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CFR > SEC Filings for CFR > Form 10-Q on 24-Jul-2013All Recent SEC Filings

Show all filings for CULLEN/FROST BANKERS, INC.

Form 10-Q for CULLEN/FROST BANKERS, INC.


24-Jul-2013

Quarterly Report


Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations

Financial Review

Cullen/Frost Bankers, Inc.

The following discussion should be read in conjunction with the Corporation's consolidated financial statements, and notes thereto, for the year ended December 31, 2012, included in the 2012 Form 10-K. Operating results for the three and six months ended June 30, 2013 are not necessarily indicative of the results for the year ending December 31, 2013 or any future period.

Dollar amounts in tables are stated in thousands, except for per share amounts.

Forward-Looking Statements and Factors that Could Affect Future Results

Certain statements contained in this Quarterly Report on Form 10-Q that are not statements of historical fact constitute forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995 (the "Act"), notwithstanding that such statements are not specifically identified as such. In addition, certain statements may be contained in the Corporation's future filings with the SEC, in press releases, and in oral and written statements made by or with the approval of the Corporation that are not statements of historical fact and constitute forward-looking statements within the meaning of the Act. Examples of forward-looking statements include, but are not limited to:
(i) projections of revenues, expenses, income or loss, earnings or loss per share, the payment or nonpayment of dividends, capital structure and other financial items; (ii) statements of plans, objectives and expectations of Cullen/Frost or its management or Board of Directors, including those relating to products or services; (iii) statements of future economic performance; and
(iv) statements of assumptions underlying such statements. Words such as "believes", "anticipates", "expects", "intends", "targeted", "continue", "remain", "will", "should", "may" and other similar expressions are intended to identify forward-looking statements but are not the exclusive means of identifying such statements.

Forward-looking statements involve risks and uncertainties that may cause actual results to differ materially from those in such statements. Factors that could cause actual results to differ from those discussed in the forward-looking statements include, but are not limited to:

Local, regional, national and international economic conditions and the impact they may have on the Corporation and its customers and the Corporation's assessment of that impact.

Volatility and disruption in national and international financial markets.

Government intervention in the U.S. financial system.

Changes in the mix of loan geographies, sectors and types or the level of non-performing assets and charge-offs.

Changes in estimates of future reserve requirements based upon the periodic review thereof under relevant regulatory and accounting requirements.

The effects of and changes in trade and monetary and fiscal policies and laws, including the interest rate policies of the Federal Reserve Board.

Inflation, interest rate, securities market and monetary fluctuations.

The effect of changes in laws and regulations (including laws and regulations concerning taxes, banking, securities and insurance) with which the Corporation and its subsidiaries must comply.

The soundness of other financial institutions.

Political instability.

Impairment of the Corporation's goodwill or other intangible assets.

Acts of God or of war or terrorism.

The timely development and acceptance of new products and services and perceived overall value of these products and services by users.

Changes in consumer spending, borrowings and savings habits.

Changes in the financial performance and/or condition of the Corporation's borrowers.

Technological changes.

Acquisitions and integration of acquired businesses.

The ability to increase market share and control expenses.

The Corporation's ability to attract and retain qualified employees.

Changes in the competitive environment in the Corporation's markets and among banking organizations and other financial service providers.

The effect of changes in accounting policies and practices, as may be adopted by the regulatory agencies, as well as the Public Company Accounting Oversight Board, the Financial Accounting Standards Board and other accounting standard setters.

Changes in the reliability of the Corporation's vendors, internal control systems or information systems.


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Changes in the Corporation's liquidity position.

Changes in the Corporation's organization, compensation and benefit plans.

The costs and effects of legal and regulatory developments including the resolution of legal proceedings or regulatory or other governmental inquiries and the results of regulatory examinations or reviews.

Greater than expected costs or difficulties related to the integration of new products and lines of business.

The Corporation's success at managing the risks involved in the foregoing items.

Forward-looking statements speak only as of the date on which such statements are made. The Corporation undertakes no obligation to update any forward-looking statement to reflect events or circumstances after the date on which such statement is made, or to reflect the occurrence of unanticipated events.

