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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D. C. 20549
FORM 10-K
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE
ACT OF 1934
FOR THE FISCAL YEAR ENDED DECEMBER 31, 1998
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES
EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM ________ TO _________
COMMISSION FILE NUMBER 0-7275
CULLEN/FROST BANKERS, INC.
(Exact name of registrant as specified in its charter)
TEXAS 74-1751768
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
100 W. HOUSTON STREET
SAN ANTONIO, TEXAS 78205
(Address of principal executive offices) (Zip Code)
REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE: (210) 220-4011
SECURITIES REGISTERED PURSUANT TO SECTION 12(B) OF THE ACT:
COMMON STOCK, $.01 PAR VALUE
(WITH ATTACHED RIGHTS)
(Title of Class)
SECURITIES REGISTERED PURSUANT TO SECTION 12(G) OF THE ACT:
NONE
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. YES [X] NO [ ]
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of the registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K. [ ]
The aggregate market value of the voting stock held by non-affiliates of
the registrant was $1,250,969,589 based on the closing price of such stock as of
March 19, 1999.
Indicate the number of shares outstanding of each of the registrant's
classes of common stock, as of the latest practicable date.
Outstanding at
Class March 19, 1999
--------------------------------- ------------------
COMMON STOCK, $.01 PAR VALUE 26,760,687
DOCUMENTS INCORPORATED BY REFERENCE
(1) Proxy Statement for Annual Meeting of Shareholders to be held May 26, 1999 (Part III)
TABLE OF CONTENTS
PAGE
----
PART I
ITEM 1. BUSINESS.................. 3
ITEM 2. PROPERTIES................ 10
ITEM 3. LEGAL PROCEEDINGS......... 10
ITEM 4. SUBMISSION OF MATTERS TO A
VOTE OF SECURITY HOLDERS... *
PART II
ITEM 5. MARKET FOR REGISTRANT'S
COMMON STOCK AND RELATED
STOCKHOLDER MATTERS....... 10
ITEM 6. SELECTED FINANCIAL DATA... 11
ITEM 7. MANAGEMENT'S DISCUSSION
AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF
OPERATIONS................ 13
ITEM 7A. QUANTITATIVE AND
QUALITATIVE DISCLOSURES
ABOUT MARKET RISK......... 32
ITEM 8. FINANCIAL STATEMENTS AND
SUPPLEMENTARY DATA........ 33
ITEM 9. CHANGES IN AND
DISAGREEMENTS WITH
ACCOUNTANTS ON ACCOUNTING
AND FINANCIAL
DISCLOSURE................ *
PART III
ITEM 10. DIRECTORS AND EXECUTIVE
OFFICERS OF THE REGISTRANT. 64
ITEM 11. EXECUTIVE COMPENSATION.... 64
ITEM 12. SECURITY OWNERSHIP OF
CERTAIN BENEFICIAL OWNERS
AND MANAGEMENT............ 64
ITEM 13. CERTAIN RELATIONSHIPS AND
RELATED TRANSACTIONS...... 64
PART IV
ITEM 14. EXHIBITS, FINANCIAL
STATEMENT SCHEDULES, AND
REPORTS ON FORM 8-K....... 65
* Not Applicable
2
PART I
ITEM 1. BUSINESS
GENERAL
Cullen/Frost Bankers, Inc. ("Cullen/Frost" or "Company"), a Texas
business corporation incorporated in 1977 and headquartered in San Antonio,
Texas, is a bank holding company within the meaning of the Bank Holding Company
Act of 1956 ("the BHC Act") and as such is registered with the Board of
Governors of the Federal Reserve System ("Federal Reserve Board"). The New
Galveston Company, incorporated under the laws of Delaware, is a wholly owned
second tier bank holding company subsidiary which owns all banking and
non-banking subsidiaries with the exception of Cullen/Frost Capital Trust, a
Delaware statutory business trust and wholly-owned subsidiary of the
Corporation. At December 31, 1998, Cullen/Frost's principal assets consisted of
all of the capital stock of two national banks. Including the acquisition of
Keller State Bank, completed in the first quarter of 1999, Cullen/Frost had 79
financial centers across Texas with 19 locations in the San Antonio area, 22 in
the Houston/Galveston area, 17 in the Fort Worth/Dallas area, five in Austin,
ten in the Corpus Christi area, three in San Marcos, two in McAllen and one in
New Braunfels. At December 31, 1998, Cullen/Frost had consolidated total assets
of $6.9 billion and total deposits of $5.8 billion. Based on information from
the Federal Reserve Board, at September 30, 1998, Cullen/Frost was the largest
of the 106 unaffiliated bank holding companies headquartered in Texas.
Cullen/Frost provides policy direction to the Cullen/Frost subsidiary banks
in, among others, the following areas: (i) asset and liability management; (ii)
accounting, budgeting, planning and insurance; (iii) capitalization; and (iv)
regulatory compliance.
CULLEN/FROST SUBSIDIARY BANKS
Each of the Cullen/Frost subsidiary banks is a separate entity which
operates under the day-to-day management of its own board of directors and
officers. The largest of these banks is The Frost National Bank ("Frost
Bank"), the origin of which can be traced to a mercantile partnership organized
in 1868. Frost Bank was chartered as a national banking association in 1899. At
December 31, 1998, Frost Bank, which accounted for approximately 98 percent of
consolidated assets, loans and deposits of Cullen/Frost, was the largest bank
headquartered in San Antonio and South Texas. The Corporation's other subsidiary
bank is United States National Bank of Galveston which had $151 million in
assets at December 31, 1998.
SERVICES OFFERED BY THE CULLEN/FROST SUBSIDIARY BANKS
COMMERCIAL BANKING
The subsidiary banks provide commercial services for corporations and other
business clients. Loans are made for a wide variety of purposes, including
interim construction financing on industrial and commercial properties and
financing on equipment, inventories, accounts receivable, leverage buyouts and
recapitalizations and turnaround situations. Frost Bank provides financial
services to business clients on both a national and international basis.
CONSUMER SERVICES
The subsidiary banks provide a full range of consumer banking services,
including checking accounts, savings programs, automated teller machines,
installment and real estate loans, home equity loans, drive-in and night deposit
services, safe deposit facilities, credit card services and discount brokerage
services.
INTERNATIONAL BANKING
Frost Bank provides international banking services to customers residing in
or dealing with businesses located in Mexico. Such services consist of accepting
deposits (in United States dollars only), making loans
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(in United States dollars only), issuing letters of credit, handling foreign
collections, transmitting funds and, to a limited extent, dealing in foreign
exchange. Reference is made to pages 22 and 29 of this document.
TRUST SERVICES
The subsidiary banks provide a wide range of trust, investment, agency and
custodial services for individual and corporate clients. These services include
the administration of estates and personal trusts and the management of
investment accounts for individuals, employee benefit plans and charitable
foundations. At December 31, 1998, trust assets with a market value of
approximately $11.7 billion were being administered by the subsidiary banks.
These assets were comprised of discretionary assets of $5.4 billion and
non-discretionary assets of $6.3 billion.
CORRESPONDENT BANKING
Frost Bank acts as correspondent for approximately 333 financial
institutions, primarily banks in Texas. These banks maintain deposits with Frost
Bank, which offers to the correspondents a full range of services including
check clearing, transfer of funds, loan participations, and securities custody
and clearance.
DISCOUNT BROKERAGE
Frost Brokerage Services was formed in March 1986 to provide discount
brokerage services and perform other transactions or operations related to the
sale and purchase of securities of all types. Frost Brokerage Services is a
subsidiary of Frost Bank.
INSURANCE
Frost Insurance Agency, Inc., a wholly-owned subsidiary of The Frost
National Bank, will offer corporate and personal property and casualty insurance
as well as group health and life insurance products to individuals and
businesses. Frost Insurance Agency, Inc. generated no income during 1998.
SERVICES OFFERED BY THE CULLEN/FROST NON-BANKING SUBSIDIARIES
Main Plaza Corporation ("Main Plaza") is a wholly-owned non-banking
subsidiary. Main Plaza occasionally makes loans to qualified borrowers. Loans
are funded with borrowings against Cullen/Frost's current cash or borrowings
against credit lines.
Daltex General Agency, Inc. ("Daltex"), a wholly-owned non-banking
subsidiary, is a managing general insurance agency. Daltex provides vendor's
single interest insurance.
COMPETITION
The subsidiary banks encounter intense competition in their commercial
banking businesses, primarily from other banks located in their respective
service areas. The subsidiary banks also compete with insurance, finance and
mortgage companies, savings and loan institutions, credit unions, money market
funds and other financial institutions. In the case of some larger customers,
competition exists with institutions in other major metropolitan areas in Texas
and in the remainder of the United States, some of which are larger than the
Cullen/Frost subsidiary banks in terms of capital, resources and personnel.
SUPERVISION AND REGULATION
CULLEN/FROST
Cullen/Frost is a legal entity separate and distinct from its bank
subsidiaries and is a registered bank holding company under the BHC Act. The BHC
Act generally prohibits Cullen/Frost from engaging in any business activity
other than banking, managing and controlling banks, furnishing services to a
bank which it owns and controls or engaging in non-banking activities closely
related to banking.
As a bank holding company, Cullen/Frost is primarily regulated by the
Federal Reserve Board which has established guidelines with respect to the
maintenance of appropriate levels of capital and payment of
4
dividends by bank holding companies. Cullen/Frost is required to obtain prior
approval of the Federal Reserve Board for the acquisition of more than five
percent of the voting shares or certain assets of any company (including a bank)
or to merge or consolidate with another bank holding company.
The Federal Reserve Act and the Federal Deposit Insurance Act ("FDIA")
impose restrictions on loans by the subsidiary banks to Cullen/Frost and certain
of its subsidiaries, on investments in securities thereof and on the taking of
such securities as collateral for loans. Such restrictions generally prevent
Cullen/Frost from borrowing from the subsidiary banks unless the loans are
secured by marketable obligations. Further, such secured loans, other
transactions, and investments by each of such bank subsidiaries are limited in
amount as to Cullen/Frost or to certain other subsidiaries to ten percent of the
lending bank subsidiary's capital and surplus and as to Cullen/Frost and all
such subsidiaries to an aggregate of 20 percent of the lending bank subsidiary's
capital and surplus.
Under Federal Reserve Board policy, Cullen/Frost is expected to act as a
source of financial strength to its banks and to commit resources to support
such banks in circumstances where it might not do so absent such policy. In
addition, any loans by Cullen/Frost to its banks would be subordinate in right
of payment to deposits and to certain other indebtedness of its banks.
SUBSIDIARY BANKS
The two subsidiary national banks are organized as national banking
associations under the National Bank Act and are subject to regulation and
examination by the Office of the Comptroller of the Currency (the "Comptroller
of the Currency").
Federal and state laws and regulations of general application to banks have
the effect, among others, of regulating the scope of the business of the
subsidiary banks, their investments, cash reserves, the purpose and nature of
loans, collateral for loans, the maximum interest rates chargeable on loans, the
amount of dividends that may be declared and required capitalization ratios.
Federal law imposes restrictions on extensions of credit to, and certain other
transactions with, Cullen/Frost and other subsidiaries, on investments in stock
or other securities thereof and on the taking of such securities as collateral
for loans to other borrowers.
The Comptroller of the Currency with respect to Cullen/Frost's bank
subsidiaries has authority to prohibit a bank from engaging in what, in such
agency's opinion, constitutes an unsafe or unsound practice in conducting its
business. It is possible, depending upon the financial condition of the bank in
question and other factors, that such agency could claim that the payment of
dividends or other payments might, under some circumstances, be such an unsafe
or unsound practice.
