Earnings Call Transcript - CFR Q3 2025

Operator, Operator

Greetings. Welcome to Cullen/Frost Bankers, Inc. Third Quarter 2025 Earnings Conference Call. Please note this conference is being recorded. I will now turn the conference over to A.B. Mendez, Senior Vice President and Director of Investor Relations. Thank you. You may begin.

A.B. Mendez, Senior Vice President and Director of Investor Relations

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

Phil Green, Chairman and CEO

Thanks, A.B. Good afternoon, everyone. Thanks for joining us. Today, we'll review third quarter 2025 results for Cullen/Frost. Our Chief Financial Officer, Dan Geddes will provide additional commentary and guidance before we take your questions. In the third quarter of 2025, Cullen/Frost earned $172.7 million or $2.67 per share, up 19.2% from a year ago. In the third quarter last year, our earnings were $144.8 million or $2.24 per share. Our return on average assets and average common equity in the third quarter were 1.32% and 16.72%, respectively. That compares with 1.16% and 15.48% in the third quarter last year. Average deposits in the third quarter were $42.1 billion, an increase of 3.3% over the $40.7 billion in the third quarter of last year and average loans grew to $21.5 billion in the third quarter, an increase of 6.8% compared with the $20.1 billion in the second quarter of last year. Our organic expansion strategy continues to generate positive results. As of quarter end, expansion deposits and loans stood at $2.9 billion and $2.1 billion, respectively, while generating almost 74,000 new households. That represents 10% of company loans and almost 7% of company deposits. Also, we were pleased to see the overall expansion reach a solid level of accretion in the third quarter, which will continue to grow as newer locations mature. Dan will share more detail in his comments but we are grateful to our owners for their support as we've reached this important milestone. Looking at our consumer business, we continue to see strong results, driven by consistent focus on customer experience across digital, phone and branch channels. And this commitment paired with strategic expansion is fueling what we believe to be industry-leading organic growth. In Q3, we recorded our strongest quarter in new checking household growth since the post-Silicon Valley flight to safety. Year-over-year, consumer checking households grew by 5.4%, a figure we believe positions us at the forefront of the industry in terms of organic growth. Mortgage lending also reached new heights this quarter with record performance across key metrics such as dollars funded, number of loans closed and solution referrals. Based on current momentum, we expect Q4 to surpass these records and we are confident of reaching our year-end goal of $0.5 billion in mortgages outstanding. Our overall consumer real estate loan portfolio, which stands at $3.5 billion in period-end outstandings has grown by $547 million year-over-year or 18.7%. Our commercial business continues to show good activity. Period-end commercial loans grew by 5.1% year-over-year, led by increases in energy, up 17% and C&I, up 6.8%. CRE balances increased 2.7% and were impacted by payoffs as some borrowers, particularly multifamily, opted for more flexible capital structures. Looking forward, I'm encouraged for a number of reasons. Calls made for the third quarter represented the second highest on record, putting us on track for the strongest year for calls made ever. Year-to-date, there have been 3,082 new commercial relationships, setting the pace for the largest number of new relationships in a year. This activity led to $5.6 billion in new opportunities created in the quarter, a 4% increase from Q2 and the highest quarter for third quarter on record. Strong new opportunity growth led to a weighted pipeline at quarter end of $1.9 billion, an increase of 20% from the second quarter and the second highest weighted pipeline ever. The weighted pipeline for CRE and C&I increased 29% and 11%, respectively and increases were seen in customer and prospects as well as core and large opportunities. Also, in addition to our consumer and commercial success, we're seeing some encouraging results for our wealth management and insurance businesses. Our overall credit quality remains good by historical standards with net charge-offs and nonperforming assets both at healthy levels. Nonperforming assets declined to $47 million at the end of the third quarter compared with $64 million last quarter and $106 million a year ago. Most of the decrease in the quarter was related to two credits. One was a borrower that returned to accrual status and the second was a successful resolution of a problem credit that had been on nonaccrual status since mid-2023. The quarter end nonperforming asset figure represents 22 basis points of period-end loans and 9 basis points of total assets. Net charge-offs for the third quarter were $6.6 million compared to $11.2 million last quarter and $9.6 million a year ago. Annualized net charge-offs for the third quarter represent 12 basis points of average loans. Total problem loans, which we define as risk grade 10, some people call that OAEM, or higher, totaled $828 million at the end of the third quarter, down from $989 million last quarter. This $169 million improvement was largely driven by the successful resolution of several risk grade 10 multifamily loans as anticipated and communicated during last quarter's earnings call. Also, as we noted on last quarter's call, while we continue to work with a few more multifamily borrowers in the risk grade 10 category and expect resolutions on each of these to occur, our overall commercial real estate lending portfolio remains stable with steady operating performance across all asset types and acceptable loan-to-value levels and debt service coverage ratios. I'm proud of these results and all of us at Frost continue to be optimistic about our strategy. That strategy, combined with our locations in the best banking markets anywhere and the dedication of our Frost bankers puts us in a great position to succeed. With that, I'll turn it over to Dan.

