Cullen/Frost Bankers, Inc. (CULLEN) — Q1 2018 Form 10-Q
Business context and reporting period
Cullen/Frost Bankers is a Texas-based financial holding company providing commercial and consumer banking, wealth management, insurance and related services. This unaudited report covers the three months ended March 31, 2018; income and cash flow comparisons are with Q1 2017, while balance-sheet comparisons are primarily with December 31, 2017.
Key financial results
| Metric | Q1 2018 / March 31, 2018 | Comparison |
|---|---|---|
| Net interest income | $229.7 million | $208.5 million, up 10.2% year over year |
| Non-interest income | $91.4 million | $83.7 million, up 9.3% |
| Total revenue, net interest plus non-interest income | $321.2 million | $292.2 million, up 9.9% |
| Provision for loan losses | $6.9 million | $8.0 million |
| Net income | $106.5 million | $84.9 million, up 25.4% |
| Net income available to common shareholders | $104.5 million | $82.9 million, up 26.0% |
| Diluted earnings per common share | $1.61 | $1.28 |
| Taxable-equivalent net interest margin | 3.52% | 3.64%; management says it rose 20 basis points excluding the tax-rate change |
| Operating cash flow | $210.7 million | $129.7 million |
| Cash and cash equivalents | $4.68 billion | $5.05 billion at year-end |
| Total assets / shareholders’ equity | $31.46 billion / $3.24 billion | $31.75 billion / $3.30 billion at year-end |
| Loans / deposits | $13.36 billion / $26.68 billion | Loans up 1.7%; deposits down 0.7% from year-end |
| Allowance for loan losses | $149.9 million; 1.12% of loans | $155.4 million at year-end; 1.18% of loans |
| Borrowings | $1.03 billion federal funds purchased and repurchase agreements; $234.8 million junior subordinated debentures and subordinated notes | Repurchase and federal funds balance was $1.15 billion at year-end |
Q1 net cash declined $372.1 million: operating activities provided $210.7 million, investing used $253.2 million and financing used $329.6 million. Cullen/Frost’s Common Equity Tier 1 and total capital ratios were 12.69% and 15.36%, respectively; Frost Bank’s were 13.00% and 13.77%. Both were above the stated well-capitalized thresholds.
Material changes versus the prior comparable period
- Higher loan yields and loan volumes, along with higher yields on interest-bearing deposits, supported net interest income. Deposit and borrowing costs also increased. The taxable-equivalent net interest margin was 12 basis points lower as reported, but management attributes much of the comparison to the federal tax-rate reduction.
- Non-interest income benefited from higher trust and investment management fees, insurance commissions and fees, and other income. Other income included $3.7 million in gains on branch and operational facility sales.
- Non-interest expense increased 4.6% to $196.6 million, including higher salaries, technology costs and other expenses. A $3.7 million charitable-foundation contribution and increased professional-services costs were among the drivers.
- Net charge-offs rose to $12.4 million from $7.9 million. Non-performing assets fell to $136.6 million from $157.3 million at year-end, while accruing past-due loans increased to $117.8 million from $107.9 million.
- Other comprehensive loss was $142.4 million after tax, principally from falling fair values of available-for-sale securities. Accumulated other comprehensive income moved from a $79.5 million gain at year-end to a $53.4 million loss.
Outlook, commentary, risks and unusual items
- The filing provides no specific earnings or revenue guidance. Management says it monitors liquidity through stress scenarios and was not aware of events likely to materially adversely affect liquidity, capital resources or operations at March 31.
- Interest-rate modeling projected net interest income over the next 12 months would be 0.9% higher with a 100-basis-point rate increase and 2.8% higher with a 200-basis-point increase, relative to a flat-rate case. A 100-basis-point decrease was projected to reduce it 3.7%; a 175-basis-point decrease, 9.7%. These are model estimates, not forecasts.
- Credit concentrations warrant attention: energy loans were 10.7% of total loans, and energy-industry unfunded commitments were $1.2 billion. The company also reported $55.3 million in potential problem loans, primarily tied to energy, nursing/assisted living and restaurant borrowers.
- During Q1, a third-party lockbox software program used by some commercial customers experienced unauthorized access to stored digital images. The company said it stopped the identified access, notified affected customers, engaged a cybersecurity firm and cooperated with law enforcement; the investigation was ongoing. It said other Frost systems were not affected.
- The company adopted revenue-recognition guidance effective January 1, 2018, reducing opening retained earnings by $2.3 million. Debit-card and ATM network costs are now netted against fees, so reported interchange fees are not directly comparable: Q1 2018 net fees were $3.2 million versus Q1 2017 gross fees of $5.6 million; the comparable 2017 net amount was $2.4 million.
- The expected-credit-loss standard is scheduled for adoption in 2020 and could increase the allowance; the company said it could not yet reasonably estimate the impact. Securities unrealized losses were attributed to market interest-rate increases, and management considered them temporary and not credit-related.
- Litigation was not expected by management to have a material adverse financial impact. The filing reported no material change in previously disclosed risk factors.
Important facts for investors to verify
- Whether loan-quality trends remain sound, especially energy exposure, non-accrual energy loans, potential problem credits and rising net charge-offs.
- How deposit pricing and competition affect funding costs, margins and the interest-rate sensitivity described in the filing.
- Whether the cybersecurity investigation identifies further customer impact, costs or remediation obligations.
- How much Q1 income growth depended on facility-sale gains and contingent insurance income, and how sustainable recurring fee growth is.
- The effect of securities valuation changes on reported equity, and the eventual impact of the expected-credit-loss standard and remaining tax-accounting estimates.
- Liquidity and capital resilience alongside substantial customer credit commitments, deposit movements and the availability of dividends from Frost Bank to the holding company.