Cullen/Frost Bankers, Inc. — Q3 2019 Form 10-Q
Business context and reporting period. Cullen/Frost is a Texas-based financial holding company offering banking, wealth management, insurance and related services, primarily in Texas. This unaudited report covers the quarter and nine months ended September 30, 2019; comparisons are with the corresponding 2018 periods unless noted. Dollar figures below are in millions unless stated otherwise.
Financial performance and position
| Metric | Q3 2019 | Q3 2018 | Nine months 2019 | Nine months 2018 |
|---|---|---|---|---|
| Net interest income | $253.0 | $241.7 | $752.9 | $708.7 |
| Non-interest income | $89.2 | $87.7 | $268.6 | $264.2 |
| Net income | $111.8 | $117.8 | $339.9 | $335.7 |
| Net income available to common shareholders | $109.8 | $115.8 | $333.9 | $329.6 |
| Diluted EPS | $1.73 | $1.78 | $5.24 | $5.08 |
| Taxable-equivalent net interest margin | 3.76% | 3.66% | 3.80% | 3.61% |
- Operating revenue, defined as net interest income plus non-interest income, was $342.2 million in Q3 and $1,021.6 million for the first nine months.
- Q3 common earnings declined 5.2%; nine-month common earnings increased 1.3%. Q3 results reflected higher operating expenses and loan-loss provision, partly offset by higher net interest income.
- Q3 provision for loan losses was $8.0 million versus $2.7 million; nine-month provision was $25.4 million versus $17.8 million. Nine-month net charge-offs decreased to $21.0 million from $35.6 million.
- Non-interest expense rose 7.8% in Q3 and 6.0% year to date. Higher staffing, employee benefits, occupancy, technology and professional-services costs contributed; deposit insurance expense fell after the FDIC surcharge ended in late 2018.
Balance sheet, cash flow and capital
- Total assets were $33.1 billion at September 30, up from $32.3 billion at year-end 2018. Loans were $14.6 billion, up 3.8%; commercial real estate loans grew 9.1% to $6.2 billion.
- Deposits were $27.1 billion, little changed from year-end. Cash and cash equivalents were $2.9 billion, down from $4.0 billion. Nine-month operating cash flow was $585.2 million; investing cash outflow was $1.21 billion and financing cash outflow was $424.9 million.
- Federal funds purchased and repurchase agreements totaled $1.20 billion; junior subordinated debentures were $136.3 million and subordinated notes $98.8 million. Total liabilities were $29.2 billion. Holding-company liquid assets, including cash and resell agreements, were $230.3 million.
- Shareholders’ equity was $3.88 billion. Cullen/Frost’s CET1 ratio was 12.35% and Frost Bank’s was 12.92%; both exceeded fully phased-in minimums and well-capitalized thresholds.
- Common dividends were $0.71 per share in Q3. The company repurchased 202,724 shares for $17.2 million during the quarter under a new $100 million authorization.
Material changes, outlook and risks
- Credit quality: Non-performing assets rose to $105.0 million from $74.9 million at year-end; the ratio to loans and foreclosed assets increased to 0.72% from 0.53%. Non-accrual loans were $97.4 million, including $70.9 million in energy loans. Management cited a $34.0 million energy relationship newly placed on non-accrual in Q3. Energy represented 10.5% of loans, with $1.3 billion of unfunded energy commitments.
- Allowance: The allowance was $136.6 million, or 0.93% of loans. Specific valuation allowances increased to $29.2 million from $16.2 million at year-end, including higher reserves on energy credits.
- CECL outlook: The expected-credit-loss standard was scheduled for adoption January 1, 2020. Based on preliminary parallel runs, management expected a 15%–25% combined increase in the loan-loss allowance and unfunded-commitment reserves; the final impact could differ, while regulatory capital impact was not expected to be significant.
- Interest-rate sensitivity: Simulations projected net interest income changes over 12 months of +0.2% and +1.3% for 100- and 200-basis-point rate increases, and −1.7% and −5.7% for equivalent decreases, relative to a flat-rate case. Management noted the balance sheet was less asset-sensitive than a year earlier and results depend on deposit-pricing assumptions.
- Unusual accounting and valuation items: Adoption of lease accounting recognized $299.5 million of right-of-use assets and $325.3 million of lease liabilities at quarter-end; the new San Antonio headquarters lease contributed $121.7 million to each when commenced. Adoption of callable-debt premium accounting reduced retained earnings by $14.7 million, including a $2.1 million correction recorded in Q3; 2019 premium amortization was expected to be about $5.2 million higher than under the prior method.
- Available-for-sale securities generated a $369.0 million after-tax increase in other comprehensive income for the nine months, moving accumulated other comprehensive income from a $63.6 million loss at year-end to a $305.4 million gain. Management considered securities impairments temporary and did not identify credit-quality impairment.
- No formal earnings guidance was provided. Management said it knew of no event reasonably likely to materially impair liquidity, capital resources or operations. Legal claims were not expected to have a material adverse effect; the filing reported no material change in previously disclosed risk factors.
Important facts for investors to verify
- Whether growth in non-performing and restructured assets—particularly energy credits—leads to additional provisions, charge-offs or reserve needs.
- The final January 2020 CECL transition impact versus the preliminary 15%–25% reserve increase estimate.
- Whether rising deposit costs and the company’s deposit-pricing assumptions affect net interest margin and interest-rate sensitivity.
- Whether higher recurring operating costs, including headquarters occupancy and technology expenses, are offset by revenue growth.
- The sustainability of securities-related unrealized gains in equity and regulatory capital, and the company’s liquidity and capital flexibility after dividends and repurchases.