Dan Geddes, Group Executive Vice President and CFO

Thank you, Phil. Let me start by giving some additional color on our expansion results. During the third quarter, expansion locations delivered $0.09 of EPS accretion driven by Houston 1.0 generating $0.14 per share with Houston 2.0 and Dallas nearing breakeven and Austin, the newest expansion region, costing $0.04 per share. The expansion efforts, which began in December 2018, now solidly reap benefits to our shareholders as the branches sown in Houston 1.0 have matured and we expect the other expansion regions to follow a similar trend. For context, Houston 1.0 average branch age is 5.5 years, while Dallas' average branch is 2.5 years, Houston 2.0 average branch is 2 years and Austin, where we are roughly halfway through the build-out is just over 1 year on average. We continue to be pleased with the volumes we've been able to achieve. On a year-over-year basis, the expansion represented 38% of total loan growth and 39% of total deposit growth. Looking at calls for the quarter, the Frost commercial bankers in expansion branches represented 19% of total calls, 12% of customer calls and 31% of prospect calls. For new commercial relationships, 26% of all new commercial relationships were brought in from the expansion bankers. And when looking at just the expansion regions of Houston, Dallas and Austin, expansion Frost bankers accounted for 40% of new commercial relationships for those combined regions. Now moving to third quarter financial performance for the company. Regarding net interest margin, our net interest margin percentage was up 2 basis points to 3.69% from 3.67% reported last quarter. Our net interest margin percentage was positively impacted primarily by a mix shift from lower-yielding taxable securities into higher-yielding balances held at the Fed, loans and tax-exempt securities. Looking at our investment portfolio. The total investment portfolio averaged $20.2 billion during the third quarter, down $198 million from the previous quarter. Investment purchases during the quarter totaled $430 million of municipal securities with a taxable equivalent yield of 5.93%. We had $134 million of municipals roll off at an average tax equivalent yield of 4.88% and $317 million of agency paydowns. The net unrealized loss on available-for-sale portfolio at the end of the quarter was $1.14 billion compared to $1.42 billion reported at the end of the second quarter. The taxable equivalent yield on the total investment portfolio during the quarter was 3.85%, up 6 basis points from the previous quarter. The taxable portfolio averaged $13.3 billion, down approximately $458 million from the prior quarter and had a yield of 3.48%, flat with the prior quarter. Our tax-exempt municipal portfolio averaged $6.9 billion during the third quarter, up $269 million from the second quarter and had a taxable equivalent yield of 4.6%, up 12 basis points from the prior quarter. At the end of the third quarter, approximately 70% of the municipal portfolio was pre-refunded or PSF insured. The duration of the investment portfolio at the end of the third quarter was 5.4 years, down from 5.5 years at the end of the second quarter. Looking at funding sources. On a linked-quarter basis, average total deposits of $42.1 billion were up $311 million from the previous quarter. The linked quarter increase was driven primarily by interest-bearing accounts. The cost of interest-bearing accounts in the third quarter was 1.94%, up 1 basis point from 1.93% in the second quarter. Customer repos for the third quarter averaged $4.6 billion, up $342 million from the second quarter. The cost of customer repos for the quarter was 3.17%, down 6 basis points from the second quarter. Looking at noninterest income and expense, I'll point out a couple of items impacting the linked quarter results. Regarding noninterest income, we saw strong relative quarter performance in insurance commission and fees and public finance underwriting fees. Total noninterest expense was up 1.7% linked quarter and was impacted by higher incentive compensation, medical expenses and technology expenses. These were offset somewhat by lower planned advertising and marketing expense during the quarter, which were down $3.9 million from last quarter. As Phil mentioned, we are encouraged by our wealth management and insurance businesses. Trust and investment fees were up 9.3% in the third quarter compared to the same quarter last year and 8.2% on a year-to-date basis over 2024. Insurance commissions and fees were up 3.9% quarter-over-quarter and 6.9% year-to-date over 2024. Both of those lines of businesses are focused on a sales culture aligned with our organic growth strategy. Regarding our guidance for full year 2025, our current outlook includes one 25 basis point cut for the Fed funds rate in December. We expect net interest income growth for the full year to fall in the range of 7% to 8% compared to our prior guidance of 6% to 7%. For net interest margin, we still expect an improvement of about 12 to 15 basis points over our net interest margin of 3.53% for 2024. This is consistent with our prior guidance. Looking at loans and deposits, we expect full year average loan growth to be in the range of 6.5% to 7.5%, in line with our prior guidance of mid- to high single digits and we expect full year average deposits to be up between 2.5% and 3.5%, slightly higher than prior guidance. Regarding noninterest income, given our strong broad-based growth in the third quarter, our updated projection for full year growth is in the range of 6.5% to 7.5%, which is an increase from our prior guidance range of 3.5% to 4.5%. And we expect noninterest expense growth to be in the 8% to 9% range, in line with our prior guidance of high single digits. Regarding net charge-offs, we expect full year 2025 to be in the range of 15 to 20 basis points of average loans, a 5 basis point improvement from our prior guidance. Our effective tax rate expectation for full year 2025 remains unchanged from last quarter at 16% to 17%. Regarding our stock buyback, I wanted to mention that during the third quarter, we utilized $69.3 million of our $150 million approved share repurchase plan to buy back approximately 549,000 shares. With that, I'll turn the call back over to Phil for questions.