Application of Critical Accounting Policies and Accounting Estimates

The accounting and reporting policies followed by the Corporation conform, in all material respects, to accounting principles generally accepted in the United States and to general practices within the financial services industry. The preparation of financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. While the Corporation bases estimates on historical experience, current information and other factors deemed to be relevant, actual results could differ from those estimates.

The Corporation considers accounting estimates to be critical to reported financial results if (i) the accounting estimate requires management to make assumptions about matters that are highly uncertain and (ii) different estimates that management reasonably could have used for the accounting estimate in the current period, or changes in the accounting estimate that are reasonably likely to occur from period to period, could have a material impact on the Corporation's financial statements. Accounting policies related to the allowance for loan losses are considered to be critical, as these policies involve considerable subjective judgment and estimation by management.

For additional information regarding critical accounting policies, refer to Note 1 - Summary of Significant Accounting Policies in the notes to consolidated financial statements and the sections captioned "Application of Critical Accounting Policies and Accounting Estimates" and "Allowance for Loan Losses" in Management's Discussion and Analysis of Financial Condition and Results of Operations included in the 2012 Form 10-K. There have been no significant changes in the Corporation's application of critical accounting policies related to the allowance for loan losses since December 31, 2012.

Overview

A discussion of the Corporation's results of operations is presented below. Certain reclassifications have been made to make prior periods comparable. Taxable-equivalent adjustments are the result of increasing income from tax-free loans and securities by an amount equal to the taxes that would be paid if the income were fully taxable based on a 35% federal income tax rate, thus making tax-exempt asset yields comparable to taxable asset yields.


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Results of Operations

Net income available to common shareholders totaled $57.0 million, or $0.94 diluted per common share, and $112.2 million, or $1.85 diluted per commons share, for the three and six months ended June 30, 2013 compared to $58.1 million, or $0.94 diluted per common share, and $119.1 million, or $1.93 diluted per common share, for the three and six months ended June 30, 2012, respectively.

Selected income statement data and other selected data for the comparable periods was as follows:

                                               Three Months Ended               Six Months Ended
                                            June 30,        June 30,        June 30,        June 30,
                                              2013            2012            2013            2012
Taxable-equivalent net interest income      $ 173,966       $ 163,972       $ 346,767       $ 328,679
Taxable-equivalent adjustment                  20,785          14,755          40,773          29,755

Net interest income                           153,181         149,217         305,994         298,924
Provision for loan losses                       3,575           2,355           9,575           3,455

Net interest income after provision for
loan losses                                   149,606         146,862         296,419         295,469
Non-interest income                            72,509          69,763         150,289         141,742
Non-interest expense                          149,758         142,536         305,572         284,576

Income before income taxes                     72,357          74,089         141,136         152,635
Income taxes                                   12,694          16,027          26,285          33,540

Net income                                     59,663          58,062         114,851         119,095
Preferred stock dividends                       2,688              -            2,688              -

Net income available to common
shareholders                                $  56,975       $  58,062       $ 112,163       $ 119,095

Earnings per common share - basic           $    0.95       $    0.94       $    1.86       $    1.94
Earnings per common share - diluted              0.94            0.94            1.85            1.93
Dividends per common share                       0.50            0.48            0.98            0.94
Return on average assets                         1.03 %          1.14 %          1.02 %          1.19 %
Return on average common equity                  9.93            9.95            9.71           10.27
Average shareholders' equity to average
total assets                                    11.00           11.51           10.97           11.57

Net income available to common shareholders decreased $1.1 million, or 1.9%, for the three months ended June 30, 2013 and decreased $6.9 million, or 5.8%, for the six months ended June 30, 2013 compared to the same periods in 2012. The decrease during the three months ended June 30, 2013 was primarily the result of a $7.2 million increase in non-interest expense, $2.7 million related to preferred stock dividends and a $1.2 million increase in the provision for loan losses partly offset by a $4.0 million increase in net interest income, a $3.3 million decrease in income tax expense and a $2.7 million increase in non-interest income. The decrease during the six months ended June 30, 2013 was primarily the result of a $21.0 million increase in non-interest expense, a $6.1 million increase in the provision for loan losses and $2.7 million related to preferred stock dividends partly offset by an $8.5 million increase in non-interest income, a $7.3 million decrease in income tax expense and a $7.1 million increase in net interest income.

