Cullen/Frost Bankers, Inc. — Q3 2021 Form 10-Q
Business context and period. Cullen/Frost is a Texas-based financial holding company offering banking, wealth management, insurance and related services. This unaudited filing covers the three and nine months ended September 30, 2021; balance-sheet comparisons are against December 31, 2020. Amounts below are in U.S. dollars; financial figures are generally rounded to millions.
Financial performance and condition
| Metric | Q3 2021 | Q3 2020 | Nine months 2021 | Nine months 2020 |
|---|---|---|---|---|
| Total revenue (net interest income plus non-interest income) | $339.3m | $327.0m | $1,021.8m | $1,107.9m |
| Net income available to common shareholders | $106.3m | $95.1m | $336.6m | $235.4m |
| Diluted earnings per share | $1.65 | $1.50 | $5.22 | $3.71 |
| Net interest income | $246.1m | $243.4m | $744.2m | $733.8m |
| Credit loss expense (benefit) | $0.0m | $20.3m | $0.1m | $227.5m |
| Non-interest income | $93.2m | $83.6m | $277.7m | $374.1m |
| Non-interest expense | $218.0m | $202.2m | $643.4m | $626.0m |
Margins and returns. Taxable-equivalent net interest margin was 2.47% in Q3, down from 2.95%; for the nine months it was 2.61%, versus 3.20%. Net interest spread was 2.43% for Q3 and 2.57% year to date. Return on average assets was 0.90% for Q3 and 1.00% year to date; return on average common equity was 9.87% and 10.72%, respectively.
Balance sheet and liquidity. At September 30, total assets were $47.9bn, up from $42.4bn at year-end 2020. Deposits rose to $39.6bn from $35.0bn, including $17.2bn of non-interest-bearing deposits. Total loans were $15.8bn, down from $17.5bn; net loans were $15.6bn. Cash and cash equivalents totaled $16.3bn, compared with $10.3bn at year-end. Management reported approximately $15.4bn held at the Federal Reserve, $3.1bn of available FHLB borrowing capacity and $8.0bn of unencumbered securities. The parent company reported $438.1m of liquid assets, including cash and resale agreements.
Funding, debt and capital. Balance-sheet funding included $2.2bn in repurchase agreements, $27.2m in federal funds purchased, $136.4m in junior subordinated debentures and $99.1m in subordinated notes. Shareholders’ equity was $4.37bn. At September 30, Cullen/Frost’s CET1, Tier 1, total capital and leverage ratios were 13.42%, 14.01%, 15.90% and 7.52%, respectively; Frost Bank’s corresponding ratios were 13.09%, 13.09%, 14.03% and 7.02%. Both exceeded the filing’s well-capitalized thresholds.
Cash flow. For the first nine months, operating activities provided $552.6m, investing activities provided $814.8m, and financing activities provided $4.60bn. Net cash and cash equivalents increased $5.97bn. Deposit growth was the main financing source; net loan repayments and maturities of securities contributed to investing cash flow.
Material changes versus comparable periods
- Common earnings increased 11.8% in Q3 and 43.0% year to date. The principal driver was much lower credit loss expense than in 2020, when COVID-19 uncertainty, oil-price volatility and adoption of the new credit-loss standard contributed to large provisions.
- Year-to-date non-interest income fell 25.8%, but 2020 included a $109.0m securities-sale gain. Excluding that gain, 2021 non-interest income increased $12.5m, or 4.7%.
- Q3 net interest income rose modestly, but margin declined as low market rates and a larger share of earning assets held as low-yielding interest-bearing deposits weighed on yields. Deposit costs also fell.
- Non-interest expense increased 7.8% in Q3 and 2.8% year to date, with higher compensation, benefits, technology and occupancy costs among the drivers.
- Deposits grew substantially while loans contracted, largely reflecting PPP loan forgiveness and repayment. Excluding PPP, loans were approximately flat versus year-end 2020.
- Accumulated other comprehensive income declined to $350.3m from $513.0m, mainly due to a $165.7m after-tax reduction in unrealized gains on available-for-sale securities. The filing states most AOCI components are excluded from regulatory capital.
Outlook, commentary and risks
- The filing provides no formal earnings or revenue guidance. Management said low market rates were expected to continue to affect net interest income and margin, while PPP participation was expected to support them in the near term. Approximately $11.5m of net PPP processing fees remained to be recognized; management expected about 75% in 2021 and the remainder in 2022.
- Management’s interest-rate simulations projected net interest income over the next 12 months to rise 3.6% under a 100-basis-point rate increase and 9.0% under a 200-basis-point increase, relative to a flat-rate scenario; a 25-basis-point decline projected a 3.0% decrease. These are model scenarios, not guidance.
- Credit metrics included $57.1m of non-accrual loans, 0.36% of total loans, and a $250.2m loan allowance, 1.58% of loans (1.67% excluding PPP). COVID-related payment deferrals remaining at quarter-end were not significant. Management retained substantial qualitative credit-loss adjustments, including $133.5m for commercial real estate risks and $58.8m for pandemic-affected industries.
- Commercial real estate was 45.8% of loans; energy was 6.2%. Management cited continuing economic and portfolio headwinds, including risks in commercial real estate construction and land lending and uncertainty for some small businesses as government support ends. COVID-19 effects, interest rates, economic conditions, energy markets, credit quality, cybersecurity, competition and regulation were among the disclosed risks.
- Management did not expect pending legal matters to have a material adverse financial-statement impact. It reported no material change in the risk factors from the 2020 Form 10-K. Disclosure controls were assessed as effective.
Important facts for investors to verify
- How much of the earnings increase reflects lower credit provisions and PPP fee recognition, and how sustainable are these sources?
- Whether deposit growth persists and whether excess cash can be deployed at yields that support net interest margin.
- Commercial real estate and energy credit trends, including the adequacy of qualitative allowance adjustments and changes in non-accruals, delinquencies and charge-offs.
- The sensitivity of actual net interest income to rate changes, including assumptions for deposit repricing and commercial demand deposit costs.
- The effect of available-for-sale securities valuation changes on reported equity, and the distinction between GAAP equity and regulatory capital.
- Dividend capacity and capital allocation, including the unused $100m share repurchase authorization and regulatory limits on upstream bank dividends.