Cullen/Frost Bankers, Inc. — Q2 2019 Form 10-Q
Business context and period. Cullen/Frost is a Texas-based financial holding company providing banking, wealth management, insurance and related financial services. This unaudited report covers the quarter and six months ended June 30, 2019; year-over-year comparisons are to the corresponding 2018 periods unless stated otherwise.
Financial performance
- Q2 revenue and earnings: Net interest income was $253.4 million, up 6.8%; non-interest income was $82.6 million, down 2.9%. Net income was $111.6 million versus $111.3 million, and net income available to common shareholders was $109.6 million versus $109.3 million. Diluted EPS increased to $1.72 from $1.68.
- First-half earnings: Net interest income was $499.9 million, up 7.0%; non-interest income was $179.4 million, up 1.6%. Common net income rose 4.8% to $224.1 million, and diluted EPS rose to $3.51 from $3.30.
- Margins and returns: Taxable-equivalent net interest margin was 3.85% in Q2, up 21 basis points year over year; first-half margin was 3.82%, up 24 basis points. First-half return on average assets was 1.44% versus 1.39%; return on average common equity was 13.32% versus 13.83%.
- Expenses and credit costs: Q2 non-interest expense increased 7.6% to $203.2 million; first-half expense increased 5.1% to $405.0 million. Provision for loan losses was $6.4 million in Q2 and $17.4 million for the first half. First-half net charge-offs declined to $14.6 million from $20.3 million.
- Cash flow: For the first half, operating activities generated $291.9 million; investing activities used $955.9 million and financing activities used $1.346 billion. Cash and cash equivalents fell $2.010 billion to $1.945 billion, primarily alongside a $1.164 billion reduction in deposits and substantial securities activity.
Financial position and changes
- At June 30, total assets were $31.82 billion, down from $32.29 billion at December 31, 2018. Loans were $14.46 billion, up 2.5%; deposits were $25.99 billion, down 4.3%.
- Shareholders’ equity was $3.74 billion, up from $3.37 billion at year-end. The change included $283.0 million of after-tax other comprehensive income, principally unrealized gains on available-for-sale securities. Accumulated other comprehensive income moved from a $63.6 million loss to a $219.4 million gain.
- Allowance for loan losses was $134.9 million, or 0.93% of loans, versus $132.1 million, or 0.94%, at year-end. Non-performing assets were $76.4 million, or 0.24% of assets, compared with $74.9 million, or 0.23%, at year-end.
- Interest-bearing deposits and repurchase agreements totaled $1.32 billion, down from $1.37 billion at year-end. Subordinated notes were $98.8 million and junior subordinated debentures were $136.3 million. The filing reports strong regulatory capital: Cullen/Frost CET1 was 12.29% and total capital was 14.60%; both Cullen/Frost and Frost Bank exceeded applicable “well capitalized” thresholds.
Management commentary, outlook and risks
- Management attributed earnings growth chiefly to higher loan and securities yields and loan growth; higher deposit and borrowing costs, and increased operating expenses, partly offset the benefit. The filing gives no earnings or revenue guidance and cautions that interim results are not necessarily indicative of full-year results.
- Energy loans were $1.48 billion, or 10.2% of loans, and energy-related unfunded credit commitments were $1.3 billion. Management reported increasing classified commercial and industrial and energy loans and identified potential problem loans of $56.9 million. It considered the allowance appropriate, but estimates may change with portfolio conditions and economic factors.
- Interest-rate simulations indicated that a 100- or 200-basis-point rate increase could raise projected 12-month net interest income by 0.4% or 1.7%; equivalent decreases could reduce it by 3.0% or 8.2%. These are model estimates, sensitive to assumptions including future pricing of commercial demand deposits.
- The company adopted lease accounting in 2019; at June 30 it reported $284.5 million of right-of-use assets and $291.7 million of lease liabilities. A new San Antonio headquarters lease accounted for $121.7 million of each during Q2. Adoption of callable-debt premium guidance reduced retained earnings by $12.6 million; management expected about $5.2 million of additional 2019 premium amortization.
- The expected-credit-loss standard (ASU 2016-13) was scheduled for adoption January 1, 2020. Management could not reasonably estimate its impact and noted adoption could increase credit-loss allowances. Legal claims were not expected by management to materially affect the financial statements; the filing reported no material change in previously disclosed risk factors.
- After quarter-end, the board authorized a new $100 million stock-repurchase program on July 24, 2019. During Q2, the company repurchased 496,307 shares for $50.0 million and paid common dividends of $0.71 per share.
Investor verification priorities
- Track deposit trends and funding costs against loan growth and net interest margin, especially as commercial demand-deposit pricing changes.
- Review energy and other classified-credit trends, non-accruals, potential problem loans, charge-offs and allowance adequacy.
- Assess the assumptions and eventual balance-sheet and earnings effects of the 2020 expected-credit-loss standard.
- Reconcile the substantial cash decline and securities portfolio activity with liquidity needs, capital distributions and the new repurchase authorization.
- Monitor expense growth, including staffing, technology, advertising and new headquarters lease costs, against revenue growth.