Phil Green, Chairman and CEO

Thank you, Dan. Okay. We'll open up the call for questions now.

Operator, Operator

Our first question is from Casey Haire with Autonomous Research.

Casey Haire, Analyst

I wanted to touch on the NIM. The guide is the same but versus last quarter but obviously, we have a Fed cut coming. Just wondering what you're thinking about for the fourth quarter.

Dan Geddes, Group Executive Vice President and CFO

I would like to mention that with the rate cut in October and another in early December, for the fourth quarter we expect some repricing benefits from our existing loans. We have some treasuries maturing in November that will assist us. However, the two rate cuts will negatively impact our net interest margin. Overall, for the fourth quarter, depending on deposit volumes, we could see our net interest margins remain relatively stable compared to the third quarter, thanks to those cuts. Ultimately, the volume of deposits will play a significant role in this.

Casey Haire, Analyst

Okay. Switching to expenses, you've mentioned that expense growth could slow down from this high single-digit rate. I have two questions: What do you consider to be the core expense inflation for the bank? And how much longer do you think it will take to reach that level from the current 9%?

Dan Geddes, Group Executive Vice President and CFO

Yes. So I think we're really focused on 2026 expenses, the growth moderating from upper single digits. We're in the middle of kind of budget processing and not ready to give 2026 guidance. But I think in general, we're focused on getting that growth down from high single digits to, I would say, on a glide path that is heading towards mid-single digits. Whether that's in '26 or '27, we're not ready to kind of say what '26 will be but we see that growth path declining.

Operator, Operator

Our next question is from Dave Rochester with Cantor Fitzgerald.

David Rochester, Analyst

We've heard from some other Texas players this earnings season talking about stronger competitive pressures in the market. And I was just wondering if you're seeing any evidence of that, any increase in pressures in the most recent quarter. And given, of course, the M&A deals that have been announced over the past few months, which is bringing additional larger competitors into your markets in a more meaningful way, how are you feeling about what that might mean for margin and growth going forward? Sometimes M&A can bring a lot of good opportunities from disruption and then it could also bring more competition. So how do you guys see that balance, that tug of war playing out?

