Cullen/Frost Bankers, Inc. — Q2 2010 Form 10-Q
Business context and period. Texas-based bank holding company offering commercial and consumer banking, trust, insurance, investment and related financial services. This unaudited filing covers the quarter and six months ended June 30, 2010; dollar amounts below are in U.S. dollars. Results are not necessarily indicative of full-year performance.
Financial performance
| Metric | Q2 2010 | Q2 2009 | Six months 2010 | Six months 2009 |
|---|---|---|---|---|
| Net interest income | $141.9m | $134.5m | $279.5m | $264.1m |
| Provision for loan losses | $8.7m | $16.6m | $22.2m | $26.2m |
| Non-interest income | $69.9m | $68.0m | $141.3m | $137.9m |
| Non-interest expense | $134.7m | $136.3m | $269.2m | $265.8m |
| Net income | $52.9m | $37.9m | $100.7m | $82.8m |
| Diluted EPS | $0.87 | $0.63 | $1.66 | $1.39 |
- Q2 net income rose 39.7% year over year; six-month net income rose 21.6%. Management attributed improvement mainly to higher net interest income and lower loan-loss provisions.
- Taxable-equivalent net interest margin was 4.18% in both the second quarter and first half, versus 4.28% and 4.30%, respectively, in comparable 2009 periods. The six-month net interest spread remained 3.98%.
- Q2 return on average assets was 1.26% and return on average equity 10.67%; first-half figures were 1.22% and 10.38%, respectively.
- Q2 non-interest income was 2.8% above the prior-year quarter; first-half non-interest expense was 1.3% higher year over year. Q2 expense was lower, in part because Q2 2009 included a $7.3m FDIC special assessment.
Financial position, cash flow and credit
- At June 30, total assets were $17.06bn, deposits $13.95bn, net loans $7.94bn and shareholders’ equity $2.04bn. Total assets increased from $16.29bn at December 31, 2009.
- Loans were $8.07bn before the allowance, down 3.6% from year-end; deposits increased 4.8% to $13.95bn. Non-interest-bearing demand deposits were $5.06bn.
- Cash and cash equivalents were $2.65bn, and available-for-sale securities were $4.75bn. Reported borrowings comprised $438.5m of federal funds purchased and repurchase agreements, $136.1m of junior subordinated debentures and $250.1m of other long-term borrowings.
- For the first half, operating cash flow was $157.8m versus $123.2m in 2009; investing cash flow was positive $208.8m versus negative $604.9m, and financing cash flow was $560.7m versus $759.3m. Investing cash flow included substantial securities purchases and sales. Ending cash and equivalents increased $927.3m from year-end.
- The allowance for loan losses was $125.4m, or 1.56% of loans. First-half net charge-offs were $22.1m versus $13.9m a year earlier; the annualized net charge-off ratio was 0.54% versus 0.32%.
- Non-performing assets declined to $159.3m, or 0.93% of assets, from $180.2m at year-end. Non-accrual loans were $134.5m; accruing loans at least 90 days past due were $33.2m. Potential problem loans increased to $23.6m from $17.4m at year-end.
- Regulatory capital ratios remained strong: Cullen/Frost total capital to risk-weighted assets was 15.52%, Tier 1 was 13.16%, and leverage was 8.80%. Frost Bank’s corresponding ratios were 14.17%, 12.73% and 8.51%; management said the bank was well capitalized.
- Cash dividends were $0.45 per share in Q2 and $0.88 per share for the first half. The company reported $141.0m of holding-company liquid assets, including $8.8m of cash collateral; this is distinct from consolidated cash and securities.
Changes, outlook and risks
- Net interest income growth benefited from larger average earning-asset volumes and lower funding costs. However, net interest margin fell as more funds were held in low-yielding deposits and loan balances declined. Average deposits grew 15.5% year over year in the first half, while average loans fell $590.3m.
- Credit indicators were mixed: non-performing assets declined, but first-half net charge-offs increased year over year and potential problem loans rose. Commercial and industrial loans and real estate loans represented 45.8% and 49.7% of the loan portfolio. Lending is concentrated in Texas; no single industry exceeded 10% of total loans.
- Management expected market interest rates to remain at historically low levels for the foreseeable future, while cautioning that rates could change. The company’s simulation showed net interest income rising 1.9% with a 100-basis-point rate increase and 4.1% with a 200-basis-point increase over 12 months; a 25-basis-point decline implied a 0.5% decrease.
- No specific earnings or full-year financial guidance was provided. Management said the allowance was adequate and was not aware of events expected to materially harm liquidity, capital resources or operations.
- The Dodd-Frank Act was signed July 21, after quarter-end. Among other provisions, it phases trust preferred securities out of Tier 1 capital beginning in 2013 and changes deposit-insurance, debit-interchange and demand-deposit rules. Management said excluding trust preferred securities at June 30 would not impair capital adequacy, but noted the legislation’s overall financial impact was uncertain and expected demand-deposit interest costs to increase.
- The company opted out of the FDIC’s extension of full coverage for certain transaction accounts; standard insurance coverage applied to its accounts from July 1, 2010. Deposit-insurance assessments could also change under pending rules and the new law.
- Off-balance-sheet exposures included $4.3bn of commitments to extend credit and $260.5m of standby letters of credit. Management did not expect pending litigation to have a material adverse financial impact. No material change to previously disclosed risk factors was reported.
- Unusual item: during the first half, the company sold approximately $10.0bn of available-for-sale securities purchased during 2010 as part of tax-planning strategies, realizing a net gain of only $6,000. The filing also reports several one-time miscellaneous write-offs, losses and refunds within Q2 expenses.
- After quarter-end, the company redeemed $12.4m of junior subordinated debentures and $12.0m of associated trust preferred securities on July 7.
Investor verification points
- Assess whether lower provisions and improving non-performing assets are sustainable in light of higher year-over-year net charge-offs and rising potential problem loans.
- Review loan and real-estate credit quality, including commercial real estate exposure, purchased shared national credits, foreclosed assets and the specific allowance methodology.
- Track the effect of low yields on excess deposits and securities, net interest margin, and the company’s sensitivity to changing rates.
- Verify the future impact of Dodd-Frank and FDIC assessment changes on capital, deposit costs, debit-card revenues and fee income.
- Monitor brokered and foreign-source deposits, off-balance-sheet commitments, and the distinction between consolidated liquidity and holding-company liquidity.