Cullen/Frost Bankers, Inc. (NYSE: CFR) — FY 2012 Form 10-K
Reporting period: Fiscal year ended December 31, 2012. Fourth-quarter figures are unaudited. Dollar amounts below are in U.S. dollars.
Business context
Cullen/Frost is a Texas-based financial holding company operating principally through Frost Bank, with commercial and consumer banking, wealth management, insurance, brokerage, leasing and related services. At year-end, consolidated assets were $23.1 billion, deposits were $19.5 billion, and Frost Bank operated more than 110 financial centers in Texas. The company acquired Houston-based human-resources consulting firm Stone Partners in 2012; the filing says the acquisition did not significantly affect financial statements.
Financial performance and condition
| Metric | FY 2012 | FY 2011 |
|---|---|---|
| Net interest income | $604.9 million | $581.8 million |
| Non-interest income | $288.8 million | $290.0 million |
| Provision for loan losses | $10.1 million | $27.4 million |
| Non-interest expense | $575.1 million | $558.1 million |
| Net income | $238.0 million | $217.5 million |
| Diluted earnings per share | $3.86 | $3.54 |
| Net interest margin | 3.59% | 3.88% |
| Return on average assets | 1.14% | 1.17% |
| Return on average equity | 10.03% | 10.01% |
Net income increased 9.4%, supported mainly by higher net interest income and a lower loan-loss provision. Average earning assets grew 13.4%, but margin contracted 29 basis points as asset yields fell and the portfolio shifted toward lower-yielding securities. Non-interest income was nearly flat: higher trust and insurance fees were offset in part by a $12.7 million decline in interchange and debit-card fees following regulatory fee limits.
In Q4 2012, net income was $60.2 million, or $0.97 diluted per share, versus $55.4 million, or $0.90, in Q4 2011. Quarterly net interest income was $154.4 million versus $150.3 million; the loan-loss provision was $4.1 million versus none in Q4 2011.
- Balance sheet: Total assets rose to $23.1 billion from $20.3 billion; loans increased 15.4% to $9.2 billion and deposits increased 16.4% to $19.5 billion.
- Credit quality: Non-performing assets declined to $105.2 million from $120.9 million; net charge-offs fell to $15.8 million, or 0.19% of average loans, from $43.6 million, or 0.54%. The allowance was $104.5 million, equal to 1.13% of year-end loans, versus 1.38% in 2011.
- Capital: Shareholders’ equity was $2.42 billion. Cullen/Frost reported a 13.68% Tier 1 risk-based capital ratio, 15.11% total risk-based capital ratio and 8.28% leverage ratio; management said the company and Frost Bank were well capitalized.
- Debt: Year-end borrowings included $123.7 million of junior subordinated debentures, $100.0 million of subordinated notes and $561.1 million of federal funds purchased and repurchase agreements. Long-term debt and other borrowings were $223.7 million.
- Liquidity and cash flow: Cash and cash equivalents were $3.52 billion, up from $2.91 billion. Operating cash flow was $300.0 million; investing cash outflow was $2.16 billion and financing cash inflow was $2.47 billion, with deposit growth a major funding source. Management reported no known event reasonably likely to materially impair liquidity or capital resources.
- Shareholder returns: Dividends were $1.90 per share for the year, up from $1.83. Management said it was committed to regular cash dividends, subject to future earnings, capital needs, financial condition and regulatory constraints. No shares were repurchased under board-authorized plans.
Material changes, outlook and risks
- The company transferred $2.3 billion of securities from available-for-sale to held-to-maturity in Q4. The transfer included a $165.7 million pre-tax unrealized gain, which will be amortized into yield over the securities’ remaining lives.
- A $4.3 million net gain on securities sales contributed to 2012 non-interest income. The filing also reports a $1.4 million settlement and a $765,000 reversal of a prior contingency accrual within miscellaneous income.
- Management cited continued low interest rates and modeled a negative 0.3% change in next-12-month net interest income for a 100-basis-point rate increase, a positive 0.2% for a 200-basis-point increase, and a negative 1.6% for a 25-basis-point decrease. The model assumed interest would begin to be paid on demand deposits in Q1 2013.
- No specific earnings or revenue guidance is provided. Management said it expected net charge-offs to remain stable for the foreseeable future; this is not a quantified forecast.
- Key exposures include Texas economic conditions, commercial lending and real estate credit risk, interest-rate and liquidity risk, and energy concentration. Commercial and industrial, construction and commercial real estate loans together represented approximately 89% of the loan portfolio; energy loans were 11.7% of total loans. About 98.8% of municipal securities were issued in Texas.
- Regulatory uncertainty included proposed Basel III capital and liquidity rules, the phase-out of trust preferred securities from Tier 1 capital, stress-testing requirements and consumer-protection oversight. Management believed the company and bank would meet proposed capital requirements on a fully phased-in basis, but final rules were not yet adopted.
- Legal proceedings arose in the ordinary course of business; management did not expect their disposition to materially adversely affect the financial statements. The independent auditor gave an unqualified opinion on the financial statements and internal control over financial reporting.
Important facts for investors to verify
- Whether rapid loan and deposit growth can be sustained without further pressure on net interest margin and funding costs.
- Whether lower provisions and improved credit metrics remain supported as the loan portfolio expands, particularly in commercial real estate, construction and energy lending.
- The effect of interest-rate movements, demand-deposit pricing and securities portfolio duration on future earnings and capital.
- The accounting and earnings implications of the Q4 securities reclassification and the remaining deferred gains from terminated cash-flow hedges.
- Dividend capacity under regulatory restrictions and the final impact and timing of capital, liquidity and stress-testing rules.