The principal source of Cullen/Frost's cash revenues is dividends from its
bank subsidiaries, and there are certain limitations on the payment of dividends
to Cullen/Frost by such bank subsidiaries. The prior approval of the Comptroller
of the Currency is required if the total of all dividends declared by a national
bank in any calendar year would exceed the bank's net profits, as defined, for
that year combined with its retained net profits for the preceding two calendar
years less any required transfers to surplus. In addition, a national bank may
not pay dividends in an amount in excess of its undivided profits less certain
bad debts. Although not necessarily indicative of amounts available to be paid
in future periods, Cullen/Frost's subsidiary banks had approximately $53.3
million available for the payment of dividends, without prior regulatory
approval, at December 31, 1998.
CAPITAL ADEQUACY
Bank regulators have adopted risk-based capital guidelines for bank holding
companies and banks. The minimum ratio of qualifying total capital to
risk-weighted assets (including certain off-balance sheet items) is eight
percent. At least half of the total capital is to be comprised of common stock,
retained earnings, perpetual preferred stocks, minority interests and for bank
holding companies, a limited amount of qualifying cumulative perpetual preferred
stock, less certain intangibles including goodwill ("Tier 1 capital"). The
remainder ("Tier 2 capital") may consist of other preferred stock, certain
other instruments, and limited amounts of subordinated debt and the allowance
for loan and lease losses.
5
In addition, bank regulators have established minimum leverage ratio (Tier
1 capital to average total assets) guidelines for bank holding companies and
banks. These guidelines provide for a minimum leverage ratio of 3 percent for
bank holding companies and banks that meet certain specified criteria, including
that they have the highest regulatory rating. All other banking organizations
will be required to maintain a leverage ratio of at least 4 percent plus an
additional cushion where warranted. The guidelines also provide that banking
organizations experiencing internal growth or making acquisitions will be
expected to maintain strong capital positions substantially above the minimum
supervisory levels, without significant reliance on intangible assets.
Furthermore, the guidelines indicate that the Federal Reserve Board will
continue to consider a "Tangible Tier 1 Leverage Ratio" in evaluating
proposals for expansion or new activities. The Tangible Tier 1 Leverage Ratio is
the ratio of Tier 1 capital, less intangibles not deducted from Tier 1 capital,
to average total assets. The bank regulators have not advised Cullen/Frost or
any bank subsidiary of any specific minimum leverage ratio applicable to it. For
information concerning Cullen/Frost's capital ratios, see the discussion under
the caption "Capital" on page 30 and Note L "Capital" on page 46.
FDICIA
The Federal Deposit Insurance Corporation Improvements Act of 1991
("FDICIA"), among other things, requires the Federal banking agencies to take
"prompt corrective action" in respect to depository institutions that do not
meet minimum capital requirements. FDICIA established five capital tiers: "well
capitalized," "adequately capitalized," "undercapitalized," "significantly
undercapitalized" and "critically undercapitalized". Under the final rules
adopted by the Federal banking regulators relating to these capital tiers, an
institution is deemed to be: well capitalized if the institution has a total
risk-based capital ratio of 10.0 percent or greater, a Tier 1 risk-based capital
ratio of 6.0 percent or greater, and a leverage ratio of 5.0 percent or greater,
and the institution is not subject to an order, written agreement, capital
directive, or prompt corrective action directive to meet and maintain a specific
capital level for any capital measure; adequately capitalized if the institution
has a total risk-based capital ratio of 8.0 percent or greater, a Tier 1
risk-based capital ratio of 4.0 percent or greater, and a leverage ratio of 4.0
percent or greater (or a leverage ratio of 3.0 percent for bank holding
companies which meet certain specified criteria, including having the highest
regulatory rating); undercapitalized if the institution has a total risk-based
capital ratio that is less than 8.0 percent, a Tier 1 risk-based capital ratio
less than 4.0 percent or a leverage ratio less than 4.0 percent (or a leverage
ratio less than 3.0 percent if the institution is rated composite 1 in its most
recent report of examination, subject to appropriate Federal banking agency
guidelines); significantly undercapitalized if the institution has a total
risk-based capital ratio less than 6.0 percent, a Tier 1 risk-based capital
ratio less than 3.0 percent, or a leverage ratio less than 3.0 percent; and
critically undercapitalized if the institution has a ratio of tangible equity to
total assets equal to or less than 2.0 percent.
At December 31, 1998, the two subsidiaries of Cullen/Frost that are insured
depository institutions -- Frost Bank and U.S. National Bank -- were considered
"well capitalized".
FDICIA generally prohibits a depository institution from making any capital
distributions (including payment of a dividend) or paying any management fee to
its holding company if the depository institution would thereafter be
undercapitalized. Undercapitalized institutions are subject to growth
limitations and are required to submit a capital restoration plan. The agencies
may not accept such a plan without determining, among other things, that the
plan is based on realistic assumptions and is likely to succeed in restoring the
depository institution's capital. In addition, for a capital restoration plan to
be acceptable, the depository institution's parent holding company must
guarantee that the institution will comply with such capital restoration plan.
The aggregate liability of the parent holding company is limited to the lesser
of (i) an amount equal to 5 percent of the depository institution's total assets
at the time it became undercapitalized and (ii) the amount which is necessary
(or would have been necessary) to bring the institution into compliance with all
capital standards applicable with respect to such institution as of the time it
fails to comply with the plan. If a depository institution fails to submit an
acceptable plan, it is treated as if it is significantly undercapitalized.
"Significantly undercapitalized" depository institutions may be subject
to a number of requirements and restrictions, including orders to sell
sufficient voting stock to become "adequately capitalized,"
6
requirements to reduce total assets, and cessation of receipt of deposits from
correspondent banks. "Critically undercapitalized" institutions are subject to
the appointment of a receiver or conservator.
FDICIA also contains a variety of other provisions that affect the
operations of Cullen/Frost, including reporting requirements, regulatory
standards for real estate lending, "truth in savings" provisions, and the
requirement that a depository institution give 90 days prior notice to customers
and regulatory authorities before closing any branch. The Federal regulatory
agencies have issued standards establishing loan-to-value limitations on real
estate lending. These standards have not had a significant effect on
Cullen/Frost and are not expected to have a significant effect in the future.
Any loans by a bank holding company to any of its subsidiary banks are
subordinate in right of payment to deposits and to certain other indebtedness of
such subsidiary banks. In the event of a bank holding company's bankruptcy, any
commitment by the bank holding company to a federal bank regulatory agency to
maintain the capital of a subsidiary bank will be assumed by the bankruptcy
trustee and be entitled to a priority of payment.
DEPOSIT INSURANCE
Cullen/Frost's subsidiary banks are subject to FDIC deposit insurance
assessments and to certain other statutory and regulatory provisions applicable
to FDIC-insured depository institutions. The risk-based assessment system
imposes insurance premiums based upon a matrix that takes into account a bank's
capital level and supervisory rating.
A depository institution insured by the FDIC can be held liable for any
loss incurred by, or reasonably expected to be incurred by, the FDIC, in
connection with (i) the default of a commonly controlled FDIC-insured depository
institution or (ii) any assistance provided by the FDIC to a commonly
controlled, FDIC-insured depository institution in danger of default.
"Default" is defined generally as the appointment of a conservator or
receiver, and "in danger of default" is defined generally as the existence of
certain conditions indicating that a "default" is likely to occur in the
absence of regulatory assistance.
DEPOSITOR PREFERENCE
Deposits and certain claims for administrative expenses and employee
compensation against an insured depository institution are afforded priority
over other general unsecured claims against such an institution, including
federal funds and letters of credit, in the "liquidation or other resolution"
of such an institution by any receiver.
ACQUISITIONS
The BHC Act generally limits acquisitions by Cullen/Frost to commercial
banks and companies engaged in activities that the Federal Reserve Board has
determined to be so closely related to banking as to be a proper incident
thereto. Cullen/Frost's direct activities are generally limited to furnishing to
its subsidiaries services that qualify under the "closely related" and
"proper incident" tests. Prior Federal Reserve Board approval is required
under the BHC Act for new activities and acquisitions of most nonbanking
companies.
The BHC Act, the Federal Bank Merger Act, and the Texas Banking Code
regulate the acquisition of commercial banks. The BHC Act requires the prior
approval of the Federal Reserve Board for the direct or indirect acquisition of
more than five percent of the voting shares of a commercial bank or bank holding
company. With respect to Cullen/Frost's subsidiary banks, the approval of the
Comptroller of the Currency is required for branching, purchasing the assets of
other banks and bank mergers in which the continuing bank is a national bank.
In reviewing bank acquisition and merger applications, the bank regulatory
authorities will consider, among other things, the competitive effect and public
benefits of the transactions, the capital position of the combined organization,
and the applicant's record under the Community Reinvestment Act and fair housing
laws.
7
The Corporation regularly evaluates acquisition opportunities and conducts
due diligence activities in connection with possible acquisitions. As a result,
acquisition discussions and, in some cases negotiations, regularly take place
and future acquisitions could occur.
INTERSTATE BANKING AND BRANCHING LEGISLATION
The Riegle-Neal Interstate Branching Efficiency Act of 1994 ("IBBEA"),
authorizes interstate acquisitions of banks and bank holding companies without
geographic limitation beginning one year after enactment. In addition, as of
June 1, 1997, IBBEA authorized a bank to merge with a bank in another state as
long as neither of the states has opted out of interstate branching between the
date of enactment of IBBEA and May 31, 1997. IBBEA further provided that states
may enact laws permitting interstate bank merger transactions prior to June 1,
1997. A bank may establish a de novo branch in a state in which the bank does
not maintain a branch if the state expressly permits de novo branching. Once a
bank has established branches in a state through an interstate merger
transaction, the bank may establish and acquire additional branches at any
location in the state where any bank involved in the merger transaction could
have established or acquired branches under applicable federal or state law. A
bank that has established a branch in a state through de novo branching may
establish and acquire additional branches in such state in the same manner and
to the same extent as a bank having a branch in such state as a result of an
interstate merger. If a state opts out of interstate branching within the
specified time period, no bank in any other state may establish a branch in the
opting out state, whether through an acquisition or de novo. On August 28, 1995,
Texas enacted legislation opting out of interstate branching; however in the
second quarter of 1998, the OCC approved a series of merger transactions
requested by a non-Texas based institution that ultimately resulted in the
merger of its Texas based bank into the non-Texas based institution. Although
challenged in the courts, the final legal ruling allowed the merger to proceed.
In addition, on May 13, 1998, the Texas Banking Commissioner began accepting
applications filed by state banks to engage in interstate mergers and branching.
REGULATORY ECONOMIC POLICIES
The earnings of the subsidiary banks are affected not only by general
economic conditions but also by the policies of various governmental regulatory
authorities. The Federal Reserve Board regulates the supply of credit in order
to influence general economic conditions, primarily through open market
operations in United States government obligations, varying the discount rate on
financial institution borrowings, varying reserve requirements against financial
institution deposits and restricting certain borrowings by such financial
institutions and their subsidiaries. The deregulation of interest rates has had
and is expected to continue to have an impact on the competitive environment in
which the subsidiary banks operate.
Governmental policies have had a significant effect on the operating
results of commercial banks in the past and are expected to continue to do so in
the future. However, Cullen/Frost cannot accurately predict the nature or extent
of any effect such policies may have on its future business and earnings.
EMPLOYEES
At December 31, 1998, Cullen/Frost employed 3,095 full-time equivalent
employees. Employees of Cullen/Frost enjoy a variety of employee benefit
programs, including a retirement plan, 401(k) stock purchase plans, various
comprehensive medical, accident and group life insurance plans and paid
vacations. Cullen/Frost considers its employee relations to be good.
8
EXECUTIVE OFFICERS OF THE REGISTRANT
The names, ages, recent business experience and positions or offices held
by each of the executive officers during 1998 of Cullen/Frost are as follows:
AGE AS OF
NAME AND POSITIONS OR OFFICES 12/31/98 RECENT BUSINESS EXPERIENCE
- ------------------------------------- --------- ------------------------------------------------------
T.C. Frost 71 Officer and Director of Frost Bank since 1950.
