Cullen/Frost Bankers, Inc. — Q2 2012 Form 10-Q
Reporting period: Quarter and six months ended June 30, 2012. Unaudited consolidated results. Cullen/Frost is a Texas-based financial holding company focused on banking and related financial services, primarily in Texas. Dollar amounts below are in millions unless noted.
Financial results and position
| Metric | Q2 2012 | Six months 2012 |
|---|---|---|
| Net interest income | $149.2 | $298.9 |
| Non-interest income | $69.8 | $141.7 |
| Net income | $58.1 | $119.1 |
| Diluted EPS | $0.94 | $1.93 |
| Net interest margin, taxable-equivalent | 3.61% | 3.67% |
| Return on average assets / equity | 1.14% / 9.95% | 1.19% / 10.27% |
- Balance sheet at June 30: Assets $20.87 billion; loans $8.49 billion gross and $8.38 billion net; deposits $17.28 billion; shareholders’ equity $2.36 billion.
- Funding and liquidity: Cash and cash equivalents were $2.30 billion. Interest-bearing deposits averaged 0.18% cost in the first half; non-interest-bearing deposits were 41.3% of period-end deposits. Holding-company liquid assets were $210.2 million, including $5.1 million of cash collateral.
- Borrowings: Federal funds purchased and repurchase agreements were $656.0 million; junior subordinated debentures $123.7 million; other long-term borrowings $100.0 million.
- Cash flow, first half: Operating cash flow $167.5 million; investing cash outflow $1.18 billion; financing cash inflow $403.7 million. Cash and equivalents fell $612.3 million, mainly reflecting investment activity, including substantial purchases and sales of available-for-sale securities.
- Credit: Allowance for loan losses was $105.6 million, or 1.24% of loans. Non-performing assets were $112.1 million (1.32% of loans and foreclosed assets); non-accrual loans were $92.3 million. Net charge-offs were $8.0 million for the first half.
- Capital: Cullen/Frost’s total risk-based capital ratio was 15.61%, Tier 1 ratio 14.07%, and leverage ratio 8.65%. Frost Bank’s corresponding ratios were 13.98%, 13.10%, and 8.06%; management reported both entities well capitalized.
Changes versus comparable periods
- Q2 net income rose 4.3% year over year to $58.1 million; first-half net income rose 10.7% to $119.1 million. Lower loan-loss provisions and higher net interest income drove the gains, partly offset by higher expenses and taxes.
- Net interest margin declined 34 basis points year over year in Q2 and 32 basis points for the first half. Management attributed pressure to historically low rates and a shift in earning assets toward lower-yielding securities, especially Treasuries. Higher asset volumes lifted first-half net interest income.
- Loans grew $494.6 million, or 6.2%, from year-end 2011; deposits increased $520.4 million. Available-for-sale securities rose to $8.48 billion from $7.79 billion at year-end.
- Credit indicators improved year over year: non-performing assets declined from $161.4 million to $112.1 million, and first-half net charge-offs fell from $22.0 million to $8.0 million. The allowance declined from $122.7 million a year earlier.
- Non-interest income was down 1.5% in Q2 and 1.0% in the first half year over year. Debit/interchange revenue fell sharply following regulatory fee limits; trust and insurance fees increased. Non-interest expense increased 4.2% in Q2 and 2.8% in the first half.
Outlook, commentary, risks and unusual items
- No formal earnings or revenue guidance is provided. Management expects net charge-offs to continue trending downward if portfolio credit quality keeps improving; it expected advertising and promotion expense for the rest of 2012 to be comparable to 2011.
- Interest-rate sensitivity modeling projected net interest income declines over the next 12 months of 1.0% and 1.4% under +100- and +200-basis-point scenarios, and 1.7% under a −25-basis-point scenario. The model assumed interest would begin to be paid on demand deposits in Q3 2012; actual repricing could differ.
- The bank charter conversion took effect June 22, 2012: Frost Bank became a Texas state-chartered member of the Federal Reserve System and ceased OCC regulation. The filing says deposits remain FDIC-insured subject to applicable limits.
- The Dodd-Frank Act requires trust preferred securities to be phased out of Cullen/Frost Tier 1 capital beginning in 2013. Proposed Basel capital rules could also change capital treatment and risk weights; management believed the company and bank would meet proposed requirements if fully effective at period-end.
- Energy exposure merits attention: energy loans were $1.06 billion, and 67.5% of purchased shared national credits were energy-related. Contractors were identified as a distressed industry, with weaker revenues, backlogs and margins.
- Unusual items included a $700,000 non-recurring equipment write-down, a $765,000 reversal of a prior contingency accrual, and a first-half net securities transaction loss of $121,000. The company also reported $14.0 billion of available-for-sale securities sales, primarily tied to Texas franchise-tax planning.
- Management reported no material expected adverse effect from pending litigation, no material change in previously disclosed risk factors, and effective disclosure controls. Interim results are not necessarily indicative of full-year results.
Important facts for investors to verify
- Whether loan growth—particularly commercial, construction and energy-related exposure—continues without deterioration in credit quality or higher reserve needs.
- Whether margin pressure persists as rates remain low and the assumed demand-deposit pricing changes take effect.
- Whether lower interchange revenue and rising operating costs are offset by growth in trust, insurance and other fee businesses.
- The sustainability and quality of reported earnings given lower provisions, the contingency reversal, equipment write-down and securities tax-planning activity.
- The effect of trust-preferred capital phase-out and final Basel rules on regulatory capital, and the holding company’s access to bank dividends and liquidity.