Cullen/Frost Bankers, Inc. (NYSE: CFR) — Q2 2020 Form 10-Q
Reporting period: Quarter and six months ended June 30, 2020. Unaudited consolidated results. Cullen/Frost is a Texas-based financial holding company providing banking, wealth management, insurance and related services.
Key financial results
| Metric | Q2 2020 | Q2 2019 | Six months 2020 | Six months 2019 |
|---|---|---|---|---|
| Net interest income | $245.8 million | $253.4 million | $490.3 million | $499.9 million |
| Credit loss expense | $32.0 million | $6.4 million | $207.2 million | $17.4 million |
| Non-interest income | $77.6 million | $82.6 million | $290.5 million | $179.4 million |
| Non-interest expense | $199.7 million | $203.2 million | $423.8 million | $405.0 million |
| Net income | $93.1 million | $111.6 million | $147.8 million | $228.1 million |
| Net income available to common shareholders | $93.1 million | $109.6 million | $140.3 million | $224.1 million |
| Diluted EPS | $1.47 | $1.72 | $2.21 | $3.51 |
| Taxable-equivalent net interest margin | 3.13% | 3.85% | 3.33% | 3.82% |
Balance sheet, liquidity and capital
- At June 30, 2020, total assets were $39.38 billion, up from $34.03 billion at December 31, 2019. Loans were $17.97 billion, including $3.16 billion of Paycheck Protection Program (PPP) loans; deposits were $32.68 billion.
- Cash and cash equivalents totaled $6.60 billion, compared with $3.79 billion at year-end 2019. Management reported approximately $5.0 billion held at the Federal Reserve, $2.7 billion of available FHLB borrowing capacity and $8.8 billion of unencumbered securities.
- Six-month cash flows: operating activities provided $207.0 million; investing activities used $2.08 billion; financing activities provided $4.68 billion. Cash and cash equivalents increased $2.81 billion.
- Reported borrowings included $1.59 billion of federal funds purchased and repurchase agreements, $136.3 million of junior subordinated debentures and $98.9 million of subordinated notes. The company drew and repaid $1.25 billion of FHLB advances during the first half.
- Cullen/Frost’s regulatory capital ratios at June 30 were 12.48% CET1, 14.43% total capital and 8.01% leverage; the filing states the company and Frost Bank exceeded required well-capitalized levels.
- Common dividends were $0.71 per share in Q2. The company redeemed its $150 million Series A preferred stock in March 2020. The previously authorized repurchase program expired July 24, 2020; no Q2 shares were repurchased.
Material changes versus comparable periods
- Q2 net income available to common shareholders declined 15.1% year over year; first-half common income declined 37.4%. Management attributed the declines mainly to much higher credit loss expense and lower net interest income.
- Net interest margin fell 72 basis points in Q2 and 49 basis points for the first half, reflecting lower market rates and asset yields. Management describes the balance sheet as asset-sensitive and expects low rates to continue to pressure net interest income and margin.
- First-half non-interest income rose 61.9%, primarily because of a $109.0 million gain on securities sales. The largest gain came from selling Treasury securities after interest-rate declines; this was not a recurring operating revenue source.
- Loans grew 21.8% from year-end, mostly due to PPP lending. Excluding PPP, loans were up only 0.4% from year-end and down 3.4% from March 31.
- Deposits increased $5.04 billion from year-end. Non-interest-bearing demand deposits grew to 44.9% of deposits from 39.3% at year-end.
- The allowance for loan losses was $250.1 million, or 1.39% of loans (1.69% excluding PPP loans), versus $132.2 million at year-end. First-half net charge-offs were $79.7 million, including $68.8 million in energy loans.
Outlook, commentary and risks
- COVID-19 and credit: Management said the pandemic’s ultimate impact could not be reliably estimated but was expected to remain material. Approximately 3,100 loans totaling $2.1 billion were under COVID-related payment deferrals at June 30. Eligible short-term deferrals were generally not classified as past due or troubled debt restructurings under the described guidance.
- Portfolio exposures: Energy loans totaled $1.42 billion, or 7.9% of loans. Management cited heightened risks in energy, restaurants, lodging, aviation, entertainment, retail and commercial real estate. Potential problem loans increased to $105.0 million from $63.4 million at year-end.
- Credit estimates: The company adopted CECL on January 1, 2020, recording a $29.3 million after-tax reduction to retained earnings. The new expected-loss approach and deteriorating economic forecasts contributed to the sharp rise in credit expense, limiting direct comparison with 2019.
- Interest rates and fees: Management expects low rates to weigh on net interest income and margin, while PPP loan fees are expected to provide a near-term benefit. It expects pandemic-related weakness in transaction fees and some insurance and investment-related revenues to continue.
- Unusual items: First-half results included the $109.0 million securities gain, approximately $6.0 million of gains on Treasury put options, and a one-time Q2 tax benefit associated with an asset contribution to a charitable trust. The preferred-stock redemption also resulted in a $5.5 million reduction to first-half income available to common shareholders.
- Legal and operational matters: Two PPP-related lawsuits were reported favorably resolved; a separate agent-fee lawsuit remained, which Frost Bank said it believed was without merit. The filing identifies cybersecurity, remote-work, vendor, regulatory, liquidity and litigation risks. No specific earnings or full-year financial guidance was provided.
Important facts for investors to verify
- Whether credit quality, deferrals, potential problem loans and charge-offs worsened after June 30, particularly in energy, commercial real estate and other pandemic-affected industries.
- How much of the $250.1 million loan allowance and $46.9 million off-balance-sheet allowance may need to change as economic forecasts and borrower conditions evolve.
- The pace of PPP forgiveness and recognition of the approximately $77.4 million of remaining net deferred PPP processing fees disclosed at quarter-end.
- Whether lower interest rates, deposit pricing and balance-sheet mix further compress net interest income and margin.
- The sustainability of earnings excluding securities and option gains, the discrete tax benefit and other nonrecurring items.
- Any developments in the PPP agent-fee litigation, regulatory requirements, dividend capacity or capital and liquidity needs.