Cullen/Frost Bankers Inc. (CFR, Financial) is down about 42% from its 52-week high of $80. The stock is currently priced at $46.32 per share. Analysts from Barclays and Macquarie have recently downgraded the stock, citing concerns about the bank’s exposure to the energy sector and the Texas economy.
Despite the downgrades, Cullen/Frost Bankers has a number of positive characteristics. The bank has not lost money since at least 1991. I’m not sure when was the last time the firm lost money since the SEC website does not have Cullen/Frost Bankers' 10-Ks before 1991. From the company’s 10-K, Cullen/Frost Bankers “is a financial holding company and a bank holding company headquartered in San Antonio that provides … a broad array of products and services throughout numerous Texas markets. The corporation offers commercial and consumer banking services as well as trust and investment management, mutual funds, investment banking, insurance, brokerage, leasing, treasury management and item processing services.”
On a 12-month trailing basis, the stock looks reasonably valued with a PE ratio of 10.5, Price-to-Book ratio of 1.06 and Dividend Yield of 4.5%. Headline numbers can be misleading. I looked at the bank’s financials to see if the downgrades were warranted.
Balance sheet
Cullen/Frost Bankers had $28.3 billion in total assets as of Sept. 30, 2015. From the table below, you can see that cash, securities and loans make up $26.7 billion or 94% of total assets.
Taken from company 10-Q, numbers in table are in thousands.
| Total Cash and Cash Equivalents | 3,754,905 |
| Securities Held to Maturity | 2,677,485 |
| Securities Available for Sale | 8,972,688 |
| Net Loans | 11,248,577 |
| Subtotal | $26,653,655 |
Looking more closely at the details from last year’s 10-K, one can see that the securities line item mainly consists of municipal bonds, U.S. treasuries and some residential mortgage-backed securities. There’s not a lot of risk in the securities portion of assets.
Taken from company 10-K, numbers in table are in thousands.
Looking at loans, Cullen/Frost Bankers grades its commercial loans on a scale of 1 to 14. Grade 1 loans are of the highest quality and grade 14 loans are charge-offs. From the table below, you can see that Energy made up ~16% of total net loans, and its risk grade rose from an average of 5.45 to 6.50 from December 2014 to September 2015.
You can also see that, over the same time period, commercial real estate’s risk grade rose from an average of 6.76 to 6.84 and “other commercial” pretty much stayed the same. Commercial real estate and “other commercial” accounted for 31% and 36% of total net loans. Grades 6, 7 and 8 are defined as "pass-grade loans to borrowers of acceptable credit quality and risk."
Taken from company 10-Q, amount numbers in table are in thousands.
| Loan Type | 9/15 Loan Amount | 9/15 Risk Grade | 12/2014 Risk Grade |
| Energy | 1,788,508 | 6.50 | 5.45 |
| Other Commercial | 4,088,391 | 6.15 | 6.16 |
| Commercial Real Estate | 3,502,856 | 6.84 | 6.76 |
| Construction | 718,991 | 6.89 | 6.97 |
| Subtotal | $10,098,746 | Ă‚ | Ă‚ |
| Total Net Loans | $11,248,577 | Ă‚ | Ă‚ |
If we look more closely at the detail behind the energy loans, we can see how risk grades 9 to 12 have grown by six times. The energy loans subtotal for risk grades 9 to 12 in September 2015 is $212 million,Ă‚ and the subtotal for December 2014 is $33.5 million.
- Grade 9 loans are “watch list” loans where restructuring may be needed in the near future.
- Grade 10 loans include “borrowers whose credit quality has clearly deteriorated and are at risk of further decline unless active measures are taken to correct the situation.”
- Grade 11 loans are “substandard” and “which the accrual of interest has not stopped.”
- Grade 12 loans are loans where interest accrual has stopped, and the interest is over 120 days past due.
Looking at liabilities, we see that deposits make up 96% of total liabilities. I consider 96% to be a positive since the firm does not have to pay a high interest rate on the money it loans to customers or uses to buy securities.
| As of 9/15 (numbers in thousands) | Ă‚ |
| Non-interest bearing deposits | 10,468,605 |
| Interest-bearing deposits | 13,855,792 |
| Total Deposits | $24,324,397 |
| Total Liabilities | $25,436,379 |
It’s interesting to note Cullen/Frost Bankers’ deposit growth from $6.5 billion in 2000 to $24.3 billion in 2015 for a CAGR of 9.19%.
Income statement
You can see the company's net income consistency in the chart below.
Numbers are in millions.
Above are the last five annual income statements from Cullen/Frost Bankers. You can see that revenue is split between interest income and noninterest income. Net interest income has been around two-thirds of total revenue. Interest income is generated from loans and securities. Noninterest income is generated from charges and fees such as investment management fees.
As the price of oil falls and uncertainty surrounding the Texas economy materializes, investors are likely most worried about slowing revenue growth and increasing credit losses provision expense. The credit loss provision is the company’s estimate for losses from bad loans.
For Q3’15, we can see that net interest income and noninterest income grew year over year. Net interest income grew 5.3%, and noninterest income grew 3.1%. However, net income declined 2%. The most important contributing factor was an increase in employees that led to higher wages, benefits and occupancy costs. Cullen/Frost Bankers acquired another company that led to the increase in head count. One should also note that income taxes were lower year over year.
During the quarter, the provision for loan losses jumped to $6.8 million from $390,000. On the Q3’15 conference call, the CEO stated that, for 2016, the company used $50 a barrel for oil as its base assumption with $37.50 as its low-end estimate. Oil is now less than $30 per barrel.
Furthermore, many nonproduction customers in industries such as service, manufacturing and transportation are “expecting total [revenue] decreases of 30% to 40% for 2015." Hearing these comments and looking at Cullen/Frost Bankers’ loans, we can reasonably project increased loan losses in the quarters to come.
Final thoughts
Cullen/Frost Bankers has an impressive track record of profitability and growing its deposits even in tough environments. It's a high quality company that I will put on the watchlist. There is no reason to jump into the stock now with so much uncertainty. Looking at the company's $212 million in energy loans that are grade risk 9 or higher gives us a sense of what potential loan losses could be. Keep in mind that those numbers were reported when oil was at $50 per barrel. I'll stay on the sidelines and pay attention to the upcoming earnings releases to see how the net loan risk changes over time.