Phil Green, Chairman and CEO

Yes, thanks. I think you caught it right. There is in my view, some increasing competition. I think we called that last quarter. I think we see a little bit more of that this quarter. I don't think anything dramatic. But it's clear there's money out there to be lent. It's mainly on terms where you see the most relevant competition to us. And I think I'm seeing some more pricing competition, although just on the margins. I'm not worried about our ability to compete. Our pipeline is good. And with regard to the acquisitions, I think you're exactly right. We have a saying that change equals regression and there's disruption brought on by these acquisitions. It gives us, we believe, a great opportunity to get customers we wouldn't otherwise have gotten. And in some of the markets we're in, we're seeing some really good success with that. And I expect that we'll have more. And if we don't, it's not because we're not trying; we're laser-focused on it. So I think that there will be some opportunity there. That said, we are not always in the market with some of these targets. We don't have exactly the same business model. So there's not always an exact overlap that we can just take advantage of. As far as the other banks coming in, larger banks, I don't want to sound casual about it but that's been our life story for the last 40 years. And I'm not worried about that at all. We, I think, differentiate ourselves very well. And frankly, our largest competitors and most significant competitors that we choose to compete against are really too big to fail. Really, I'd say, just to be honest, Chase, Wells, BofA are our most significant competitors and, therefore, that's where our focus is. It's easiest to differentiate our value proposition against those banks. And they're good banks. I'm not saying there's anything wrong with them but they're very large and I think it's difficult in the segments that we are really good at and choose to compete in, difficult for them to do it at the same level of service and relationship that we have. So I'm not concerned with the other banks coming into the market. And I think we'll continue to do well competitively just like we have to date. It's my view.

Dan Geddes, Group Executive Vice President and CFO

Just something to mention is that the three largest money center banks generally have about a 50% market share in the larger markets in Texas. And that happens to be where we get 50% of our new relationships from the larger banks.

David Rochester, Analyst

How it works out that way. That's great. I guess maybe just switching to the margin. Appreciate the color on where that goes for 4Q. I was curious how you're thinking about that on a more normalized basis, just given the forward curve, the cuts that are expected next year. I know you're still working through the budget. But what do you see in terms of just overall NIM trend over time? Can we move higher over the next couple of years? Obviously, you've got loans and deposits growing in legacy parts of the business and your expansion as well. Just given that backdrop and the forward curve, how much more upside is there to margin?

Dan Geddes, Group Executive Vice President and CFO

Yes. I'll discuss this again as I've mentioned in previous quarters. For the fourth quarter, we have approximately $800 million in maturities, calls, or prepayments, with a yield of 3.80%. This presents us with an opportunity to invest at higher yields. In 2026, this figure will exceed $2.5 billion at a yield of 3.60%. Therefore, we have potential to increase yield. However, if we experience significant rate cuts, it could negatively impact our net interest margin. While the situation is one aspect, a substantial number of rate cuts might also lead to faster deposit growth. Keep this in mind as you consider the prospects for 2026 and beyond, particularly if we enter a lower interest rate environment.

Operator, Operator

Our next question is from Steven Alexopoulos with TD Cowen.

Steven Alexopoulos, Analyst

I want to start by asking Dan about his response to Casey's question. With expense growth expected to moderate over the next 18 months to 2 years down to mid-single digits, does this assume the same level of new branch openings each year? Or will there need to be a reduction in the number of openings to achieve mid-single digit growth?

Dan Geddes, Group Executive Vice President and CFO

That's based on what we typically see in a year of expanding branch openings. We haven't factored in slower growth. It's working, and we will continue to pursue it.

Steven Alexopoulos, Analyst

Got it. So it's just the cost of new as sort of in the run rate at that point.

Dan Geddes, Group Executive Vice President and CFO

Yes. If you consider that we've opened about 70 new branches, bringing our total to 200, opening 10 to 15 branches each year becomes a smaller percentage compared to when we had 130 branches.

