CFR

Business Context and Reporting Period

Company: Cullen/Frost Bankers, Inc.
Filing Type: Form 10-Q (Quarterly Report)
Period Ended: September 30, 2009
Business Overview: A financial holding company headquartered in San Antonio, Texas, operating primarily through its subsidiary, Frost Bank. The company provides commercial and consumer banking, trust and investment management, insurance, and brokerage services across Texas markets.

Key Financial Metrics

Liquidity & Capital:

• Cash and Cash Equivalents: $1.79 billion (Sep 30, 2009).
• Net Cash from Operating Activities (9 months): $213.6 million.
• Regulatory Capital: The bank subsidiary, Frost Bank, is "well capitalized" with a Tier 1 capital ratio of 11.37% and a total capital ratio of 12.72% (Sep 30, 2009).

Material Changes vs. Prior Period

• Net Income Decline: Net income decreased 8.7% for the quarter and 17.3% for the nine-month period compared to 2008. The decline was driven by increased non-interest expenses and lower non-interest income, partially offset by lower tax expenses.
• Net Interest Margin Compression: The net interest margin decreased 62 basis points to 4.12% for the quarter and 45 basis points to 4.24% for the nine-month period year-over-year, reflecting lower market interest rates. However, net interest income increased slightly due to a 16.2% growth in average earning assets.
• Expense Growth: Non-interest expense increased 7.5% for the quarter and 9.6% for the nine-month period. Significant drivers included a $17.9 million increase in deposit insurance expense (due to FDIC rate hikes and special assessments) and higher costs related to foreclosed assets.
• Asset Quality Deterioration: Non-performing assets increased significantly to $220.9 million (2.58% of total loans and foreclosed assets) from $78.0 million at year-end 2008. Non-accrual loans rose to $191.8 million. Net charge-offs for the nine months totaled $30.3 million, up from $14.5 million in the prior year.
• Deposit Growth: Total deposits increased $1.41 billion (12.3%) year-over-year, providing a stable funding base.

Outlook, Risks, and Management Commentary

• Interest Rate Environment: Management expects federal funds and prime rates to remain at historically low levels for the foreseeable future. The company has utilized interest rate swaps to hedge $1.2 billion of variable-rate loans, reducing sensitivity to rate changes.
• Credit Quality Risks: Management cites weak economic conditions as the primary driver for increased non-performing assets, particularly in land development and residential construction sectors. The allowance for loan losses was increased to 1.45% of total loans to address these risks.
• Regulatory Assessments: The company faces increased FDIC deposit insurance assessments, including a special assessment of 5 basis points on assets less Tier 1 capital. Future special assessments remain a possibility depending on the Deposit Insurance Fund reserve ratio.
• Segment Performance: The Banking segment remained profitable, while the Financial Management Group (FMG) saw a 69.1% decline in net income for the nine-month period due to lower trust fees driven by declining asset values in equity and bond markets.

Key Facts for Investor Verification

• Non-Performing Asset Ratio: Verify the trend of non-performing assets rising to 2.58% of total loans and foreclosed assets and the adequacy of the $123.1 million allowance.
• Deposit Insurance Costs: Monitor the impact of FDIC special assessments and potential future rate increases on non-interest expense.
• Net Interest Margin: Assess the ability to maintain net interest income given the compressed margin environment and the effectiveness of interest rate hedging strategies.
• Trust Asset Values: Review the correlation between declining market values of trust assets and the significant drop in FMG segment income.
• Energy Sector Exposure: Note that 10.4% of total loans are in the energy sector, and 63.6% of purchased shared national credits are energy-related, posing concentration risk.