Details of the changes in the various components of net income are further discussed below.

Net Interest Income

Net interest income is the difference between interest income on earning assets, such as loans and securities, and interest expense on liabilities, such as deposits and borrowings, which are used to fund those assets. Net interest income is the Corporation's largest source of revenue, representing 67.1% of total revenue during the first six months of 2013. Net interest margin is the ratio of taxable-equivalent net interest income to average earning assets for the period. The level of interest rates and the volume and mix of earning assets and interest-bearing liabilities impact net interest income and net interest margin.

The Federal Reserve influences the general market rates of interest, including the deposit and loan rates offered by many financial institutions. The Corporation's loan portfolio is significantly affected by changes in the prime interest rate. The prime interest rate, which is the rate offered on loans to borrowers with strong credit, remained at 3.25% for the entire year in 2012 and through the second quarter of 2013. The Corporation's loan portfolio is also impacted, to a lesser extent, by changes in the London Interbank Offered Rate (LIBOR). At June 30, 2013, the one-month and three-month U.S. dollar LIBOR rates were 0.20% and 0.27%, respectively, while at June 30, 2012, the one-month and three-month U.S. dollar LIBOR rates were 0.25% and 0.46%, respectively. The intended federal funds rate, which is the cost of immediately available overnight funds, remained at zero to 0.25% for the entire year in 2012 and through the second quarter of 2013.


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The Corporation's balance sheet has historically been asset sensitive, meaning that earning assets generally reprice more quickly than interest-bearing liabilities. Therefore, the Corporation's net interest margin was likely to increase in sustained periods of rising interest rates and decrease in sustained periods of declining interest rates. During the fourth quarter of 2007, in an effort to make the Corporation's balance sheet less sensitive to changes in interest rates, the Corporation entered into various interest rate swaps which effectively converted certain variable-rate loans into fixed-rate instruments for a period of time. During the fourth quarter of 2008, the Corporation also entered into an interest rate swap which effectively converted variable-rate debt into fixed-rate debt for a period of time. As a result of these actions, the Corporation's balance sheet was more interest-rate neutral and changes in interest rates had a less significant impact on the Corporation's net interest margin than would have otherwise been the case. During the fourth quarter of 2009, a portion of the interest rate swaps on variable-rate loans were terminated, while the remaining interest rate swaps on variable-rate loans were terminated during the fourth quarter of 2010. These actions increased the asset sensitivity of the Corporation's balance sheet. The deferred accumulated after-tax gain applicable to the settled interest rate contracts included in accumulated other comprehensive income totaled $49.3 million ($32.0 million on an after-tax basis) at June 30, 2013. The remaining deferred gain of $49.3 million ($32.0 million on an after-tax basis) will be recognized ratably in earnings through October 2014. See Note 8 -Derivative Financial Instruments in the accompanying notes to consolidated financial statements included elsewhere in this report for additional information related to these interest rate swaps.

The Corporation is primarily funded by core deposits, with non-interest-bearing demand deposits historically being a significant source of funds. This lower-cost funding base is expected to have a positive impact on the Corporation's net interest income and net interest margin in a rising interest rate environment. The Dodd-Frank Wall Street Reform and Consumer Protection Act (the "Dodd-Frank Act") repealed the federal prohibitions on the payment of interest on demand deposits, thereby permitting depository institutions to pay interest on business transaction and other accounts beginning July 21, 2011. Although the ultimate impact of this legislation on the Corporation has not yet been determined, the Corporation may begin to incur interest costs associated with demand deposits in the future as market conditions warrant. See Item 3. Quantitative and Qualitative Disclosures About Market Risk elsewhere in this report for information about the expected impact of this legislation on the Corporation's sensitivity to interest rates. Further analysis of the components of the Corporation's net interest margin is presented below.

