that their loss estimate related to the aforementioned bank failures had increased. As a result, we accrued an additional $7.7 million ($6.1 million after tax), related to an expected update of the special assessment during the first quarter of 2024. Upon receipt of the update during the second quarter of 2024, we accrued an additional $1.2 million ($984 thousand after tax) related to the special assessment. This updated assessment was made under the FDIC's final rule whereby the estimated loss pursuant to the systemic risk determination can be periodically adjusted. The FDIC has also retained the ability to cease collection early, extend the special assessment collection period and impose a final shortfall special assessment. The extent to which any such additional future assessments will impact our future deposit insurance expense is currently uncertain.

Other Non-Interest Expense. Other non-interest expense for the three and nine months ended September 30, 2024 increased $3.9 million, or 7.0%, and increased $19.0 million, or 11.7%, respectively, compared to the same periods in 2023. The increase during the three months ended September 30, 2024 included increases in professional services expense (up $1.3 million), which was primarily related to information technology services; sundry and other miscellaneous expense (up $959 thousand); travel, meals and entertainment (up $618 thousand); and business development expense (up $592 thousand), among other things. These increases were partly offset by decreases in fraud losses (down $1.5 million) and advertising/promotions expense (down $951 thousand), among other things. The increase during the nine months ended September 30, 2024 included increases in advertising/promotions expense (up $3.8 million); professional services expense (up $3.4 million), which was primarily related to information technology services; business development expense (up $1.3 million); travel, meals and entertainment (up $1.2 million); stationery/printing expense (up $1.1 million); research and platform fees (up $968 thousand); postage expense (up $796 thousand); and sundry and other miscellaneous expense (up $781 thousand), among other things.

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 14 - 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 and nine months ended September 30, 2024 decreased $10.1 million, or 6.6%, and decreased $67.2 million, or 14.0%, respectively, compared to the same periods in 2023. The decrease during the three months ended September 30, 2024 was primarily the result of a $26.9 million increase in non-interest expense and an $8.2 million increase in credit loss expense partly offset by an $18.8 million increase in net interest income, a $3.5 million increase in non-interest income and a $2.7 million decrease in income tax expense. The decrease during the nine months ended September 30, 2024 was primarily the result of a $93.1 million increase in non-interest expense and an $18.6 million increase in credit loss expense partly offset by a $23.0 million increase in net interest income, an $11.0 million decrease in income tax expense, and a $10.6 million increase in non-interest income.

Net interest income for the three and nine months ended September 30, 2024 increased $18.8 million, or 4.9%, and increased $23.0 million, or 2.0%, respectively, compared to the same periods in 2023. The increase during the three months ended September 30, 2024 was primarily related to increases in the average volume of and yield on loans; increases in the average yields on taxable and tax-exempt securities; and an increase in the average volume of interest-bearing deposits (primarily amounts held in an interest-bearing account at the Federal Reserve), among other things. The impact of these items was partly offset by an increase in the average volume of higher-yielding time deposit accounts; decreases in the average volumes of taxable and tax-exempt securities; increases in the average costs of interest-bearing deposit accounts; and an increase in the average volume of repurchase agreements, among other things. The increase during the nine months ended September 30, 2024 was primarily related to increases in the average volume of and yield on loans and increases in the average yields on interest-bearing deposits (primarily amounts held in an interest-bearing account at the Federal Reserve) and taxable securities, and to a lesser extent, tax-exempt securities, among other things. The impact of these items was partly offset by an increase in the average volume of higher-yielding time deposit accounts combined with increases in the average costs of interest-bearing deposit accounts and repurchase agreements and decreases in the average volumes of tax-exempt securities, taxable securities, and interest-bearing deposits (primarily amounts held in an interest-bearing account at the Federal Reserve), among other things. Net interest income for the first nine months of 2024 was also positively impacted by an additional day as a result of leap year. See the analysis of net interest income included in the section captioned “Net Interest Income” included elsewhere in this discussion.

