DALLAS - Frost Bank executive vice president for finance Don Frost has a simple explanation for why his family's namesake institution added municipal bond underwriting services to its commercial banking operations. In a word, "relationships."
"Frost is all about relationships," Frost said. "We have the capital strength, we have the distribution network, we have the competency to give you the best price discovery of any of the other big boys. Yet, what I think we bring is a level of being in the people business.
"And if I can't have a relationship with someone, I don't want to do business with them."
Why did Frost convert its 113-year-old federal charter to a state charter in 2012 after the Dodd-Frank regulations were enacted? "Relationships."
With Dodd-Frank adding cost and complexity to smaller, federally-chartered banks, Frost Bank shifted to Texas, where it could maintain more personal contact with the regulators, Frost said.
"When you're nationally chartered, you're regulated by the Office of the Comptroller of the Currency," Frost said. "We did not feel we could maintain a relationship with them and get the guidance we needed."
Why did Frost invite a group of San Antonio Independent School District students to study the pricing of their district's $307 million bond issue last month? Yes, "relationships."
"I think it was an opportunity to reinforce to all our bankers that we are in the people business and that we do grow our business deliberately with face-to-face meetings," Frost said. "That event was evidence of that building of face-to-face relationships."
Indeed, Frost won the job as senior manager and book runner on the SAISD deal based, in part, on its pledge to invite the business students at Sidney Lanier Magnet School to watch the pricing on their hometown bank's trading floor.
"With Frost Bank's headquarters located in San Antonio, they were in the unique position to be able to commit to providing a group of district students with the opportunity to experience real time accessibility to the sale of the bonds on the only trading floor located in San Antonio," said Lisa Pepi, director of cash and treasury management for the district.
Involving the high school students in the mechanics of bond pricing was the idea of San Antonio Independent School District chief financial officer Larry Garza. As the son of migrant workers who worked his way through college, Garza said he wanted to open doors to high finance for students whose families might be struggling to manage their own meager resources. For the district and its stakeholders, the process also enhanced the transparency of the deal, he said.
The district invited seniors and two teachers from the school to take part in the process as part of their banking and finance studies. While Frost demonstrated the pricing process, the district's financial advisors, bond counsel and underwriter's counsel also explained the procedures leading up to the negotiated sale and material events that might come later.
"I thought it was a tremendous idea," Frost said. "All of the students were very engaged. They saw the inside of the bank instead of just the outside of the tower. We took the mystique out of what we were doing."
Along with the students came the local media, adding the glare of publicity to an event that typically happens below the radar. Fortunately for Don Frost, who served as lead banker on the deal, demand was strong that day.
"I'm proud to say Frost obtained about $600 million of orders during the day for whole syndicate [including 5 other banks], and Frost produced greater than $400 million of the $600 million," Frost said.
Because of the size of its balance sheet, the San Antonio bank has to be selective about which deals it wants to participate in, Frost said. Therefore, the bank only takes investment-grade bonds it is willing to hold on its balance sheet, he said. It also wants to deal with familiar faces.
In 2012, one of Frost's first major deals as book runner came on $128 million of bonds for Bexar County, which includes San Antonio. Most recently, Frost was named co-manager on $800 million of Texas Transportation Commission refunding bonds.
"There are some underwriters who only want the fee," Frost said. "We only want to focus on the high-quality Texas paper. We only want to underwrite paper that we want to put on our own balance sheet."
Operating under its parent corporation Cullen-Frost Bankers, the bank had a nearly $11.4 billion securities portfolio as of Dec. 31. About half of the portfolio consisted of U.S. Treasury securities and residential mortgage-backed securities issued by U.S. government agencies, according to Standard & Poor's. The other half of the portfolio consists primarily of municipal bonds, which S&P considers a "substantial proportion relative to most banks."
Almost all of the munis were issued by political subdivisions of agencies in Texas, and the vast majority were either guaranteed by the triple-A-rated Texas Permanent School Fund or secured by U.S. Treasuries via defeasance of the debt of the issuers.
"Even though regulators' current rules don't count municipal bonds as highly liquid assets, we think Cullen/Frost still has ample liquidity," S&P primary credit analyst E. Robert Hansen wrote in a March report.
S&P's counterparty rating of A for Cullen-Frost comes with a negative outlook, based largely on Texas' weakening oil market.
"Although the company's loan performance has been very strong and loan losses have been very modest, its loan performance could deteriorate over the next two years given its substantial loan exposure to the energy industry," Hansen said.
Despite the concern about Texas' economy, Frost survived the energy market collapse of the late 1980s, the savings and loan crisis that ensued through 1995, and the financial collapse of 2008 relatively unscathed.
During the Texas economic crisis of the 1980s, when energy prices and real estate plummeted, Frost was the only one of the 10 largest Texas-based banking companies to survive without federal assistance or a takeover by an out-of-state financial institution.
In 2000, Frost got out of the residential mortgage business because the industry had moved away from the relationship model. In part because of that decision, Frost had no direct exposure during the mortgage crisis that began in 2007.
In 2008, Frost was the first bank in the nation to turn down federal funding under the Troubled Asset Relief Program (TARP) because the company didn't need the money, was very well capitalized, and determined that taking TARP funds would have diluted shareholder value.
Tom Frost, chairman emeritus of the bank his great-grandfather Col. Thomas C. Frost founded in 1868, provided some withering Congressional testimony against the investment bank bailouts after the 2008 collapse of the financial markets. Sheltering the investment banks under the umbrella of commercial bank protection created enormous risk, Tom Frost testified in 2012 before the Senate Subcommittee on Financial Institutions and Consumer Affairs.
"I would suggest that the two types of institutions have separate ownership, separate management, separate regulation," Tom Frost said. "My conviction comes after seeing both systems which were separate, but now have been joined, to create a situation which in 2008 brought about the near catastrophe of collapse of the world financial systems.
"Following the path that we are on currently will not only provide opportunity for the same consequences to be repeated, but also mean the end of a banking system consisting of many providers," he added. "It seems we are rapidly approaching a system which will be an oligopoly of a few major institutions."