The following table presents the changes in taxable-equivalent net interest income and identifies the changes due to differences in the average volume of earning assets and interest-bearing liabilities and the changes due to changes in the average interest rate on those assets and liabilities. The changes in net interest income due to changes in both average volume and average interest rate have been allocated to the average volume change or the average interest rate change in proportion to the absolute amounts of the change in each. The comparison also includes, where applicable, an additional change factor that shows the effect of the difference in the number of days in each period, as further discussed below.

                                                    Quarter to Date             Year to Date
                                                     June 30, 2013             June 30, 2013
                                                          vs.                       vs.
                                                     June 30, 2012             June 30, 2012
Due to changes in average volumes                  $          18,316           $       27,158
Due to changes in average interest rates                      (8,322 )                 (7,264 )
Due to difference in the number days in
each of the comparable periods                                    -                    (1,806 )

Total change                                       $           9,994           $       18,088

Taxable-equivalent net interest income for the three months ended June 30, 2013 increased $10.0 million, or 6.1%, while taxable-equivalent net interest income for the six months ended June 30, 2013 increased $18.1 million, or 5.5%, compared to the same periods in 2012, respectively. The increase during the three months ended June 30, 2013 was primarily related to an increase in the average volume of interest-earning assets partly offset by a decrease in the net interest margin. Taxable-equivalent net interest income for the first six months of 2013 included 181 days compared to 182 days for the first six months of 2012 as a result of leap year. The additional day added approximately $1.8 million to taxable-equivalent net interest income during the first six months of 2012. Excluding the impact of the additional day during 2012 results in an effective increase in taxable-equivalent net interest income of approximately $19.9 million during the first six months of 2013, which was primarily related to an increase in the average volume of interest-earning assets partly offset by a decrease in the net interest margin. The average volume of interest-earning assets for the three and six months ended June 30, 2012 increased $1.9 billion and $2.1 billion compared to the same periods in 2012. Over the same time frame, the net interest margin decreased 18 basis points from 3.61% during the three months ended June 30, 2012 to 3.43% during the three months ended June 30, 2013 and decreased 23 basis points from 3.67% during the six months ended June 30, 2012 to 3.44% during the six months ended June 30, 2013. The decrease in the net interest margin during the comparable periods was partly due to


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an increase in the relative proportion of average interest-earning assets invested in lower-yielding, interest-bearing deposits during 2013 compared to 2012 while the relative proportion of average interest-earning assets invested in higher-yielding securities decreased. The net interest margin was also negatively impacted by a decrease in the average yield on loans, as further discussed below. The average yield on interest-earning assets decreased 26 basis points from 3.82% in the first six months of 2012 to 3.56% in the first six months of 2013 while the average cost of funds decreased 5 basis points from 0.25% in the first six months of 2012 to 0.20% in the first six months of 2013. The average yield on interest-earning assets is primarily impacted by changes in market interest rates as well as changes in the volume and relative mix of interest-earning assets. As stated above, market interest rates have remained at historically low levels during the reported periods. The effect of lower average market interest rates during the reported periods on the average yield on average interest-earning assets was partly limited by the aforementioned interest rate swaps on variable-rate loans.

The average volume of loans during the first six months of 2013 increased $999.4 million compared to the same period in 2012. Loans made up approximately 44.8% of average interest-earning assets during the first six months of 2013 compared to 44.5% during the first six months of 2012. The average yield on loans was 4.59% during the first six months of 2013 compared to 4.90% during the first six months of 2012. Loans generally have significantly higher yields compared to securities, interest-bearing deposits and federal funds sold and resell agreements and, as such, have a more positive effect on the net interest margin.

The average volume of securities increased $84.9 million during the first six months of 2013 compared to the same period in 2012. Securities made up approximately 44.1% of average interest-earning assets during the first six months of 2013 compared to 48.6% during the first six months of 2012. The average yield on securities was 3.34% in the first six months of 2013 compared to 3.32% in the first six months of 2012. Despite a significant decrease in market rates for investment securities during the comparable periods, the average yield on securities increased 2 basis points during the first six months of 2013 compared to the first six months of 2012 as the Corporation increased the relative proportion of investments held in higher-yielding, tax-exempt municipal securities. The relative proportion of higher-yielding, tax-exempt municipal securities totaled 36.4% of average securities during the first six months of 2013 compared to 25.1% during the first six months of 2012. The average yield on taxable securities was 1.90% in the first six months of 2013 compared to 2.17% in first six months of 2012, while the average taxable-equivalent yield on tax-exempt securities was 5.82% in the first six months of 2013 compared to 6.94% in first six months of 2012.