Steven Alexopoulos, Analyst

Got it. Okay. And then for you, Phil, so you've been pretty clear on these calls. You always get asked about pursuing M&A and you've been pretty clear you're internally focused. The organic growth playbook is working. I'm just curious, as you think long term, I know you guys always play the long game and you look at potentially over the long term, taking the model outside of Texas. Are you poking around at all to see if there's a small bank out there, which would give you a toehold outside of Texas, just given this window seems to be wide open now to announce and approve deals? Or are you not even exploring that?

Phil Green, Chairman and CEO

I am not exploring it. My preference is to move into new markets organically when the time comes. I believe this approach is cleaner, and we would want to hire local talent. However, I don't think we need to involve a financial institution, which would bring along various complications, risks, and challenges associated with acquisitions. In my experience, even minor acquisitions can drain resources as companies integrate them, especially when our brand and service proposition are as curated as ours. I believe we can pursue growth completely organically, mixing in Frost bankers from our legacy operations with new talent in markets that align with our value proposition. As you mentioned, we play the long game, and while this strategy may take more time, I believe it carries less risk and has a higher likelihood of success. That's how I see things at the moment.

Operator, Operator

Our next question is from Jared Shaw with Barclays.

Jared Shaw, Analyst

How should we be thinking about the capital generation and return from here in light of the buyback? Is that really just driven by feeling like 14% CET1 is high enough and we're solving for that? Or is it more in reaction to the underlying demand and opportunity for loan growth?

Phil Green, Chairman and CEO

I don't think it signals any kind of lack of optimism of success for growth. I want to make sure that we're clear on that. We are having good growth, as Dan talked about. We've got a great pipeline. I think we're going to be successful with loan growth. But keep in mind, we're starting out from a 50% loan-to-deposit ratio. So we've got lots of dry powder, whether it's in liquidity or it's in capital. So there is no signal whatsoever through those stock buybacks that we're not successful and going to be successful in competing in the marketplace and being successful. I think what's true is that we are generating significant amounts of capital and profitability. And we're taking the opportunity occasionally to utilize that capital and buy some stock back when it's clear that we've got room to do so. And that's what we did. It was not a play on price per se. I mean it was pretty much in line with where we are today. I think it's good intrinsic value for our shareholders. We have a lot of capital that we can utilize in that way. And so that's why we did it.

Jared Shaw, Analyst

Okay. Shifting gears a bit, when considering the expansion markets, are there opportunities for accelerated fee income from the newer markets, or is it primarily about direct balance sheet lending? As we look ahead over the next year or two, what potential do we see for fee income from these new locations?

Dan Geddes, Group Executive Vice President and CFO

Jared, that's a valid point. As Phil highlighted, we are acquiring new customers at what we consider to be an industry-leading rate, especially in these expansion regions where we're successfully adding new customers. We're experiencing results that exceed our projections in terms of service charges, which is mainly driven by volume. We've onboarded more customers than we initially anticipated, and this presents us with opportunities to increase our fee income.

Operator, Operator

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

Peter Winter, Analyst

I wanted to just follow up on capital. The TCE ratio is on the low side versus peers. It certainly had a nice increase this quarter given the AOCI. Is there a level you'd like to see the TCE ratio get to? And maybe any thoughts on restructuring the securities portfolio?

Phil Green, Chairman and CEO

I wouldn't say that restructuring the portfolio is a focus for us right now. It's been a topic in the industry for some time, with certain players taking that route, but we expect those assets to mature at par, and we have strong liquidity to hold them. So, we're not looking to make changes there. Regarding our capital, we're currently at some of the highest levels we've ever experienced, which gives us flexibility in how we manage that. This was evident in the buybacks we executed this quarter, and I anticipate that we will continue to utilize that approach over time at varying levels.

Peter Winter, Analyst

Okay. Just on the branch expansion, great to see it accretive to earnings. It's been a pretty long journey.

Phil Green, Chairman and CEO

Yes, it is.

Peter Winter, Analyst

Last quarter, you mentioned it was going to be accretive to '26, so probably a little bit earlier than, I guess, we were assuming. Can you provide any additional color maybe on the level of accretion you're expecting next year?

Phil Green, Chairman and CEO

Not next year. We're not going to give any guidance on anything next year as is our practice until January. But I think we can give some color on it, Dan?

