Cullen/Frost Bankers, Inc. — Q1 2014 Form 10-Q
Business context and reporting period. Cullen/Frost is a Texas-based financial holding company operating principally through Frost Bank, with Banking and Frost Wealth Advisors businesses. This unaudited report covers the three months ended March 31, 2014; balance-sheet figures are compared with December 31, 2013, and income and cash-flow figures with Q1 2013.
Financial performance and position
| Metric | Q1 2014 / March 31, 2014 | Comparable period / prior year-end |
|---|---|---|
| Total revenue (net interest income plus non-interest income) | $237.8 million | $230.6 million, Q1 2013 |
| Net interest income | $160.3 million | $152.8 million, Q1 2013 |
| Net income | $61.2 million; $59.2 million available to common shareholders | $55.2 million, Q1 2013 |
| Diluted earnings per common share | $0.96 | $0.91, Q1 2013 |
| Net interest margin, taxable-equivalent | 3.42% | 3.45%, Q1 2013 |
| Return on average assets / average common equity | 1.00% / 9.97% | 1.01% / 9.49%, Q1 2013 |
| Total assets | $24.69 billion | $24.31 billion, December 31, 2013 |
| Loans, net of allowance | $9.66 billion | $9.42 billion, December 31, 2013 |
| Total deposits | $21.07 billion | $20.69 billion, December 31, 2013 |
| Cash and cash equivalents | $5.18 billion | $4.56 billion, December 31, 2013 |
| Shareholders’ equity | $2.57 billion | $2.51 billion, December 31, 2013 |
Cash flow and funding. Operating activities generated $72.6 million in cash in Q1 2014, versus a $45.2 million use in Q1 2013. Investing activities provided $339.5 million and financing activities provided $209.9 million; cash and cash equivalents increased $622.0 million. Deposit growth and securities maturities contributed to liquidity. At quarter-end, short-term borrowings were $515.2 million, junior subordinated debentures $123.7 million, and other long-term borrowings $100.0 million. Management reported $345.0 million of liquid assets at the parent holding-company level, including cash and resell agreements.
Capital and credit. Cullen/Frost reported total risk-based capital of 15.38%, Tier 1 risk-based capital of 14.41%, and a leverage ratio of 8.59%; Frost Bank’s respective ratios were 13.04%, 12.50%, and 7.45%. Management said both entities were well capitalized and expected to meet fully phased-in Basel III requirements. The allowance for loan losses was $95.2 million, or 0.98% of loans. Non-performing assets were $61.3 million, 0.25% of assets; annualized net charge-offs were 0.16% of average loans.
Material changes versus comparable periods
- Net income available to common shareholders rose $4.0 million, or 7.2%, year over year. Higher net interest income and lower income tax expense more than offset higher expenses, provision for loan losses, and preferred dividends.
- Taxable-equivalent net interest income increased 8.7%, mainly from higher average earning-asset volume. Net interest margin edged down three basis points to 3.42%; management cited a greater share of lower-yielding interest-bearing deposits and lower loan yields, partly offset by a shift toward tax-exempt municipal securities.
- Non-interest income was nearly flat at $77.5 million. Trust and investment management fees increased 16.1%, while other income declined largely because Q1 2013 included a building-sale gain.
- Non-interest expense increased 1.4%. Salary costs rose with higher staffing and merit increases; Q1 2013 had included $7.2 million of property and other asset write-downs.
- Loans increased 2.5% and deposits increased from year-end. Non-performing assets declined $8.5 million from year-end, but potential problem loans rose to $29.7 million from $13.8 million.
Outlook, risks, contingencies, and unusual items
- The filing provides no specific full-year earnings or revenue guidance. Management cautioned that interim results are not necessarily indicative of full-year or future results.
- The pending WNB Bancshares acquisition was expected to close in Q2 2014, subject to regulatory approval and other conditions. Consideration includes 2 million Cullen/Frost shares and cash of $220 million less the value of those shares, with adjustments. Q1 included $1.1 million of related costs.
- Interest-rate sensitivity modeling projected that a 100- or 200-basis-point rate increase would raise next-12-month net interest income by 0.2% or 1.1%, respectively, relative to a flat-rate case; a 25-basis-point decrease would lower it by 3.0%. The model assumed the company would begin paying interest on certain demand deposits in Q2 2014; actual deposit pricing could differ.
- Credit risks include borrower performance, commercial and real estate exposures, and uncertainty in estimating loan-loss reserves. Energy represented 57.3% of purchased shared national credits, though no industry other than energy exceeded 10% of total loans. Management identified contractors as a distressed industry but said certain contractor segments improved.
- Management said securities with unrealized losses were temporarily impaired, largely because of interest-rate changes, and it did not intend to sell them before recovery. The portfolio includes substantial long-dated securities; fair value and recovery may vary with rates and market conditions.
- Debit-card interchange fee rules remained subject to legal and regulatory uncertainty. The filing reported no material change in previously disclosed risk factors; management did not expect pending legal matters to have a material adverse effect.
- Q1 2013 comparability included a $4.3 million recognized gain from a building and parking-garage sale and a $15.0 million charge-off on one commercial loan relationship. Q1 2014 included $1.1 million of WNB acquisition costs. A remaining $0.6 million deferred building-sale gain was expected to be recognized over the remaining lease period.
Important facts for investors to verify
- Track whether loan growth, potential problem loans, classified credits, and the allowance develop consistently; potential problem loans increased despite lower reported non-performing assets.
- Confirm WNB transaction approval, closing timing, final consideration and adjustments, and integration costs.
- Monitor deposit pricing, interest-rate sensitivity, net interest margin, and the effect of any interest paid on demand deposits.
- Assess the securities portfolio’s rate exposure and the assumptions supporting management’s view that unrealized losses are temporary.
- Verify capital and liquidity remain adequate after acquisition funding, dividends, and implementation of Basel III requirements.