Cullen/Frost Bankers, Inc. (NYSE: CFR) — Q3 2013 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2013. The unaudited filing covers a Texas-based financial holding company providing banking, wealth management, insurance, investment banking and related services, primarily in Texas. Dollar amounts below are in millions unless stated otherwise.
Financial performance
| Metric | Q3 2013 | Q3 2012 | Nine months 2013 | Nine months 2012 |
|---|---|---|---|---|
| Total revenue (net interest income plus non-interest income) | $229.3 | $222.7 | $685.6 | $663.4 |
| Net interest income | $155.4 | $151.5 | $461.3 | $450.5 |
| Provision for loan losses | $5.1 | $2.5 | $14.7 | $6.0 |
| Non-interest income | $74.0 | $71.2 | $224.3 | $212.9 |
| Non-interest expense | $151.8 | $144.5 | $457.4 | $429.0 |
| Net income | $60.4 | $58.7 | $175.3 | $177.8 |
| Net income available to common shareholders | $58.4 | $58.7 | $170.6 | $177.8 |
| Diluted EPS | $0.96 | $0.95 | $2.81 | $2.88 |
| Return on average assets | 1.01% | 1.11% | 1.02% | 1.16% |
| Return on average common equity | 10.07% | 9.75% | 9.83% | 10.09% |
Margins: Taxable-equivalent net interest margin was 3.38% in Q3, down from 3.54%; year-to-date margin was 3.42%, down from 3.63%. Growth in average earning assets lifted net interest income, but lower asset yields and a greater share of funds held in low-yielding deposits pressured margin.
Balance sheet, liquidity and capital
- At September 30, 2013, total assets were $23.53 billion, loans were $9.31 billion, and deposits were $19.98 billion. Versus December 31, 2012, assets increased 1.8%, loans 0.9%, and deposits 2.5%.
- Cash and cash equivalents were $4.32 billion, up from $3.52 billion at year-end. The filing reports nine-month operating cash flow of $100.3 million, compared with $269.2 million in 2012; investing cash flow was $213.4 million versus an outflow of $1.715 billion. These cash-flow movements reflect banking balance-sheet activity and securities transactions.
- Shareholders’ equity was $2.48 billion, including $144.5 million of newly issued Series A preferred stock. The company also completed a $144 million accelerated common-stock repurchase, buying 2.24 million shares at an average price of approximately $64.38.
- Funding included $19.98 billion of deposits, $587.1 million of federal funds purchased and repurchase agreements, $123.7 million of junior subordinated debentures, and $100 million of other long-term borrowings.
- Cullen/Frost’s total capital, Tier 1 capital and leverage ratios were 15.68%, 14.53% and 8.61%, respectively; Frost Bank’s were 13.58%, 12.88% and 7.64%. Management said both were well capitalized. Frost Bank could pay up to $231.5 million in dividends to the parent without prior regulatory approval, subject to applicable requirements.
Credit quality and material changes
- Non-performing assets were $98.1 million, down from $105.2 million at year-end; the ratio to loans and foreclosed assets improved to 1.05% from 1.14%. Non-accrual loans were $79.1 million, versus $89.7 million.
- The allowance for loan losses fell to $93.1 million from $104.5 million, or 1.00% of loans versus 1.13% at year-end. Nine-month net charge-offs rose to $26.0 million from $10.7 million, and the annualized net charge-off ratio increased to 0.38% from 0.17%.
- A single commercial and industrial borrower accounted for $18.8 million of charge-offs in 2013 ($15.0 million in Q1 and $3.8 million in Q3); the borrower entered bankruptcy in April. Excluding this relationship, management reported nine-month net charge-offs of $7.2 million, or 0.11% of average loans on an annualized basis.
- Classified commercial and industrial and commercial real estate loans together declined approximately $26.3 million, or 12.0%, from year-end. Management cited improving Texas economic indicators and generally improving credit trends, while identifying contractors as a distressed industry for reserve purposes.
- Year-to-date common earnings fell 4.0%, despite revenue growth, mainly because non-interest expense rose 6.6%, the loan-loss provision increased, and preferred dividends began in 2013. Q3 common earnings were down 0.4% year over year; lower tax expense and higher net interest income partly offset higher expenses, provisions and preferred dividends.
Outlook, risks and unusual items
- The filing provides no specific earnings, revenue or margin guidance. Management cautions that interim results are not necessarily indicative of full-year or future results.
- Interest-rate simulations projected a 0.1% decline in next-12-month net interest income under a 100-basis-point rate increase, a 1.1% increase under a 200-basis-point increase, and a 2.7% decline under a 25-basis-point decrease, relative to a flat-rate case. The model assumed interest would begin to be paid on demand deposits in Q4 2013; actual deposit pricing could differ.
- Basel III capital rules were scheduled to take effect beginning January 1, 2015, subject to phase-in. Management expected the company and bank to meet fully phased-in capital requirements; trust preferred securities would be phased out of bank-holding-company Tier 1 capital by 2016.
- A proposed acquisition of WNB Bancshares, based in Odessa, Texas, remained pending and was expected to close in 2014, subject to regulatory and other conditions. Consideration was to include two million Cullen/Frost shares plus cash, with adjustments; the filing recorded $873,000 of related costs through Q3.
- Unusual items included a $7.2 million first-quarter write-down of land and other assets, including $6.2 million for downtown San Antonio property; a $5.6 million gain on a building and parking-garage sale, of which $4.7 million was recognized through September; and a $1.8 million reversal of an acquisition-contingency accrual. Nine-month income taxes were lower, with an effective tax rate of 17.9% versus 22.2%, largely reflecting tax-exempt income.
- Management identified uncertainty around a court ruling and appeal concerning debit-card interchange fee rules. Other stated risks include economic and financial-market conditions, interest rates, credit quality and loan-loss estimates, regulation, competition, technology, acquisitions and litigation. Management did not expect existing legal matters to have a material adverse effect; it reported no material change in the prior Form 10-K risk factors.
- Available-for-sale securities had a $95.9 million pre-tax decline in unrealized value during the first nine months, contributing to a $92.3 million after-tax other comprehensive loss. Management considered reported securities impairments temporary and said it did not intend, and was not likely to need, to sell the securities before recovery.
Most important facts for investors to verify
- Whether credit performance and reserve adequacy remain sound after the large single-borrower charge-off, including trends in non-performing, classified and past-due loans.
- Whether margin pressure persists as asset yields, deposit costs and deposit mix change, and how actual demand-deposit pricing compares with the interest-rate model assumptions.
- The source and sustainability of earnings growth, including expense trends, tax-exempt income, securities-related gains and other unusual items.
- Completion terms, regulatory approval, final consideration and integration costs for the pending WNB Bancshares acquisition.
- The effects of securities valuation changes and the transition to Basel III on capital, dividends and flexibility for future repurchases.