Cullen/Frost Bankers, Inc. — FY 2010 Form 10-K
Business context and reporting period
Cullen/Frost is a Texas-focused financial holding company operating principally through Frost Bank, with banking and financial-management businesses across major Texas markets. This filing covers the fiscal year ended December 31, 2010; comparisons are primarily with 2009. Fourth-quarter figures are included where noted. The company made no acquisitions in 2010.
Financial performance and condition
| Metric | 2010 | 2009 |
|---|---|---|
| Total revenue (net interest income plus non-interest income) | $845.5 million | $830.4 million |
| Net interest income | $563.5 million | $536.7 million |
| Net interest margin | 4.08% | 4.23% |
| Provision for loan losses | $43.6 million | $65.4 million |
| Non-interest income | $282.0 million | $293.7 million |
| Non-interest expense | $535.5 million | $532.2 million |
| Net income / diluted EPS | $208.8 million / $3.44 | $179.0 million / $3.00 |
| Operating cash flow | $424.5 million | $273.9 million |
| Year-end total assets | $17.6 billion | $16.3 billion |
| Year-end loans / deposits | $8.12 billion / $14.48 billion | $8.37 billion / $13.31 billion |
| Shareholders’ equity | $2.06 billion | $1.89 billion |
Net income rose 16.6%, mainly on higher net interest income and a lower loan-loss provision. Net interest income increased despite a lower margin: average earning assets grew 11.1%, while the margin declined 15 basis points as more funds were held in lower-yielding cash and securities and loan balances fell. The cost of funds declined to 0.55% from 0.92%.
Credit indicators improved from 2009 but remained elevated versus earlier years: non-performing assets were $165.0 million, or 0.94% of assets, compared with $180.2 million, or 1.11%; net charge-offs were $42.6 million, or 0.52% of average loans, versus $50.3 million, or 0.58%. The allowance was $126.3 million, 1.56% of year-end loans. Commercial and industrial, construction, and commercial real estate lending together represented about 86% of loans.
Liquidity and capital were substantial at year-end: cash and cash equivalents were $2.82 billion; parent-company liquid assets were $156.3 million. Frost Bank was reported well capitalized, with a 13.26% Tier 1 risk-based capital ratio, 14.43% total risk-based capital ratio, and 8.33% leverage ratio. Cullen/Frost’s corresponding ratios were 13.82%, 15.91%, and 8.68%. Total borrowings were approximately $849.4 million, comprising $475.7 million in federal funds and repurchase agreements, $123.7 million in junior subordinated debentures, and $250.0 million in other long-term borrowings. A $150 million subordinated note matures in 2011.
Cash dividends were $1.78 per share for 2010, up from $1.71; the payout ratio was 51.7%. Frost Bank could pay approximately $309.1 million in dividends to the parent without prior regulatory approval at year-end, subject to applicable requirements.
Material changes versus comparable periods
- FY 2010 net income improved from 2009, while 2009 earnings had declined 13.6% from 2008.
- The loan-loss provision declined by $21.8 million in 2010, following a $27.6 million increase in 2009. Loans contracted 3.0% year over year, while deposits grew 8.8% at year-end.
- Non-interest income fell 4.0%, partly because 2009 included a $17.7 million gain from terminating interest-rate swaps on repaid FHLB advances. Excluding that gain, management said other non-interest income increased in 2010.
- Non-interest expense increased only 0.6%; 2009 included a $7.3 million FDIC special assessment. 2010 deposit-insurance expense was $20.5 million.
- Q4 2010 net income was $53.1 million and diluted EPS was $0.87, versus $51.5 million and $0.86 in Q4 2009.
- Cash and cash equivalents increased $1.10 billion during 2010, supported principally by $1.17 billion of net deposit growth and accompanied by substantial securities purchases and sales.
Outlook, commentary, risks and unusual items
The filing provides no formal earnings or revenue guidance. Management expected costs on demand deposits to rise after interest-payment restrictions were lifted beginning July 21, 2011, and anticipated the balance sheet becoming less asset-sensitive. The Federal Reserve’s proposed debit interchange rules could reduce PIN debit and Visa check-card revenues to less than one-third of then-current levels if adopted as proposed; the final impact was uncertain.
- Regulatory change is significant: Dodd-Frank requires the phase-out of trust preferred securities from Tier 1 capital over three years beginning in 2013. Basel III capital and liquidity standards were also in development; their eventual impact was uncertain.
- Interest-rate risk remains important. Management’s model projected net interest income changes over 12 months of +0.1% and +1.0% for rate increases of 100 and 200 basis points, respectively, and -0.7% for a 25-basis-point decline.
- Credit and economic risks include the Texas economy, real estate weakness, high unemployment, large commercial exposures, and uncertainty in loan-loss estimates. Seven relationships totaling $33.8 million were identified as potential problem loans outside non-accrual and past-due categories.
- Other risks include deposit liquidity and funding costs, competition, counterparty and operational risks, cybersecurity and vendor interruptions, and potential goodwill impairment. Goodwill and other intangible assets totaled $542.0 million.
- The company redeemed $12.4 million of junior subordinated debentures in July 2010. In 2009, a $17.7 million swap-termination gain was an unusual earnings item. Management did not expect pending ordinary-course litigation to materially affect the financial statements.
Ernst & Young issued unqualified opinions on the financial statements and internal control over financial reporting. Management also concluded that disclosure controls were effective.
Important facts for investors to verify
- Whether credit quality continues to improve, particularly non-accrual commercial and real-estate loans, criticized credits, charge-offs, and allowance adequacy.
- Whether deposit growth persists and how demand-deposit pricing changes affect funding costs, net interest margin, and interest-rate sensitivity.
- The final effect of debit-interchange regulation on card revenues and of Dodd-Frank/Basel rules on capital, liquidity, and deposit-insurance costs.
- The refinancing or repayment plan for the $150 million subordinated note maturing in 2011, and the parent’s reliance on subsidiary dividends.
- How much future earnings depend on tax-exempt securities, trust fees tied to asset values, and other potentially variable or nonrecurring income.