DBRS Comments on the Q4 2008 Earnings of Cullen/Frost Bankers, Inc. – Senior at “A”

DBRS today commented on the Q4 2008 earnings of Cullen/Frost Bankers, Inc. (Cullen/Frost or the Company). Even with a deteriorating economic environment, Cullen/Frost reported solid earnings of $52.9 million for the quarter, up from $48.9 million for Q3 2008, yet down from $54.7 million for Q4 2007. On a sequential quarter basis, earnings benefited from a 55% decrease in provisions for loan loss reserves, of which 37% was for reserve build, partially offset by a 14 basis point (bp) narrowing of net interest margin (NIM) and a 10% decrease in non-interest income. On an annual quarter basis, earnings were pressured by a 1.4 times increase in provisions for loan loss reserves and a ten bp narrowing of NIM, somewhat offset by a 4% increase in non-interest income. The Company’s credit fundamentals continue to support the current rating levels – “A” for senior obligations – and Stable trend.

Although the rapid deterioration of the economy has led to a considerable escalation in asset quality erosion throughout the banking universe, Cullen/Frost’s asset quality deterioration was much more restrained. At December 31, 2008, non-performing assets (NPAs) increased moderately to 0.88% of loans from 0.64% at September 30, 2008, and 0.38% for December 31, 2007. The bulk of the sequential quarter increase in NPAs reflected two credits within the homebuilding industry. The Company’s Q4 2008 net charge-offs (NCOs) remained modest at 0.25% of average loans, down slightly from 0.30% for the prior quarter, yet up somewhat from 0.18% for Q4 2007. For 2008, loan loss provisions of $37.8 million exceeded NCOs by 1.9 times. The Company’s allowance for loan loss reserves to non-accruals and foreclosed assets was solid at 141%.

DBRS believes that further erosion in Cullen/Frost’s asset quality is likely, given the rapidly deteriorating economy and the downturn in the energy sector. Moreover, in Texas, where the Company is based, Hurricane Ike struck Houston and devastated Galveston, which may lead to higher future levels of non-accruals. DBRS comments that $10 million out of the $18.9 million in loan loss provisions for Q3 2008 was related to exposures that were likely affected by Hurricane Ike. DBRS believes that Cullen/Frost can readily absorb the likely incremental loan losses from earnings without impairing its capital and franchise strengths.

Cullen/Frost’s Q4 2008 NIM narrowed by 14 bps to 4.60% from 4.74% in Q3 2008. NIM was diluted, as the Company placed the proceeds from a sizable component of Fed Funds purchased into its Federal Reserve account for a small spread. DBRS comments that Cullen/Frost’s NIM has generally stayed within a fairly moderate range over the past few years, evidencing its solid interest rate risk management. Moreover, the Company’s margin continues to benefit from the implementation of a $1.2 billion interest rate swap (pay floating/receive fixed), which it put in place during October 2007. On a sequential quarter basis, Cullen/Frost’s non-interest income was pressured by lower insurance commissions and trust fees.

Cullen/Frost’s liquidity position remains strong, as core deposits account for approximately 117% (at September 30, 2008) of net loans. A good quality securities portfolio and access to the Federal Home Loan Bank (FHLB), underpin the Company’s liquidity profile.

Unlike most banks, Cullen/Frost did not seek funds from the U.S. Department of the Treasury’s Capital Purchase Program. Cullen/Frost’s capital metrics remain ample as evidenced by its December 31, 2008, Tier 1 and Total risk-based capital ratios of 10.30% and 12.58%, respectively.

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

The applicable methodology is Rating Banks and Bank Holding Companies Operating in the United States, which can be found on our website under Methodologies.

This is a Corporate (Financial Institutions) rating.