Credit loss expense for the three and nine months ended September 30, 2024 totaled $19.4 million and $48.8 million, respectively, compared to $11.2 million and $30.2 million during the same periods in 2023. 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 and nine months ended September 30, 2024 increased $3.5 million, or 5.6%, and increased $10.6 million, or 5.8%, respectively, compared to the same periods in 2023. The increases during the three and nine months ended September 30, 2024 were primarily related to increases in service charges on deposit accounts; insurance commissions and fees; and interchange and card transaction fees partly offset by decreases in other charges, commissions and fees; and, for the three months ended September 30, 2024, a decrease in other non-interest income. The increases in service charges on deposit accounts were primarily related to increases in commercial service charges and overdraft charges on consumer and commercial accounts. The increases in insurance commissions and fees were primarily related to increases in commercial lines property and casualty commissions and, to a lesser extent during the nine months ended September 30, 2024, an increase in personal lines property and casualty commissions. The increases in commercial and personal lines property and casualty commissions during the nine months ended September 30, 2024 were partly offset by decreases in life insurance commissions and benefit plan commissions. The decreases in other charges, commissions, and fees were primarily related to decreases in capital markets advisory fees, other service charges, and commitment fees on unused lines of credit, among other things, partly offset by increases in letter of credit fees, and merchant services rebates/bonuses, among other things. The decrease in other non-interest income during the three months ended September 30, 2024 was primarily related to decreases in sundry and other miscellaneous income and income from customer derivative and foreign exchange transactions, among other things, partly offset by increases in public finance underwriting fees, partly offset by increases in gains on the sale of foreclosed and other assets and public finance underwriting fees, among other things. 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 and nine months ended September 30, 2024 increased $26.9 million, or 10.6%, and increased $93.1 million, or 12.4%, respectively, compared to the same periods in 2023. While all categories of non-interest expense increased during the three and the nine months ended September 30, 2024, the largest increases were in salaries and wages; other non-interest expense; deposit insurance expense; technology, furniture, and equipment expense; and employee benefits expense. The increases in salaries and wages were primarily related to increases in salaries due to annual merit and market increases and increases in the number of employees. Salaries and wages were also impacted, to a lesser extent, by increases in incentive compensation. The increase in other non-interest expense during the three months ended September 30, 2024 included increases in professional services expense, which was primarily related to information technology services; sundry and other miscellaneous expense; travel, meals and entertainment; and business development expense, among other things, partly offset by decreases in fraud losses and advertising/promotions expense, among other things. The increase in other non-interest expense during the nine months ended September 30, 2024 included increases in advertising/promotions expense, professional services expense, which was primarily related to information technology services; business development expense; stationery/printing expense; postage expense; and sundry and other miscellaneous expense, among other things. The increase in deposit insurance expense during the three months ended September 30, 2024 was primarily related to an increase in the assessment rate. The increase in deposit insurance expense during the nine months ended September 30, 2024 was primarily related to additional accruals for a special deposit insurance assessment, and, to a lesser extent, an increase in the average assessment rate. The increases in technology, furniture, and equipment expense were primarily related to increases in cloud services expense, service contracts expense, software amortization, and, during the nine months ended September 30, 2024, software maintenance, among other things. The increases from these items were partly offset by decreases in depreciation on furniture and equipment, among other things. The increases in employee benefits expense were primarily related to medical/dental benefits expense and payroll taxes, among other things, partly offset, during the nine months ended September 30, 2024, by a decrease in 401(k)/profit sharing plan expense, primarily related to discretionary profit sharing contributions, and increases in the net periodic benefit related to our defined benefit retirement plan, among other things. See the analysis of these categories of non-interest expense included in the section captioned “Non-Interest Expense” included elsewhere in this discussion.

Frost Wealth Advisors

Net income for the three and nine months ended September 30, 2024 increased $812 thousand, or 11.9%, and increased $987 thousand, or 4.0%, respectively, compared to the same periods in 2023. The increase during the three months ended September 30, 2024 was primarily the result of a $4.2 million increase in non-interest income partly offset by a $3.3 million increase in non-interest expense, among other things. The increase during the nine months ended September 30, 2024 was primarily the result of a $11.0 million increase in non-interest income partly offset by a $9.6 million increase in non-interest expense, among other things.

