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CFR > SEC Filings for CFR > Form 10-Q on 23-Apr-2014All Recent SEC Filings

Show all filings for CULLEN/FROST BANKERS, INC.

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


23-Apr-2014

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, 2013, included in the 2013 Form 10-K. Operating results for the three months ended March 31, 2014 are not necessarily indicative of the results for the year ending December 31, 2014 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.

Changes in the Corporation's liquidity position.

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


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The costs and effects of legal and regulatory developments, the resolution of legal proceedings or regulatory or other governmental inquiries, the results of regulatory examinations or reviews and the ability to obtain required regulatory approvals.

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 2013 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, 2013. 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 $59.2 million, or
$0.96 diluted per common share, for the three months ended March 31, 2014
compared to $55.2 million, or $0.91 diluted per common share, for the three
months ended March 31, 2013.
Selected income statement data, returns on average assets and average common
equity and dividends per common share for the comparable periods was as follows:
                                                                   Three Months Ended
                                                            March 31, 2014     March 31, 2013
Taxable-equivalent net interest income                     $      187,795     $      172,802
Taxable-equivalent adjustment                                      27,460             19,989
Net interest income                                               160,335            152,813
Provision for loan losses                                           6,600              6,000
Net interest income after provision for loan losses               153,735            146,813
Non-interest income                                                77,490             77,780
Non-interest expense                                              157,941            155,814
Income before income taxes                                         73,284             68,779
Income taxes                                                       12,096             13,591
Net income                                                         61,188             55,188
Preferred stock dividends                                           2,016                  -
Net income available to common shareholders                $       59,172     $       55,188
Earnings per common share - basic                          $         0.97     $         0.91
Earnings per common share - diluted                                  0.96               0.91
Dividends per common share                                           0.50               0.48
Return on average assets                                             1.00 %             1.01 %
Return on average common equity                                      9.97               9.49
Average shareholders' equity to average assets                      10.63              10.94

Net income available to common shareholders for the three months ended March 31, 2014 increased $4.0 million, or 7.2%, compared to the same period in 2013. The increase was primarily the result of a $7.5 million increase in net interest income and a $1.5 million decrease in income tax expense, partly offset by a $2.1 million increase in non-interest expense, a $2.0 million increase in preferred stock dividends, a $600 thousand increase in the provision for loan losses and a $290 thousand decrease in non-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 67.4% of total revenue during the first three months of 2014. 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 2013 and through the first quarter of 2014. The Corporation's loan portfolio is also impacted, to a lesser extent, by changes in the London Interbank Offered Rate (LIBOR). At March 31, 2014, the one-month and three-month U.S. dollar LIBOR rates were 0.15% and 0.23%, respectively, while at March 31, 2013, the one-month and three-month U.S. dollar LIBOR rates were 0.20% and 0.28%, 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 2013 and through the first quarter of 2014.
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


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swaps which effectively converted certain variable-rate loans into fixed-rate instruments for a period of seven years. 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 five years. 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 was 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 gain applicable to the settled interest rate contracts included in accumulated other comprehensive income totaled $21.3 million ($13.8 million on an after-tax basis) at March 31, 2014. The remaining deferred gain of $21.3 million ($13.8 million on an after-tax basis) will be recognized ratably in interest income 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 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.

                                          Quarter to Date
                                          March 31, 2014
                                                vs.
                                          March 31, 2013
Due to changes in average volumes        $        16,498
Due to changes in average interest rates          (1,505 )
Total change                             $        14,993

Taxable-equivalent net interest income for the first quarter of 2014 increased $15.0 million, or 8.7%, compared to the same period in 2013. The increase 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 first quarter of 2014 increased $1.8 billion compared to the same period in 2013. Over the same time frame, the net interest margin decreased 3 basis points from 3.45% during the first quarter of 2013 to 3.42% during the first quarter of 2014. The decrease in the net interest margin was partly due to an increase in the relative proportion of average interest-earning assets invested in lower-yielding, interest-bearing deposits during 2014 compared to 2013 while the relative proportion of interest-earning assets invested in higher-yielding securities and loans decreased. The net interest margin was also negatively impacted by a decrease in the average yield on loans. The net interest margin was positively impacted by an increase in the average yield on securities which resulted from an increase in the relative proportion of higher-yielding tax-exempt municipal securities relative to the lower-yielding taxable securities. These items are more fully discussed below. The average yield on interest-earning assets decreased 9 basis points from 3.57% in the first quarter of 2013 to 3.48% in the first quarter of 2014 while the average cost of funds decreased 10 basis points from 0.20% in the first quarter of 2013 to 0.10% in the first quarter of 2014. 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 quarter of 2014 increased $468.9 million compared to the same period in 2013. Loans made up approximately 43.1% of average interest-earning assets during the first quarter of 2014 compared to 44.6% during the first quarter of 2013. The average yield on loans was 4.48% during the first quarter of 2014 compared to 4.62% during the first quarter of 2013. 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.


