Cullen/Frost Bankers, Inc. (CULLEN) — Q2 2014 Form 10-Q
Reporting period: Quarter and six months ended June 30, 2014. Unaudited; filed July 30, 2014. Dollar amounts below are in U.S. dollars.
Business context and reporting period
Cullen/Frost is a Texas-based financial holding company offering commercial and consumer banking, wealth management, insurance, investment banking and related services. On May 30, 2014, it acquired WNB Bancshares for approximately $198.1 million, comprising $149.0 million in stock and $49.1 million in cash. WNB’s results are included from the acquisition date; Western National Bank was integrated into Frost Bank on June 20. The purchase-price allocation was preliminary.
Financial performance and position
- Q2 earnings: Net income was $66.5 million, up 11.4% from $59.7 million. Net income available to common shareholders was $64.5 million; diluted EPS was $1.02 versus $0.94.
- Six-month earnings: Net income was $127.7 million, up 11.1%; diluted EPS was $1.99 versus $1.85. Return on average assets was 1.02% and return on average common equity was 10.15%.
- Q2 revenue and margins: Net interest income was $169.6 million, up 10.7%; non-interest income was $79.2 million, up 9.2%. Taxable-equivalent net interest margin was 3.48%, versus 3.43% a year earlier. The six-month margin was 3.45%, versus 3.44%.
- Expenses and credit costs: Q2 non-interest expense rose 9.5% to $164.0 million; provision for loan losses rose to $4.9 million from $3.6 million. The six-month provision was $11.5 million versus $9.6 million.
- Balance sheet at June 30: Assets were $26.52 billion, up from $24.31 billion at year-end 2013; loans were $10.68 billion, up 12.2%, and deposits were $22.52 billion, up 8.8%. Non-interest-bearing deposits were $9.51 billion, or 42.2% of deposits.
- Cash flow, six months: Operating activities provided $100.2 million, compared with cash used of $33.3 million in 2013. Investing activities provided $310.9 million, including $830.7 million of net cash received in acquisitions; financing activities provided $53.4 million. Cash and cash equivalents ended at $5.02 billion.
- Debt and capital: Federal funds purchased and repurchase agreements were $613.0 million; junior subordinated debentures were $137.1 million; other long-term borrowings were $100.0 million. Shareholders’ equity was $2.77 billion. Cullen/Frost’s total risk-based capital ratio was 14.76% and Tier 1 ratio 13.84%; management said the company and Frost Bank were well capitalized and expected to meet fully phased-in Basel III requirements.
- Liquidity: Management reported no known event likely to materially adversely affect liquidity. It stated the holding company had $289.6 million of liquid assets, including cash and resell agreements; this is distinct from consolidated cash and cash equivalents.
Material changes versus comparable periods
- Q2 common earnings increased 13.1%, mainly from higher net interest income and fee income, partly offset by increased operating costs and loan-loss provision. Six-month common earnings increased 10.2%.
- Average interest-earning assets and average deposits expanded, aided by WNB and organic deposit growth. Lower funding costs and a higher yield on securities supported net interest margin; loan yields declined amid competitive pricing.
- Trust and investment management fees rose 18.6% in Q2, reflecting higher investment fees, oil and gas fees and estate fees. Fee growth also benefited from higher average equity valuations and a fee-schedule change.
- Q2 and six-month expenses included $4.8 million and $6.0 million, respectively, of WNB acquisition costs. Excluding acquisition costs and specified 2013 asset write-downs, management reported underlying other expense growth of 9.6% for Q2 and 9.4% for the six-month period.
- Non-performing assets declined to $68.6 million from $69.8 million at year-end, while non-accrual loans increased to $59.6 million from $56.7 million. Annualized six-month net charge-offs improved to 0.12% of average loans from 0.45%, which included a $15 million charge-off in 2013.
Outlook, risks and unusual items
- No specific earnings or revenue guidance was provided. Management cautioned that interim results are not necessarily indicative of full-year results.
- Interest-rate modeling projected net interest income changes over the next 12 months, relative to a flat-rate scenario, of +0.4% for a 100-basis-point increase, +1.3% for a 200-basis-point increase, and -3.2% for a 25-basis-point decrease. The model assumed interest would begin to be paid on certain demand deposits in Q3 2014; actual deposit pricing may differ.
- Energy loans were 14.3% of total loans, the only industry concentration above 10%. Loan performance is exposed to borrower, industry, Texas economic, real-estate, interest-rate and collateral risks. Management identified contractor segments as distressed industries, while overall classified commercial loans and weighted-average risk grades improved from year-end.
- The allowance for loan losses was $98.3 million, or 0.92% of loans, compared with $92.4 million at year-end. Management considered it adequate, but noted estimates depend on economic and portfolio conditions.
- Management considered securities’ unrealized losses temporary and reported no credit-related impairment. Available-for-sale securities were exposed to market-rate movements.
- Unusual items included a $1.3 million small-business investment company distribution and $1.3 million recovery of interest on previously charged-off loans in Q2 2014. Six-month 2013 other income included a $4.5 million gain on a building and parking-garage sale.
- Commitments to extend credit were $7.30 billion and standby letters of credit were $219.6 million. Management did not expect pending legal matters to have a material adverse impact. The filing reported no material change in previously disclosed risk factors.
Most important facts for investors to verify
- How much of loan, deposit and earnings growth is attributable to WNB, and whether integration costs or synergies differ from expectations.
- Whether the 14.3% energy-loan concentration, contractor exposure, non-accrual trends and allowance remain manageable as the Texas economy and borrower conditions change.
- Whether fee growth, particularly trust fees, is sustainable apart from market valuations and fee-schedule changes; and how recurring expenses evolve after acquisition costs.
- Actual deposit repricing and net interest income sensitivity versus the filing’s model assumptions, especially if rates fall or demand-deposit costs rise.
- Capital and liquidity levels, including the distinction between consolidated cash and the holding company’s reported liquid assets, and the effects of acquisition integration and regulatory requirements.