Cullen/Frost Bankers, Inc. (NYSE: CFR) — Q1 2019 Form 10-Q
Reporting period: Three months ended March 31, 2019; balance-sheet comparisons are to December 31, 2018 unless noted. The interim financial statements are unaudited. Cullen/Frost is a Texas-based financial holding company whose subsidiaries provide banking, wealth management, insurance, and related financial services.
Financial performance and position
- Revenue: Net interest income was $246.5 million, up 7.3% from $229.7 million in Q1 2018. Non-interest income was $96.8 million, up 5.8%. Together, these components totaled $343.3 million.
- Profit: Net income was $116.5 million, up 9.4%; net income available to common shareholders was $114.5 million, up 9.6%. Diluted EPS increased to $1.79 from $1.61. Return on average assets was 1.48%, versus 1.36%; return on average common equity was 14.08%, versus 13.62%.
- Interest margin: Taxable-equivalent net interest margin rose to 3.79% from 3.52%. Taxable-equivalent net interest income increased 7.4% to $271.2 million. Average loan yield increased to 5.33% from 4.65%, while the average cost of interest-bearing deposits rose to 0.69% from 0.28%.
- Expenses and credit costs: Non-interest expense increased 2.6% to $201.8 million. Provision for loan losses rose to $11.0 million from $6.9 million. Net charge-offs declined to $6.8 million from $12.4 million.
- Loans and asset quality: Loans were $14.4 billion, up 2.2% from year-end. Non-performing assets rose to $97.4 million from $74.9 million; the ratio to loans and foreclosed assets increased to 0.68% from 0.53%. Non-accrual loans were $92.2 million. The allowance was $136.4 million, or 0.95% of loans, versus $132.1 million, or 0.94%, at year-end.
- Cash flow and liquidity: Operating cash flow was $146.1 million, compared with $210.7 million in Q1 2018. Investing activities used $785.5 million and financing activities used $1.0 billion; cash and cash equivalents fell $1.67 billion to $2.28 billion. Deposits declined $854.3 million during the quarter to $26.3 billion. Management reported no known event reasonably likely to materially adversely affect liquidity; holding-company liquid assets, including cash and resell agreements, were $256.7 million.
- Debt and capital: Federal funds purchased and repurchase agreements totaled $1.23 billion; subordinated notes were $98.7 million and junior subordinated debentures were $136.3 million. Cullen/Frost’s CET1, Tier 1, total capital, and leverage ratios were 12.34%, 13.00%, 14.68%, and 9.35%, respectively. Management stated the company and Frost Bank exceeded fully phased-in Basel III requirements and were well capitalized.
- Equity and distributions: Shareholders’ equity was $3.59 billion, up from $3.37 billion. The increase included $157.4 million of after-tax other comprehensive income, largely reflecting higher unrealized gains on available-for-sale securities. The quarterly common dividend was $0.67 per share, versus $0.57 a year earlier. No shares were repurchased under the public plan during Q1.
Material changes versus comparable periods
- Higher loan and securities yields and loan growth drove stronger net interest income and margin; higher deposit and borrowing costs partly offset the benefit.
- Average non-interest-bearing deposits decreased $779.8 million year over year, while average interest-bearing deposits increased $462.5 million. At quarter-end, total deposits were down $854.3 million from year-end.
- Non-performing assets rose $22.5 million from year-end, including higher non-accrual commercial real estate and commercial and industrial loans and $4.0 million of restructured loans. Classified commercial, energy, and commercial real estate loans totaled $313.0 million, up from $269.6 million at year-end.
- Operating lease accounting adoption added $165.5 million in right-of-use assets and $171.8 million in lease liabilities at quarter-end. The company also adopted callable-debt-security premium amortization guidance, reducing opening retained earnings by $12.6 million; it expects 2019 premium amortization expense to be about $5.2 million higher than under the prior method.
Outlook, commentary, risks, and unusual items
- No specific earnings, revenue, or EPS guidance is provided. Management cautions that quarterly results are not necessarily indicative of full-year or future results.
- Management’s interest-rate model projected that, over the next 12 months, a 100- or 200-basis-point rate increase would raise net interest income by 0.2% or 1.2% relative to a flat-rate scenario; equivalent decreases would reduce it by 2.5% or 7.3%. The company described its balance sheet as less asset-sensitive than a year earlier and assumed commercial demand-deposit interest payments begin in Q2 2019 for modeling purposes.
- Key stated risks include Texas and broader economic conditions, market and commodity volatility, interest-rate changes, loan quality and reserve estimates, deposit competition and liquidity, regulatory and tax changes, cybersecurity and technology disruptions, and legal or regulatory matters. Management said pending legal matters were not expected to have a material adverse financial impact and reported no material change in previously disclosed risk factors.
- Unusual or potentially nonrecurring items included $931,000 of recovery of previously written-off interest and a $250,000 settlement within sundry income, plus $4.0 million of gains on sales of branch and operational facilities. Q1 2018 expenses included a significant charitable-foundation contribution and costs related to a third-party lockbox data-security incident.
- The company expects to recognize an additional $110 million to $140 million in right-of-use assets and lease liabilities in Q2 2019 for its new San Antonio headquarters. It is evaluating the expected-credit-loss standard effective January 1, 2020; management said adoption could increase credit-loss allowances but could not yet reasonably estimate the impact.
Investor verification priorities
- Assess the increase in non-performing assets and classified loans, particularly commercial real estate, commercial and industrial, and energy exposures; review the adequacy and assumptions behind the $136.4 million allowance.
- Determine whether deposit outflows and the lower quarter-end cash balance were temporary, and review the company’s funding and contingency-liquidity position.
- Track deposit pricing, commercial demand-deposit interest costs, and whether net interest margin can be sustained as rates and competition change.
- Separate recurring operating performance from facility-sale gains and other sundry income, and monitor expense growth against revenue growth.
- Review the effects of the new headquarters lease and the 2020 expected-credit-loss standard, including any future balance-sheet or reserve changes.
- Confirm capital and dividend capacity, including regulatory restrictions on upstream bank dividends and share repurchases.