Cullen/Frost Bankers, Inc. — Q3 2014 Form 10-Q
Business and period: Unaudited results for the quarter and nine months ended September 30, 2014. Cullen/Frost is a Texas-based financial holding company operating primarily through commercial and consumer banking and wealth-management businesses. Results include WNB Bancshares from its May 30 acquisition; Western National Bank was integrated into Frost Bank on June 20.
Key financial results
| Metric | Q3 2014 | Q3 2013 | 9M 2014 | 9M 2013 |
|---|---|---|---|---|
| Net interest income | $178.0m | $155.4m | $507.9m | $461.3m |
| Non-interest income | $80.9m | $74.0m | $237.5m | $224.3m |
| Non-interest expense | $163.8m | $151.8m | $485.7m | $457.4m |
| Net income | $77.6m | $60.4m | $205.3m | $175.3m |
| Net income available to common shareholders | $75.6m | $58.4m | $199.2m | $170.6m |
| Diluted EPS | $1.19 | $0.96 | $3.18 | $2.81 |
| Taxable-equivalent net interest margin | 3.39% | 3.38% | 3.43% | 3.42% |
Q3 common earnings rose 29.4% year over year; nine-month common earnings rose 16.8%. Management attributed improvement chiefly to higher net interest income, higher fee income and lower loan-loss provision, partly offset by increased expenses and taxes. Returns on average assets and average common equity were 1.13% and 11.32% for Q3, versus 1.01% and 10.07% a year earlier.
Balance sheet at September 30: Assets were $27.37bn, up from $24.31bn at year-end 2013; loans were $10.75bn, up from $9.52bn; deposits were $23.49bn, up from $20.69bn; and shareholders’ equity was $2.82bn, up from $2.51bn. Cash and cash equivalents totaled $5.30bn, compared with $4.56bn at year-end. Non-interest-bearing demand deposits were 43.3% of deposits.
Cash flow and funding: For the first nine months, operating cash flow was $174.8m, investing cash flow was negative $397.7m, and financing cash flow was $967.2m; cash and equivalents increased $744.3m. Financing cash flow included $1.18bn net deposit growth. Balance-sheet borrowings included $581.0m of federal funds purchased and repurchase agreements, $137.1m of junior subordinated debentures and $100.0m of other long-term borrowings. Cullen/Frost separately reported parent-company liquid assets of $289.7m.
Credit and capital: The allowance for loan losses was $98.3m, or 0.91% of loans, versus $92.4m and 0.97% at year-end. Nine-month net charge-offs were $6.0m, or 0.08% of average loans annualized, versus $26.0m and 0.38% in 2013. Non-performing assets were $63.0m, down from $69.8m; however, accruing past-due loans rose to $81.8m from $38.9m. Energy loans represented 14.9% of total loans. Cullen/Frost and Frost Bank were reported well capitalized: total risk-based capital ratios were 14.81% and 13.21%, respectively.
Material changes and unusual items
- WNB acquisition consideration was approximately $198.8m, including $149.7m in stock and $49.1m in cash. The preliminary allocation included $117.2m goodwill; acquired loans were recorded at fair value without a carryover loan-loss allowance.
- Growth in average earning assets drove most of the increase in taxable-equivalent net interest income. The nine-month average loan yield declined to 4.44% from 4.57%; lower funding costs and a larger share of higher-yielding tax-exempt municipal securities supported margin.
- Q3 provision expense fell to $0.4m from $5.1m, helped by increased recoveries, including a $3.4m recovery on one commercial and industrial relationship. The allowance-to-loans ratio declined despite loan growth.
- WNB-related acquisition expenses were $7.1m for nine months. Q3 other non-interest income included a $1.1m distribution from a small business investment company; nine-month 2014 income included $2.4m of such distributions and $1.3m recovery of interest on previously charged-off loans. The prior-year period included a $4.7m recognized gain on a building and parking-garage sale.
- Management noted rising past-due loans and an uncertain economic environment, including recent market volatility and decreasing oil prices. Classified commercial and industrial and commercial real estate loans together were down $40.2m from year-end; management cited improved risk grades in certain contractor segments.
Outlook, risks and contingencies
No specific earnings or revenue guidance is provided. Management’s interest-rate simulations estimated that a 100- or 200-basis-point rate increase would raise 12-month net interest income by 0.1% or 0.5%, respectively, while a 25-basis-point decrease would reduce it by 3.1%, relative to a flat-rate case. These estimates assume interest begins to be paid on certain demand deposits in Q4 2014. Management said the balance sheet was slightly less asset-sensitive than a year earlier.
Key risks include economic and market conditions, interest-rate changes, credit quality and loan-loss estimates, concentrations in Texas and energy lending, competition, regulation, acquisition integration, and the ability to attract and retain employees. The filing reports no material change in risk factors from the 2013 Form 10-K. Management did not expect pending legal claims to materially adversely affect the financial statements. Disclosure controls were deemed effective; management reported no material quarterly change in internal control over financial reporting.
Important facts for investors to verify
- Whether the increase in past-due loans persists or results in higher non-accruals, charge-offs or provisions.
- Energy-sector and broader Texas credit exposure, including the effect of oil-price changes and the acquired WNB loan portfolio.
- How deposit pricing, especially any interest paid on demand deposits, affects funding costs and the interest-rate sensitivity outlook.
- Whether earnings growth continues after accounting for acquisition-related costs and non-recurring investment distributions and recoveries.
- Final WNB purchase-price allocation and the acquired goodwill and intangible-asset assumptions; the allocation remained preliminary.