DBRS Comments on the Q3 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 Q3 2009 earnings results. The trend on all ratings remains Stable.

Cullen/Frost’s franchise resides in the state of Texas, which has until recently, avoided much of the severity of the recession. Nonetheless, the Texas economy has slowed and unemployment has elevated. During Q3 2009, the Company’s earnings increased materially to $45 million, up from $38 million for the prior quarter, yet down from $49 million for Q3 2008. The sequential quarterly increase in net income reflected a moderate decrease in non-interest expense, slightly higher revenues, and a lower effective tax rate, which contracted due to the Company’s purchases of municipal securities. During Q3 2009, provisions for loan loss reserves increased by 2%. The bulk of the decrease in non-interest expenses reflected the Company’s Q2 2009 $7.3 million FDIC special assessment fee. Meanwhile the modest increase in revenues reflected a 2% increase in non-interest income, driven by higher service charges on deposit accounts and insurance commissions. Cullen/Frost’s net interest income contracted slightly during Q3 2009, and reflected a 16 basis points (bps) narrowing of net interest margin (NIM) to 4.12%, partially offset by higher levels of average earning assets. On an annual quarter basis, net income was negatively impacted by higher expenses, lower revenues, and a 62 bps narrowing of NIM, which was somewhat offset by higher average earning assets. Provisions for loan loss reserves were down 11%, year-over-year.

Despite the declining Texas economy and higher unemployment, Cullen/Frost’s asset quality remains sound. Although asset quality deteriorated during Q3 2009, the size of non-performing assets (NPAs) and net charge-offs (NCOs) was relatively moderate and manageable. At September 30, 2009, the Company’s NPAs increased to $221 million or 2.58% of total loans from $190 million or 2.20% of total loans, at June 30, 2009. Meanwhile Cullen/Frost’s NCOs expanded to $16.3 million or 0.75% of average loans, from $8.3 million or 0.38% for Q2 2009. The increase in NPAs reflected one fairly large exposure to a commercial crane operator, which filed for Chapter 11 bankruptcy. Cullen/Frost’s loss of principal is expected to be minimal. The bulk of the Company’s NCOs were C&I exposures and to a far lesser extent commercial real estate and consumer loans. DBRS comments that the Company’s allowance for loan loss reserves was moderate at 0.56% of NPAs. DBRS believes that further erosion in the Company’s asset quality is likely, given the slowdown in the Texas economy and higher unemployment. Nonetheless, it is DBRS’s view that Cullen/Frost can readily absorb any likely incremental loan losses from earnings without impairing its capital and franchise strengths.

During Q3 2009, Cullen/Frost’s NIM narrowed by 16 bps to 4.12%, as average deposits grew and average loans contracted and the rate earned on the excess liquidity was below the average cost of deposits.

Cullen/Frost’s liquidity position remains strong, as core deposits account for a high 132% (at June 30, 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 remains ample as evidenced by its September 30, 2009, estimated Tier 1 and Total risk-based capital ratios of 11.49% and 13.72%, respectively, which are up from 10.91% and 13.34%, respectively, at June 30, 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.