Cullen/Frost Bankers, Inc. — Q2 2022 Form 10-Q
Reporting period: Quarter and six months ended June 30, 2022. Cullen/Frost is a Texas-based financial holding company providing banking, wealth management, insurance and related services. Financial statements are unaudited.
Key financial results
Amounts below are in millions except per-share data and percentages.
| Metric | Q2 2022 | Q2 2021 | Six months 2022 | Six months 2021 |
|---|---|---|---|---|
| Net interest income | $288.2 | $257.2 | $537.3 | $498.0 |
| Non-interest income | $97.9 | $91.2 | $199.3 | $184.5 |
| Non-interest expense | $246.3 | $215.3 | $485.1 | $425.4 |
| Net income | $119.1 | $118.1 | $218.2 | $234.1 |
| Net income available to common shareholders | $117.4 | $116.4 | $214.9 | $230.3 |
| Diluted EPS | $1.81 | $1.80 | $3.31 | $3.57 |
| Taxable-equivalent net interest margin | 2.56% | 2.65% | 2.45% | 2.68% |
- Profitability and trends: Q2 net income available to common shareholders rose 0.9%; six-month common income fell 6.7%. Higher net interest income and fee income were offset by significantly higher expenses and, year to date, higher income taxes.
- Balance sheet at June 30: Assets were $51.8 billion; loans were $16.7 billion, up 2.4% from year-end (up 4.6% excluding PPP loans). Deposits were $45.6 billion, up $2.9 billion from year-end. Shareholders’ equity was $3.35 billion, down from $4.44 billion at December 31, 2021.
- Cash flow and liquidity: Six-month operating cash flow was $295.1 million; investing cash outflow was $5.0 billion, principally reflecting securities purchases; financing cash inflow was $1.75 billion. Cash and cash equivalents ended at $13.66 billion, down $2.92 billion from year-end. The company reported $12.7 billion at the Federal Reserve, $3.2 billion of FHLB borrowing capacity and $14.1 billion of unpledged securities.
- Credit and debt: The loan-loss allowance was $239.6 million, or 1.43% of loans (1.44% excluding PPP), versus $248.7 million, or 1.52%, at year-end. Non-accrual loans were $35.1 million, 0.21% of loans, down from $53.7 million. Deposits are the principal funding source; reported borrowings included $1.66 billion of repurchase agreements, $99.3 million of subordinated notes and $123.0 million of junior subordinated debentures.
Material changes and management commentary
- Q2 net interest income increased 12.1%, supported by increased taxable securities and higher yields on interest-bearing deposits. Margin nevertheless declined year over year as asset yields and loan volumes were pressured while deposit and borrowing costs rose.
- Average deposits grew year over year, while average loans declined, primarily because PPP balances and related fee income were substantially lower. Excluding PPP loans, average loans increased 13.2% in Q2.
- Non-interest expense rose 14.4% in Q2 and 14.0% for six months. Wage and staffing costs were the largest driver; management cited merit and market increases, a $20 minimum hourly wage implemented in December 2021, and a competitive labor market.
- Available-for-sale securities had $1.125 billion of gross unrealized losses at June 30, primarily attributed to higher market interest rates. After-tax accumulated other comprehensive loss was $874.2 million, compared with a $347.3 million gain at year-end. Management stated it did not intend, and believed it was not more likely than not it would be required, to sell the securities before recovery; it recorded no credit-loss allowance on them.
- Regulatory capital remained above minimum “well capitalized” thresholds: Cullen/Frost CET1 was 12.64%, total capital 14.75% and leverage 7.03%; Frost Bank ratios were 12.42%, 13.28% and 6.62%, respectively.
Outlook, risks and unusual items
- The filing provides no specific earnings or revenue guidance. Management noted the Federal Reserve’s July 28, 2022 rate increase and its expectation that further increases would be appropriate. Its rate model estimated net interest income would increase 2.9% under a 100-basis-point rise and 6.1% under a 200-basis-point rise over the following 12 months versus a flat-rate scenario; model results depend on assumptions, including deposit pricing.
- The company aimed to complete remaining LIBOR loan transitions by Q1 2023 and expected to begin regular 1–4 family mortgage originations in late 2022. Changes to consumer overdraft and returned-item fees were expected to reduce annual revenue by as much as $3.5 million.
- Management’s key risks include economic weakness, inflation and interest-rate changes, market volatility, geopolitical disruption, credit deterioration, Texas market conditions, cybersecurity and other operational risks. Credit-loss estimates include additional overlays for commercial real estate, office properties, concentrated relationships and potential downside economic conditions.
- Energy was the largest industry loan concentration at 5.9% of total loans. Commercial real estate represented 48.2% of loans. The filing reported $25.8 billion of deposits not covered by deposit insurance.
- Management said pending legal matters were not expected to have a material adverse effect. It reported no material change to previously disclosed risk factors and no significant change in market-risk types. The board’s $100 million repurchase authorization remained unused at quarter-end.
Important facts for investors to verify
- Whether rising deposit costs and changing asset yields sustain or further compress net interest margin.
- The size and duration of unrealized securities losses, and the implications if liquidity needs require securities sales.
- Loan growth, credit quality and the adequacy of the allowance, especially in commercial real estate, office/construction and consumer lending.
- How expense growth, labor-market pressures and the overdraft-fee changes affect earnings.
- Deposit stability, uninsured deposit levels, available borrowing capacity and regulatory capital as market and economic conditions change.