Dan Geddes, Group Executive Vice President and CFO

We wanted to highlight the significant accretion that occurred this quarter, which was more than double that of previous quarters. We've been around breakeven for several quarters, so we felt it was important to emphasize that not only is it accretive, but it is also growing. The ages of the expansions are relevant here; Houston has been generating $0.14 after 5.5 years, while Houston 2.0 and Dallas are both at breakeven after 2 and 2.5 years, respectively. This illustrates the trajectory for future earnings growth, especially as Houston 1.0 matures and as 2.0 and Dallas reach 4- and 5-year milestones. For the fourth quarter, we anticipate similar EPS accretion, but it's possible that the recent rate cuts might slightly impact profitability by $0.01 to $0.02 for the expansions.

Phil Green, Chairman and CEO

Dan raises an important point regarding rate cuts, and it's vital to recognize our perspective on this matter. Our approach is rooted in a long-term strategy. We conducted our pro formas based on what we believe to be a normalized interest rate environment, which we define as a 3% Fed funds and a 6% prime rate. Currently, we are slightly above those levels, and the direction of the Fed’s actions remains uncertain. If the Fed lowers rates, as Dan mentioned, it may reduce the current earnings of any intermediary that is asset sensitive, but that doesn't diminish the success we are experiencing. Rates are cyclical; we've encountered low rates before, and we will face higher rates again. What we are witnessing is the strong performance from Houston 1.0, which is contributing positively and adding value. As Houston 2.0 and Dallas reach similar performance levels, the growth potential will continue to expand. This is an exciting development for us.

Operator, Operator

Our next question is from Sean Sorahan with Evercore ISI.

Sean Sorahan, Analyst

So wanted to circle back on the fee commentary earlier. I heard in your prepared remarks that full year '25 fees are now expected up 6.5% to 7.5%. A quick back of the envelope math there says 4Q should be essentially flat or down a touch. And when you annualize that number, it looks in line with Street estimates for next year, which means any growth there should be interpreted pretty positively. Can you unpack drivers of that flat 4Q expectation? And to the extent that you can for next year, frame out any growth?

Dan Geddes, Group Executive Vice President and CFO

Yes, I’d be happy to. In the fourth quarter, we’ve seen good growth in trust and service charges, and insurance, across the board. However, the insurance business is a bit lighter in the fourth quarter. Additionally, our public finance underwriting experienced some pull forward in school bond underwriting, which we don’t expect to happen to the same extent this quarter. This will affect our fee income. Those are a couple of points to consider for the fourth quarter.

Sean Sorahan, Analyst

Got it. And then maybe shifting to credit just because you haven't touched on that yet. Results look great in the quarter. NPAs were down and NCLs were just 12 basis points, both were encouraging. But I think there's a bit of incremental apprehension regarding credit in the market today, maybe relative to a couple of months ago. Can you talk through some of the underlying trends you're seeing and maybe highlight any of the areas you're monitoring more closely given some of the broader macro uncertainties remain, if you had to flag any?

Phil Green, Chairman and CEO

Thank you. Credit has remained very strong and is improving. The level of nonperforming loans is the lowest I have ever seen, which is encouraging. The previous concerns around commercial real estate and multifamily have been addressed, especially as private equity is taking on more of those loans and as these projects mature. While there is still work to be done in the multifamily area, I feel confident that the situation is stable. The term NDFI has come up recently, and based on our reports, we have approximately $860 million in NDFIs, which constitutes about 4% of our loans. It's essential to grasp what this means. A significant portion, about $532 million, consists of subscription lines for private equity, while $308 million pertains to loans for family offices, insurance companies, and other investors. Additionally, we have $327 million in loans to private credit intermediaries, including $74 million related to consumer credit intermediaries, such as Buy Here Pay Here businesses, which are performing well. Although we faced some weaknesses in that segment back in mid-2023, we've since reduced our exposure by about $50 million, leaving us with $74 million, which we feel good about. Our largest relationship in this category is around $60 million and has been established since 1958, demonstrating our conservative approach. Overall, we have $1.5 billion in deposits from these clients, significantly exceeding the $860 million lent out, illustrating the strength of our relationships. The average tenure with these clients is 11 years. While no banking operation is without challenges, I am not concerned about our current portfolio as I observe the market conditions. We have made adjustments to our policies, enhancing field audits to mitigate risks further. Although perfection in banking is unattainable, I remain confident in our position amidst market fluctuations.