Senior Chairman of the Board Chairman of the Board of Cullen/Frost from 1973 to
and Director October 1995. Member of the Executive Committee of
Cullen/Frost 1973 to present. Chief Executive Officer
of Cullen/Frost from July 1977 to October 1997. Senior
Chairman of Cullen/Frost from October 1995 to present.
Richard W. Evans, Jr. 52 Officer of Frost Bank since 1973. Executive Vice
Chairman of the Board, President of Frost Bank from 1978 to April 1985.
Chief Executive Officer President of Frost Bank from April 1985 to August
and Director 1993. Chairman of the Board and Chief Executive
Officer of Frost Bank from August 1993 to present.
Director and Member of the Executive Committee of
Cullen/Frost from August 1993 to present. Chairman of
the Board and Chief Operating Officer of Cullen/Frost
from October 1995 to October 1997. Chairman of the
Board and Chief Executive Officer of Cullen/Frost from
October 1997 to present.
Patrick B. Frost 38 Officer of Frost Bank since 1985. President of Frost
President of Frost Bank Bank from August 1993 to present. Director of
and Director Cullen/Frost from May 1997 to present. Member of the
Executive Committee of Cullen/Frost from July 1997 to
present.
Phillip D. Green 44 Officer of Frost Bank since July 1980. Vice President
Senior Executive Vice President and Controller of Frost Bank from January 1981 to
and Chief Financial Officer January 1983. Senior Vice President and Controller of
Frost Bank from January 1983 to July 1985. Senior Vice
President and Treasurer of Cullen/Frost from July 1985
to April 1989. Executive Vice President and Treasurer
of Cullen/Frost from May 1989 to October 1995.
Executive Vice President and Chief Financial Officer
of Cullen/Frost from October 1995 to July 1998. Senior
Executive Vice President and Chief Financial Officer
from July 1998 to present.
Diane Jack, age 50, has been an officer of Frost Bank since 1984 and Secretary
of Cullen/Frost from October 1993 to present.
There are no arrangements or understandings between any executive officer of
Cullen/Frost and any other person pursuant to which he was or is to be selected
as an officer.
9
ITEM 2. PROPERTIES
The executive offices of Cullen/Frost, as well as the principal banking
quarters of Frost Bank, are housed in both a 21-story office tower and a
nine-story office building located on approximately 3.5 acres of land in
downtown San Antonio. Cullen/Frost and Frost Bank lease approximately 50 percent
of the office tower. The nine-story office building was purchased in April 1994.
Frost Bank also leases space in a seven-story parking garage adjacent to the
banking quarters. In June 1987, Frost Bank consummated the sale of its office
tower and leased back a portion of the premises under a 13-year primary lease
term with options allowing for occupancy up to 50 years. The Bank also sold its
related parking garage facility and leased back space in that structure under a
12-year primary lease term with options allowing for occupancy up to 50 years.
Both leases allow for purchase of the related asset under specific terms.
The subsidiary bank located in Galveston is housed in facilities which,
together with tracts of adjacent land used for parking and drive-in facilities,
are either owned or leased by the subsidiary bank.
ITEM 3. LEGAL PROCEEDINGS
Certain subsidiaries of Cullen/Frost are defendants in various matters of
litigation which have arisen in the normal course of conducting a commercial
banking business. In the opinion of management, the disposition of such pending
litigation will not have a material effect on Cullen/Frost's consolidated
financial position.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None.
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON STOCK AND RELATED STOCKHOLDER MATTERS
COMMON STOCK MARKET PRICES AND DIVIDENDS
The table below sets forth for each quarter the high and low sales prices
for Cullen/Frost's common stock and the dividends per share paid for each
quarter. The Company's common stock began trading on The New York Stock Exchange
("NYSE") on August 14, 1997 under the symbol: CFR. Therefore high and low
sales prices for the period August 14, 1997 through December 31, 1998 are as
reported by the NYSE. For the period January 1, 1997 through August 13, 1997
prices are as reported through the NASDAQ National Market System. Prices quoted
on the NASDAQ National Market System reflect inter-dealer prices, without retail
mark-up, mark-down or commissions and represent actual transactions.
1998 1997
-------------------- --------------------
MARKET PRICE (per share) HIGH LOW High Low
- ----------------------------------------------------------------------------
First Quarter................... $ 61.19 $ 50.75 $ 38.63 $ 32.63
Second Quarter.................. 60.69 49.50 43.25 33.75
Third Quarter................... 58.00 40.88 48.00 40.38
Fourth Quarter.................. 56.94 43.63 62.75 47.44
The number of record holders of common stock at February 19, 1999 was 2,647.
CASH DIVIDENDS (per share) 1998 1997
- -----------------------------------------------------------
First Quarter........................ $ .25 $ .21
Second Quarter....................... .30 .25
Third Quarter........................ .30 .25
Fourth Quarter....................... .30 .25
--------------------
Total........................... $ 1.15 $ .96
====================
The Corporation's management is committed to the continuation of the
payment of regular cash dividends, however there is no assurance as to future
dividends because they are dependent on future earnings, capital requirements
and financial conditions. See "Capital" section on page 30 in Item 7 for
further discussion and Note K "Dividends" on page 46.
10
ITEM 6. SELECTED FINANCIAL DATA
CONSOLIDATED STATEMENTS OF OPERATIONS
(dollars in thousands, except per share amounts)
Year Ended December 31
----------------------------------------------------------------
1998 1997 1996 1995 1994 1993
- -------------------------------------------------------------------------------------------------------
INTEREST INCOME:
Loans, including fees............ $ 300,721 $ 261,607 $ 219,279 $ 180,696 $ 125,571 $ 104,391
Securities....................... 120,259 110,070 112,921 109,593 104,986 103,600
Federal funds sold and securities
purchased
under resale agreements........ 7,111 12,423 7,506 7,154 4,337 8,157
----------------------------------------------------------------
TOTAL INTEREST INCOME....... 428,091 384,100 339,706 297,443 234,894 216,148
INTEREST EXPENSE:
Deposits......................... 138,283 131,140 117,179 100,785 69,154 64,457
Federal funds purchased and
securities sold
under repurchase agreements.... 11,606 8,739 9,773 15,347 8,336 5,284
Guaranteed preferred beneficial
interests in the
Corporation's junior
subordinated deferrable
interest debentures............ 8,475 7,652
Long-term notes payable.......... 380
Other borrowings................. 1,754 1,434 1,037 739 8 47
----------------------------------------------------------------
TOTAL INTEREST EXPENSE...... 160,118 148,965 127,989 116,871 77,498 70,168
----------------------------------------------------------------
NET INTEREST INCOME......... 267,973 235,135 211,717 180,572 157,396 145,980
Provision (credit) for possible loan
losses............................. 10,393 9,174 8,494 7,605 473 (5,851)
----------------------------------------------------------------
NET INTEREST INCOME AFTER
PROVISION (CREDIT) FOR
POSSIBLE LOAN LOSSES...... 257,580 225,961 203,223 172,967 156,923 151,831
NON-INTEREST INCOME:
Trust fees....................... 46,863 43,275 36,898 34,342 31,767 28,149
Service charges on deposit
accounts....................... 53,601 47,627 41,570 33,364 30,848 30,326
Other service charges, collection
and exchange charges, commissions
and fees....................... 15,482 11,349 9,199 11,456 9,668 7,972
Net gain (loss) on securities
transactions................... 359 498 (892) (1,382) (4,767) 1,503
Other............................ 22,361 18,953 17,403 18,241 15,628 14,273
----------------------------------------------------------------
TOTAL NON-INTEREST INCOME... 138,666 121,702 104,178 96,021 83,144 82,223
NON-INTEREST EXPENSE:
Salaries and wages............... 111,423 98,874 85,646 70,104 62,412 60,672
Pension and other employee
benefits....................... 21,295 19,874 18,224 13,313 11,720 13,417
Net occupancy of banking
premises....................... 25,486 22,812 21,486 20,238 17,779 22,109
Furniture and equipment.......... 18,921 16,147 14,697 13,276 12,631 11,467
Merger related charges........... 12,244
Restructuring costs.............. 400 830 10,285
Intangible amortization.......... 13,293 11,920 11,306 8,124 7,627 6,877
Other............................ 75,844 65,514 58,695 61,933 63,189 63,268
----------------------------------------------------------------
TOTAL NON-INTEREST
EXPENSE................... 278,506 235,141 210,054 187,388 176,188 188,095
----------------------------------------------------------------
INCOME BEFORE INCOME TAXES
AND
CUMULATIVE EFFECT OF
ACCOUNTING CHANGE......... 117,740 112,522 97,347 81,600 63,879 45,959
Income taxes......................... 42,095 39,555 34,409 28,213 22,100 1,788
----------------------------------------------------------------
Income before cumulative effect of
accounting change.................. 75,645 72,967 62,938 53,387 41,779 44,171
Cumulative effect of change in
accounting for income taxes........ 8,439
----------------------------------------------------------------
NET INCOME.................. $ 75,645 $ 72,967 $ 62,938 $ 53,387 $ 41,779 $ 52,610
================================================================
Net income per common share:
Basic............................ $ 2.85 $ 2.75 $ 2.37 $ 2.01 $ 1.58 $ 2.02
Diluted.......................... 2.77 2.67 2.31 1.98 1.56 1.98
Return on Average Assets............. 1.18% 1.28% 1.23% 1.20% 1.02% 1.33%
Return on Average Equity............. 15.44 16.38 15.63 14.84 13.17 19.16
Historical amounts have been restated to reflect the merger with Overton
Bancshares, Inc.
11
SELECTED FINANCIAL DATA
(dollars in thousands, except per share amounts)
Year Ended December 31
----------------------------------------------------------------------------
1998 1997 1996 1995 1994 1993
----------------------------------------------------------------------------
BALANCE SHEET DATA
Total assets..................... $ 6,869,605 $ 6,045,573 $ 5,599,248 $ 4,774,750 $ 4,260,076 $ 4,072,763
Guaranteed preferred beneficial
interest in the Corporation's
junior subordinated deferrable
interest debentures, net....... 98,458 98,403
Shareholders' equity............. 512,919 462,929 424,786 382,003 326,569 301,594
Average shareholders' equity to
average total assets........... 7.63% 7.83% 7.87% 8.10% 7.76% 6.96%
Tier 1 risk based capital
ratio.......................... 12.23 13.21 11.39 12.73 14.17 14.13
Total risk based capital ratio... 13.48 14.46 12.64 13.98 15.42 15.38
PER COMMON SHARE DATA
Net income-basic................. $ 2.85** $ 2.75 $ 2.37 $ 2.01 $ 1.58 $ 2.02*
Net income-diluted............... 2.77** 2.67 2.31 1.98 1.56 1.98*
Cash dividends paid-CFR.......... 1.15 .96 .81 .57 .34 .08
Shareholders' equity............. 19.20 17.49 15.92 14.35 12.34 11.50
LOAN PERFORMANCE INDICATORS
Non-performing assets............ $ 17,104 $ 18,088 $ 14,069 $ 18,681 $ 22,114 $ 33,834
Non-performing assets to:
Total loans plus foreclosed
assets.................... .47% .58% .53% .87% 1.27% 2.36%
Total assets................ .25 .30 .25 .39 .52 .83
Allowance for possible loan
losses......................... $ 53,616 $ 48,073 $ 42,821 $ 36,525 $ 29,017 $ 29,073
Allowance for possible loan
losses
to period-end loans............ 1.47% 1.54% 1.60% 1.71% 1.67% 2.04%
Net loan charge-offs
(recoveries)................... $ 6,100 $ 6,027 $ 2,825 $ 527 $ (1,894) $ (469)
Net loan charge-offs (recoveries)
to
average loans.................. .18% .21% .12% .03% (.12)% (.04)%
COMMON STOCK DATA
Common shares outstanding at
period end..................... 26,713 26,470 26,682 26,612 26,459 26,221
Weighted average common shares... 26,575 26,499 26,597 26,522 26,329 26,045
Dilutive effect of stock
options........................ 765 876 629 473 433 560
Dividends as a percentage of net
income***...................... 35.79% 30.50% 29.80% 24.47% 18.29% 3.35%
NON-FINANCIAL DATA
Number of employees.............. 3,095 3,045 2,743 2,399 2,198 2,137
Shareholders of record........... 2,624 2,358 2,336 2,463 2,553 2,644
*1993 basic and diluted earnings per share before cumulative effect of an
accounting change were $1.70 and $1.66, respectively.
