Cullen/Frost Bankers (CFR)

TOP CONTRIBUTORS

Thomas Shyr

Vikram Parsani

With total consolidated assets of $16.3 billion^[1], Cullen/Frost Bankers (NYSE:CFR) is the 5th largest bank and financial holding company in Texas, behind J P Morgan Chase, Bank of America, Wells Fargo and Banco Bilbao Vizcaya.^[2] The company's revenues come from two sources: a) interest on loans provided; and b) fees for services rendered. In 2009, Cullen/Frost Bankers had net interest income of $536 million and total non-interest income of $293.7 million^[3] In addition to the company's wholly-owned commercial and consumer banking subsidiary called Frost Bank, Cullen/Frost Bankers also has subsidiaries in the insurance, brokerage and securities industries. However, virtually all of its net income comes from its banking segment.^[4]

The company's primary source of funds are deposits, of which 65.7% are interest bearing and 34.3% are non-interest bearing.^[5] As of 31 December 2008, 55.1% of these funds were invested in loans and 27.1% in securities like treasuries and bonds.^[5] This compares to its 2008 levels of 60.7% and 24.3% respectively, demonstrating that Cullen Frost Bankers has become more conservative with their lending, choosing instead to put a higher percentage of its deposits into U.S. Treasuries. Unlike its competitors, Cullen/Frost Bankers isn't geographically diversified and operates exclusively in the state of Texas. As a result, economic conditions in this state and the United States as a whole significantly impact demand for the company's products and services, sources of funding and the ability of its customers to repay loans.^[6]

Company Overview

Headquartered in San Antonio, Cullen/Frost Bankers operates exclusively in the state of Texas and offers clients a wide range of financial services, including commercial and consumer banking, trust and investment management, insurance, brokerage, investment banking and treasury management services.^[7] Although the company has many subsidiaries, its Banking segment accounted for virtually all of its 2009 net income.

From late 2005 to mid 2008, Cullen/Frost Bankers expanded its presence in major Texan cities by acquiring Horizon Capital Bank (Houston), Texas Community Bancshares (Dallas), Alamo Corporation of Texas (Rio Grande Valley), Summit Bancshares (Fort Worth), Prime Benefits (Austin), and R.G. Seeberger Company (Dallas).^[8]

Business and Financial Metrics

In 2009, Cullen/Frost Bankers had total interest income of $623 million, total non-interest income of $294 million and net income of $179 million.^[3] Although total interest income declined from its 2008 level of $675 million, so too did its interest expense, decreasing from $142 million in 2008 to $86 million in 2009.^[3] However, Cullen/Frost Bankers' provision for loan losses increased dramatically from $37.8 million in 2008 to $65.4 million in 2009.

Business Segments

Cullen/Frost Bankers has 3 operating segments: i) Banking; ii) Financial Management Group; and iii) Non-Banks.

Banking

The Banking segment covers commercial and consumer banking services, Frost Insurance Agency and Frost Securities. Commercial banking services are provided to corporations and other business clients and include a range of lending and cash management products. Consumer banking services include direct lending and depository services. Frost Insurance Agency provides insurance brokerage services to individuals and businesses. Frost Securities provides advisory and private equity services to middle market companies. In 2009, the Banking segment had a net income of $179.4 million, $9.6 million less than its 2008 net income.^[4] The lower income was laregly attributed to increases in its provision for loan losses, which increased by $27.6 million in 2009.

Financial Management Group (FMG)

The FMG segment covers fee-based services within private trust and retirement services in addition to personal wealth management and brokerage services. In 2009, the FMG segment's contribution to net income was $8.64 million, down considerably from its 2008 net income of $26.9 million.^[9] The company attributed this decrease to lower interest and non-interest income as a result of the recessionary environment throughout 2009.

Non-Banks

The Non-Banks segment covers the parent holding company and other insignificant non-bank subsidiaries that, for the most part, have little or no activity.^[10] The parent company's main activities include direct and indirect ownership of banking and non-banking subsidiaries as well as the issuance of debt and equity. In 2009, this segment's net loss was $9.0 million, up slightly from its 2008 loss of $8.6 million.^[11] The increased loss was largely related to a decrease in mineral interest income (mineral interest income is related to bonus, rental and shut-in payments and oil and gas royalties received from severed mineral interests).

Key Trends and Forces

The company hedges against interest rate fluctuations

U.S. interest rates over time

In 2008, Cullen/Frost Bankers entered into an interest rate swap contract covering a total notional amount of $120 million designed to protect quarterly interest payments on the company's debentures from fluctuations in the 3-month LIBOR.^[12] In 2007, Cullen/Frost Bankers entered into a similar contract covering a total notional amount of $1.2 billion designed to protect the company's monthly interest income from a rolling portfolio of variable-rate loans.^[12] As a result, the company's balance sheet has become more interest-neutral and interest rate fluctuations are expected to have a lesser impact on its net interest margin and net interest spread.^[13]

Commercial and industrial loans make up 85.8% of the company's loan portfolio

Loan Portfolio Breakdown for Cullen/Frost Bankers in 2008^[14]

