Cullen/Frost Bankers, Inc. (NYSE: CFR) — FY 2014 10-K
Reporting period: Fiscal year ended December 31, 2014. Cullen/Frost is a Texas-focused financial holding company operating primarily through Frost Bank, with commercial and consumer banking, wealth management, insurance and related services. The company acquired WNB Bancshares on May 30, 2014; its results are included from that date.
Financial results and position
| Metric | 2014 | 2013 |
|---|---|---|
| Net interest income | $686.9 million | $620.6 million |
| Net income | $278.0 million | $237.9 million |
| Net income available to common shareholders | $269.9 million | $231.1 million |
| Diluted EPS | $4.29 | $3.80 |
| Return on average assets | 1.05% | 1.02% |
| Return on average common equity | 10.51% | 9.93% |
| Net interest margin | 3.41% | 3.41% |
- Fourth quarter: Net income available to common shareholders was $70.7 million, or $1.11 diluted EPS, versus $60.6 million, or $0.99, in Q4 2013. Net interest income was $179.0 million versus $159.2 million; provision for loan losses was $4.4 million versus $5.9 million.
- Revenue and costs: Total non-interest income rose 5.7% to $320.1 million, led by trust and investment management fees, up 16.3% to $106.2 million. Non-interest expense increased 7.0% to $654.7 million.
- Cash flow: Operating activities provided $286.7 million; investing activities used $2.282 billion; financing activities provided $1.803 billion. Cash and cash equivalents declined $192.0 million to $4.364 billion.
- Balance sheet: Total assets were $28.28 billion, loans $10.99 billion, deposits $24.14 billion, and shareholders’ equity $2.85 billion at year-end. Loans grew 15.5% and deposits 16.7% from year-end 2013.
- Debt and liquidity: Long-term debt and other borrowings were $237.1 million; federal funds purchased and repurchase agreements were $803.1 million. Parent-company liquid assets were $294.0 million. Management reported no known event expected to materially impair liquidity or capital resources.
- Capital and credit: Cullen/Frost’s total risk-based capital ratio was 14.55%, Tier 1 ratio 13.68%, and leverage ratio 8.16%; Frost Bank was reported well capitalized. Allowance for loan losses was $99.5 million, or 0.91% of loans. Net charge-offs fell to $9.2 million (0.09% of average loans) from $32.6 million (0.35%) in 2013.
Material changes and notable items
- Common-shareholder income increased $38.8 million year over year, primarily from higher net interest income and non-interest income and a lower loan-loss provision, partly offset by higher expenses, taxes and preferred dividends.
- WNB added $1.6 billion of deposits, $670.6 million of loans and $879.7 million of cash and cash equivalents. Purchase consideration was approximately $198.8 million, including $149.7 million in stock and $49.1 million in cash; the preliminary allocation included $117.3 million of goodwill. Acquisition expenses were $7.1 million in 2014.
- Energy loans rose to $1.774 billion, or 16.1% of loans, from 11.7% a year earlier. Management cited the sharp decline in oil prices—about $53 per barrel at year-end versus $98 in 2013—as a risk if low prices persist.
- Non-performing assets decreased to $65.2 million from $69.8 million, but non-accrual loans increased to $59.9 million from $56.7 million, and accruing past-due loans rose to $63.8 million from $38.9 million.
- The 2014 provision was $16.3 million, down from $20.6 million in 2013; 2013 charge-offs included $18.8 million tied to one commercial and industrial relationship. The allowance-to-loans ratio declined to 0.91% from 0.97%.
- All $30.6 million of deferred gains from terminated interest-rate swaps was recognized in loan interest income during 2014; amortization ended in October. Management used $840 million of excess liquidity to buy municipal securities, expecting their yield to replace that income stream.
- A $2.2 million settlement accrual was included in 2014 miscellaneous expenses. In 2013, the company recorded $7.2 million of write-downs on land and other assets, including downtown San Antonio property.
Outlook, risks and contingencies
- The filing provides no numerical earnings or revenue guidance. Management said higher-yielding municipal securities were expected to offset the end of swap-gain amortization; future results remain sensitive to loan pricing, asset mix, deposit costs and interest rates.
- Year-end interest-rate simulations projected net interest income 0.6% lower under a 100-basis-point rate increase, 0.2% lower under a 200-basis-point increase, and 2.6% lower under a 25-basis-point decrease, versus a flat-rate case. The model assumed the bank would begin paying interest on certain demand deposits in Q1 2015; actual pricing could change the sensitivity.
- Management expected Cullen/Frost and Frost Bank to meet Basel III capital requirements on a fully phased-in basis. Basel III rules became effective January 1, 2015, with certain provisions phased in through 2019; trust-preferred securities begin to phase out of Tier 1 capital.
- As a condition of WNB acquisition approval, the company agreed to enhance compliance programs, including fair-lending controls, before submitting further expansionary proposals; enhancements were in progress.
- Key risks include Texas economic concentration, lower oil prices, commercial and real-estate credit exposure, interest-rate and liquidity risk, competition, regulatory change, cybersecurity and vendor risk. Energy comprised 16.1% of loans; 97.4% of municipal securities were issued by Texas entities.
- The company was party to ordinary-course legal claims; management did not expect their disposition to have a material adverse effect. The financial-statement auditor issued an unqualified opinion, and management and the auditor reported effective internal control over financial reporting.
Important facts for investors to verify
- How the enlarged energy exposure and persistently low oil prices affected borrower performance, criticized loans and reserves after year-end.
- Whether elevated past-due loans translated into higher non-accruals, charge-offs or provisions, and whether the 0.91% allowance ratio remained adequate as loans grew.
- Whether WNB integration delivered expected revenue and cost benefits, and how final purchase accounting affected goodwill and acquired-loan marks.
- Actual deposit repricing and net interest income performance relative to the filing’s interest-rate scenarios and the end of swap-gain amortization.
- Post-2014 Basel III capital ratios, trust-preferred phase-out effects, and progress on fair-lending compliance enhancements.
- Dividend sustainability: 2014 common dividends were $2.03 per share, while regulatory restrictions and preferred-stock terms can constrain future distributions.