Cullen/Frost Bankers, Inc. — 2018 Form 10-K
Business context and reporting period. This filing covers the fiscal year ended December 31, 2018, with unaudited quarterly results. Cullen/Frost is a Texas-focused financial holding company operating primarily through Frost Bank, with banking and wealth-advisory businesses. It reported $32.3 billion in consolidated assets and operated approximately 131 financial centers across Texas.
Key financial results
Dollar amounts are in millions unless otherwise stated.
| Metric | 2018 | 2017 | Change |
|---|---|---|---|
| Net interest income | $957.9 | $866.4 | +10.6% |
| Non-interest income | $351.3 | $336.5 | +4.4% |
| Total revenue (net interest income plus non-interest income) | $1,309.2 | $1,202.9 | +8.8% |
| Provision for loan losses | $21.6 | $35.5 | −39.0% |
| Non-interest expense | $778.9 | $759.1 | +2.6% |
| Net income | $454.9 | $364.1 | +24.9% |
| Net income available to common shareholders | $446.9 | $356.1 | +25.5% |
| Diluted earnings per common share | $6.90 | $5.51 | +25.2% |
- Fourth quarter: Net income was $119.3 million and diluted EPS was $1.82, versus $100.5 million and $1.53 in fourth-quarter 2017. Common-shareholder income was $117.2 million.
- Margins and returns: Taxable-equivalent net interest margin was 3.64%, down 5 basis points from the reported 2017 figure of 3.69%. Management said that, using a consistent 21% tax rate for both periods, margin increased 27 basis points. Return on average assets was 1.44% (1.17% in 2017); return on average common equity was 14.23% (11.76%).
- Balance sheet: Total assets were $32.3 billion, loans $14.1 billion, deposits $27.1 billion, and shareholders’ equity $3.37 billion at year-end. Loans grew 7.3%; deposits grew 1.0%; assets grew 1.7% year over year.
- Credit quality: Allowance for loan losses was $132.1 million, or 0.94% of loans, versus $155.4 million, or 1.18%, a year earlier. Net charge-offs increased to $44.8 million from $33.1 million, or 0.33% of average loans versus 0.27%. Non-performing assets fell to $74.9 million from $157.3 million; their ratio to loans plus foreclosed assets declined to 0.53% from 1.20%.
- Capital and funding: Cullen/Frost’s CET1, Tier 1, total risk-based capital, and leverage ratios were 12.65%, 13.34%, 15.09%, and 9.06%, respectively. Frost Bank was also reported well capitalized. Non-interest-bearing deposits remained a significant funding source; average deposit cost rose to 0.29% from 0.07% as rates increased.
- Debt and liquidity: Year-end federal funds purchased and repurchase agreements were $1.37 billion, primarily overnight repurchase agreements. Subordinated notes and junior subordinated debentures totaled approximately $235 million. Consolidated cash and cash equivalents were $4.0 billion, down from $5.1 billion; parent-company liquid assets were $236.4 million. Management reported no known events expected to materially adversely affect liquidity or capital.
- Cash flow: Operating activities provided $562.4 million; investing activities used $1.91 billion, including $1.01 billion of net loan growth; financing activities provided $253.7 million. Cash and cash equivalents decreased $1.10 billion overall.
Material changes and notable items
- Earnings growth reflected higher net interest income, increased fee income, lower loan-loss provision, and a lower effective tax rate. Interest income rose substantially, but interest expense also increased, from $26.5 million to $93.3 million, mainly as deposit and borrowing costs rose.
- Taxable-equivalent net interest income rose only 0.9% as reported because the tax-equivalent calculation changed with the federal statutory rate reduction from 35% to 21%. On a consistent 21% tax basis, management estimated an increase of approximately $98.8 million.
- The 2018 allowance provision declined despite higher net charge-offs. Management cited fewer classified loans and improved risk-grade trends, particularly in energy and commercial and industrial portfolios. Energy still represented 11.4% of loans; commercial real estate represented 40.4% and total real estate 48.3%.
- Other comprehensive income included a $152.6 million after-tax loss, primarily from lower unrealized gains on securities. Accumulated other comprehensive income moved from a $79.5 million gain to a $63.6 million loss.
- The company repurchased $100 million of common stock and paid $173.5 million in common and preferred dividends during 2018. Common dividends were $2.58 per share, up from $2.25.
- Adoption of revenue-recognition guidance changed debit-card and ATM network costs to be reported net against related fee income. This reduced reported interchange and debit-card fees and affects direct comparison with prior-year presentation. The adoption also reduced opening retained earnings by $2.3 million.
Outlook, risks, contingencies, and unusual items
- The filing provides no specific quantitative earnings or revenue guidance. Management’s disclosures emphasize sensitivity to interest rates, Texas economic conditions, oil-price volatility, loan quality, and competition. Interest-rate simulations showed estimated net interest income effects over the next 12 months of +0.3% and +1.5% for +100 and +200 basis-point shocks, and −2.7% and −7.5% for −100 and −200 basis-point shocks, relative to a flat-rate scenario.
- Credit and concentration risks include energy lending, commercial real estate, and the concentration of operations and municipal securities in Texas. Crude oil was approximately $45 per barrel at year-end 2018, down from $60 at year-end 2017. Management also noted concerns about commercial real estate valuations.
- A 2018 security incident involved unauthorized access to a third-party lockbox software program used by certain commercial customers. The identified access was stopped; the incident did not affect other Frost systems. The company notified affected customers and law enforcement and incurred $2.1 million of out-of-pocket costs; the investigation was ongoing.
- Upcoming accounting changes include lease accounting effective January 1, 2019, for which the company expected to recognize initial right-of-use assets of $170.4 million and lease liabilities of $174.4 million, plus additional amounts for its new headquarters lease. The expected initial impact of the new credit-loss standard, scheduled for 2020, was not yet reasonably estimable and could increase reserves.
- The company reported various legal claims arising in the ordinary course of business but did not expect their disposition to have a material adverse effect. The auditors issued unqualified opinions on the financial statements and internal control over financial reporting.
Most important facts for investors to verify
- Whether loan-loss trends remain favorable, particularly given higher 2018 net charge-offs and continuing energy exposure.
- How deposit repricing and any interest paid on commercial demand deposits affect funding costs and net interest margin.
- The value and credit sensitivity of the Texas-heavy municipal securities portfolio, including the effect of market-rate changes on accumulated other comprehensive income.
- The eventual allowance and capital impact of adopting the expected-credit-loss standard, and the balance-sheet impact of lease accounting and the new headquarters lease.
- Any further costs, customer effects, or regulatory consequences arising from the lockbox cybersecurity incident.