Cullen/Frost Bankers, Inc. (NYSE: CFR) — Q2 2013 Form 10-Q
Reporting period: Quarter and six months ended June 30, 2013. Unaudited consolidated financial statements. Dollar amounts below are in millions unless noted.
Business context and reporting period
Cullen/Frost is a Texas-based financial holding company whose principal businesses are commercial and consumer banking, wealth management, insurance and related financial services. Results are compared with the quarter and six months ended June 30, 2012; balance-sheet comparisons are primarily with December 31, 2012.
Key financial metrics
| Metric | Q2 2013 | Q2 2012 | Six months 2013 | Six months 2012 |
|---|---|---|---|---|
| Total revenue, net interest income plus non-interest income | $225.7 | $219.0 | $456.3 | $440.7 |
| Net interest income | $153.2 | $149.2 | $306.0 | $298.9 |
| Provision for loan losses | $3.6 | $2.4 | $9.6 | $3.5 |
| Non-interest income | $72.5 | $69.8 | $150.3 | $141.7 |
| Non-interest expense | $149.8 | $142.5 | $305.6 | $284.6 |
| Net income | $59.7 | $58.1 | $114.9 | $119.1 |
| Net income available to common shareholders | $57.0 | $58.1 | $112.2 | $119.1 |
| Diluted earnings per common share | $0.94 | $0.94 | $1.85 | $1.93 |
| Net interest margin, taxable-equivalent | 3.43% | 3.61% | 3.44% | 3.67% |
| Return on average assets | 1.03% | 1.14% | 1.02% | 1.19% |
| Return on average common equity | 9.93% | 9.95% | 9.71% | 10.27% |
- At June 30, total assets were $22.57 billion, down from $23.12 billion at year-end 2012. Loans were $9.23 billion, broadly stable; deposits were $19.08 billion, down from $19.50 billion.
- Cash and cash equivalents were $2.90 billion, versus $3.52 billion at year-end. Securities totaled $9.20 billion: $3.17 billion held to maturity and $6.03 billion available for sale.
- Allowance for loan losses was $93.4 million, or 1.01% of loans, down from $104.5 million and 1.13% at year-end. Six-month net charge-offs were $20.6 million, versus $8.0 million a year earlier; excluding a $15.0 million single-borrower charge-off, management reported $5.6 million, or 0.12% of average loans annualized.
- Six-month operating cash flow was negative $33.3 million, compared with positive $167.5 million in 2012. Investing cash flow was negative $133.4 million and financing cash flow negative $457.0 million; cash declined $623.6 million. The filing attributes much of the operating cash movement to changes in accrued liabilities and other working balances.
- Interest-bearing borrowings included $549.8 million of federal funds purchased and repurchase agreements, $123.7 million of junior subordinated debentures and $100.0 million of other long-term borrowings. Regulatory capital ratios were well above stated minimums: holding-company total capital ratio 15.39%, Tier 1 ratio 14.22% and leverage ratio 8.60%.
Material changes versus comparable periods
- Common earnings declined 1.9% in Q2 and 5.8% for the first half, even as Q2 net income increased. The Q2 difference reflects $2.7 million of preferred dividends following the February 2013 preferred-stock issuance. First-half results also absorbed higher expenses and loan-loss provision.
- Net interest income rose, helped by greater average earning-asset and loan volumes and lower funding costs, but margin narrowed. Management cited lower loan yields and a higher share of low-yield interest-bearing deposits as pressures.
- Non-interest income grew 3.9% in Q2 and 6.0% for the first half. Trust fees and some other fees increased; deposit service charges declined. First-half other income included gains on asset sales, notably a building and parking garage.
- Non-interest expense increased 5.1% in Q2 and 7.4% year to date. Salaries, benefits, technology-related expenses and other costs increased; the first half included a $7.2 million write-down of land and other assets, including $6.2 million on downtown San Antonio property.
- Non-performing assets decreased to $101.7 million from $105.2 million at year-end, and the ratio to total assets eased to 0.45% from 0.46%. Accruing past-due loans increased to $50.9 million from $43.0 million.
- Unrealized securities losses drove an $82.4 million after-tax decline in other comprehensive income for the first half; accumulated other comprehensive income fell to $155.6 million from $238.0 million. Management said the losses were largely rate-related, considered temporary, and not credit impairments.
Outlook, risks and unusual items
- The filing gives no specific earnings or revenue guidance. Management cautions that interim results are not necessarily indicative of full-year or future performance.
- A single commercial and industrial borrower entered bankruptcy in April, producing a $15.0 million first-quarter charge-off and contributing to the higher first-half provision. The allowance remains subject to management estimates and changes in economic conditions, borrower performance, interest rates and regulatory judgments.
- Credit exposures are concentrated in Texas and the portfolio is principally commercial and industrial and commercial real estate lending. Management identified contractors as a distressed industry; commercial real estate, construction, borrower cash flows and collateral values remain relevant risks.
- Interest-rate sensitivity is uncertain. The June 30 model projected net interest income changes over the next 12 months of negative 0.4% for a 100-basis-point increase, positive 0.4% for a 200-basis-point increase and negative 2.5% for a 25-basis-point decrease. These estimates assume the bank begins paying interest on demand deposits in Q3 2013.
- In February, the company issued $150 million liquidation preference of 5.375% Series A preferred stock and used $144 million of proceeds for an accelerated share repurchase. Final ASR settlement was expected in Q3 2013; the ultimate shares repurchased could vary with the share-price formula and settlement terms.
- Basel III rules were finalized in July 2013 and take effect beginning in 2015, with phase-in thereafter. Management said the company and bank would meet fully phased-in capital requirements based on June 30 positions; trust preferred securities are phased out of holding-company Tier 1 capital beginning in 2015.
- Management reported no known event likely to materially adversely affect liquidity, capital resources or operations. Litigation was not expected to have a material adverse effect; the company reported no material change in previously disclosed risk factors.
Most important facts for investors to verify
- Whether credit quality and allowance adequacy remain sound after the $15.0 million charge-off; monitor delinquencies, classified loans, charge-offs and contractor exposure.
- Whether net interest margin stabilizes, particularly as rates change and the bank potentially begins paying interest on demand deposits.
- Whether expense growth and one-time property write-downs subside, and how recurring earnings compare with reported results.
- Final ASR settlement, shares repurchased and any resulting capital or per-share effects; also consider preferred dividends and common-dividend restrictions.
- How securities valuations and accumulated other comprehensive income respond to interest rates, and whether reported unrealized losses remain temporary.
- Liquidity and deposit trends: deposits and cash balances declined from year-end, while six-month operating cash flow was negative.
- Actual capital treatment and compliance under the Basel III phase-in, including the future treatment of trust preferred securities.