**1998 basic and diluted earnings per share before the after-tax merger related
charge were $3.20 and $3.11, respectively.
***Includes dividends paid by Overton and excludes the after-tax impact of the
$12.2 million merger related charge in 1998.
12
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
FINANCIAL REVIEW
Discussed below are the operating results for Cullen/Frost Bankers, Inc.
and Subsidiaries ("Cullen / Frost" or the "Corporation") for the years 1996
through 1998. During the second quarter of 1998, the Corporation completed the
merger with Overton Bancshares, Inc., as discussed below. The merger was
accounted for as a "pooling of interests" transaction and as such, historical
amounts have been restated to reflect the merger. In addition, as described
below, the Corporation completed acquisitions during the first quarter of 1998
and 1997 and two during the first quarter of 1996. These acquisitions were all
accounted for as purchase transactions and as such their results of operations
are included from the date of acquisition.
All balance sheet amounts presented in the following financial review are
averages unless otherwise indicated. Certain reclassifications have been made to
make prior periods comparable. Taxable-equivalent adjustments assume a 35
percent federal tax rate. Dollar amounts in tables are stated in thousands,
except for per share amounts.
MERGER AND ACQUISITIONS
On May 29, 1998, the Corporation completed the merger of Overton
Bancshares, Inc., ("Overton") in Fort Worth, Texas, and its wholly-owned
subsidiary Overton Bank & Trust, N.A. The merger was the Corporation's first
entry into the Fort Worth market. With the merger, the Corporation had twelve
locations in Fort Worth/Arlington and two in Dallas. The Corporation issued
approximately 4.38 million common shares as part of this transaction. As a
result of the transaction, the Corporation recorded a merger related charge of
$12.2 million primarily consisting of severance payments and other employee
benefits, and investment banking fees. In addition, shortly after the merger was
consummated the Corporation reclassified approximately $116 million of held to
maturity securities of Overton to available for sale securities.
On January 2, 1998, the Corporation paid approximately $55.3 million to
acquire Harrisburg Bancshares, Inc., including its subsidiary Harrisburg Bank in
Houston, Texas. The Corporation acquired loans of approximately $125 million and
deposits of approximately $222 million. Total intangibles associated with the
acquisition amounted to approximately $34.2 million. This acquisition did not
have a material impact on the Corporation's 1998 net income.
On March 7, 1997, the Corporation paid approximately $32.2 million to
acquire Corpus Christi Bancshares, Inc., including its subsidiary Citizens State
Bank, based in Corpus Christi, Texas. Total intangibles associated with the
acquisition were approximately $20.9 million. The Corporation acquired loans of
approximately $108 million and deposits of approximately $184 million. This
acquisition did not have a material impact on the Corporation's 1997 net income.
On January 5, 1996, the Corporation paid approximately $17.7 million to
acquire S.B.T. Bancshares, Inc., including its subsidiary, State Bank and Trust
Company in San Marcos, Texas. The Corporation acquired deposits of approximately
$112 million. Total intangibles associated with the acquisition were
approximately $11.0 million. On February 15, 1996, the Corporation paid
approximately $33.5 million to acquire Park National Bank in Houston, Texas. The
Corporation acquired deposits of approximately $225 million. Total intangibles
associated with the acquisition were $16.0 million. These acquisitions did not
have a material impact on the Corporation's 1996 net income.
RESULTS OF OPERATIONS
For the year ended December 31, 1998, the Corporation reported net income
of $75.6 million or $2.77 per diluted common share, an all-time high. Operating
earnings for the year ended December 31, 1998 were $85.2 million or $3.11 per
diluted common share. Operating earnings exclude the after-tax impact of the
merger related charge of $12.2 million associated with the merger of Overton.
Net income for 1997 was $73.0 million or $2.67 per diluted common share,
compared with $62.9 million or $2.31 per diluted
13
common share for 1996. The Corporation's return on average assets for 1998 was
1.18 percent compared with 1.28 percent in 1997 and 1.23 percent in 1996, while
return on average equity was 15.44 percent in 1998 compared with 16.38 percent
in 1997 and 15.63 percent in 1996. Operating return on average assets and
average equity for 1998 were 1.33 percent and 17.38 percent, respectively.
1998 Change 1997 Change
EARNINGS SUMMARY 1998 From 1997 1997 From 1996 1996
- -----------------------------------------------------------------------------------------------------------
Taxable-equivalent net interest
income............................. $ 270,772 $33,687 $ 237,085 $ 24,096 $ 212,989
Taxable-equivalent adjustment........ 2,799 849 1,950 678 1,272
--------------------------------------------------------------------
Net interest income.................. 267,973 32,838 235,135 23,418 211,717
Provision for possible loan losses... 10,393 1,219 9,174 680 8,494
Non-interest income:
Net gain (loss) on securities
transactions.................. 359 (139) 498 1,390 (892)
Other........................... 138,307 17,103 121,204 16,134 105,070
--------------------------------------------------------------------
Total non-interest
income.................. 138,666 16,964 121,702 17,524 104,178
Non-interest expense:
Intangible amortization......... 13,293 1,373 11,920 614 11,306
Merger related charge........... 12,244 12,244
Other operating expenses........ 252,969 29,748 223,221 24,473 198,748
--------------------------------------------------------------------
Total non-interest
expense................. 278,506 43,365 235,141 25,087 210,054
--------------------------------------------------------------------
Income before income taxes........... 117,740 5,218 112,522 15,175 97,347
Income taxes......................... 42,095 2,540 39,555 5,146 34,409
--------------------------------------------------------------------
Net income........................... $ 75,645 $ 2,678 $ 72,967 $ 10,029 $ 62,938
====================================================================
Per common share:
Net income-basic................ $ 2.85* $ .10 $ 2.75 $ .38 $ 2.37
Net income-diluted.............. 2.77* .10 2.67 .36 2.31
Return on Average Assets............. 1.18%* (.10)% 1.28% .05% 1.23%
Return on Average Equity............. 15.44* (.94) 16.38 .75 15.63
* Operating basic and diluted earnings per share for 1998 were $3.20 and $3.11,
respectively. Operating ROA and ROE for 1998 were 1.33 percent and 17.38
percent, respectively.
RESULTS OF SEGMENT OPERATIONS
The Corporation's operations are managed along two major Operating
Segments: Banking and the Financial Management Group. A description of each
business and the methodologies used to measure financial performance are
described in Note V to the Consolidated Financial Statements on page 57. The
following table summarizes operating earnings and net income by Operating
Segment for each of the last three years:
YEAR ENDED DECEMBER 31
-------------------------------
(dollars in thousands) 1998 1997 1996
- ----------------------------------------------------------------------
Banking.............................. $ 78,826 $ 68,312 $ 57,801
Financial Management Group........... 14,497 12,878 9,244
Non-Banks............................ (8,167) (8,223) (4,107)
-------------------------------
Consolidated operating earnings...... $ 85,156* $ 72,967 62,938
Consolidated net income.............. $ 75,645 $ 72,967 $ 62,938
===============================
* Excludes the after-tax impact of the $12.2 million Overton merger related
charge. See discussion on page 13.
The increase in Banking net income in both 1998 and 1997 was due primarily
to loan growth and higher service charge income coupled with the impact of the
acquisitions of Corpus Christi Bancshares, Inc. and Harrisburg Bancshares, Inc.
14
The increase in the Financial Management Group net income in both years was
due mainly to the appreciation in market value of Trust assets, new accounts and
the acquisition of Corpus Christi Bancshares, Inc.
The increase in the operating loss in Non-Banks during 1997 reflects
partially increased funding costs due to the issuance of the Trust Preferred
Capital Securities.
NET INTEREST INCOME
Net interest income on a taxable equivalent basis for 1998 was $270.8
million, an increase from $237.1 million recorded in 1997 and the $213.0 million
recorded in 1996. The primary reason for the yearly increase has been the
consistent growth in loans generated both internally and through acquisitions.
See "Consolidated Average Balance Sheets" on pages 60 and 61 and "Rate Volume
Analysis" on page 62. The net interest margin, was 4.93 percent for the year
ended December 31, 1998, compared to 4.87 percent and 4.91 percent for the years
1997 and 1996, respectively. The increase in the net interest margin from a year
ago is due to higher loan volumes and lower deposit costs. The slight decrease
in the net interest margin in 1997 from 1996 is reflective of higher deposit
costs and interest expense related to the $100 million Trust Preferred Capital
Securities issued in early 1997, see Note I "Borrowed Funds" on Page 44. Net
interest spread for 1998 increased five basis points to 4.04 percent. The
increase in net interest spread for 1998 is primarily due to the Corporation's
ability to maintain its earnings on funds with higher loan volumes and the
favorable impact of the acquisitions, while deposit costs decreased. Net
interest spread was 3.99 percent and 4.10 percent for 1997 and 1996,
respectively. The decrease in net interest spread for 1997 is largely the result
of the issuance of the $100 million Trust Preferred Capital Securities.
The net interest spread as well as the net interest margin could be
impacted by future changes in short-and long-term interest rate levels.
MARKET RISK DISCLOSURE -- INTEREST RATE SENSITIVITY
Market risk is the potential loss arising from adverse changes in the fair
value of a financial instrument due to the changes in market rates and prices.
In the ordinary course of business, the Corporation's market risk is primarily
that of interest rate risk. The Corporation's interest rate sensitivity and
liquidity are monitored by its Asset/Liability Management Committee on an
ongoing basis. The Committee seeks to avoid fluctuating net interest margins and
to maintain consistent growth of net interest income through periods of changing
interest rates. A variety of measures are used to provide for a comprehensive
view of the magnitude of interest rate risk, the distribution of risk, level of
risk over time and exposure to changes in certain interest rate relationships.
The Corporation utilizes an earnings simulation model as the primary
quantitative tool in measuring the amount of interest rate risk associated with
changing market rates. The model quantifies the effects of various interest rate
scenarios on the projected net interest income and net income over the ensuing
12 month period. The model was used to measure the impact on net interest income
relative to a base case scenario, of rates increasing or decreasing ratably 200
basis points over the next 12 months. These simulations incorporate assumptions
regarding balance sheet growth and mix, pricing and the repricing and maturity
characteristics of the existing and projected balance sheet. All off-balance
sheet financial instruments such as derivatives are included in the model. Other
interest rate-related risks such as prepayment, basis and option risk are also
considered. The resulting model simulations show that a 200 basis point increase
in rates will result in a positive variance in net interest income of 0.7
percent relative to the base case over the next 12 months, while a decrease of
200 basis points will result in a negative variance in net interest income of
0.7 percent. This compares to last year when a 200 basis points increase in
rates resulted in a positive variance in net interest income of 1.3 percent
relative to the base case over the next 12 months while a decrease of 200 basis
points resulted in a negative variance in net interest income of 1.7 percent.
The Corporation's trading portfolio is immaterial and as such separate
quantitative disclosure is not presented.