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The average volume of securities during the first quarter of 2014 decreased $266.6 million compared to the same period in 2013. Securities made up approximately 39.7% of average interest-earning assets during the first quarter of 2014 compared to 44.5% during the first quarter of 2013. The average yield on securities was 3.81% in the first quarter of 2014 compared to 3.32% in the first quarter of 2013. Despite a significant decrease in market rates for investment securities during the comparable periods, the average yield on securities increased 49 basis points during the first quarter of 2014 compared to the first quarter of 2013 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 50.4% of average securities during the first quarter of 2014 compared to 35.8% during the first quarter of 2013. The average yield on taxable securities was 2.00% in the first quarter of 2014 compared to 1.93% in the first quarter of 2013, while the average taxable-equivalent yield on tax-exempt securities was 5.57% in the first quarter of 2014 compared to 5.78% in the first quarter of 2013.
Average federal funds sold, resell agreements and interest-bearing deposits during the first quarter of 2014 increased $1.6 billion compared to the same period in 2013. Federal funds sold, resell agreements and interest-bearing deposits made up approximately 17.2% of average interest-earning assets during the first quarter of 2014 compared to 10.9% during the first quarter of 2013. The combined average yield on federal funds sold, resell agreements and interest-bearing deposits was 0.26% during the first quarter of 2014 compared to 0.25% during the first quarter of 2013. The increase in average federal funds sold, resell agreements and interest-bearing deposits compared to the first quarter of 2013 was primarily related to excess liquidity from deposit growth. Average deposits increased $1.8 billion during the first quarter of 2014 compared to the first quarter of 2013. Average interest-bearing deposits for the first quarter of 2014 increased $1.1 billion compared to the same period in 2013, while average non-interest-bearing deposits for the first quarter of 2014 increased $722.2 million compared to the same period in 2013. The ratio of average interest-bearing deposits to total average deposits was 60.2% during the first quarter of 2014 compared to 60.3% during the first quarter of 2013. 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 0.08% and 0.05% during the first quarter of 2014 compared to 0.14% and 0.09% during the same period in 2013. 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 8.8% during the first quarter of 2013 to 7.6% during the first quarter of 2014. 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 3.38% during the first quarter of 2014 compared to 3.37% during the first quarter of 2013. 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. 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 $6.6 million for the first quarter of 2014 compared to $6.0 million for 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.


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Non-Interest Income
The components of non-interest income were as follows:
                                                Three Months Ended
                                             March 31,      March 31,
                                                2014           2013
Trust and investment management fees        $    25,411    $    21,885
Service charges on deposit accounts              19,974         20,044
Insurance commissions and fees                   13,126         13,070
Interchange and debit card transaction fees       4,243          4,011
Other charges, commissions and fees               8,207          7,755
Net gain (loss) on securities transactions            -              5
Other                                             6,529         11,010
Total                                       $    77,490    $    77,780

Total non-interest income for the three months ended March 31, 2014 decreased $290 thousand, or 0.4%, compared to the same period in 2013. Changes in the components of non-interest income are discussed below.
Trust and Investment Management Fees. Trust and investment management fees for the three months ended March 31, 2014 increased $3.5 million, or 16.1%, compared to the same period in 2013. Trust investment fees are the most significant component of trust and investment management fees, making up approximately 70% and 69% of total trust and investment management fees for the first three months of 2014 and 2013, respectively. Investment and other custodial account fees are generally based on the market value of assets within a trust account. Volatility in the equity and bond markets impacts the market value of trust assets and the related trust investment fees.
The increase in trust and investment management fees during the three months ended March 31, 2014 compared to the same period in 2013 was primarily the result of an increase in trust investment fees (up $2.7 million), real estate fees (up $495 thousand) and oil and gas fees (up $214 thousand). The increase in trust investment fees during the three months ended March 31, 2014 compared to the same period in 2013 was partly due to higher average equity valuations during 2014 and an increase in the number of accounts. The increase in real estate fees was partly the result additional fees for services in connection with a large property sale during the first quarter of 2014.
At March 31, 2014, trust assets, including both managed assets and custody assets, were primarily composed of equity securities (45.8% of assets), fixed income securities (40.1% of assets) and cash equivalents (8.8% of assets). The estimated fair value of these assets was $29.8 billion (including managed assets of $12.2 billion and custody assets of $17.6 billion) at March 31, 2014, compared to $29.0 billion (including managed assets of $11.9 billion and custody assets of $17.1 billion) at December 31, 2013 and $27.1 billion (including managed assets of $11.3 billion and custody assets of $15.8 billion) at March 31, 2013.

Service Charges on Deposit Accounts. Service charges on deposit accounts for the . . .

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