Cullen/Frost Bankers, Inc. — 2011 Form 10-K
Business context and reporting period
Cullen/Frost is a Texas-based financial holding company centered on Frost Bank, with banking and wealth-advisory operations and related insurance, trust, investment, and other services. This filing covers the fiscal year ended December 31, 2011; fourth-quarter comparisons are also reported. Unless otherwise stated, dollar amounts below are in millions.
Financial performance and condition
| Metric | 2011 | 2010 |
|---|---|---|
| Total revenue (net interest income plus non-interest income) | $871.8 | $845.5 |
| Net interest income | $581.8 | $563.5 |
| Net income | $217.5 | $208.8 |
| Diluted earnings per share | $3.54 | $3.44 |
| Net interest margin | 3.88% | 4.08% |
| Return on average assets / equity | 1.17% / 10.01% | 1.21% / 10.30% |
| Net cash from operating activities | $274.4 | $424.5 |
- Net income rose 4.2%; higher net interest income, lower loan-loss provision, and increased non-interest income outweighed higher operating expenses and taxes. Provision for loan losses declined to $27.4 from $43.6.
- Fourth-quarter net income was $55.4 versus $53.1 in Q4 2010; diluted EPS was $0.90 versus $0.87. Q4 2011 provision for loan losses was zero, compared with $11.3 in Q4 2010.
- At year-end, total assets were $20.3 billion, loans $8.0 billion, deposits $16.8 billion, and shareholders’ equity $2.28 billion. Loans declined 1.5% year over year, while deposits increased 15.7% and assets increased 15.3%.
- Cash and cash equivalents were $2.91 billion. 2011 cash flows were $274.4 operating, $(2,455.3) investing, and $2,267.5 financing; cash increased $86.6 for the year. The large investing outflow principally reflects securities purchases net of sales and maturities.
- Year-end allowance for loan losses was $110.1, or 1.38% of loans, versus $126.3, or 1.56%, in 2010. Net charge-offs were $43.6, 0.54% of average loans, compared with $42.6, 0.52%. Non-performing assets improved to $120.9 (0.60% of assets) from $165.0 (0.94%).
- Regulatory capital remained strong: Cullen/Frost Tier 1 risk-based capital ratio 14.38%, total risk-based capital 16.24%, and leverage ratio 8.66%. Frost Bank was also described as well capitalized.
- Year-end borrowings included $722.2 of federal funds purchased and repurchase agreements, $123.7 of junior subordinated debentures, and $100.0 of subordinated notes. The filing reports $223.7 of long-term debt and other borrowings in selected balance-sheet data, excluding short-term funding.
Material changes versus the prior comparable period
- Net interest income increased 3.3%, supported by 9.4% growth in average earning assets, while net interest margin fell 20 basis points to 3.88% as asset yields declined faster than funding costs.
- Non-interest income increased 2.8%; trust fees rose, but deposit service charges and card-related income were pressured. Non-interest expense increased 4.2%, including increased salaries, technology costs, and marketing.
- Non-performing assets and classified loans declined, contributing to the lower provision. Net charge-offs nevertheless increased slightly, including several large commercial credits charged off during Q3.
- Available-for-sale securities increased to $7.79 billion from $5.16 billion. After-tax accumulated other comprehensive income rose to $247.7 from $154.3, mainly reflecting unrealized securities gains.
- Cash dividends increased to $1.83 per share from $1.78; total dividends paid were $112.2. Book value per share rose to $37.27 from $33.74.
Outlook, management commentary, risks, contingencies, and unusual items
- No specific earnings or revenue guidance is provided. Management expected net charge-offs to continue trending down if portfolio credit quality continued to improve, while noting results depend on economic and credit conditions.
- Management’s year-end interest-rate simulation indicated net interest income would be 1.7% lower under a 100-basis-point rate increase, 2.2% lower under a 200-basis-point increase, and 1.6% lower under a 25-basis-point decrease over the following 12 months. The model assumed interest would begin to be paid on demand deposits in Q1 2012.
- The Durbin Amendment’s debit interchange limits took effect October 1, 2011. The company expected future debit interchange revenue to be about half prior levels and Visa check-card revenue to be about one-third of prior levels.
- A $4.1 tax expense adjustment corrected prior-year municipal bond premium-amortization tax treatment. A $6.4 securities gain in Q3 arose from sales of longer-duration municipal securities; annual net securities gains were $6.4.
- The company acquired the Clark Benefit Group insurance agency in 2011. Stone Partners was acquired January 1, 2012; neither transaction was expected to significantly affect the reported financial statements.
- Management said it expected to meet Basel III capital requirements on a fully phased-in basis based on year-end 2011 conditions. Dodd-Frank provisions will phase out trust preferred securities from Tier 1 capital beginning in 2013. Future regulatory rules, deposit-insurance costs, interest-rate changes, Texas economic conditions, and the commercial real estate and construction exposures remain material risks.
- Legal claims arose in the ordinary course; management did not expect their disposition to materially affect the financial statements. The independent auditor issued unqualified opinions on the financial statements and internal control over financial reporting.
Important facts for investors to verify
- Whether asset quality continues to improve and whether the lower loan-loss provision is sustainable; examine classified loans, potential problem loans, and the allowance methodology.
- How deposit pricing changes, including any interest paid on demand deposits, affect funding costs and the declining net interest margin.
- The realized revenue impact of debit-card interchange caps and any offsets from transaction growth or other fee businesses.
- The composition, duration, valuation, and interest-rate sensitivity of the rapidly expanded securities portfolio, including Texas municipal concentration.
- Liquidity and funding resilience, including sizable demandable deposits, short-term repurchase funding, and the parent company’s reliance on subsidiary dividends.
- Implementation and capital effects of Dodd-Frank and Basel III, including the planned trust-preferred capital deductions and the proposed Texas state-bank charter change.