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Morningstar | Narrow-Moat-Rated Cullen/Frost Reports Strong 2018 and Is Well-Positioned Looking Forward

Narrow-moat-rated Cullen/Frost Bankers reported good fourth-quarter and full-year 2018 results that were in line with our expectations. Based on these results, we do not anticipate materially changing our $102 per share fair value estimate. Earnings per diluted share grew 25.2% to $6.90, which represents a 14.2% return on average common equity. The net interest margin grew to 3.72%, which is one of the best in our regional bank coverage, largely due to commercial loans repricing upwards from rate hikes. Loan growth picked up the pace at 9.3% in 2018, versus 7.8% in 2017. The result was 10.6% net interest income growth. Management expects to maintain a high-double-digit loan growth in 2019, assuming a steady economy.

The only concerning factor in Cullen/Frost’s results was 6 basis points of year-over-year credit deterioration to the still-pristine level of 33 basis points in net charge-offs. That said, many of the written-off loans already had provisioning for the loan losses allocated to them. We think that Cullen/Frost’s credit cost advantage remains intact and relevant. The bank has maintained excellent credit quality despite the fact that the underlying commodities for its relatively large energy loan exposure experienced near-term price volatility.

Noninterest income grew 4.4%, largely due to growth in Cullen/Frost's trust and investment management division. We particularly like the bank’s investment management business because it deepens Cullen/Frost’s already-strong client relationships. Noninterest expense growth slowed to about 2.6% from 3.6% in 2017, which combined with strong revenue growth dropped our estimated efficiency ratio by about 4 basis points. While we think that Cullen/Frost can improve its efficiency ratio over the longer term, the bank's current expansion into Houston could weigh on expenses in the short term. Regardless, we still think it is the right strategy to invest for longer-term profitability.

Industry tailwinds, such as rising rates, have certainly helped Cullen/Frost’s asset-sensitive loan book achieve impressive results. Overall, we largely see further net interest margin improvement slowing, particularly as additional rate hikes come to a halt. Even so, we still see some additional NIM expansion for the bank in 2019 as certain longer duration assets roll over at higher yields, even without any rate hikes for the year.

For a more detailed view of our expectations regarding interest rates and their effects on banking profitability, please see our December 2018 Observer, "The Return of the Bank: Net Interest Margins Reach a Turning Point--Funding Advantages and Net Interest Income."