15
As the table below indicates, the Corporation is liability-sensitive, on a
cumulative basis, at time periods of one year or less (assuming non-maturity
deposits are immediately rate sensitive). This gap analysis is based on a point
in time and may not be meaningful because assets and liabilities must be
categorized according to contractual maturities and repricing periods rather
than estimating more realistic behaviors as is done in the sensitivity model
discussed above. Also, the gap analysis does not consider subsequent changes in
interest rate levels or spreads between asset and liability categories.
The Corporation continuously monitors and manages the balance between
interest rate-sensitive assets and liabilities. The Corporation's objective is
to manage the impact of fluctuating market rates on net interest income within
acceptable levels. In order to meet this objective, the Corporation may lengthen
or shorten the duration of assets or liabilities or enter into derivative
contracts to mitigate potential market risk.
December 31, 1998
-------------------------------------------------------------------------------
Non-Rate
Immediately Sensitive
Rate Sensitive Rate Sensitive Within ----------
CUMULATIVE INTEREST RATE SENSITIVITY --------------- ---------------------------------- > Five
(PERIOD-END BALANCE) 0-30 Days 90 Days One Year Five Years Years Total
- -------------------------------------------------------------------------------------------------------------------------
Earning Assets:
Loans............................... $ 1,831,516 $2,030,435 $2,572,529 $3,358,681 $ 287,922 $ 3,646,603
Securities.......................... 184,938 406,592 933,595 1,550,298 541,405 2,091,703
Federal funds....................... 102,900 102,900 102,900 102,900 102,900
-------------------------------------------------------------------------------
Total earning assets........... $ 2,119,354 $2,539,927 $3,609,024 $5,011,879 $ 829,327 $ 5,841,206
===============================================================================
Interest-Bearing Liabilities:
Savings and Interest-on-Checking.... $ 961,597 $ 961,597 $ 961,597 $ 961,597 $ 961,597
Money market deposit accounts....... 1,493,778 1,493,778 1,493,778 1,493,778 1,493,778
Certificates of deposit and other
time accounts..................... 272,005 646,548 1,295,565 1,375,498 $171,115 1,546,613
Federal funds purchased and other
borrowings........................ 318,859 318,859 318,859 318,859 98,458 417,317
-------------------------------------------------------------------------------
Total interest-bearing
liabilities.................. $ 3,046,239 $3,420,782 $4,069,799 $4,149,732 $ 269,573 $ 4,419,305
===============================================================================
Interest sensitivity gap................ $ (926,885) $ (880,855) $ (460,775) $ 862,147 $ 559,754 $ 1,421,901
===============================================================================
Ratio of earning assets to
interest-bearing liabilities.......... .70 .74 .89 1.21
====================================================
In developing the classifications used for this analysis, it was necessary to
make certain assumptions and approximations in assigning assets and liabilities
to different maturity categories. For example, savings and Interest-on-Checking
are subject to immediate withdrawal and as such are presented as repricing
within the earliest period presented even though their balances have
historically not shown significant sensitivity to changes in interest rates.
Loans are included net of unearned discount of $3,357,000. Consumer loans are
distributed in the immediately rate-sensitive category for those tied to market
rates or to other categories according to the repayment schedule.
The above table does not reflect interest rate swaps further discussed on page
27.
LIQUIDITY
Asset liquidity is provided by cash and assets which are readily marketable
or pledgeable or which will mature in the near future. Liquid assets include
cash, short-term time deposits in banks, securities available for sale,
maturities and cash flow from securities held to maturity, and Federal funds
sold and securities purchased under resale agreements.
Liability liquidity is provided by access to funding sources which include
core depositors and correspondent banks in the Corporation's natural trade area
which maintain accounts with and sell Federal funds to subsidiary banks of the
Corporation, as well as Federal funds purchased and securities sold under
repurchase agreements from upstream banks. The liquidity position of the
Corporation is continuously monitored and adjustments are made to the balance
between sources and uses of funds as deemed appropriate.
16
NON-INTEREST INCOME
Non-interest income of $138.7 million was reported for 1998, compared with
$121.7 million for 1997 and $104.2 million for 1996. Excluding securities
transactions, total non-interest income increased 14.1 percent from 1997. The
non-interest income growth in 1998 and 1997 was favorably impacted by the
acquisitions of Harrisburg Bancshares, Inc. and Corpus Christi Bancshares, Inc.
in the first quarter of 1998 and 1997, respectively.
Year Ended December 31
----------------------------------------------------------------------
1998 1997 1996
-------------------- -------------------- --------------------
PERCENT Percent Percent
NON-INTEREST INCOME AMOUNT CHANGE Amount Change Amount Change
- -------------------------------------------------------------------------------------------------------------
Trust fees........................... $ 46,863 + 8.3% $ 43,275 + 17.3% $ 36,898 + 7.4%
Service charges on deposit
accounts........................... 53,601 + 12.5 47,627 + 14.6 41,570 + 24.6
Other service charges, collection and
exchange charges, commissions and
fees............................... 15,482 + 36.4 11,349 + 23.4 9,199 - 19.7
Net gain (loss) on securities
transactions....................... 359 - 27.9 498 N/M (892) + 35.5
Other................................ 22,361 + 18.0 18,953 + 8.9 17,403 - 4.6
-------- -------- --------
Total........................... $138,666 + 13.9 $121,702 + 16.8 $104,178 + 8.5
======== ======== ========
Trust income was up $3.6 million or 8.3 percent during 1998. Trust fees
increased during 1998 as the market value of trust assets continued to grow
impacted by the market and the addition of new accounts. The volatility of
general market conditions experienced throughout 1998 did have some impact on
the overall level of growth in trust fees; however, some of the growth
experienced in other service charges and other non-interest income is
attributable to fees collected through financial management services, such as
mutual fund fees, brokerage commissions and annuity income. The market value of
trust assets increased to $11.7 billion from $10.8 billion last year. The
December 31, 1998 trust assets were comprised of discretionary assets of $5.4
billion and non-discretionary assets of $6.3 billion compared to $5.5 billion
and $5.3 billion last year, respectively. The $6.4 million or 17.3 percent
increase in trust income from 1996 to 1997 is attributable to the increase in
the number of accounts held and trust asset growth resulting from improvement in
the stock and bond market.
Deposit service charges increased $6.0 million or 12.5 percent from 1997.
The increase occurred as the result of some fee increases and broad based
deposit growth that generated increases in overdraft charges, cash management
fees on commercial and individual deposits, as well as increases in ATM income.
Deposit service charges increased $6.1 million or 14.6 percent from 1996. The
increase was due mainly to higher service charges related to commercial
deposits, volumes processed for correspondent banks and overdraft charges. Other
service charges and fees increased $4.1 million or 36.4 percent when compared to
1997. This increase was primarily due to higher fees in accounts receivable
factoring and mutual fund fees collected through financial management services.
The $2.2 million or 23.4 percent increase in other service charges from 1996 to
1997 was primarily due to the same factors mentioned above for the growth in
1998 offset by lower bankcard discounts resulting from the Corporation's
outsourcing of its bankcard processing operation which was completed in May
1996.
During 1998 and 1997, the Corporation sold portions of its available for
sale investment portfolio resulting in net gains of $359,000 and $498,000,
respectively. This compares to an $892,000 loss in 1996 which resulted primarily
from the Corporation restructuring a portion of its available for sale
investment portfolio by replacing lower-yielding securities with higher-yielding
securities.
Other non-interest income increased $3.4 million or 18.0 percent to $22.4
million in 1998 compared to an 8.9 percent increase in 1997. The increase in
1998 is primarily due to growth in VISA check card income, gains on the sale of
student and mortgage loans and gains on the disposition of foreclosed assets.
17
The increase in 1997 from 1996 was primarily due to gains recorded on the sale
of student loans, mineral interest income and VISA check card income. These
increases were offset by higher gains on the disposition of certain loans and
foreclosed assets recorded by the Corporation in 1996.
NON-INTEREST EXPENSE
Excluding the merger-related charge of $12.2 million during the second
quarter of 1998 which was associated with the merger of Overton, non-interest
expense was $266.3 million for 1998 compared with $235.1 million for 1997 and
$210.1 million for 1996. The acquisitions of Harrisburg Bancshares, Inc. and
Corpus Christi Bancshares, Inc. in the first quarter of 1998 and 1997,
respectively, impacted the growth in non-interest expense.
Year Ended December 31
--------------------------------------------------------------------
1998 1997 1996
-------------------- -------------------- --------------------
PERCENT Percent Percent
NON-INTEREST EXPENSE AMOUNT CHANGE Amount Change Amount Change
- ------------------------------------------------------------------------------------------------------------
Salaries and wages................... $111,423 +12.7% $ 98,874 +15.4% $ 85,646 +22.2%
Pension and other employee
benefits........................... 21,295 + 7.2 19,874 + 9.1 18,224 +36.9
Net occupancy of banking premises.... 25,486 +11.7 22,812 + 6.2 21,486 + 6.2
Furniture and equipment.............. 18,921 +17.2 16,147 + 9.9 14,697 +10.7
Intangible amortization.............. 13,293 +11.5 11,920 + 5.4 11,306 +39.2
Merger related charge................ 12,244
Other................................ 75,844 +15.8 65,514 +11.6 58,695 - 5.8
-------- -------- --------
Total........................... $278,506 +18.4 $235,141 +11.9 $210,054 +12.1
======== ======== ========
Salaries and wages increased by $12.5 million in 1998 and $13.2 million in
1997 or 12.7 percent and 15.4 percent, respectively. Salaries and wages in both
years have experienced increases related to acquisitions and merit increases.
Pension and other employee benefits increased by $1.4 million or 7.2 percent
during 1998 as a result of retirement plan expense and the impact of the
acquisition on payroll taxes and medical insurance. The $1.7 million or 9.1
percent increase in pension and other employee benefits from 1996 to 1997 was
primarily due to the impact of the 1997 acquisition on payroll taxes and medical
insurance expense offset by lower contributions to fund the employer match on
the employee related stock plans due to the use of forfeited shares.
Net occupancy of banking premises increased $2.7 million or 11.7 percent
during 1998 primarily attributable to higher property taxes, depreciation and
lease expense as influenced by the acquisition and de novo branches opened late
in 1997 and 1998. The 6.2 percent increase in 1997 compared to 1996 was higher
building maintenance costs, property taxes and operating expenses, partially
offset by higher tenant income. Furniture and equipment costs increased $2.8
million or 17.2 percent in 1998 primarily due to the continued expansion of the
Corporation, as well as, technology initiatives and upgrades. Intangible
amortization increased by $1.4 million or 11.5 percent and by $614,000 or 5.4
percent in 1998 and 1997, respectively, due to the acquisitions.
Also included in 1998 was a $12.2 million merger related charge associated
with the merger of Overton. Of the $12.2 million charge, the majority was
related to severance payments and other employee benefits, and investment
banking fees.
Other non-interest expense increased $10.3 million or 15.8 percent during
1998 as a result of outside computer services related to the Year 2000
compliance program, see "Year 2000" on page 19, as well as, an increase in the
volume of VISA check cards issued after its initial introduction in late 1997.
Other non-interest expense was up 11.6 percent in 1997 mostly due to expenses
related to the Year 2000 compliance program and higher operating expenses, such
as, sales promotion, guard services, supplies, travel and telephone, which also
were impacted by the acquisitions.
18
YEAR 2000
The Corporation has an extensive program in place to address the internal
and external risks associated with the century date change to the Year 2000.
Currently, the Corporation estimates that the dollar amount to be spent on
incremental costs will be approximately $4.6 million over the three year period
beginning in 1997, funded out of its earnings, with approximately $3.6 million
spent through 1998. These costs are being expensed as incurred. Additionally,
the Corporation is spending about 30 percent of its annual technology budget to
facilitate progress on the Year 2000 program. The cost of compliance and
completion dates is based upon management's best estimates, which were derived
utilizing assumptions of future events, including the continued availability of
resources.
