DBRS Comments on Cullen/Frost’s 3Q13 Results; Ratings Unchanged - Senior at “A”, Stable Trend

DBRS, Inc. (DBRS) has commented today that its ratings for Cullen/Frost Bankers, Inc. (Cullen/Frost or the Company), including its Issuer & Senior Debt rating of “A”, are unchanged following the release of 3Q13 results. The trend on all ratings is Stable. For the quarter, the Company reported net income of $58.4 million, up from $57.0 million in 2Q13. Earnings equated to a return on average assets of 1.01% and return on average common equity of 10.07%, roughly in line with the linked quarter.

During the quarter, the Company announced a definitive agreement to acquire WNB Bancshares, Inc. (WNB). DBRS views the planned acquisition as consistent with Cullen/Frost’s strategy to expand its commercial banking presence in Texas. Additionally, WNB appears to have similar organizational culture and business focus. The transaction is expected to close in 1H14 pending customary regulatory approvals and other closing conditions. With $1.4 billion in assets, privately-held WNB is the parent company of Western National Bank which operates 8 branches predominately in the Texas markets of Midland and Odessa. While all acquisitions pose integration risks, the relative small size of the transaction and retention of WNB’s senior management as well as Cullen/Frost’s familiarity with these Texas markets should assuage the level of risk. At the time of the announcement, DBRS commented that Cullen/Frost’s ratings were unaffected.

Cullen/Frost continues to display solid fundamentals, reflecting both the strength of its franchise and the Texas market. Highlights for the quarter included sustained growth in average loans and deposits and expected continued loan growth given existing pipelines. For 3Q13, Cullen/Frost reported 0.5% growth in average loans QoQ and 3.7% growth in average deposits. Finally, asset quality remains sound reflecting manageable levels of net charge-offs (NCOs) and declining non-performing assets (NPAs).

As with most banks, the current low rate environment continues to pressure earnings. However, Cullen/Frost’s net interest margin (NIM) was fairly resilient in 3Q13 narrowing just 5 bps to 3.38%. Additionally, QoQ growth in earnings assets combined with improving investment securities yields through reinvestment helped offset the margin drag of increased levels of liquidity generated from robust deposit growth. For 3Q13, Cullen/Frost’s spread income (TE basis) increased 3% QoQ to $179.1 million. Management anticipates some continued pressure on margin, yet spread income should continue to benefit from sustained loan growth and reinvestment of the Company’s sizeable liquidity position.

Third quarter non-interest income was $74.0 million, up 2% from 2Q13. The increase reflected increases in most categories and notably higher insurance commissions and fees, service charges on deposit accounts and other charges, commissions and fees. Meanwhile, expenses remain well-controlled in DBRS’s view, and increased $2.1 million or 1.4% QoQ. Of the increase, $0.9 million was related to transaction-related expenses associated with the WNB acquisition.

Asset quality continues to be highly manageable. NPAs declined QoQ and represented 1.05% of loans and foreclosed assets, at September 30, 2013, down 5 bps from the prior quarter and 36 bps from a year ago. Additionally, NCOs, increased a modest $1.6 million, QoQ and, at 0.23% of average loans are more in line with recent low charge-off levels. As such, DBRS considers the allowance for loan loss reserves to be adequate at 1% of period-end loans.

DBRS views Cullen/Frost’s funding profile to be a key strength, underpinned by its large core deposit base and low loan to deposit ratio. Finally, the Company’s capital position remains solid, and provides ample loss absorption capacity, especially given its historically well managed asset quality. At September 30, 2013, Cullen/Frost’s tangible common equity ratio was 7.81% and its Tier 1 capital ratio was 14.53%. Following the close of the WNB acquisition, capital levels will decline from current levels, although remaining solid. When the acquisition was announced, Cullen/Frost estimated that, at close, pro forma TCE/TA will be approximately 7.5% and Tier 1 common will be 11.6%.

Notes:
All figures are in U.S. dollars unless otherwise noted.

[Amended on May the 23rd, 2014 to remove unnecessary disclosures.]