Cullen/Frost Keeps Cool: Best Small Banks

Cullen/Frost Bankers famously talked its way out of taking TARP funds, and it remains well-capitalized enough to raise its dividend at a time when most banks are barely able to pay one at all.
Publish date:



) -- Two years ago

Cullen/Frost Bankers

(CFR) - Get Report

, a small bank in Texas, flew below the radar for most bank industry observers

But that changed when the company made headlines as the first bank to refuse government bailout funds, even as industry leaders

JPMorgan Chase

(JPM) - Get Report


Wells Fargo

(WFC) - Get Report


U.S. Bancorp

(USB) - Get Report

and others succumbed to government pressure.

It was a bold move, but one that longtime Chairman and CEO Richard Evans Jr. says was necessary.

Richard 'Dick' Evans Jr., chairman and CEO of Cullen/Frost Bankers

Cullen/Frost was offered $330 million in TARP funds in late 2008, but after engaging in its own due diligence of the offer, management decided that the capital injection -- while being trumpeted by the government as having an attractive interest rate of 5% -- in reality would cost Cullen/Frost more like 11% in interest, Evans says.

Cullen/Frost presented its case to regulators, who ultimately agreed to the request. Evans and other members of the Cullen/Frost management team then took to the road to stave off any investor concerns, since the perception in the markets at the time was that only good banks were receiving TARP funds.

Evans, a 40-year veteran to the Texas banking industry, is humble about the bank's achievements.

"We had run a conservative company and our shareholders had invested in a company that was run that way and it wasn't in their best interests

to receive the TARP funds because our capital was high," Evans said in an interview last week with


. "In fact our capital was at a level that most banks were getting to when they took the TARP money. We were already there. We didn't need the money. Our capital was already strong and it

TARP funding was much more costly from our analysis than originally presented."

Cullen/Frost, with assets of $16.8 billion, provides commercial and consumer banking products, investment and brokerage services, and insurance products. Its subsidiary, Frost Bank, operates more than 100 branches across Texas -- an area which remained stable during the housing downturn. Cullen/Frost is mainly a business bank, however, as its loan book is 85% commercial loans, mainly C&I lending and commercial real estate. It does not make any residential mortgage loans.

"We felt that the residential mortgage business had become a commodity and no longer really had the long-term relationship factor to it," Evans says. "It wasn't because we had any idea what would happen." (Cullen/Frost has a partnership with Cornerstone Mortgage Company of Houston to provide customers with residential mortgages. Cullen/Frost does not receive any money from the transaction, but is able to capitalize on offering customers other banking services, Evans says.)

The lack of residential mortgage loans and being located in one more the stable economies in the country were key factors in helping the bank remain above water as many of its peers similar in size were drowning.

The recent credit crisis is reminiscent of the 1980s, in which Texas banks experienced massive failure and consolidation as banks overextended credit to energy and energy-related industries, and an industrywide commercial real estate overflow came to roost. Of the 10 largest banks in Texas at that time, Cullen/Frost was the only one that didn't go bankrupt, or have to sell themselves, Evans says.

"I feel that my number one job as CEO of this company is to be sure that the entire company knows and understands our philosophy," Evans says. "Our mission statement is we will grow and prosper building long-term relationships based on top quality service and ethical standards and safe sound assets. ... The trick is to live it and to practice it in good times and in bad times."

Cullen/Frost's wise move when it came to declining TARP funds, given the controversy eventually surrounded the banks that did receive the funds, exemplifies one of many ways the company stands out from the pack and why its stock has a premium valuation.

"When you look at other banks that assert their earnings power,

Cullen/Frost has not needed to divest any businesses through this credit cycle," BMO Capital analyst Peter Winter says. "They have not needed to raise a penny in additional capital. And when you look at the capital, ratios are above the levels of when they first declined TARP."

Cullen/Frost has also benefited from the general flight to quality of deposits as customers looked to safe sound institutions when so many banks have failed. The company has also been doing an aggressive calling effort for new customers, Winter says. Deposits rose 18% to $13.5 billion compared to a year earlier.

J.D. Power & Associates even named Cullen/Frost's banking subsidiary, Frost National Bank, the top ranked bank for customer loyalty and satisfaction in Texas, according to its annual retail banking satisfaction survey released last month.

Cullen/Frost is not a stock that gets much play from investors as its trailing three-month daily volume average is just 340,000 shares, and the shares aren't cheap. According to

Thomson Reuters

, Cullen/Frost has a forward price-to-earnings ratio of 15.75 times, compared to 2011 estimates, while a name like

Bank of America

(BAC) - Get Report

trades at less than 10 times on a similar basis.

But those who have been along for the ride have been rewarded so far. Cullen/Frost shares hit a new 52-week-high on Friday of $60.78, a 72% increase from its March 6, 2009 near-term low of $35.36.

Brett Rabatin, an analyst Sterne, Agee & Leach, calls Cullen/Frost a "dependable holding" and currently rates it at buy.

Cullen/Frost "should enjoy a premium given the quality of earnings, high profitability, excellent core deposit franchise and significant leverage to an improving economy given an asset sensitive balance sheet and a C&I lending focus," Rabatin wrote in a note following the company's first-quarter results last week, when the company reported a profit of $47.8 million, or 79 cents per diluted share, for the first three months of 2010.

Rabatin put a 12-month price target of $64 on Cullen/Frost shares and raised his earnings estimates for 2010 and 2011.

An further example of Cullen/Frost's capital advantages is its ability to consistently pay a dividend to shareholders.

Most banks have put dividend raises on the sidelines until it's clear the economy is on sound footing, but investors are starting to get antsy now that the worst of the crisis has passed. Cullen/Frost not only has a 3% dividend yield at the moment, it just announced plans to increase its quarterly payout by 2 cents to 45 cents a share. The 4.7% increase is payable on June 15 to shareholders of record on June 1.

"We have been fortunate through this recession that we have been profitable," Evans says. "We're staying consistent with what we've done through the years and having a consistent dividend."

Cullen/Frost's share price may be setting new 52-week-highs of late, but Evans says that he does not make watching the bank's stock price his main concern.

"What we need is to stay focused on building value and taking care of customers," Evans says. "I've been in this business over 40 years and the price of the stock will seek the right level as long as we continue to grow and bring in customers and treat them right and stay with our value proposition. I don't worry about the price of the stock. I let the investors make the decisions."

--Written by Laurie Kulikowski in New York.

>>>Best In Class: JPMorgan Chase


>>>Best in Class: U.S. Bancorp

>>>Best in Class: Hudson City

>>>Best in Class: First Niagara