Cullen/Frost Bankers, Inc. — Q2 2018 Form 10-Q
Business and period: Texas-based financial holding company providing banking, trust and investment management, insurance, and related services. This unaudited filing covers the quarter and six months ended June 30, 2018; comparisons are primarily with 2017 for earnings and December 31, 2017 for balance-sheet amounts.
Financial performance and position
- Q2 earnings: Net income was $111.3 million and income available to common shareholders was $109.3 million, up 30.9% year over year. Diluted EPS was $1.68, versus $1.29. For the first six months, common income was $213.8 million, up 28.4%, and diluted EPS was $3.30, versus $2.57.
- Revenue and margins: Q2 net interest income was $237.3 million, versus $214.8 million; six-month net interest income was $467.0 million, versus $423.3 million. Taxable-equivalent net interest margin was 3.64% for Q2 and 3.58% year to date, compared with 3.70% and 3.67%. Management said the lower federal tax rate affected comparability; excluding that effect, margin increased 26 and 23 basis points, respectively. Non-interest income increased 4.9% in Q2 and 7.1% year to date.
- Costs and credit provision: Non-interest expense rose 0.5% in Q2 and 2.5% year to date. Provision for loan losses was $8.3 million in Q2 and $15.2 million year to date, compared with $8.4 million and $16.4 million.
- Loans and credit quality: Loans were $13.71 billion, up 4.3% from year-end. Energy loans were 11.1% of loans; commercial real estate was 40.2%. Non-performing assets declined to $122.8 million, or 0.40% of assets, from $157.3 million and 0.50% at year-end. The allowance was $150.2 million, or 1.10% of loans. Six-month net charge-offs were $20.3 million, versus $19.9 million.
- Balance sheet and funding: Assets were $30.69 billion, down from $31.75 billion at year-end. Deposits were $26.00 billion, down from $26.87 billion. Cash and cash equivalents were $3.32 billion, compared with $5.05 billion. Federal funds purchased and repurchase agreements totaled $977.5 million; subordinated notes and junior subordinated debentures totaled approximately $234.8 million.
- Cash flow: For the first six months, operating cash flow was $254.0 million, investing cash flow was negative $887.1 million, and financing cash flow was negative $1.10 billion. Cash and cash equivalents decreased $1.74 billion.
- Capital and dividends: Shareholders’ equity was $3.31 billion. At June 30, Common Equity Tier 1 was 12.69% at Cullen/Frost and 12.92% at Frost Bank; both exceeded fully phased-in Basel III requirements and “well-capitalized” thresholds. Common dividends were $1.24 per share for the first half.
Material changes, outlook and risks
- Management attributed earnings growth mainly to higher net interest income, reflecting loan growth and higher loan yields, partly offset by higher deposit funding costs. The federal funds rate rose 50 basis points in the first half. Management expects deposit pricing and market-rate movements to affect future margins.
- Reported accumulated other comprehensive income shifted from a $79.5 million gain at year-end to a $63.3 million loss, primarily from lower fair values of available-for-sale securities as market rates rose. Management said the securities losses were temporary and not credit-related and did not intend to sell the affected securities.
- Q2 and first-half other income included gains of $4.2 million from sales of branch and operating facilities, a $2.4 million recovery of prior write-offs, and a $1.2 million private-equity distribution. These items contributed to non-interest income growth.
- A first-quarter security incident involved unauthorized access to a third-party lockbox software program used by some commercial customers. The company said access had been stopped, affected customers contacted, and the investigation remained ongoing. Incident-related costs were $1.4 million through June 30.
- Interest-rate simulations projected net interest income changes over the next 12 months of +0.5% and +1.8% for rate increases of 100 and 200 basis points, and -3.2% and -8.6% for decreases of the same size. The filing provides no earnings or revenue guidance. Management reported no known liquidity event expected to have a material adverse effect; it also said litigation was not expected to materially affect the financial statements and that risk factors had not materially changed.
- Accounting changes included adoption of revenue-recognition guidance, which reduced beginning retained earnings by $2.3 million and changed debit-card fee presentation to net of network costs. The company was evaluating the future impact of expected-credit-loss guidance; adoption could increase the allowance, but the impact was not yet estimable.
Important facts for investors to verify
- Whether loan growth and improved non-performing-asset levels persist, particularly given energy exposure and $1.1 billion of unfunded energy commitments.
- How rising deposit costs affect net interest margin and whether actual rate sensitivity tracks management’s simulation assumptions.
- The extent and duration of securities-related AOCI losses, and any resulting effect on capital or liquidity if securities must be sold.
- Whether the lockbox security incident leads to additional costs, claims, regulatory action, or customer impacts; the investigation was ongoing.
- The recurring contribution of unusual gains and recoveries to reported non-interest income, and the eventual allowance impact from expected-credit-loss accounting.