As of December 31, 2009, Cullen/Frost Bankers had approximately 83% of its loan portfolio consisted of commercial, industrial, construction and commercial real estate loans.^[15] Although these loans are typically larger and earn better interest rates than consumer and residential real estate loans, the company also views them as being riskier.^[16] Nonetheless, the company has largely been insulated from the subprime lending crisis and credit crunch because just 0.8% of its loan portfolio consists of 1-4 family residential mortgages.^[17] As a result, Cullen/Frost Bankers was one of only a handful of regional banks to turn down government assistance from the Troubled Assets Relief Program (TARP).^[18]

The company's earnings rely on the energy industry and the state of Texas

Loans to any given sector do not constitute more than 10% of the company's total loan portfolio. However, the energy industry has a relatively higher concentration of funds with $830 million or 9.9% of the company's loans tied directly to this sector.^[19] This represents the company's largest concentration in any given industry. The next largest concentration is medical services with 5.7% of the company's loans. Cullen/Frost Bankers operates exclusively in the state of Texas and, more specifically, in the areas of Austin, Corpus Christi, Dallas, Fort Worth, Houston, Rio Grande Valley and San Antonio regions. The company's dependence on these metropolitan areas can best be seen from each area's contribution to total deposits. As of 31 December 2009, Cullen/Frost Bankers had just 4.8% of its deposits coming from areas outside the 7 listed above, making its success in these metropolitan areas extremely critical.^[20]

The company's non-performing assets increased 131% in 2009

Cullen/Frost Bankers' total non-performing assets increased 131% in 2009 from $78.0 million in 2008 to $180.1 million in 2009.^[21] This marks the second consecutive year in which its non performing assets has grown by more than 100%. In 2008, Cullen/Frost Bankers' total non-performing assets increased 161% from $29.8 million to $78.0 million.^[22] While the weak economic conditions drove these increases, how Cullen/Frost Bankers handles these increases and higher level of non-performing assets remains to be seen.

Competition

Chief among the company's competitors are Bank of America (BAC), J P Morgan Chase (JPM) and Wells Fargo (WFC). In terms of deposits, Cullen/Frost Bankers ranks 5th in Texas with $10.8 billion or 2.7% of Texas' $393 billion in total deposits.^[2]

• Bank of America (BAC) is one of the world's leading bank and financial holding companies with net interest income of $34.4 billion, non-interest income of $31.8 billion and net income of $15 billion in 2007.^[23] Within Texas, Bank of America competes with Cullen/Frost Bankers in both the Banking and FMG segments. With total deposits of $59.9 Billion in Texas, it ranks 2nd in the state with a 15.3% market share.^[2]

• J P Morgan Chase (JPM) is one of the largest financial institutions in the United States and the leader in Texas by total deposits. With its 19.6% market share and $77.0 billion in deposits, it operates 750 branches throughout the state.^[2] In 2007, it earned had net interest income of $26.4 billion, non-interest income of $45.0 billion and net income of $15.4 billion.^[24]

• Wells Fargo (WFC) is the 5th largest financial institution in the United States with over 6,000 branches and the 3rd largest ATM network in America. In Texas, it holds an 11.5% market share with total deposits in 2008 of $45.1 billion.^[2] In 2007, it had net interest income of $20.9 billion, non-interest income of $18.4 billion and net income of $8.1 Billion.^[25]

References

1. ↑ CFR 10-K 2009 Item 1 Pg. 3
2. ↑ ^{2.0 2.1 2.2 2.3 2.4 2.5 2.6 2.7} First National Bankshares Investor Relations
3. ↑ ^{3.0 3.1 3.2} CFR 10-K 2009 Item 6 Pg. 33
4. ↑ ^{4.0 4.1} CFR 10-K 2009 Item 7 Pg. 49
5. ↑ ^{5.0 5.1} CFR 10-K 2009 Item 7 Pg. 53
6. ↑ CFR 10-K 2008 Item 1A Pg. 21
7. ↑ CFR 10-K 2006 Item 1 Pg. 3
8. ↑ CFR 10-Q 2008 Item 1 Pg. 8
9. ↑ CFR 10-K 2009 Item 7 Pg. 50
10. ↑ CFR 10-K 2007 Item 8 Pg. 108
11. ↑ CFR 10-K 2009 Item 7 Pg. 52
12. ↑ ^{12.0 12.1} CFR 10-K 2007 Item 8 Pg. 110
13. ↑ CFR 10-K 2007 Item 7 Pg. 38
14. ↑ CFR 10-K 2008 Item 7 Pg. 51
15. ↑ CFR 10-K 2009 Item 1 Pg. 21
16. ↑ CFR 10-K 2007 Item 1 Pg. 19
17. ↑ CFR 10-K 2009 Item 8 Pg. 92
18. ↑ Regional banks see sweet spot in Collin County, Dallas Business Journal.
19. ↑ CFR 10-K 2009 Item 7 Pg. 56
20. ↑ CFR 10-K 2009 Item 7 Pg. 70
21. ↑ CFR 10-K 2009 Item 7 Pg. 61
22. ↑ CFR 10-K 2008 Item 7 Pg. 58
23. ↑ ^{23.0 23.1} BAC 10-K 2007 Pg. 16
24. ↑ J P Morgan Chase & Co Financial Statements, Reuters
25. ↑ ^{25.0 25.1} WFC Annual Report 2007 Pg. 74
26. ↑
27. ↑ JPM 10-K 2008 Item 6 Pg. 26