Cullen/Frost Bankers, Inc. (CFR) — 2015 Form 10-K
Reporting period: Fiscal year ended December 31, 2015. The filing also presents unaudited quarterly results, including the fourth quarter. Cullen/Frost is a Texas-focused financial holding company whose principal subsidiary is Frost Bank.
Business context and reporting period
The company provides commercial and consumer banking, trust and investment management, insurance, brokerage, and related services across Texas. It reported $28.6 billion of assets and $24.3 billion of deposits at year-end. Energy loans were 15.3% of total loans. No acquisitions were completed in 2015; WNB Bancshares, acquired in May 2014, contributed to year-over-year balance-sheet growth.
Financial performance and condition
| Metric | 2015 | 2014 |
|---|---|---|
| Net interest income | $736.6 million | $686.9 million |
| Provision for loan losses | $51.8 million | $16.3 million |
| Non-interest income | $328.7 million | $320.1 million |
| Non-interest expense | $693.7 million | $654.7 million |
| Net income | $279.3 million | $278.0 million |
| Net income available to common shareholders | $271.3 million | $269.9 million |
| Diluted earnings per common share | $4.28 | $4.29 |
| Net interest margin | 3.45% | 3.41% |
| Return on average assets | 0.97% | 1.05% |
| Return on average common equity | 9.86% | 10.51% |
- Fourth quarter: Net income available to common shareholders was $56.2 million, or $0.90 diluted EPS, versus $70.7 million, or $1.11 diluted EPS, in fourth-quarter 2014. The provision for loan losses was $34.0 million, compared with $4.4 million.
- Cash flow: Net cash from operating activities was $393.5 million; investing activities used $1.239 billion; financing activities provided $72.8 million. Cash and cash equivalents fell $772.6 million to $3.592 billion.
- Balance sheet: Total loans were $11.487 billion, up 4.5%; total deposits were $24.344 billion, up 0.9%; total assets were $28.567 billion. Shareholders’ equity was $2.890 billion.
- Credit quality: Allowance for loan losses rose to $135.9 million, or 1.18% of year-end loans, from $99.5 million, or 0.91%. Net charge-offs were $15.5 million, or 0.14% of average loans. Non-performing assets increased to $85.7 million from $65.2 million.
- Capital and liquidity: Cullen/Frost’s CET1, Tier 1, total risk-based capital, and leverage ratios were 11.37%, 12.38%, 13.85%, and 7.79%, respectively. Management said both the parent and Frost Bank were well capitalized. Year-end cash and cash equivalents were $3.592 billion. Frost Bank could pay approximately $419.7 million in dividends to the parent without prior regulatory approval, subject to stated conditions.
- Debt and funding: Deposits were the primary funding source. Year-end borrowings included $893.5 million of federal funds purchased and repurchase agreements, $137.1 million of junior subordinated debentures, and $100 million of subordinated notes. The subordinated notes mature in February 2017.
- Shareholder returns: Common dividends were $2.10 per share for 2015, versus $2.03 in 2014. The company repurchased $100 million of common stock under a program authorized in April 2015.
Material changes versus the prior comparable period
- Common shareholder net income increased 0.5%, but diluted EPS edged down from $4.29 to $4.28; return on average assets and common equity also declined.
- Net interest income increased $49.7 million, primarily reflecting growth and a shift of earning assets toward securities and loans. Average loan yield declined to 3.90% from 4.34%, partly due to competitive pricing and the end of amortization benefits from terminated interest-rate swaps.
- The provision for loan losses increased $35.5 million. Energy reserves rose substantially as credit grades weakened: the energy allowance was $54.7 million, versus $14.9 million a year earlier.
- Non-interest expense increased 6.0%, including higher salaries, benefits, occupancy, and deposit insurance costs. A new operations and support center began entering service during the year, with further depreciation expected as additional components are placed in service.
- Energy loans were broadly flat year over year, but energy-related credit deterioration was pronounced: non-accrual energy loans rose to $21.2 million from $0.6 million; classified energy loans increased to $98.0 million from $6.0 million. Potential problem loans rose to $110.3 million from $15.1 million, with 73.4% tied to five energy customers.
Outlook, commentary, risks, contingencies, and unusual items
- No quantitative earnings or revenue guidance is provided. Management stated it remained committed to regular common dividends, while noting future payments depend on earnings, capital needs, and financial condition.
- Management highlighted continued oil-price volatility and the Texas energy downturn. Crude oil was about $37 per barrel at year-end 2015 and fell below $30 in January 2016. A fourth-quarter stress analysis using a $28.13 oil-price assumption led to an additional $22 million energy-related loan-loss provision.
- Interest-rate simulations showed projected 12-month net interest income changes versus a flat-rate case of +0.1% for a 100-basis-point increase, +1.1% for a 200-basis-point increase, and -6.3% for a 50-basis-point decrease. Results rely on assumptions, including anticipated interest on certain commercial demand deposits beginning in 2016.
- Other key risks include Texas economic concentration, commercial and real estate credit exposure, interest-rate and liquidity risk, regulatory and compliance requirements, cybersecurity, and dependence on dividends from Frost Bank. The company was enhancing compliance programs, including fair-lending controls, under an agreement related to the WNB acquisition; further expansionary proposals are restricted pending those enhancements, with stated exceptions.
- The company discontinued Frost Securities’ operations effective June 30, 2015. It also entered into a development agreement involving a planned headquarters sale and leaseback; closing was expected in the second half of 2016, subject to contingencies, with the new building expected in 2018 or 2019. Management did not expect the property transactions, in aggregate, to significantly affect operations.
- Management did not expect the disposition of ordinary-course legal matters to have a material adverse effect. The independent auditor issued an unqualified opinion on the financial statements and internal control over financial reporting.
Most important facts for investors to verify
- Subsequent energy-loan performance, borrowing-base redeterminations, non-accrual migration, and adequacy of the $54.7 million energy allowance.
- Whether the $110.3 million of potential problem loans, particularly energy exposures, migrate to classified or non-performing status.
- Loan-loss provision trends and the effect of continued oil-price weakness on earnings and capital.
- Deposit stability and funding concentration, including the $11.95 billion of deposits not covered by deposit insurance.
- Net interest margin sensitivity as deposit pricing responds to rate changes, and the actual cost of interest on commercial demand deposits.
- Capital ratios and distribution capacity as Basel III buffers phase in, trust preferred capital treatment changes, and the $100 million subordinated notes approach maturity.
- Progress and regulatory implications of the required compliance enhancements, and contingencies and economics of the headquarters development and sale-leaseback agreement.