Operator, Operator

Our next question is from Manan Gosalia with Morgan Stanley.

Manan Gosalia, Analyst

Could you discuss the trends in loan growth and what you are observing? Last quarter, you mentioned increased competition related to pricing and structure. You also pointed out CRE paydowns this quarter. How long do you anticipate this being a challenge? Do you believe the situation has improved or worsened over the last quarter?

Phil Green, Chairman and CEO

That's a really interesting question. Thank you. I'll tell you that as I have been out in the field talking to our lenders and I think this is proven by the pipeline numbers that I discussed earlier, here's what I'm hearing from them that the summer was tough, particularly the end of the summer, activity was slowing. And I think we saw that a little bit at the end of that summer period. But what they have told me, I'd say 9 out of 10 of the relationship managers I've talked to have talked about how things are moving forward now. And I think that's new. And I think that's encouraging. And again, as you looked at our pipeline for this quarter, it was up 20% on a linked quarter basis. Now I'm not saying that was all related to that but it certainly would have been a factor. I remember one conversation I had with one lender in Dallas and he gave this example of what a customer said that my customer told me, you know what, I wish I had just done the deal 18 months ago. Because it seemed like every time you turn around, there's some problem where the world is going to fall off a cliff and you wait and you wait and if I had just done this, I'd be 1.5 years into the project. So I think there's some people that are getting more comfortable with uncertainty, frankly. I think there's not uncertainty there but there's enough certainty and the need for business to move forward that they're starting to do it. And I'm hearing that more broadly in our business. And I think that's a trend that I hope continues. I think it may well be doing that through the end of the year.

Manan Gosalia, Analyst

Got it. And I guess, does that mean that there's enough opportunity to grow despite the higher level of competition and maybe despite the high level of CRE paydowns that you're seeing?

Phil Green, Chairman and CEO

I don't believe that competition will prevent us from achieving success. While it exists, during times of growth, we typically capture our fair share of business. Customers choose to bank with us because we are reliable and consistently present in the market, eliminating any uncertainty about our stability. Therefore, I am not particularly concerned about competition at this moment. I view our company as a low-cost producer in terms of funding, which allows me to be aggressive and effective with pricing. The structural challenges are another matter that we always address. However, when it comes to potentially countering paydown challenges in areas such as multifamily, our regional teams feel confident about their ability to manage it. They are well-informed about expected paydowns and are in close communication with their customers regarding the timelines. Despite these paydowns, they still anticipate some growth, and those projections are what Dan considers when providing estimates. So, I would say yes, we believe we can offset those challenges.

Dan Geddes, Group Executive Vice President and CFO

Earlier this year, particularly in the first quarter, we faced challenges, especially in commercial real estate. However, it was encouraging to see that our commercial real estate weighted pipeline grew by 30% from the previous quarter. About 60% of this weighted pipeline consists of existing customers, which provides a good balance, with 40% coming from new prospects. The presence of these customers indicates that the payoffs we've seen have allowed us to take on new projects for developers. Having been in this field for 20 years, I understand the challenges of payoffs, but they also open doors to future projects. We anticipate strong commitment trends despite elevated payoffs this year. Looking ahead to 2026, we expect some multifamily projects to payoff through refinancing, especially if the market conditions change, which could also generate new loan opportunities for us.

Operator, Operator

Our next question is from Catherine Mealor with KBW.

Catherine Mealor, Analyst

You talked about how this quarter was some of the best you've seen in the consumer checking. And if I look at your loan growth versus deposit growth, you've been growing loan growth successfully in the high single-digit range. Deposit growth is typically kind of 2% to 3%. But it feels like we're seeing a shift in deposit growth this quarter and then with just with the profitability of your new branches, too. And so just kind of curious, is it fair to assume that, that deposit growth rate accelerates into '26 and so that average earning assets or our balance sheet growth tends to look a little bit better into next year relative to what we've seen over the past couple of years?