Average federal funds sold, resell agreements and interest-bearing deposits during the first six months of 2013 increased $1.0 billion compared to the same period in 2012. Federal funds sold, resell agreements and interest-bearing deposits made up approximately 11.1% of average interest-earning assets during the first six months of 2013 compared to 6.9% during the first six months of 2012. The combined average yield on federal funds sold, resell agreements and interest-bearing deposits was 0.26% during the first six months of 2013 compared to 0.30% during the first six months of 2012. The increase in average federal funds sold, resell agreements and interest-bearing deposits compared to the first six months of 2012 was primarily related to excess liquidity from deposit growth.

Average deposits increased $2.1 billion during the first six months of 2013 compared to the first six months of 2012. Average interest-bearing deposits for the first six months of 2013 increased $1.3 billion compared to the same period in 2012, while average non-interest-bearing deposits for the first six months of 2013 increased $827.7 million compared to the same period in 2012. The ratio of average interest-bearing deposits to total average deposits was 60.3% during both the first six months of 2013 and 2012. The average cost of deposits is primarily impacted by changes in market interest rates as well as changes in the volume and relative mix of interest-bearing deposits. The average cost of interest-bearing deposits and total deposits was 0.14% and 0.08% during the first six months of 2013 compared to 0.18% and 0.11% during the same period in 2012. The decrease in the average cost of interest-bearing deposits during the comparable periods was primarily the result of decreases in interest rates offered on certain deposit products due to decreases in average market interest rates and decreases in renewal interest rates on maturing certificates of deposit given the current low interest rate environment. Additionally, the relative proportion of higher-cost certificates of deposit to total average interest-bearing deposits decreased from 6.2% during the first six months of 2012, to 5.3% during the first six months of 2013.

The Corporation's net interest spread, which represents the difference between the average rate earned on earning assets and the average rate paid on interest-bearing liabilities, was 3.36% during the first six months of 2013 compared to 3.57% during the first six months of 2012. The net interest spread, as well as the net interest margin, will be impacted by future changes in short-term and long-term interest rate levels, as well as the impact from the competitive environment. A discussion of the effects of changing interest rates on net interest income is set forth in Item 3. Quantitative and Qualitative Disclosures About Market Risk included elsewhere in this report.


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The Corporation's hedging policies permit the use of various derivative financial instruments, including interest rate swaps, swaptions, caps and floors, to manage exposure to changes in interest rates. Details of the Corporation's derivatives and hedging activities are set forth in Note 8 - Derivative Financial Instruments in the accompanying notes to consolidated financial statements included elsewhere in this report. Information regarding the impact of fluctuations in interest rates on the Corporation's derivative financial instruments is set forth in Item 3. Quantitative and Qualitative Disclosures About Market Risk included elsewhere in this report.

Provision for Loan Losses

The provision for loan losses is determined by management as the amount to be added to the allowance for loan losses after net charge-offs have been deducted to bring the allowance to a level which, in management's best estimate, is necessary to absorb probable losses within the existing loan portfolio. The provision for loan losses totaled $3.6 million and $9.6 million for the three and six months ended June 30, 2013 compared to $2.4 million and $3.5 million for the three and six months ended June 30, 2012. The increase in the provision for loan losses during the three and six months ended June 30, 2013 compared to the three and six months ended June 30, 2012 was impacted by a $15.0 million charge-off related to a single commercial and industrial loan relationship during the first quarter of 2013. See the section captioned "Allowance for Loan Losses" elsewhere in this discussion for further analysis of the provision for loan losses.

Non-Interest Income

The components of non-interest income were as follows:



                                                  Three Months Ended              Six Months Ended
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