Non-interest income for the three and nine months ended September 30, 2024 increased $4.2 million, or 9.7%, and increased $11.0 million, or 8.3%, respectively, compared to the same periods in 2023. The increases during the three and nine months ended September 30, 2024 were primarily due to increases in trust and investment management fees; other charges, commissions, and fees; and other non-interest income. The increases in trust and investment management fees were primarily related to increases in investment management fees and oil and gas fees, partly offset by decreases in estate fees and real estate fees. The increases in investment management fees were primarily related to increases in the average value of assets maintained in accounts partly related to higher equity valuations during 2024 relative to 2023. The increases in other charges, commissions, and fees during the three and nine months ended September 30, 2024 were primarily related to increases in income from the placement of money market accounts, and annuities, among other things. The increase in other charges, commissions and fees during the three months ended September 30, 2024 was partly offset by a decrease in income from the placement of mutual funds. The increases in other non-interest income were primarily due to increases in income from customer securities trading activities, partly offset during the nine months ended September 30, 2024 by a decrease in the volume bonuses received from a clearing broker. See the analysis of trust and investment management fees, other non-interest income 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 and nine months ended September 30, 2024 increased $3.3 million, or 8.8%, and increased $9.6 million, or 9.0%, respectively, compared to the same periods in 2023. The increases were primarily related to increases in salaries and wages; other non-interest expense and employee benefits expense partly offset by decreases in net occupancy expense. The increases in salaries and wages were primarily due to increases in salaries, due to annual merit and market increases, as well as increases in commission and incentive expense, among other things. The increases in other non-interest expense were primarily related to increases in research and platform fees; sundry and other miscellaneous expenses; and professional services expense; among other things, partly offset by decreases in the corporate overhead expense allocation, among other things. The increases in employee benefits were primarily related to increases in payroll taxes, medical benefits expense and 401(k)/profit sharing plan expense, among other things. The decreases in net occupancy expense were primarily due to decreases in property taxes.

Non-Banks

The Non-Banks operating segment had net losses of $3.4 million and $11.8 million during the three and nine months ended September 30, 2024, respectively, compared to net losses of $3.6 million and $10.3 million during the same respective periods in 2023. The decrease in the net loss during the three months ended September 30, 2024 was primarily due to an increase in income tax benefit due to an increase in the effective tax rate. The increase in net loss during the nine months ended September 30, 2024 was primarily due to an increase in net interest expense due to an increase in the average rates paid on our long-term borrowings partly offset by an increase in income tax benefit due to an increase in the effective tax rate.

Income Taxes

During the three months ended September 30, 2024, we recognized income tax expense of $28.7 million, for an effective tax rate of 16.4%, compared to $31.3 million, for an effective tax rate of 16.8%, for the same period in 2023. During the nine months ended September 30, 2024, we recognized income tax expense of $84.3 million, for an effective tax rate of 16.5%, compared to $96.3 million, for an effective tax rate of 16.3%, for the same period in 2023. The effective income tax rates differed from the U.S. statutory federal income tax rate of 21% during 2024 and 2023 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 decreases in income tax expense during the three and nine months ended September 30, 2024 were primarily due to decreases in projected pre-tax net income. The decrease in the effective tax rate during the three months ended September 30, 2024 was primarily related to an increase in tax benefits associated with stock compensation while the increase in the effective tax rate during the nine months ended September 30, 2024 was primarily related to a decrease in projected tax-exempt income from securities, among other things.

Average Balance Sheet

Average assets totaled $49.2 billion for the nine months ended September 30, 2024 representing a decrease of $608.6 million, or 1.2%, compared to average assets for the same period in 2023. Earning assets decreased $552.8 million, or 1.2%, during the nine months ended September 30, 2024, compared to the same period in 2023. The decrease in earning assets was primarily related to a $1.3 billion decrease in average taxable securities, a $947.0 million decrease in tax-exempt securities, and a $236.3 million decrease in average interest-bearing deposits (primarily amounts held in an interest-bearing account at the Federal Reserve) partly offset by a $2.0 billion increase in average loans. Average deposits decreased $867.5 million, or 2.1%, during the nine months ended September 30, 2024, compared to the same period in 2023. The decrease included a $1.8 billion decrease in non-interest-bearing deposits partly offset by a $918.4 million increase in interest-bearing deposits. Average non- interest-bearing deposits made up 33.9% and 37.5% of average total deposits during the nine months ended September 30, 2024 and 2023, 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 $1.2 billion, or 6.5%, from $18.8 billion at December 31, 2023 to $20.1 billion at September 30, 2024. 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 2023 Form 10-K for a more detailed discussion of our loan origination and risk management processes.