The Corporation has systematically inventoried and assessed the importance
of application software and system hardware and software during the now
completed awareness and assessment phase of its information technology. The
Corporation has also completed the renovation of mission critical systems and
has implemented 99 percent of the renovated mission critical systems. The
Corporation has completed the renovation, testing and installation of 99 percent
of technology systems in its owned facilities, including vault doors, elevators,
climate control systems, and security systems. In addition, the Corporation has
completed 98 percent of the testing of mission critical systems. The Corporation
expects to be completed with the non-mission critical applications by the second
quarter of 1999. The Corporation has commenced, and will continue into 1999,
integration testing to assure that logically related systems can interact and
process information correctly.
During 1998, the Corporation reviewed the Year 2000 preparedness of its
vendors and suppliers, and recently completed on-site due diligence visits with
key service providers. The great majority of these suppliers appear to be making
adequate progress. The Corporation will continue to monitor vendor and supplier
progress and develop contingency plans where necessary and feasible. The
Corporation is testing for key dates in the new century with critical third
party service providers, although it may be necessary to rely on proxy testing
in some cases. The majority of this work is expected to be done in the first
half of 1999. The Corporation will make available testing documentation, known
as proxy tests, to clients utilizing certain products and services. The
Corporation also relies on entities such as the Federal Reserve System,
Depository Trust Company, Participants Trust Company, Society for Worldwide
Interbank Financial Telecommunications (SWIFT), and the Clearing House Interbank
Payment Systems (CHIPS) in its securities processing and banking businesses, as
do other financial services providers in similar businesses. Testing of data
exchanges with organizations such as these is underway and is expected to be
completed during by the second quarter of 1999.
Although the Corporation is attempting to monitor and validate the efforts
of other parties, it cannot control the success of these efforts. The
Corporation is developing contingency plans where practical to provide
alternatives in situations where a third party furnishing a critical product or
service experiences significant Year 2000 issues. The Corporation is also
updating existing business continuity plans for the date change. This process is
well underway and will continue through the third quarter, 1999, as plans are
reviewed and validated.
As part of its credit analysis process, the Corporation has developed a
project plan for assessing the Year 2000 readiness of its significant credit
customers. An initial assessment of Year 2000 readiness has been completed for
the customers who have responded to the Corporation's inquiries about their
progress, which make up the majority of its credit customers and represent most
of its credit exposure. The Corporation will continue to monitor the progress of
these customers.
The Financial Management Group's (FMG) mission critical systems, such as
the trust and brokerage accounting and trading systems, are and have been
included in the Corporation's evaluation and testing of systems. FMG is also
updating current contingency plans to include possible Year 2000 circumstances.
In addition to the systems aspect, the FMG recognizes that there could be other
types of risks and is in the process of reviewing the managed assets comprising
the investment portfolios of FMG clients. The review process includes obtaining
public information provided by companies/issuers to regulatory bodies, such as
19
the Securities and Exchange Commission. Other public information that may be
relied upon for evaluating a company's/issuer's Year 2000 readiness are
analysts' reports and/or official statements from companies/issuers.
Although the FMG is attempting to review and monitor the efforts of other
parties, it cannot warrant the facts, circumstances, or the outcome of such
efforts. Where the Corporation does not serve in a fiduciary capacity for a
customer's assets it cannot provide any assurances on factors outside its
control such as the quality of assets, potential economic uncertainties and
other service providers. The Corporation also does not accept responsibility for
ensuring that its clients' own systems are Year 2000 compliant. In addition, the
Corporation does not guarantee that there will not be any disruptions on receipt
or disbursements of income. There may be disruptions that are beyond the control
of the Corporation. An example of this would be if an issuer/company or its
paying agent does not pay income as scheduled.
The Corporation's program is regularly reviewed by examiners from various
external agencies such as the Comptroller of the Currency and the Federal
Reserve Bank.
The Corporation expects to successfully complete its Year 2000 effort as
planned. However, it is subject to unique risks and uncertainties due to the
interdependencies in business and financial markets, and the numerous activities
and events outside of its control. Since the Corporation is still conducting
external testing and monitoring of third parties, it is unable to make
definitive assumptions as to the extent of Year 2000 failures that could result,
nor quantify the potential adverse effect that such failures could have on the
Corporation's operations, liquidity, and financial condition. Year 2000 risks
will be continually evaluated and contingency plans revised throughout 1999.
INCOME TAXES
The Corporation recognized income tax expense of $42.1 million in 1998,
compared to $39.6 million in 1997, and $34.4 million in 1996. The effective tax
rate in 1998 was 35.75 percent compared to 35.15 percent in 1997 and 35.35
percent in 1996. For a detailed analysis of the Corporation's income taxes see
Note O "Income Taxes" on page 52.
20
CASH EARNINGS
Historically, excluding the merger with Overton, the Corporation's
acquisitions have been accounted for using the purchase method of accounting
which results in the creation of intangible assets. These intangible assets are
deducted from capital in the determination of regulatory capital. Thus, "cash"
or "tangible" earnings represents the regulatory capital generated during the
year and can be viewed as net income excluding intangible amortization, net of
tax. While the definition of "cash" or "tangible" earnings may vary by
company, we believe this definition is appropriate as it measures the per share
growth of regulatory capital, which impacts the amount available for dividends
and acquisitions. The following table reconciles reported earnings to net income
excluding intangible amortization ("cash" earnings) for each of the three most
recent year periods:
Year Ended December 31
-----------------------------------------------------------------------------------
1998 1997
-------------------------------------- -----------------------------------------
REPORTED INTANGIBLE "CASH" Reported Intangible "Cash"
EARNINGS AMORTIZATION EARNINGS Earnings Amortization Earnings
- --------------------------------------------------------------------------------------------------------------------------
Income before income taxes........... $117,740 $ 13,293 $131,033 $112,522 $ 11,920 $124,442
Income taxes......................... 42,095 3,242 45,337 39,555 3,145 42,700
-----------------------------------------------------------------------------------
Net income........................... $ 75,645 $ 10,051 $ 85,696 $ 72,967 $ 8,775 $ 81,742
===================================================================================
Net income per diluted common
share(1)............................ $ 2.77 $ .36 $ 3.13 $ 2.67 $ .32 $ 2.99
Return on assets(1).................. 1.18 % 1.34 %* 1.28 % 1.44 %*
Return on equity(1).................. 15.44 17.49 ** 16.38 18.35 **
Year Ended December 31
----------------------------------
1996
----------------------------------
Reported Intangible "Cash"
Earnings Amortization Earnings
- ------------------------------------- -----------------------------------
Income before income taxes........... $97,347 $ 11,306 $108,653
Income taxes......................... 34,409 3,267 37,676
----------------------------------
Net income........................... $62,938 $ 8,039 $ 70,977
==================================
Net income per diluted common
share(1)............................ $ 2.31 $ .30 $ 2.61
Return on assets(1).................. 1.23% 1.39 %*
Return on equity(1).................. 15.63 17.63 **
(1) 1998 diluted operating earnings per share and diluted operating cash
earnings per share were $3.11 and $3.48, respectively. Operating cash ROA
and cash ROE for 1998 were 1.48 percent and 19.43 percent, respectively.
Operating earnings exclude the after-tax impact of the $12.2 million
merger related charge associated with the merger with Overton.
* CALCULATED AS A/B
** CALCULATED AS A/C
- -------------------
1998 1997 1996
--------- --------- ---------
(A) Net income before intangible
amortization (including goodwill
and core deposit intangibles, net
of tax).......................... $ 85,696 $ 81,742 $ 70,977
(B) Total average assets............. 6,417,569 5,687,577 5,113,495
(C) Average shareholders' equity..... 489,958 445,450 402,687
SOURCES AND USES OF FUNDS
Average assets for 1998 of $6.4 billion increased by 12.8 percent from 1997
levels and increased 11.2 percent between 1996 and 1997. Funding sources in 1998
reflected an increase in demand deposits and Federal funds purchased. The
Corporation's uses of funds continued a trend which started in 1995 of replacing
securities with loans as the largest component of earning assets. This reflects
the increases in loan volumes from a year ago.
Percentage of Total Average
-------------------------------
SOURCES AND USES OF FUNDS 1998 1997 1996
- ----------------------------------------------------------------------
Sources of Funds:
Deposits:
Demand..................... 25.4% 24.3% 24.0%
Time....................... 59.7 61.4 62.2
Federal funds purchased......... 3.9 3.3 4.0
Equity capital.................. 7.6 7.8 7.9
Borrowed funds.................. 2.0 2.0 0.4
Other liabilities............... 1.4 1.2 1.5
-------------------------------
Total...................... 100.0% 100.0% 100.0%
===============================
Uses of Funds:
Loans........................... 53.5% 51.3% 47.8%
Securities...................... 30.1 30.4 34.5
Federal funds sold.............. 2.0 4.0 2.8
Non-earning assets.............. 14.4 14.3 14.9
-------------------------------
Total...................... 100.0% 100.0% 100.0%
===============================
21
LOANS
Average loans for 1998 were $3.4 billion, an increase of 17.8 percent from
1997. This increase was driven by continued improved economic conditions in the
Texas markets the Corporation serves and the 1998 acquisition.
December 31
------------------------------------------------------------------------------------
1998
---------------------------
LOAN PORTFOLIO ANALYSIS PERCENTAGE OF
(PERIOD-END BALANCES) AMOUNT TOTAL LOANS 1997 1996 1995 1994
- ---------------------------------------------------------------------------------------------------------------------------
Real estate:
Construction.................... $ 292,789 8.0% $ 179,201 $ 125,054 $ 89,704 $ 65,742
Land............................ 75,397 2.1 60,339 53,742 40,005 39,383
Permanent Mortgages:
Commercial.................... 346,479 9.5 259,320 230,205 203,659 181,898
Residential................... 655,484 18.0 516,345 472,878 375,365 305,220
Other........................... 349,255 9.6 355,475 355,712 282,467 246,922
------------------------------------------------------------------------------------
Total real estate............... 1,719,404 47.2 1,370,680 1,237,591 991,200 839,165
Commercial and
industrial......................... 1,211,180 33.2 989,355 831,841 637,714 477,082
Consumer............................. 625,018 17.1 645,988 526,778 431,223 354,907
Financial institutions............... 7,416 .2 3,767 12,749 10,409 7,173
Foreign.............................. 45,187 1.2 72,911 45,562 43,847 45,290
Other................................ 41,755 1.2 37,388 20,891 22,380 17,906
Unearned discount.................... (3,357) (.1) (3,194) (2,098) (2,063) (3,958)
------------------------------------------------------------------------------------
Total........................... $ 3,646,603 100.0% $ 3,116,895 $ 2,673,314 $ 2,134,710 $ 1,737,565
====================================================================================
Percent change from previous year.... +17.0% +16.6% +25.2% +22.9% +20.9%
Period-end loans increased to $3.6 billion at year-end 1998, up 17.0
percent from the previous year-end. Most of the increase in period-end loans is
attributable to commercial and industrial loans and residential real estate
loans which increased $222 million and $139 million, respectively. Home equity
loans accounted for approximately 59 percent of the increase in residential real
estate loans. The increase in period-end loans was offset by a $21 million
decrease in consumer loans primarily related to a reduction in indirect lending.
Approximately 76 percent of the increase in loans from a year ago resulted from
internally generated growth.
Total real estate loans at December 31, 1998 were $1.7 billion, up 25.4
percent from year-end 1997. Amortizing permanent mortgages represented 58.3
percent of the total real estate loan portfolio at year end. Residential
mortgages increased $139 million or 26.9 percent. Real estate loans categorized
as "other" are primarily amortizing commercial and industrial loans with
maturities of less than five years. Approximately 58 percent of all commercial
real estate loans are owner occupied or have a major tenant (National or
Regional company), which historically has resulted in a lower risk, provides
financial stability and is less susceptible to economic swings. See page 25 for
further discussion for the loan portfolio and "Loan Maturity and Sensitivity"
on page 62.
