Cullen/Frost Bankers, Inc. — Q2 2017 Form 10-Q
Business context and period. Cullen/Frost is a Texas-based financial holding company providing banking, wealth management, insurance, and related services. This unaudited report covers the quarter and six months ended June 30, 2017; comparisons are with the same 2016 periods unless stated otherwise. Amounts below are in U.S. dollars.
Financial performance and position
- Revenue and earnings: Q2 net interest income was $214.8 million, up 12.8%; non-interest income was $81.1 million, up 3.9%. Net income was $85.6 million, up 19.6%, and diluted EPS was $1.29 versus $1.11. For the first half, net income was $170.5 million, up 21.5%, and diluted EPS was $2.57 versus $2.19.
- Margins and returns: Taxable-equivalent net interest margin was 3.70% for Q2 versus 3.57%, and 3.67% for the first half versus 3.58%. First-half return on average assets was 1.11% versus 0.97%; return on average common equity was 11.31% versus 9.63%.
- Expenses and credit costs: Q2 non-interest expense rose 4.8% to $188.1 million; first-half expense rose 4.8% to $376.0 million. Loan-loss provision was $8.4 million in Q2 and $16.4 million for the first half, down from $9.2 million and $37.7 million, respectively, in 2016.
- Cash flow: First-half operating cash flow was $188.5 million; investing activities used $340.6 million and financing activities used $283.0 million. Cash and cash equivalents decreased $435.1 million to $3.706 billion.
- Balance sheet and liquidity: Total assets were $30.206 billion at June 30, little changed from year-end. Loans were $12.512 billion, up 4.5% from December 31; deposits were $25.614 billion, down 0.8%. Cash and cash equivalents were $3.706 billion. Management reported $339.5 million of liquid assets at the holding-company level and stated it knew of no events reasonably likely to materially harm liquidity or capital.
- Debt and capital: Federal funds purchased and repurchase agreements totaled $924.9 million. Junior subordinated debentures were $136.2 million and subordinated notes were $98.5 million. In March, the company issued $100 million of 4.50% subordinated notes due 2027 and redeemed $100 million of 5.75% notes. Cullen/Frost’s Common Equity Tier 1 ratio was 12.81% and total capital ratio 15.65%; Frost Bank’s corresponding ratios were 12.94% and 13.74%. Both exceeded fully phased-in Basel III requirements and well-capitalized thresholds.
Material changes and credit quality
- First-half net interest income increased $43.1 million, reflecting growth in loans and tax-exempt securities and higher loan and deposit-asset yields. Higher market rates also contributed; the Federal Reserve increased its target rate during the period.
- First-half non-interest income declined 5.4%, mainly because 2016 included $14.9 million of net securities gains. Excluding securities transactions, management reported first-half non-interest income growth of 3.5%.
- Loans grew by $536.9 million from year-end. Commercial real estate represented 39.9% of loans and energy 11.3%. Non-performing assets fell to $90.2 million, or 0.30% of assets, from $102.6 million, or 0.34%, at year-end. Non-accrual loans were $86.4 million.
- Potential problem loans rose to $131.0 million from $62.7 million at year-end; 55.9% were energy-related. The allowance for loan losses was $149.6 million, or 1.20% of loans, compared with $153.0 million, or 1.28%, at year-end. First-half net charge-offs were $19.9 million, including $10.5 million in energy loans.
- Energy credit indicators improved on balance: classified energy loans declined to $225.4 million from $302.0 million, and the weighted-average risk grade improved to 7.49 from 7.95. However, Houston-area commercial real estate conditions contributed to higher related macroeconomic reserve allocations.
Outlook, risks, and unusual items
- The filing provides no specific earnings or revenue guidance. Management cautions that interim results are not necessarily indicative of full-year or future results.
- Interest-rate sensitivity modeling projected net interest income increases of 1.0% and 2.8% under 100- and 200-basis-point rate increases, and decreases of 4.8% and 10.1% under 100- and 125-basis-point decreases, respectively, over the following 12 months versus a flat-rate case. These are model estimates, including assumptions about paying interest on certain commercial demand deposits beginning in Q3 2017.
- Risk factors include economic and financial-market conditions, interest-rate and commodity volatility, borrower performance, loan concentrations and credit losses, regulation, competition, technology, liquidity, and legal or regulatory developments. Management reported no material change in the risk factors from its 2016 Form 10-K.
- The company sold approximately $8.2 billion of U.S. Treasury securities during the first half, primarily for Texas franchise-tax planning, and recorded a $50,000 net loss. Q2 included $700,000 of amortization of a deferred gain from the December 2016 headquarters sale; the first half included $1.5 million.
- Management expects the new revenue-recognition standard, effective for the company in 2018, to change treatment of certain non-interest revenue streams but not to have a significant financial-statement impact. Management also stated pending claims and legal actions were not expected to materially adversely affect the financial statements.
Most important facts for investors to verify
- Whether growth in net interest income and margin can continue as rates, asset mix, and deposit pricing change.
- Whether the increase in potential problem loans, particularly energy and manufacturing exposures, leads to further deterioration, charge-offs, or reserve needs.
- How first-half loan growth and the concentration in commercial real estate and energy affect credit quality and capital requirements.
- Whether rising operating costs—including deposit insurance, fraud losses, and occupancy—remain controlled relative to revenue growth.
- Whether the reported interest-rate sensitivity assumptions, especially demand-deposit pricing, match actual customer behavior and funding costs.
- The effects of securities portfolio activity, tax-planning transactions, and market-driven unrealized gains or losses on future results and capital.