DBRS Comments on the Q2 2009 Earnings of Cullen/Frost Bankers, Inc. – Senior at “A”

DBRS has today commented that the ratings of Cullen/Frost Bankers, Inc. (Cullen/Frost or the Company), including its Issuer & Senior Debt rating of “A”, are unaffected by the Company’s Q2 2009 earnings results. The trend on all ratings remains Stable.

Cullen/Frost’s franchise resides in the state of Texas, which has avoided the severity of the recession faced by the rest of the nation. Nonetheless, the Texas economy has slowed and state unemployment increased. The Company’s earnings decreased moderately to $37.9 million for the quarter, down from $44.9 million for the prior quarter and $52.5 million for Q2 2008. The majority of the sequential and annual quarterly decreases in earnings reflected the Q2 2009 $7.3 million FDIC special assessment and linked and annual quarterly increases in loan loss provisions of 73% and 162%, respectively. On a quarter-over-quarter basis, earnings benefited from a 5% increase in net interest income to $144.3 million from $137.7 million, and on an annual quarter basis, net interest income was up 6% from $136.2 million. The rise in net interest income stemmed from an increase in average earning assets, somewhat offset by a decline in net interest margin. NIM was 4.28% for Q2 2009, versus 4.33% for Q1 2009 and 4.68% for Q2 2008.

The Company’s average loans of $8.8 billion were relatively flat on a sequential quarterly basis, yet were up 7.3% from $8.2 billion for the second quarter of 2008. Of the $600 million increase versus the year ago quarter, about half was in C&I loans, 40% was in commercial real estate, and the rest of the growth was spread out over commercial construction and consumer real estate, including HELOCs. Reflecting higher customer savings rates, Cullen/ Frost’s average deposits increased 6% to $12.2 billion on a sequential quarter basis and 17% from the year ago quarter.

Non-interest income for Q2 2009 was $68 million, down slightly from the $69.8 million for the prior quarter and $70.6 million for the year ago quarter. DBRS notes that service charges for deposit accounts and trust fees were up on a sequential quarter basis. Non-interest expense for the quarter was $136.3 million, an increase of 5% over the $129.5 million in the prior quarter and a 13.5% increase over the $120.1 million reported for Q2 2008. Most of the increase in non-interest expense in the current quarter is attributable to the FDIC special assessment charge of $7.3 million.
Asset quality erosion continued in Q2 2009 but at a more measured pace than the rest of the banking industry. At June 30, 2009, the Company’s non-performing assets (NPAs) increased to $190 million or 2.20% of total loans from $128 million or 1.45% at March 31, 2009 and $50 million or 0.59% at June 30, 2008. Meanwhile Cullen/Frost’s net charge-offs (NCOs) remained modest at 0.38% of average loans, up slightly from 0.26% for the prior quarter and 0.21% for Q2 2008. The increase in NPAs reflected exposures to a large energy credit, a manufacturing concern, home builders and commercial loans to Mexican entities. Cullen/Frost’s allowance for loan loss reserves to loans was adequate at 1.42% of total loans. The Q2 2009 provision for loan losses was $16.6 million, compared to charge-offs of $8.3 million. DBRS believes that further erosion in the Company’s asset quality is likely, given the declining economy in Texas. Nonetheless, 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 liquidity position remains strong, as core deposits account for approximately 126% (at March 31, 2009) of net loans. The company’s securities portfolio and access to the Federal Home Loan Bank (FHLB), round out its liquidity profile.

Unlike most banks, Cullen/Frost did not seek funds from the U.S. Department of the Treasury, Capital Purchase Program. Cullen/Frost’s capital metrics remain ample as evidenced by its June 30, 2009, estimated Tier 1 and Total risk-based capital ratios of 10.91% and 13.34%, respectively, which are up from 10.64% and 12.98% respectively at March 31, 2009.

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

The applicable methodologies are Rating Banks and Bank Holding Companies Operating in the United States, and Enhanced Methodology for Bank Ratings – Intrinsic and Support Assessments which can be found on our website under Methodologies.

This is a Corporate (Financial Institutions) rating.