Commercial and Industrial. Commercial and industrial loans decreased $144.2 million, or 2.4%, from $6.0 billion at December 31, 2023 to $5.8 billion at September 30, 2024. 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 $133.0 million, or 14.2%, from $936.7 million at December 31, 2023 to $1.1 billion at September 30, 2024. Energy loans are one of our largest industry concentrations totaling 5.3% of total loans at September 30, 2024, up from 5.0% of total loans at December 31, 2023. 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. SNCs are participations purchased from upstream financial organizations and tend to be larger in size than our originated portfolio. Our purchased SNC portfolio totaled $832.3 million at September 30, 2024, increasing $32.8 million, or 4.1%, from $799.5 million at December 31, 2023. At September 30, 2024, 35.7% of outstanding purchased SNCs were related to the construction industry while 13.0% were related to the energy industry and 12.6% 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. 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 $797.9 million, or 8.9%, from $9.0 billion at December 31, 2023 to $9.8 billion at September 30, 2024. Commercial real estate loans represented 77.0% and 78.5% of total real estate loans at September 30, 2024 and December 31, 2023, respectively. 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 September 30, 2024, approximately 48.7% 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 $462.2 million, or 18.8%, from $2.5 billion at December 31, 2023 to $2.9 billion at September 30, 2024. Combined, home equity loans and lines of credit made up 59.1% and 60.5% of the consumer real estate loan total at September 30, 2024 and December 31, 2023, 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. We began offering 1-4 family mortgage loans to our employees during the first quarter of 2023 and subsequently gradually expanded our production of 1-4 family mortgage loans for customers thereafter. 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 $18.2 million, or 3.8%, from

December 31, 2023. 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.

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.

Accruing past due loans at September 30, 2024 increased $43.3 million compared to December 31, 2023. The increase was primarily related to increases in past due commercial real estate - buildings, land, and other loans (up $55.8 million) partly offset by decreases in past due commercial real estate - construction loans (down $6.8 million) and past due energy loans (down $5.9 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.

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Non-accrual loans at September 30, 2024 increased $44.0 million from December 31, 2023 primarily due to increases in non-accrual commercial and industrial loans and non-accrual commercial real estate - buildings, land, and other loans

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. Non-accrual commercial and industrial loans included two credit relationships in excess of $5.0 million totaling $30.2 million at September 30, 2024. One of these credit relationships was reported as non-accrual at December 31, 2023 and totaled $13.8 million at that date. This credit totaled $10.2 million at September 30, 2024. Non-accrual energy loans included one credit relationship in excess of $5.0 million totaling $5.9 million at December 31, 2023. Principal payments received during 2024 reduced the outstanding balance of this credit relationship to $4.1 million at September 30, 2024. Non-accrual commercial real estate loans included one credit relationship in excess of $5.0 million totaling $16.4 million at September 30, 2024 and $17.4 million at December 31, 2023. Another credit relationship had an aggregate balance of $5.6 million at September 30, 2024 of which $5.0 million was included with non-accrual commercial real estate loans and $586 thousand was included with non-accrual commercial and industrial loans.

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 2023 Form 10-K for additional information regarding our accounting policies related to credit losses. Also see Note 3 - Loans in the accompanying notes to consolidated financial statements for information related to model updates during the first quarter of 2024.

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.

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The allowance allocated to commercial and industrial loans totaled $80.6 million, or 1.38% of total commercial and industrial loans, at September 30, 2024 increasing $6.6 million, or 8.9%, compared to $74.0 million, or 1.24% of total commercial and industrial loans, at December 31, 2023. Specific allocations for commercial and industrial loans that were evaluated for expected credit losses on an individual basis increased $13.0 million from $2.4 million at December 31, 2023 to $15.4 million at September 30, 2024. The increase in specific allocations for commercial and industrial loans was primarily related to new specific allocations for new individually assessed loans. Modeled expected credit losses decreased $1.8 million while qualitative factor (“Q-Factor”) and other qualitative adjustments related to commercial and industrial loans decreased $4.6 million.

The allowance allocated to energy loans totaled $12.1 million, or 1.13% of total energy loans, at September 30, 2024 decreasing $5.7 million, or 32.0%, compared to $17.8 million, or 1.90% of total energy loans, at December 31, 2023. Modeled expected credit losses related to energy loans decreased $4.2 million while Q-Factor and other qualitative adjustments related to energy loans decreased $1.5 million. Specific allocations for energy loans that were evaluated for expected credit losses on an individual basis totaled $2.7 million at both September 30, 2024 and December 31, 2023.