Dan Geddes, Group Executive Vice President and CFO

I believe there is an opportunity here, particularly if we experience several interest rate cuts. There are funds currently in off-balance sheet money market accounts that could suddenly make us more competitive. This could allow us to grow our deposits by transferring some of those funds onto our balance sheet. Additionally, we see significant deposit growth from our expanding relationships. Our year-to-date deposit growth is largely driven by new customer acquisition, which I expect to continue into 2026 and 2027. There will be ongoing competitive pressure on deposit rates and growth, but I see potential for us to slightly increase our growth in the coming years, even if we don't return to the high single-digit levels of the past.

Catherine Mealor, Analyst

And then separately from that, if you look at your slides from this past quarter that you put out, I think Slide 28 shows a really interesting progression in the EPS from the branch investments that you've made and it shows a big pop in EPS in '26 and '27 and you've already talked a lot about that on this call so far. And so it would tell you that we've got big EPS growth just coming from that expansion strategy in '26 and really even more so in '27. And then if you look at consensus estimates, there's very little single-digit kind of EPS growth in consensus estimates today. So do you think the Street is appropriately viewing the profitability improvement that you think can come from the branch expansion? Or are there just structurally other things that are in there that are offsetting it that we need to be aware of?

Dan Geddes, Group Executive Vice President and CFO

The most significant assumption we make is a normalized Fed funds rate of 3%. Currently, we are in a higher interest rate environment. If rates decrease, that will be one of the factors to consider in your model, as the entire business is affected by the interest rate environment. Other than that, we expect a positive trajectory in a normalized environment due to the volumes we've achieved in Houston, Dallas, and now Austin.

Operator, Operator

And our final question comes from David Chiaverini with Jefferies.

David Chiaverini, Analyst

How should we think about operating leverage? You mentioned the glide path of high single digit to mid-single digit on expenses looking out to 2027. Any comment on the operating leverage that could potentially come with that?

Dan Geddes, Group Executive Vice President and CFO

We're focused on that expense number. I will tell you that. And with us able to acquire new customers and with our organic growth strategy, I mean, those do help when you think about noninterest income, kind of fee revenue with wealth management, insurance, those lines of business, we're optimistic about us growing in those two areas. As we continue to grow in Texas, they're very aligned with our organic growth strategy. So I think there's opportunities there. The headwind is going to be the interest rate environment that we're in and just on the net interest income. And just that growth, that would be my only comment there is, we're going to see opportunities to reprice back book on both loans and our investment portfolio but we're also interest rate sensitive as well. So I think those components that we look at. We do think there is this glide path on the expense side to where we're not running high single digits in the foreseeable future.

David Chiaverini, Analyst

Very helpful. And then a follow-up on credit quality. There's been some volatility in oil prices in recent months. Can you remind us at what price level your borrowers would potentially come under some stress?

Phil Green, Chairman and CEO

Well, it depends on various factors, including the basins they operate in and their operating costs. You would want to consider the industry numbers, and generally, there is a consensus that if prices drop into the 40s, companies may experience some stress. A key factor is how much hedging we require on our portfolio, which is significant. We review our loan portfolio every quarter, and although lower prices do increase interest levels, the leverage in our portfolio is currently very low, and our hedging levels are high, resulting in strong cash flow and EBITDAX. Overall, the portfolio is in excellent shape. Additionally, energy prices are at mid-single digits compared to three times that a decade ago, making me feel confident about the portfolio. Even if prices do fall into the 40s temporarily, I am not overly concerned as we have adequate hedging in place, allowing time to address any issues. In short, stress could appear in the 40s.

Dan Geddes, Group Executive Vice President and CFO

And just keep in mind, the portfolio comprises approximately 25% gas and 75% oil, so it’s not solely focused on crude.

Phil Green, Chairman and CEO

That's true.

Operator, Operator

This concludes our question-and-answer session. I would like to turn the conference back over to Phil Green for closing remarks.

Phil Green, Chairman and CEO

Okay. Well, that's all we have for you today. We thank everyone for their interest and we appreciate you being on the call. Thank you. We're adjourned.

Operator, Operator

Thank you. This will conclude today's conference. You may disconnect at this time and thank you for your participation.