Cullen/Frost Bankers, Inc. (NYSE: CFR) — FY2017 Form 10-K
Reporting period: Fiscal year ended December 31, 2017; comparisons are primarily with FY2016. Fourth-quarter figures are unaudited. Cullen/Frost is a Texas-based financial holding company whose principal subsidiary, Frost Bank, provides banking and wealth, trust, insurance and related services across Texas. Auditors issued an unqualified opinion on the financial statements and internal controls.
Financial and operating performance
| Metric | FY2017 | FY2016 | Change / note |
|---|---|---|---|
| Total assets, year-end | $31.75 billion | $30.20 billion | Up 5.1% |
| Total loans, year-end | $13.15 billion | $11.98 billion | Up 9.8% |
| Total deposits, year-end | $26.87 billion | $25.81 billion | Up 4.1% |
| Net interest income | $866.4 million | $776.3 million | Up 11.6%; taxable-equivalent NIM was 3.69%, up 13 basis points |
| Non-interest income | $336.5 million | $349.7 million | Down 3.8%, including a shift from securities gains to losses |
| Non-interest expense | $759.1 million | $733.0 million | Up 3.6% |
| Net income / common earnings | $364.1 million / $356.1 million | $304.3 million / $296.2 million | Common earnings up 20.2% |
| Diluted EPS | $5.51 | $4.70 | Up 17.2% |
| Operating cash flow | $538.1 million | $437.8 million | Investing cash flow was $(670.6) million; financing cash flow was $1.044 billion |
| Shareholders’ equity, year-end | $3.30 billion | $3.00 billion | Capital ratios remained strong |
Fourth-quarter 2017 net income was $100.5 million, net income available to common shareholders was $98.5 million, and diluted EPS was $1.53. Fourth-quarter common earnings and diluted EPS were $81.7 million and $1.28, respectively, a year earlier.
Credit, capital, debt and liquidity
- Asset quality weakened year over year: non-performing assets rose to $157.3 million from $102.6 million, or 0.50% of assets versus 0.34%. Non-accrual loans increased to $150.3 million from $100.2 million, with energy non-accruals at $94.3 million.
- The allowance for loan losses was $155.4 million, 1.18% of year-end loans, versus $153.0 million and 1.28% in 2016. Net charge-offs were $33.1 million, or 0.27% of average loans. The provision fell to $35.5 million from $51.7 million.
- Energy loans were 11.4% of loans. Commercial real estate was 40.2% of loans; management also highlighted concentration in Texas markets and Texas municipal securities.
- Cullen/Frost’s CET1, total risk-based capital and leverage ratios were 12.42%, 15.15% and 8.46%, respectively. Frost Bank was reported as well capitalized.
- Year-end deposits were $26.9 billion. Cash and cash equivalents were $5.05 billion. Long-term debt and other borrowings totaled $234.7 million; federal funds purchased and repurchase agreements were $1.15 billion.
- Common dividends were $2.25 per share for the year, up from $2.15; the payout ratio was 40.5%. A new $150 million repurchase authorization was approved, with no purchases under that plan in 2017; $100 million of shares were repurchased under prior plans.
Material changes, outlook and notable items
- Earnings improvement was driven chiefly by higher net interest income and a lower loan-loss provision. Loan growth and rising market rates supported interest income; deposit costs also increased.
- The 2017 effective tax rate was 10.8%. The Tax Cuts and Jobs Act produced a provisional $4.0 million tax benefit from deferred-tax remeasurement, and a separate $2.9 million benefit corrected prior-year tax treatment of certain tax-exempt loans. Management expected the new 21% federal rate to lower the 2018 effective tax rate by about 600 basis points versus the prior law, subject to future results and discrete items.
- Non-interest income included a $4.9 million net securities loss, compared with a $15.0 million net gain in 2016. Other notable items included deferred gain amortization from the 2016 headquarters sale and leaseback, and 2017 severance expense of approximately $2.5 million related mainly to branch closures and job reductions.
- Management provided no specific earnings guidance. It cited no known events expected to materially adversely affect liquidity, capital or operations at year-end, while noting that results remain sensitive to Texas economic conditions, oil-price volatility, interest rates, credit quality, competition, regulation and cybersecurity.
- The company expects to begin paying interest on certain commercial demand deposits in 2018 for modeling purposes. Interest-rate simulations indicated net interest income would rise 1.1% under a 100-basis-point increase and fall 4.6% under a 100-basis-point decrease over the next 12 months, relative to a flat-rate case.
- Legal claims arose in the ordinary course of business; management did not expect their disposition to have a material adverse effect. The filing also disclosed $7.95 billion in commitments to extend credit and $236.6 million in standby letters of credit; contractual amounts are not necessarily expected cash outflows.
Most important facts for investors to verify
- Whether rising non-performing assets—particularly energy and commercial/industrial exposures—and the $61.4 million of potential problem loans lead to further losses or reserve needs.
- Whether loan growth, net interest margin and deposit pricing remain favorable as rates change and competition for deposits increases.
- How the 2018 tax-rate reduction affects actual earnings, including the final accounting for tax-law changes and prior-period tax corrections.
- How much of the authorized repurchase program is used, and whether dividends and buybacks remain consistent with capital needs and regulatory limits.
- Whether the Texas economy, energy markets and concentrations in Texas municipal securities create increased credit or valuation risk.