The allowance allocated to commercial real estate loans totaled $142.8 million, or 1.46% of total commercial real estate loans, at September 30, 2024 increasing $12.2 million, or 9.4%, compared to $130.6 million, or 1.45% of total commercial real estate loans, at December 31, 2023. Q-Factor and other qualitative adjustments related to commercial real estate loans increased $6.4 million while modeled expected credit losses related to commercial real estate loans increased $3.7 million. Specific allocations for commercial real estate loans that were evaluated for expected credit losses on an individual basis increased from $2.7 million at December 31, 2023 to $4.8 million at September 30, 2024. The increase in specific allocations for commercial real estate loans was mostly related to an increased specific allocation for a loan that was previously individually assessed.

The allowance allocated to consumer real estate loans totaled $17.7 million, or 0.60% of total consumer real estate loans, at September 30, 2024 increasing $4.1 million, or 30.4%, compared to $13.5 million, or 0.55% of total consumer real estate loans, at December 31, 2023 primarily due to a $3.9 million increase in modeled expected credit losses.

The allowance allocated to consumer loans totaled $10.0 million, or 2.17% of total consumer loans, at September 30, 2024, compared to $10.0 million, or 2.10% of total consumer loans, at December 31, 2023. Modeled expected credit losses related to consumer loans increased $727 thousand while specific allocations for consumer loans that were evaluated for expected credit losses on an individual basis increased $187 thousand. Q-Factor and other qualitative adjustments decreased $999 thousand, which was primarily due to a decrease in the consumer overlay, which is further discussed below.

As more fully described in our 2023 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 September 30, 2024, we utilized the Moody’s Analytics September 2024 Consensus Scenario (the “September 2024 Consensus Scenario”) to forecast the macroeconomic variables used in our models. The September 2024 Consensus Scenario was based on the review of a variety of surveys of baseline forecasts of the U.S. economy. The September 2024 Consensus Scenario projections included, among other things, (i) U.S. Nominal Gross Domestic Product annualized quarterly growth rate of 3.41% during the remainder of 2024 followed by average annualized quarterly growth rates of 4.04% in 2025 and 4.13% through the end of the forecast period in the third quarter of 2026; (ii) average U.S. unemployment rate of 4.22% during the remainder of 2024 followed by average annualized quarterly rates of 4.21% in 2025 and 4.11% through the end of the forecast period in the third quarter of 2026; (iii) average Texas unemployment rate of 4.15% during the remainder of 2024 followed by average annualized quarterly rates of 4.02% in 2025 and 3.90% through the end of the forecast period in the third quarter of 2026; (iv) projected average 10 year Treasury rate of 3.88% during the remainder of 2024, increasing to 3.92% during 2025 and 3.98% through the end of the forecast period in the third quarter of 2026 and (v) average oil price of $77.17 per barrel during the remainder of 2024 and decreasing to $76.22 per barrel in 2025 and $74.07 per barrel through the end of the forecast period in the third quarter of 2026.

In estimating expected credit losses as of December 31, 2023, we utilized the Moody’s Analytics December 2023 Consensus Scenario (the “December 2023 Consensus Scenario”) to forecast the macroeconomic variables used in our models. The December 2023 Consensus Scenario was based on the review of a variety of surveys of baseline forecasts of the U.S. economy. The December 2023 Consensus Scenario projections included, among other things, (i) U.S. Nominal Gross Domestic Product average annualized quarterly growth rate of 2.86% during 2024 and 4.24% during 2025; (ii) average annualized U.S. unemployment rate of 4.33% during 2024 and 4.18% in 2025; (iii) average annualized Texas unemployment rate of 4.30% during 2024 and 4.00% during 2025; (iv) projected average 10 year Treasury rate of 4.24% during 2024 and 4.04% during 2025; and (v) average oil price of $83.02 per barrel during 2024 and $78.13 per barrel during 2025.

