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Cullen/Frost Bankers, Inc. (CFR - Analyst Report) reported third-quarter 2013 earnings of 96 cents per share. The results were in line with the Zacks Consensus Estimate, while it beat the prior-year figure by a penny.

Top-line growth and a strong capital position were the tailwinds for the quarter. Further, increase in loans and deposits were impressive. However, higher provision for credit losses and elevated operating expenses remain concerns.

Net income available to common shareholders came in at $58.4 million, compared with $58.7 million in the prior-year quarter.

Quarter in Detail

Total revenue, net of interest expenses, increased 6.1% year over year to $253.1 million. Revenues also surpassed the Zacks Consensus Estimate of $244 million.

Cullen/Frost’s net interest income on a taxable-equivalent basis was $179.1 million, up 7.1% from the year-ago quarter. The increase was primarily driven by better interest earning assets, partly mitigated by a decline in net interest margin (NIM), which reduced 16 basis points year over year to 3.38%.

Cullen/Frost’s non-interest income of $74.0 million advanced 4.0% year over year. The increase was mainly backed by a rise in trust and investment management fees, insurance commissions and fees, other charges, commissions and fees.

On the flip side, Cullen/Frost’s non-interest expense rose 5.1% year over year to $151.8 million. This was due to an increase in salaries and employee benefit expenses, furniture and equipment costs and other expenditures. These negatives were partially offset by a decline in intangible amortization costs.

Credit Quality

Credit metrics was a mixed bag during the reported quarter. As of Sep 30, 2013, non-performing assets were $98.1 million, down from $101.7 million in the prior-year quarter. The allowance for loan losses as a percentage of total loans stood at 1.00% as of Sep 30, 2013, down from 1.20% in the prior-year quarter.

Non-accrual loans decreased and came in at $79.1 million, compared with $106.4 million in the prior-year quarter. However, provisions for credit losses were $5.1 million, up from $2.5 million in the prior-year quarter.

Net charge-offs jumped to $5.4 million from $2.7 million in the prior-year quarter. Net charge-offs as a percentage of average loans were 0.23%, up 10 basis points year over year.

Capital Position

Cullen/Frost had a strong capital position. Tier 1 Risk-Based Capital Ratio was 14.53%, compared with 14.10% in the prior-year quarter. Total Risk-Based Capital Ratio was 15.68%, compared with 15.62% in prior-year quarter.

Leverage ratio was 8.61%, up from 8.59% in the prior-year quarter. The tangible common equity ratio was 7.81%, compared with 8.80% in the last-year quarter.

Total loans increased 5.7% to $9.3 billion on a year-over-year basis. Additionally, total deposits surged 9.9% to $20.0 billion. Adjusted stockholders’ equity rose 9.5% year over year to $2.3 billion as of Sep 30, 2013.

Our Viewpoint

Growth in total loans and deposits are expected to drive Cullen/Frost’s profitability going forward. However, the prevalent low interest rate environment and continuing pressure on NIM remain areas of concern. Moreover, surging expenses pose a challenge to bottom-line growth. Nevertheless, with an eventual revival of the economy, we expect the company to deliver better earnings.

In Aug 2013, in an attempt to expand its footprint in Texas, Cullen/Frost signed a definitive merger agreement with WNB Bancshares, Inc. The merger will enable Cullen/Frost to reinforce its Texas franchise and enter the profitable Midland and Odessa markets and thereby aid expansion.

Cullen/Frost currently carries a Zacks Rank #2 (Buy). Other better performing Southwest banks include Banc of California, Inc. (BANC - Snapshot Report) and Southside Bancshares Inc. (SBSI - Snapshot Report) with a Zacks Rank #1 (Strong Buy), while First Financial Bankshares Inc. (FFIN - Snapshot Report) carries a Zacks Rank #2.

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