Cullen/Frost Bankers, Inc. — Q1 2012 Form 10-Q
Business context and period. The Texas-based financial holding company provides banking, insurance, trust, investment management and related services. This unaudited filing covers the three months ended March 31, 2012; comparisons are primarily with Q1 2011. Unless noted otherwise, dollar amounts below are in millions.
Key financial results
| Metric | Q1 2012 | Comparable period |
|---|---|---|
| Total revenue (net interest income plus non-interest income) | $221.7 | $214.1, Q1 2011 |
| Net interest income | $149.7 | $141.8, Q1 2011 |
| Net income / diluted EPS | $61.0 / $0.99 | $51.9 / $0.85, Q1 2011 |
| Net interest margin, taxable-equivalent | 3.73% | 4.03%, Q1 2011 |
| Operating cash flow | $101.9 | $71.2, Q1 2011 |
- Net income rose 17.5% year over year. The company attributed the increase principally to an $8.4 million lower loan-loss provision and $7.9 million higher net interest income, partly offset by higher taxes and expenses.
- Net interest income increased 5.6% year over year; taxable-equivalent net interest income increased 5.2%. Management said leap year added approximately $1.8 million to taxable-equivalent net interest income; excluding that effect, the increase was about $6.3 million.
- The margin contracted 30 basis points year over year. Average earning assets grew, but their mix shifted toward lower-yielding securities; average earning-asset yield fell to 3.89% from 4.34%. Average cost of funds declined to 0.26% from 0.47%.
- Non-interest income was $72.0 million, down 0.5% year over year. Interchange and debit card fees fell 48.8%, largely following new regulatory fee limits; insurance commissions rose 17.9%, partly reflecting acquisitions and seasonal contingent commissions.
- Non-interest expense rose 1.4% year over year to $142.0 million. Higher employee benefits, salaries and technology costs were partly offset by lower deposit insurance expense.
Balance sheet, credit, liquidity and capital
- At March 31, total assets were $20.42 billion, up from $17.94 billion a year earlier. Loans were $8.13 billion, up 1.6% from year-end 2011; deposits were $16.91 billion, up 0.9% from year-end and 15.0% year over year.
- Cash and cash equivalents were $2.13 billion, down $778.9 million from year-end. Cash flow from investing was negative $925.3 million, mainly reflecting securities purchases and sales; financing cash flow was positive $44.5 million. The filing reports no standalone corporate revenue or earnings guidance.
- Borrowings included $637.1 million of federal funds purchased and repurchase agreements, $123.7 million of junior subordinated debentures and $100.0 million of other long-term borrowings. Shareholders’ equity was $2.32 billion.
- Non-performing assets totaled $120.5 million, or 0.59% of assets, versus $154.7 million and 0.86% a year earlier. Non-accrual loans were $97.9 million. Potential problem loans totaled $41.0 million; 70.3% related to one construction customer.
- The allowance for loan losses was $107.2 million, 1.32% of loans, versus $124.3 million and 1.55% a year earlier. Q1 provision was $1.1 million; annualized net charge-offs were 0.20% of average loans, down from 0.57% in Q1 2011. Management said it expected net charge-offs to continue trending downward if portfolio credit quality improved.
- Regulatory capital ratios remained above “well capitalized” thresholds: Cullen/Frost total risk-based capital was 16.10%, Tier 1 was 14.47%, and leverage was 8.68%; Frost Bank ratios were 14.48%, 13.54%, and 8.12%, respectively. Frost Bank could pay up to $233.8 million in dividends to the parent without prior regulatory approval, subject to applicable restrictions.
- The parent reported $197.3 million of liquid assets, including cash and resale agreements. Management said it knew of no event reasonably likely to materially adversely affect liquidity, capital resources or operations.
Material changes, outlook and risks
- Management attributed improving credit indicators to a declining trend in classified loans and net charge-offs. However, non-accrual loans increased modestly from year-end, and the allowance-to-loans ratio declined.
- The company reported a $491,000 net securities loss. It described active Treasury repositioning and substantial securities sales associated with Texas franchise-tax planning; sales of available-for-sale securities totaled $9.99 billion in proceeds during the quarter.
- Stone Partners, a Houston-based human resources consulting firm, was acquired on January 1 and integrated into Frost Insurance Agency. The company said the acquisition did not significantly affect the financial statements. Insurance revenue also reflected the earlier Clark Benefits Group acquisition.
- Management’s interest-rate simulations showed projected net interest income below the base case over the next 12 months under both rising-rate scenarios (1.8% lower with a 100-basis-point increase; 2.7% lower with a 200-basis-point increase) and a 25-basis-point decline (1.5% lower). The modeled sensitivity worsened from 2011, reflecting growth in fixed-rate securities and an assumed start to paying interest on demand deposits in Q2 2012. Actual deposit pricing could differ.
- The filing gives no formal earnings or revenue forecast. Management expected advertising and promotion expense for the remainder of 2012 to be comparable with 2011. It also noted that results for this interim period are not necessarily indicative of full-year results.
- Other disclosed risks include Texas and broader economic conditions, borrower performance and industry concentrations, interest-rate and securities-market movements, regulatory changes, liquidity, technology and operational controls, acquisitions, and litigation. Management did not expect pending legal matters to materially adversely affect the financial statements; reported no material change to previously disclosed risk factors.
- Frost Bank applied to convert from a national to a Texas state charter and to become a Federal Reserve member bank. If approved, its primary regulators would change. The filing also notes that trust preferred securities begin to be deducted from Tier 1 capital over three years starting in 2013; management said excluding them would not impair compliance with capital requirements at quarter-end.
Most important facts for investors to verify
- Whether net interest margin and asset yields stabilize as the balance sheet’s securities mix and deposit pricing evolve.
- Whether the downward trend in charge-offs and non-performing assets continues, particularly for construction and other commercial credits, and whether the allowance remains adequate.
- How much of insurance commission growth reflects recurring business versus acquisitions and seasonal contingent commissions.
- Whether the securities repositioning and tax-planning sales produce lasting benefits, and the resulting exposure to rate-driven valuation changes.
- Actual interest costs on demand deposits, outcomes of the charter-conversion applications, and the future regulatory-capital effect of trust preferred securities.