Cullen/Frost Bankers, Inc. — Q1 2020 Form 10-Q
Business context and reporting period. Cullen/Frost is a Texas-based financial holding company providing commercial and consumer banking, wealth management, insurance and related services. This unaudited report covers the three months ended March 31, 2020; comparisons are with Q1 2019 unless otherwise noted. Results reflect the initial economic disruption from COVID-19 and sharp declines in oil prices.
Financial performance and position
| Metric | Q1 2020 / March 31, 2020 | Comparable period / prior year-end |
|---|---|---|
| Net income | $54.8 million; diluted EPS $0.75 | $116.5 million; diluted EPS $1.79 in Q1 2019 |
| Net income available to common shareholders | $47.2 million | $114.5 million in Q1 2019 |
| Net interest income | $244.5 million; taxable-equivalent net interest margin 3.56% | $246.5 million; margin 3.79% in Q1 2019 |
| Credit loss expense | $175.2 million, including $172.9 million for loans | $11.0 million in Q1 2019 |
| Non-interest income / expense | $212.9 million / $224.2 million | $96.8 million / $201.8 million in Q1 2019 |
| Total assets | $34.15 billion | $34.03 billion at December 31, 2019 |
| Loans, net of allowance | $15.07 billion; gross loans $15.34 billion | Net loans $14.62 billion; gross loans $14.75 billion at December 31, 2019 |
| Allowance for loan credit losses | $263.9 million, or 1.72% of loans | $132.2 million at December 31, 2019 |
| Deposits | $28.14 billion | $27.64 billion at December 31, 2019 |
| Cash and cash equivalents | $4.20 billion | $3.79 billion at December 31, 2019 |
| Shareholders’ equity | $3.83 billion | $3.91 billion at December 31, 2019 |
Operating cash flow was $248.9 million, versus $146.1 million in Q1 2019. Investing activities provided $391.0 million, compared with $785.5 million used in Q1 2019; financing activities used $232.5 million. The filing does not provide a conventional profit margin figure.
Regulatory capital remained above well-capitalized thresholds: Cullen/Frost’s CET1 ratio was 12.02%, total capital ratio 13.97%, and leverage ratio 8.84% at quarter-end. Federal funds purchased and repurchase agreements were $1.17 billion, down from $1.70 billion at year-end; junior subordinated debentures were $136.3 million and subordinated notes $98.9 million.
Material changes versus the prior comparable period
- Common-shareholder income fell 58.8%; net income declined 53.0%. The main driver was the $164.2 million year-over-year rise in credit loss expense, reflecting CECL adoption and deteriorating expected conditions tied to COVID-19 and oil prices.
- Non-interest income rose $116.1 million, principally because of a $109.0 million realized gain on securities sales. Excluding that gain, non-interest income increased $7.1 million.
- Net interest income declined $1.9 million. Taxable-equivalent margin fell 23 basis points to 3.56%, amid lower market rates, partly offset by lower funding costs and higher loan and deposit balances.
- Non-interest expense increased $22.4 million, or 11.1%, including higher staffing, occupancy, technology and other costs.
- Non-performing assets decreased to $67.5 million from $109.5 million at year-end, but accruing past-due loans rose to $122.1 million from $58.2 million. Potential problem loans increased to $105.9 million from $63.4 million.
- The company adopted CECL on January 1, 2020, reducing retained earnings by $29.3 million after tax. The loan allowance rose sharply during the quarter, particularly for energy loans; Q1 includes a $33.8 million energy-loan charge-off.
Outlook, management commentary, risks and unusual items
- Management said COVID-19’s ultimate adverse impact could not then be reliably estimated but was expected to be material. It anticipated continued credit deterioration and defaults, especially in energy, hospitality, restaurants, aviation, entertainment, retail and commercial real estate. Customers could request payment deferrals of up to 90 days.
- Management expected net interest income and margin to decline later in 2020 because of low rates, with PPP participation expected to provide some offset. No full-year earnings guidance was provided.
- After quarter-end, Cullen/Frost reported funding about $3.0 billion of SBA-approved PPP loans to more than 10,500 customers through April 27, 2020, and expected approximately $87 million of processing fees recognized over loan terms. It also borrowed $250 million from the FHLB for six months at 0.25% to support PPP originations.
- Oil was a material credit risk: energy loans were $1.57 billion, or 10.2% of loans. Management’s March 31 CECL estimate used a low-oil scenario and included additional energy qualitative reserves; its stress analysis identified a borrowing-base deficiency among certain production borrowers. WTI was approximately $20 per barrel at quarter-end and $13 on April 27, compared with $61 at year-end.
- A one-time $109.0 million securities gain materially supported Q1 non-interest income; $107.1 million came from U.S. Treasury securities sold to realize gains and provide liquidity. The quarter also included approximately $6.0 million in gains on short-term Treasury put options that expired unexercised.
- The company redeemed all Series A preferred stock for $150 million in March; $5.5 million of issuance costs reduced income available to common shareholders. It repurchased $13.7 million of shares during the quarter and said it did not anticipate further repurchases under the program amid pandemic uncertainty.
- PPP-related class-action lawsuits were filed against Frost Bank alleging, among other things, violations of the CARES Act and SBA program. The bank stated it believed the claims were without merit. Management said other litigation was not expected to have a material adverse impact.
- Management identified risks to operations, fee income, asset values, liquidity and funding from the pandemic, including remote-work and vendor disruptions. It also warned that market volatility and lower rates could pressure net interest income; the bank is more asset-sensitive, and its model estimated a 4.5% decline in 12-month net interest income from a 25-basis-point rate decrease versus a flat-rate case.
Most important facts for investors to verify
- Whether subsequent loan performance, deferrals and charge-offs validate the $263.9 million allowance and the assumptions underlying CECL, particularly the energy portfolio.
- How COVID-19 and oil-market conditions affect non-performing, past-due and potential problem loans, and whether deferred loans later become delinquent or require restructuring.
- Whether PPP loan forgiveness, fee recognition, funding costs and any participation in the Federal Reserve PPP Facility develop as described.
- Whether recurring earnings can offset the unusually large securities gain and whether lower rates further compress net interest income and margin.
- Whether fee income, expenses, deposits, liquidity and capital remain resilient, including the effect of the preferred-stock redemption, dividends and suspended buybacks.
- The progression and financial or reputational consequences of PPP-related litigation and any material regulatory or legal developments.