Cullen/Frost Bankers, Inc. — Q3 2015 Form 10-Q
Business context and period. Cullen/Frost is a Texas-based financial holding company operating primarily through commercial and consumer banking, wealth management, insurance and related services. This unaudited quarterly filing covers the three and nine months ended September 30, 2015; comparisons are with the corresponding 2014 periods unless noted. WNB Bancshares, acquired in May 2014, is included in 2015 results and in 2014 results from its acquisition date.
Key financial metrics
- Q3 revenue and earnings: Net interest income was $187.0 million and non-interest income was $83.4 million, for combined revenue of $270.4 million, up from $258.5 million. Net income was $75.9 million versus $77.4 million; net income available to common shareholders was $73.8 million versus $75.4 million. Diluted EPS was $1.17 versus $1.18.
- Nine-month results: Combined revenue was $796.1 million versus $745.4 million. Net income was $221.1 million versus $205.3 million; net income available to common shareholders was $215.0 million versus $199.2 million. Diluted EPS was $3.39 versus $3.18.
- Margins and returns: Taxable-equivalent net interest margin was 3.48% in Q3 versus 3.39%; nine-month margin was 3.45% versus 3.43%. Nine-month return on average assets was 1.03% and return on average common equity was 10.47%.
- Balance sheet at September 30: Total assets were $28.34 billion, deposits $24.32 billion, loans $11.36 billion and shareholders’ equity $2.90 billion. Compared with December 31, 2014, loans increased $371 million and deposits increased $188 million. Cash and cash equivalents declined to $3.75 billion from $4.36 billion.
- Credit reserves and asset quality: The allowance for loan losses was $110.4 million, or 0.97% of loans, versus $99.5 million, or 0.91%, at year-end 2014. Non-performing assets were $58.2 million, 0.21% of assets, versus $65.2 million, 0.23%. Nine-month provision expense was $17.8 million versus $11.9 million.
- Cash flow and liquidity: Nine-month operating cash flow was $357.9 million; investing cash flow was negative $817.3 million and financing cash flow negative $149.8 million. Cash and equivalents fell $609.2 million over the period. Management reported no known event expected to materially impair liquidity; Cullen/Frost parent-company liquid assets, including cash and resell agreements, totaled $222.7 million.
- Debt and capital: Balance-sheet funding included $632.2 million of federal funds purchased and repurchase agreements, $137.1 million of junior subordinated debentures and $100 million of other long-term borrowings. At September 30, Cullen/Frost’s CET1, Tier 1, total capital and leverage ratios were 11.57%, 12.61%, 13.96% and 7.91%, respectively; management said both the company and Frost Bank exceeded fully phased-in Basel III minimums.
Material changes and management commentary
- Q3 common earnings declined 2.0%, primarily as non-interest expense rose $11.7 million and loan-loss provision rose $6.4 million; higher net interest income and lower tax expense partly offset the increases. For the first nine months, common earnings rose 7.9%, led by higher net interest income and non-interest income.
- Nine-month non-interest expense increased 7.1% to $520.3 million. Higher staffing, benefits and occupancy costs contributed; some increases reflect WNB-related scale and new facilities. Management expected additional building depreciation as the new operations and support center is completed.
- Energy loans were 15.7% of total loans. Energy risk grades deteriorated, and non-accrual energy loans rose to $13.2 million from $0.6 million at year-end. Potential problem loans increased to $93.7 million from $15.1 million; management identified energy, manufacturing and real estate exposures among these credits. The Texas Leading Index declined to 123.7 at August 31 from 129.3 at year-end 2014.
- Management said Q3 economic uncertainty and oil-price volatility prompted additional provision above that needed for loan growth, classified loans and net charge-offs. It also said the reserve was appropriate based on its estimate of probable losses; estimates remain sensitive to economic and portfolio developments.
- Interest-rate simulations projected no material net-interest-income variance from a 100-basis-point rise over the next 12 months, a 0.6% increase from a 200-basis-point rise, and a 3.5% decline from a 25-basis-point fall. These projections assumed interest would begin to be paid on certain demand deposits in Q4 2015.
- The company authorized a $100 million, two-year share repurchase program in April 2015 and repurchased $74.9 million of shares during the first nine months. Common dividends were $1.57 per share for the nine-month period.
- Frost Securities ceased operations and closed effective June 30, 2015. A July 2015 agreement provides for sale of the current headquarters building, expected to close in mid-2016 subject to contingencies, and leaseback until a replacement building is expected to be completed in 2018. Management does not expect the related property sales to have a significant aggregate operating impact.
- Management expected no material adverse impact from pending legal matters; the filing reported no material change in previously disclosed risk factors. Disclosure controls were assessed as effective. The filing provides no specific earnings or revenue guidance.
Important facts for investors to verify
- Whether energy-sector weakness, including the deterioration in risk grades and the increase in potential problem loans, leads to further delinquencies, charge-offs or reserve increases.
- Whether loan yields, deposit pricing and the assumed repricing of demand deposits affect future net interest margin and the interest-rate sensitivity estimates.
- Whether rising operating costs—particularly staffing, occupancy and future depreciation—outpace revenue growth.
- How much of nine-month earnings growth and non-interest income reflects recurring activity versus contingent commissions, asset-sale gains and other unusual or variable items.
- Completion and terms of the headquarters property transactions, use of the remaining repurchase authorization, and capital and dividend capacity as regulatory rules phase in.