MEXICAN LOANS
At December 31, 1998, the Corporation's cross-border outstandings to
Mexico, excluding $19.8 million in loans secured by liquid U.S. assets, totaled
$25.4 million, down from $48.6 million last year. The decrease from a year ago
represents normal fluctuations in lines of credit used by Mexican banks to
finance trade. Of the trade-related credits, approximately 65 percent are
related to companies exporting from Mexico. In addition, loans insured by the
Export Import Bank were made to Mexican businesses to
22
purchase goods of the United States. At December 31, 1998, 1997 and 1996, none
of the Mexican-related loans were on non-performing status.
December 31
---------------------------------------------------------------------
1998 1997
---------------------------------------------------------------------
PERCENTAGE PERCENTAGE Percentage Percentage
OF TOTAL OF TOTAL of Total of Total
MEXICAN LOANS AMOUNT LOANS ASSETS Amount Loans Assets
- ------------------------------------------------------------------------------------------------------------
Financial institutions............... $21,346 .6% .3% $35,563 1.2% .6%
Commercial and industrial............ 4,016 .1 .1 13,034 .4 .2
---------------------------------------------------------------------
Total................................ $25,362 .7% .4% $48,597 1.6% .8%
=====================================================================
December 31
---------------------------------
1996
---------------------------------
Percentage Percentage
of Total of Total
MEXICAN LOANS Amount Loans Assets
- ------------------------------------- ---------------------------------
Financial institutions............... $24,932 .9% .4%
Commercial and industrial............ 5,000 .2 .1
----------------------------------
Total................................ $29,932 1.1% .5%
==================================
The above table excludes $19,825,000, $24,314,000 and $15,630,000 in loans
secured by liquid assets held in the United States in 1998, 1997 and 1996,
respectively.
NON-PERFORMING ASSETS
Non-performing assets were $17.1 million at December 31, 1998, compared
with $18.1 million at December 31, 1997 and $14.1 million at December 31, 1996.
Non-performing assets as a percentage of total loans and foreclosed assets were
.47 percent at December 31, 1998, down from .58 percent one year ago.
December 31
-----------------------------------------------------
NON-PERFORMING ASSETS 1998 1997 1996 1995 1994
- --------------------------------------------------------------------------------------------
Non-accrual.......................... $ 12,997 $ 13,077 $ 10,733 $ 15,372 $ 17,316
Foreclosed assets.................... 4,107 5,011 3,336 3,309 4,798
-----------------------------------------------------
Total............................ $ 17,104 $ 18,088 $ 14,069 $ 18,681 $ 22,114
=====================================================
As a percentage of total assets...... .25% .30% .25% .39% .52%
As a percentage of total loans plus
foreclosed assets.................. .47 .58 .53 .87 1.27
After-tax impact of lost interest per
common share....................... $ .04 $ .04 $ .04 $ .05 $ .06
Accruing loans 90 days past due:
Consumer........................... $ 1,347 $ 3,410 $ 1,841 $ 1,294 $ 574
All other.......................... 9,434 3,412 4,108 4,378 3,070
-----------------------------------------------------
Total............................ $ 10,781 $ 6,822 $ 5,949 $ 5,672 $ 3,644
=====================================================
The Corporation did not have any restructured loans for the years ended December
31, 1998-1994.
Interest income that would have been recorded in 1998 on non-performing assets,
had such assets performed in accordance with their original contract terms, was
$1,262,000 on non-accrual loans and $392,000 on foreclosed assets. During 1998,
the amount of interest income actually recorded on non-accrual loans was
$742,000.
There were no foreign loans 90 days past due as of December 31, 1998.
Loans to a customer whose financial condition has deteriorated are
considered for non-accrual status whether or not the loan is 90 days or more
past due. All non-consumer loans 90 days or more past due are classified as
non-accrual unless the loan is well secured and in the process of collection.
When a loan is placed on non-accrual status, interest income is not recognized
until collected, and any previously accrued but uncollected interest is
reversed. A loan is considered to be restructured if it has been modified as to
original terms, resulting in a reduction or deferral of principal and/or
interest as a concession to the debtor. Classification of an asset in the
non-performing category does not preclude ultimate collection of loan principal
or interest.
At December 31, 1998, the Corporation had $5,597,000 in loans to borrowers
experiencing financial difficulties which had not been included in either of the
non-accrual or 90 days past due loan categories. Management monitors such loans
closely and reviews their performance on a regular basis.
ALLOWANCE FOR POSSIBLE LOAN LOSSES
The allowance for possible loan losses was $53.6 million or 1.47 percent of
period-end loans at December 31, 1998, compared to $48.1 million or 1.54 percent
of period-end loans at year-end 1997. The
23
allowance for possible loan losses as a percentage of non-accrual loans was
412.5 percent at December 31, 1998, compared with 367.6 percent at December 31,
1997.
The Corporation recorded a $10.4 million provision for possible loan losses
during 1998, compared to $9.2 million and $8.5 million recorded during 1997 and
1996, respectively. The provision is reflective of the continued growth in the
loan portfolio. The provision is also influenced by prior loan portfolio losses;
the current condition of the loan portfolio both as to specific and in the
aggregate; the present business/economic environment within which the bank
operates; and changes in other conditions which influence credit risk. These
other conditions include but are not limited to; the bank's lending policies and
procedures dealing with underwriting standards; the experience, ability, and
depth of lending management and staff; the existence of any concentrations of
credit and changes in the level of such concentrations; the effect of external
factors such as competition and legal and regulatory requirements; and changes
in the quality of the bank's loan review system and the degree of oversight by
the bank's board of directors.
The Corporation recorded net charge-offs of $6.1 million for the year ended
December 31, 1998, compared to net charge-offs of $6.0 million and $2.8 million
in 1997 and 1996, respectively. The Corporation's gross charge-offs in 1998
consisted primarily of consumer loans which increased $871,000 to $8.1 million
and commercial and industrial loans which increased $2.0 million to $4.0
million. The Corporation's gross charge-offs in 1997 consisted primarily of
consumer loans which increased $3.4 million to $7.2 million and commercial and
industrial loans which decreased $4.5 million to $2.0 million. The Corporation's
gross charge-offs in 1996 consisted primarily of commercial and industrial loans
which increased to $6.5 million from $739,000 in 1995 and consumer loans which
decreased slightly from 1995.
Year Ended December 31
--------------------------------------------------------------------
ALLOWANCE FOR POSSIBLE LOAN LOSSES 1998 1997 1996 1995 1994
- -----------------------------------------------------------------------------------------------------------
Average loans outstanding during
year, net of unearned discount..... $ 3,437,510 $ 2,917,371 $ 2,445,759 $ 1,971,663 $ 1,552,189
====================================================================
Balance of allowance for possible
loan losses at beginning of year... $ 48,073 $ 42,821 $ 36,525 $ 29,017 $ 29,073
Provision for possible loan losses... 10,393 9,174 8,494 7,605 473
Loan loss reserve of acquired
(disposed) institutions............ 1,250 2,105 627 430 (2,423)
Charge-offs:
Real estate........................ (397) (650) (351) (288) (1,366)
Commercial and industrial.......... (3,980) (2,028) (6,485) (739) (561)
Consumer........................... (8,081) (7,209) (3,776) (3,856) (2,401)
Other, including foreign........... (90) (40) (9) (2)
--------------------------------------------------------------------
Total charge-offs............... (12,548) (9,927) (10,621) (4,885) (4,328)
--------------------------------------------------------------------
Recoveries:
Real estate........................ 1,674 956 2,476 1,277 1,976
Commercial and industrial.......... 2,176 965 3,747 1,796 2,495
Consumer........................... 2,528 1,853 1,445 1,231 1,698
Other, including foreign........... 70 126 128 54 53
--------------------------------------------------------------------
Total recoveries................ 6,448 3,900 7,796 4,358 6,222
--------------------------------------------------------------------
Net (charge-offs) recoveries......... (6,100) (6,027) (2,825) (527) 1,894
Balance of allowance for possible
loan losses at end of year......... $ 53,616 $ 48,073 $ 42,821 $ 36,525 $ 29,017
====================================================================
Net (charge-offs) recoveries as a
percentage of average loans
outstanding during year, net of
unearned discount.................. (.18)% (.21)% (.12)% (.03)% .12%
Allowance for possible loan losses as
a percentage of year-end loans, net
of unearned discount............... 1.47 1.54 1.60 1.71 1.67
There were no foreign charge-offs in 1998-1994.
24
The Corporation has certain lending policies and procedures in place which
are designed to maximize loan income within an acceptable level of risk. These
policies and procedures, some of which are described below, are reviewed
regularly by senior management. A reporting system supplements this review
process by providing management and the board of directors with frequent reports
related to loan production, loan quality, concentrations of credit, loan
delinquencies and non-performing and potential problem loans.
Commercial and industrial loans are a diverse group of loans to small,
medium and large businesses. The purpose of these loans vary from supporting
seasonal working capital needs to term financing of equipment. These loans are
underwritten focusing on evaluating and understanding management's ability to
operate profitably and prudently expand their business. Once it is determined
management possess sound ethics and solid business acumen, current and projected
cash flows are examined to determine the ability to repay their obligations as
agreed upon. In addition, collateral must be of good quality and single purpose
projects are avoided. Underwriting standards are designed to promote
relationship banking rather than transactional banking. While some short-term
loans may be made on an unsecured basis, most are secured by the assets being
financed with appropriate collateral margins.
Diversification in the loan portfolio is a means of managing risk
associated with fluctuations in economic conditions. At December 31, 1998, the
Corporation had no concentration of commercial and industrial loans in any
single industry that exceeded 10 percent of total loans.
The diversity of the commercial real estate portfolio allows the
Corporation to reduce the impact of a decline in a single market or industry. In
addition to monitoring and evaluating commercial real estate loans based on
collateral, geography and risk grade criteria, management closely tracks its
level of owner-occupied commercial real estate loans versus non-owner occupied
loans. Additionally, the Corporation utilizes the knowledge of third party
experts to provide insight and guidance about the economic conditions and
dynamics of the markets served by the Corporation. Within the commercial real
estate loan category, the Corporation's primary focus has been the growth of
loans secured by owner-occupied properties. At December 31, 1998, a majority of
the Corporation's commercial real estate loans were secured by owner-occupied
properties. These loans are viewed primarily as cash flow loans and secondarily
as loans secured by real estate. Consequently, these loans must withstand the
analysis of a commercial loan and the underwriting process of a commercial real
estate loan.
Loans secured by non-owner occupied commercial real estate are made to
developers and builders who have a relationship with the Corporation and who
have a proven record of success. These loans are underwritten through the use of
feasibility studies, independent appraisal reviews, sensitivity analysis of
absorption and lease rates and financial analysis of the developers and property
owners. Sources of repayment for these types of loans may be pre-committed
permanent loans from approved long-term lenders, sales of developed property or
an interim loan commitment from the Corporation. These loans are closely
monitored by on-site inspections and are considered to have higher risks than
the other real estate loans due to their ultimate repayment being sensitive to
interest rate changes, general economic conditions and the availability of
long-term financing.
