Cullen/Frost Bankers, Inc. — Q2 2016 Form 10-Q
Business and period: 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, 2016; comparisons are with the corresponding 2015 periods unless stated otherwise. Dollar amounts below are in millions unless noted.
Financial results and position
- Q2 earnings: Net income was $71.5 million versus $73.1 million; net income available to common shareholders was $69.5 million versus $71.1 million. Diluted EPS was $1.11 in both periods.
- First-half earnings: Net income was $140.3 million versus $145.2 million; common earnings were $136.2 million versus $141.2 million. Diluted EPS was $2.18 versus $2.22.
- Interest income and margin: Net interest income was $190.5 million in Q2, up from $182.8 million; first-half net interest income was $380.2 million, up from $363.5 million. Taxable-equivalent net interest margin rose to 3.57% from 3.47% in Q2 and to 3.58% from 3.44% year to date.
- Credit costs: Provision for loan losses was $9.2 million in Q2 versus $2.9 million and $37.7 million for the first half versus $11.0 million. First-half net charge-offs rose to $23.8 million from $4.0 million. The allowance was $149.7 million, or 1.29% of loans, at June 30.
- Other income and expenses: Non-interest income was $78.0 million in Q2 versus $79.0 million; first-half income increased to $174.2 million from $162.2 million, including $14.9 million in securities gains versus $0.2 million. Non-interest expense rose to $179.4 million in Q2 from $173.2 million and to $358.6 million for the first half from $344.8 million.
- Taxes and returns: Effective tax rates were 10.5% for Q2 and 11.3% for the first half, down from 14.7% and 14.5%, respectively; management attributed the lower rates mainly to a higher proportion of tax-exempt income. First-half return on average assets was 0.97% versus 1.02%, and return on average common equity was 9.62% versus 10.34%.
- Balance sheet and liquidity: At June 30, total assets were $29.0 billion, loans $11.6 billion, deposits $24.3 billion, and shareholders’ equity $3.14 billion. Cash and cash equivalents were $3.37 billion. First-half operating cash flow was $179.7 million; investing cash outflow was $122.7 million and financing cash outflow was $283.4 million.
- Funding and debt: Deposits were broadly stable versus year-end 2015, down $56.1 million. Federal funds purchased and repurchase agreements were $733.2 million; junior subordinated debentures were $136.1 million and other long-term borrowings $99.9 million. Cullen/Frost parent-company liquid assets, including cash and resell agreements, were $202.0 million.
- Capital: Cullen/Frost’s CET1, Tier 1, total capital and leverage ratios were 11.90%, 12.73%, 14.36% and 8.13%, respectively; Frost Bank’s were 12.76%, 12.76%, 13.62% and 8.13%. Both exceeded fully phased-in Basel III minimums and well-capitalized thresholds.
Material changes, outlook and risks
- Common earnings declined 2.2% in Q2 and 3.5% for the first half. Higher net interest income was outweighed mainly by sharply higher loan-loss provisions and higher operating expenses.
- Energy loans fell to $1.50 billion, or 13.0% of loans, from $1.76 billion, or 15.3%, at year-end. Energy risk grades deteriorated; classified energy loans increased to $270.5 million from $98.0 million. Non-accrual energy loans rose to $42.8 million from $21.2 million.
- Total non-performing assets increased to $89.5 million from $85.7 million at year-end. Accruing past-due loans rose to $112.4 million from $67.6 million. Management cited sustained weakness in the energy sector and related pressure on Houston commercial real estate.
- First-half securities gains included sales of municipal securities after management judged certain Texas energy-exposed issuers’ creditworthiness had significantly deteriorated, as well as gains on U.S. Treasury sales. Management said remaining securities with unrealized losses were not credit-impaired and it did not expect to need to sell them before recovery.
- Operating costs increased partly due to new facilities, higher depreciation, software maintenance, staffing and deposit insurance assessments. Trust fees were weaker, partly reflecting lower oil-and-gas fees and the prior termination of securities-lending operations.
- Management provided no specific earnings or revenue guidance. It described the balance sheet as more asset-sensitive than a year earlier: its model estimated net interest income changes of +0.3% under a 100-basis-point rate increase, +1.3% under a 200-basis-point increase, and -5.7% under a 50-basis-point decrease over 12 months, relative to a flat-rate scenario. Results depend on assumptions, including anticipated commercial demand-deposit pricing.
- Other disclosed risks include economic and commodity-market conditions, borrower performance, interest rates, liquidity, regulation, competition, technology and legal or regulatory matters. Management said it knew of no event reasonably likely to materially adversely affect liquidity, capital resources or operations; it did not expect pending legal matters to have a material adverse impact. No material change to previously reported risk factors was noted.
Important facts for investors to verify
- Whether energy-credit deterioration, charge-offs and classified loans continue to rise, and whether the allowance adequately reflects those trends.
- How much of first-half earnings and year-over-year revenue growth depended on securities gains, and whether those gains are repeatable.
- Whether net interest margin improvement persists as rates and deposit pricing change, particularly if the company begins paying interest on commercial demand deposits.
- The quality and concentration of deposits, commitments to lend (including $1.1 billion to energy customers), and liquidity available at the parent company versus the consolidated group.
- Whether expense growth and weaker trust-related fees affect future profitability; interim results are not necessarily indicative of full-year results.