The overall loan portfolio as of September 30, 2024 increased $1.2 billion, or 6.5%, compared to December 31, 2023. This increase included a $797.9 million, or 8.9%, increase in commercial real estate loans; a $462.2 million, or 18.8%, increase in consumer real estate loans; and a $133.0 million, or 14.2%, increase in energy loans. These increases were partly offset by a $144.2 million, or 2.4%, decrease in commercial and industrial loans; and an $18.2 million, or 3.8%, decrease in consumer and other loans.

The weighted average risk grade for commercial and industrial loans increased to 6.71 at September 30, 2024 from 6.60 at December 31, 2023. The increase was primarily related to a $103.1 million increase in higher-risk grade classified loans. Classified loans consist of loans having a risk grade of 11, 12 or 13. The increase was also partly related to an increase in the weighted-average risk grade of pass grade commercial and industrial loans, which increased to 6.34 at September 30, 2024 from 6.32 at December 31, 2023. The weighted-average risk grade for energy loans decreased to 5.91 at September 30, 2024 from 6.05 at December 31, 2023. Pass-grade energy loans increased $150.9 million while the weighted-average risk grade of such loans decreased from 5.73 at December 31, 2023 to 5.72 at September 30, 2024. The decrease in the weighted-average risk grade on energy loans was also partly the result of a $18.9 million decrease in classified energy loans. The weighted average risk grade for commercial real estate loans increased to 7.37 at September 30, 2024 from 7.24 at December 31, 2023. The increase was primarily related to increases in commercial real estate loans graded as “watch” and “special mention” (together up $537.4 million) and an increase in classified commercial real estate loans (up $92.1 million). The effect of these items was partly offset by a decrease in the weighted-average risk grade of pass grade loans from 7.07 at December 31, 2023 to 7.05 at September 30, 2024.

As noted above, our credit loss models utilized the economic forecasts in the Moody's September 2024 Consensus Scenario for our estimated expected credit losses as of September 30, 2024 and the Moody’s December 2023 Consensus Scenario for our estimate of expected credit losses as of December 31, 2023. 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 September 30, 2024, modeled expected credit losses were adjusted upwards by a weighted-average Q-Factor adjustment of approximately 4.1%, resulting in a $3.7 million total adjustment, compared to 4.4% at December 31, 2023, which resulted in a $3.9 million total adjustment.

We have also provided additional qualitative adjustments, or management overlays, as of September 30, 2024 as management believes there are still significant risks impacting certain categories of our loan portfolio. Q-Factor and other qualitative adjustments as of September 30, 2024 are detailed in the table below.

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, most of our non-owner occupied and construction loans are originated with floating interest rates. As a result, these borrowers have been significantly impacted by the most recent cycle of rising interest rates, despite a slight decrease in market interest rates in September 2024.

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 global wars/military conflicts, 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 September 30, 2024, we used the Moody’s Analytics S3 Alternative Scenario Downside - 90th Percentile. In modeling expected credit losses using this scenario, we also assume each non-classified loan within our modeled loan pools is downgraded by one risk grade level. 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, 2023, we provided qualitative adjustments, as detailed in the table below. Further information regarding these qualitative adjustments is provided in our 2023 Form 10-K.

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.

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We recorded a net credit loss expense related to loans totaling $43.8 million for the nine months ended September 30, 2024 while we recorded a net credit loss expense totaling $38.2 million during the same period in 2023. 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 nine months of 2024 primarily reflects an increase in expected credit losses associated with commercial real estate loans; commercial and industrial loans; and consumer real estate loans, primarily related to increases in modeled expected credit losses and, to a lesser extent, specific allocations for commercial and consumer real estate loans and an increase in specific allocations for commercial and industrial loans. The net credit loss expense related to loans during the first nine months of 2024 also reflects charge-off trends related to commercial and industrial loans as well as consumer real estate and consumer and other loans (primarily related to overdrafts). The impact of these items was partly offset by a decrease in expected credit losses associated with energy loans; primarily related to decreases in modeled expected losses and the overlay for credit concentrations; a decrease in the down-side scenario overlay related on commercial and industrial loans, primarily due to a decrease in the expected probability of the downside scenario occurring; and a decrease in the consumer overlay, primarily associated with the model updates discussed in Note 3 - Loans in the accompanying notes to consolidated financial statements.

The ratio of the allowance for credit losses on loans to total loans was 1.31% at both September 30, 2024 and December 31, 2023. 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 $56.7 million and $51.8 million at September 30, 2024 and December 31, 2023, 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. The allowance for credit losses on off-balance-sheet credit exposures at September 30, 2024 was also impacted by a $4.3 million specific allocation related to certain unfunded letters of credit for a commercial and industrial borrower that was evaluated for expected credit losses on an individual basis. We also recognized specific allocations for funded loans to this borrower totaling $7.2 million at September 30, 2024, which were included in the increase of specific allocations for commercial and industrial loans discussed above. We recognized a net credit loss expense related to off-balance-sheet credit exposures totaling $5.0 million during the nine months ended September 30, 2024, compared to a net credit loss benefit of $8.2 million during the same period in 2023. Our policies and methodology used to estimate the allowance for credit losses on off-balance-sheet credit exposures are further described in our 2023 Form 10-K. This methodology was also impacted by the model updates during the first quarter of 2024 described in Note 3 - Loans in the accompanying notes to consolidated financial statements elsewhere in this report. The overall approximate impact of model updates during the first quarter was a $1.8 million increase in modeled expected credit losses for off-balance-sheet credit exposures.

Capital and Liquidity

Capital. Shareholders’ equity totaled $4.1 billion at September 30, 2024 and $3.7 billion at December 31, 2023. Sources of capital during the nine months ended September 30, 2024 included net income of $427.7 million; other comprehensive income, net of tax, of $203.8 million; $15.5 million in proceeds from stock option exercises and $10.0 million related to stock-based compensation. Uses of capital during the nine months ended September 30, 2024 included $185.9 million of dividends paid on preferred and common stock and $52.3 million of treasury stock purchases.

The accumulated other comprehensive income/loss component of shareholders’ equity totaled a net, after-tax, unrealized loss of $915.4 million at September 30, 2024, compared to a net, after-tax, unrealized loss of $1.1 billion at December 31, 2023. The decrease in the net, after-tax, unrealized loss was primarily due to a $202.8 million net, after-tax, increase in the fair value of securities available for sale.

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 6 - Capital and Regulatory Matters in the accompanying notes to consolidated financial statements included elsewhere in this report.

We paid a quarterly dividend of $0.92, $0.92, and $0.95 per common share during the first, second and third quarters of 2024, respectively and a quarterly dividend of $0.87, $0.87 and $0.92 per common share during the first, second and third quarters of 2023, respectively. These dividend amounts equate to a common stock dividend payout ratio of 42.8% and 35.2% during the first nine months of 2024 and 2023, 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 6 - 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 provide management the ability to repurchase shares of our common stock opportunistically in instances where management believes the market price undervalues our company. Such plans also provide us with the ability to repurchase shares of common stock that can be used to satisfy obligations related to stock compensation awards in order to mitigate the dilutive effect of such awards. For additional details, see Note 6 - 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.

Liquidity. As more fully discussed in our 2023 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 September 30, 2024, we had approximately $8.4 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 September 30, 2024, based upon available, pledgeable collateral, our total borrowing capacity with the FHLB was approximately $6.2 billion. Furthermore, at September 30, 2024, we had approximately $9.4 billion in securities that were available to pledge and could be used to support additional borrowings, as needed, through repurchase agreements or the Federal Reserve discount window.

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 6 - Capital and Regulatory Matters in the accompanying notes to consolidated financial statements included elsewhere in this report regarding such dividends. At September 30, 2024, Cullen/Frost had liquid assets, primarily consisting of cash on deposit at Frost Bank, totaling $313.9 million.

Accounting Standards Updates

See Note 16 - 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.

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 2023 Form 10-K. There has been no significant change in the types of market risks we face since December 31, 2023.

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.

Our model simulations as of September 30, 2024 indicate that our projected balance sheet is slightly less asset sensitive in comparison to our balance sheet as of December 31, 2023. For modeling purposes, as of September 30, 2024, 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 1.6% and 3.1%, 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 negative variances in net interest income of 1.5% and 2.8%, respectively, relative to the flat-rate case over the next 12 months. For modeling purposes, as of December 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 1.7% and 3.5%, 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 negative variances in net interest income of 1.3% and 3.0%, 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 September 30, 2024 and December 31, 2023, 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.

As of September 30, 2024, 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.

As of the end of the period covered by this Quarterly Report on Form 10-Q, an evaluation was conducted 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.