The consumer loan portfolio has three distinct segments -- indirect
consumer loans, which represent 41 percent of the consumer loan portfolio,
direct non-real estate consumer loans, which represent 29 percent of the
portfolio and direct real estate consumer loans, which represent 30 percent. The
indirect segment is composed almost exclusively of new and used automobile
financing. Non-real estate direct loans include automobile loans, unsecured
revolving credit products, personal loans secured by cash and cash equivalents,
and other similar types of credit facilities. The direct real estate loans are
primarily Home Equity, home improvement and residential lot loans. Effective
January 1, 1998, in accordance with a constitutional amendment allowing for the
existence of Home Equity loans in the State of Texas, the Corporation began
offering Home Equity loans up to 80 percent of the estimated value of the
personal residence of the borrower less the balances on existing mortgage and
home improvement loans. As of December 31, 1998, Home Equity loans aggregated
approximately $82 million, and were originated for a general variety of purposes
including: education, business start-ups, debt consolidation and automobile
financing. It is anticipated this product will continue to grow and eventually
represent the largest distinct segment of the
25
consumer portfolio. To date the primary growth of this product has been from
existing customers. Underwriting standards for this product are heavily
influenced by the statute requirements, which include but are not limited to;
maximum loan-to-value percentage, collection remedies, the number of such loans
a borrower can have at one time and documentation requirements.
A computer based credit scoring analysis is used to supplement the consumer
loan underwriting process. To monitor and manage consumer loan risk, policies
and procedures are developed and modified, as needed, jointly by line and staff
personnel. This activity, coupled with relatively small loan amounts that are
spread across many individual borrowers, minimizes the risk. Additionally, trend
and outlook reports are provided to senior management on a frequent basis to aid
in planning.
The Corporation has an independent Loan Review Division that reviews and
validates the credit risk program on a periodic basis. Results of these reviews
are presented to senior management and the board of directors. Loan Review's
function complements and reinforces the risk identification and assessment
decisions made by lenders and credit personnel as well as the Corporation's
policies and procedures.
Loans identified as losses by management, internal loan review and/or bank
examiners are charged-off. Furthermore, consumer loan accounts are charged-off
automatically based on regulatory requirements.
An allowance for possible loan losses is maintained in an amount which, in
management's judgment, provides an adequate reserve to absorb potential loan
losses inherent in the loan portfolio. Industry concentrations, specific credit
risks, loan loss experience, current loan portfolio quality, the impact of
rising interest rates, experience level and effectiveness of employees,
economic, competitive, political and regulatory conditions and other pertinent
factors are all considered in determining the adequacy of the allowance.
An audit committee of non-management directors reviews the adequacy of the
allowance for possible loan losses quarterly.
December 31
------------------------------------------------------------------------------
1998 1997 1996
----------------------- ------------------------ ------------------------
ALLOWANCE Allowance Allowance
FOR AS A for As a for As a
POSSIBLE PERCENTAGE Possible Percentage Possible Percentage
ALLOCATION OF ALLOWANCE FOR POSSIBLE LOAN OF TOTAL Loan of Total Loan of Total
LOAN LOSSES LOSSES LOANS Losses Loans Losses Loans
- ---------------------------------------------------------------------------------------------------------------------
Commercial and industrial............ $15,604 .43% $ 14,346 .46% $ 9,648 .36%
Real estate.......................... 9,594 .26 9,460 .31 9,853 .37
Consumer............................. 17,913 .49 17,486 .56 13,903 .52
Purchasing or carrying securities.... 85 88 6
Financial institutions............... 45 60 44
Other, including foreign............. 172 .01 371 .01 213 .01
Not allocated........................ 10,203 .28 6,262 .20 9,154 .34
------------------------------------------------------------------------------
TOTAL............................. $53,616 1.47% $ 48,073 1.54% $ 42,821 1.60%
==============================================================================
December 31
------------------------------------------------------
1995 1994
------------------------------------------------------
Allowance Allowance
for As a for As a
Possible Percentage Possible Percentage
ALLOCATION OF ALLOWANCE FOR POSSIBLE Loan of Total Loan of Total
LOAN LOSSES Losses Loans Losses Loans
- ----------------------------------------------------------------------------------------------
Commercial and industrial............ $ 10,411 .49% $ 5,742 .33%
Real estate.......................... 11,479 .54 10,349 .60
Consumer............................. 12,201 .57 10,439 .60
Purchasing or carrying securities.... 6 7
Financial institutions............... 32 28
Other, including foreign............. 167 .01 160 .01
Not allocated........................ 2,229 .10 2,292 .13
TOTAL............................. $ 36,525 1.71% $ 29,017 1.67%
Allocation of a portion of the allowance does not preclude its availability
to absorb losses in other categories. The unallocated portion of the allowance
represents an additional amount beyond that specifically reserved for specific
risks available to absorb unidentified losses in the current loan portfolio.
SECURITIES
Total securities, including securities available for sale, were $2.1
billion at year-end 1998 compared to $1.8 billion a year ago. Securities
available for sale totaled $2.0 billion at December 31, 1998, compared to $1.5
billion at year-end 1997. These securities consist primarily of U.S. Treasury
securities and obligations of U.S. Government agencies. Securities classified as
held to maturity are carried at amortized cost and consist primarily of U. S.
Government agency obligations. The remaining securities, consisting primarily of
municipal bonds, are classified as trading and are carried at fair value.
26
Debt securities are classified as held to maturity when the Corporation has
the positive intent and ability to hold the securities to maturity. Available
for sale securities are stated at fair value, with unrealized gains and losses,
net of tax, reported as a separate component of shareholders' equity. Trading
securities held primarily for sale in the near term are valued at their fair
values, with unrealized gains and losses included immediately in other income.
The average yield of the securities portfolio for the year ended December
31, 1998 was 6.32 percent compared with 6.43 percent for 1997. See page 63
"Maturity Distribution and Securities Portfolio Yields."
Total securities including trading, available for sale and held to maturity
are summarized below:
December 31
-------------------------------------------------------------------------------
1998 1997 1996
----------------------- ----------------------- -----------------------
PERIOD-END PERCENTAGE Period-end Percentage Period-end Percentage
SECURITIES BALANCE OF TOTAL Balance of Total Balance of Total
- -----------------------------------------------------------------------------------------------------------------------
U.S. Treasury........................ $ 189,574 9.1% $ 341,681 19.3% $ 261,840 15.3%
U.S. Government agencies
and corporations................... 1,719,580 82.2 1,367,500 77.2 1,405,822 82.1
States and political subdivisions.... 125,939 6.0 46,171 2.6 36,016 2.1
Other................................ 56,610 2.7 16,066 .9 8,601 .5
-------------------------------------------------------------------------------
Total........................... $2,091,703 100.0% $1,771,418 100.0% $1,712,279 100.0%
===============================================================================
Average yield earned during the year
(taxable-equivalent basis)......... 6.32% 6.43% 6.46%
INTEREST RATE SWAPS/FLOORS
The Corporation has off-balance sheet interest rate swaps to hedge its
interest rate risk by essentially converting fixed-rate loans into synthetic
variable-rate instruments. These swap transactions allow management to structure
the interest rate sensitivity of the asset side of the Corporation's balance
sheet to more closely match their view of the interest rate sensitivity of the
Corporation's funding sources. The Corporation had 22 interest rate swaps at
December 31, 1998 compared to 42 interest rate swaps at December 31, 1997. Each
swap was a hedge against a specific commercial fixed-rate loan or against a
specific pool of consumer fixed-rate loans, with a notional amount of $75
million and $267 million at December 1998 and 1997, respectively. In each case,
the amortization of the interest rate swap generally matches the expected
amortization of the underlying loan or pool of loans and was a hedge against
either a specific commercial loan or a specific pool of consumer loans with
lives ranging from two to ten years. Each counterparty to a swap transaction has
a credit rating that is investment grade. The net amount payable or receivable
under interest rate swap/floor is accrued as an adjustment to interest income
and was not material in 1998 or 1997. In the third quarter of 1998, the
Corporation terminated interest rate swaps hedging fixed rate consumer loans.
The Corporation is amortizing the loss on the transaction of $1.9 million over
the remaining term of the interest swaps ending in the second quarter of 2002.
During 1998, the Corporation terminated all three of its interest rate
floor agreements with a notional amount totaling $500 million and an original
term of three years. These interest rate floors were purchased in 1997 for the
purpose of hedging floating interest rate exposure in commercial loan accounts
in an environment of falling interest rates. The Corporation is amortizing the
gain on the transaction of $2.8 million over the remaining term of the interest
rate floors.
27
DEPOSITS
Total average demand deposits increased 17.9 percent from 1997. This can be
attributed to an increase in commercial and individual levels of $244.0 million.
The increase in commercial and individual is partially related to the 1998
acquisition. The Corporation has made a strategic effort in growing its
correspondent bank relationships in the markets it serves. Reflective of this
effort the Corporation ranks 26th in the United States for correspondent bank
balances as of June 30, 1998.
1998 1997 1996
--------------------- --------------------- ----------------------
AVERAGE PERCENT Average Percent Average Percent
DEMAND DEPOSITS BALANCE CHANGE Balance Change Balance Change
- ----------------------------------------------------------------------------------------------------------------
Commercial and individual............ $1,387,824 +21.3% $1,143,828 +16.7% $ 979,757 +20.3%
Correspondent banks.................. 195,555 + 1.7 192,231 - 3.9 199,983 +52.3
Public funds......................... 43,507 - 1.5 44,183 - 2.3 45,200 + 7.5
---------- ---------- ------------
Total........................... $1,626,886 +17.9 $1,380,242 +12.7 $ 1,224,940 +24.0
========== ========== ============
Total average time deposits increased 9.7 percent from 1997 with the
largest increase coming from money market deposit accounts partially related to
the 1998 acquisition. In addition, time accounts of $100,000 or more and savings
and Interest-on-Checking accounts also showed a strong increase from 1997
levels.
1998 1997 1996
-------------------------- ---------------------------- -----------------------------
AVERAGE PERCENT Average Percent Average Percent
TIME DEPOSITS BALANCE CHANGE COST Balance Change Cost Balance Change Cost
- -----------------------------------------------------------------------------------------------------------------------------------
Savings and Interest-on-Checking..... $ 901,960 +10.2% 1.21% $ 818,216 +10.4% 1.32 % $ 741,102 N/M 1.37%
Money market deposit accounts........ 1,387,994 +16.1 3.91 1,195,773 +13.5 4.08 1,053,819 +31.6% 3.82
Time accounts of $100,000 or more.... 656,776 +15.9 5.23 566,588 +13.2 5.14 500,354 + 2.1 4.92
Time accounts under $100,000......... 629,260 - 1.5 4.65 638,673 - 1.0 4.81 644,840 +13.7 4.89
Public funds......................... 251,570 - 6.5 3.73 269,027 + 9.7 4.35 245,266 +94.7 4.36
---------- ---------- ----------
Total............................ $3,827,560 + 9.7 3.61 $3,488,277 + 9.5 3.76 $3,185,381 +16.9 3.68
========== ========== ==========
The following table summarizes the certificates of deposit in amounts of
$100,000 or more as of December 31, 1998 by time remaining until maturity.
December 31
------------------------
1998
REMAINING MATURITY OF PRIVATE ------------------------
CERTIFICATES OF DEPOSIT PERCENTAGE
OF $100,000 OR MORE AMOUNT OF TOTAL
- ----------------------------------------------------------------
Three months or less................. $ 335,460 50.6%
After three, within six months....... 175,914 26.6
After six, within twelve months...... 138,806 20.9
After twelve months.................. 12,743 1.9
------------------------
Total........................... $ 662,923 100.0%
========================
Percentage of total private time
deposits 17.8%
Other time deposits of $100,000 or more were $108.0 million at December 31,
1998. Of this amount 73.7 percent matures within three months, 18.0 percent
matures between three and six months and the remainder matures between six
months and one year.
28
Mexico is a part of the natural trade territory of the banking offices of
Cullen/Frost. Thus, dollar-denominated foreign deposits from Mexican sources
have traditionally been a significant source of funding. The Corporation's
average foreign deposits increased 5.8 percent from 1997. The Mexican economic
recovery and growth in manufacturing which began in 1996 continued to improve
through 1998.
FOREIGN DEPOSITS 1998 1997 1996
- -------------------------------------------------------------------------
Average balance...................... $ 642,822 $ 607,642 $ 573,583
Percentage of total average
deposits........................... 11.8% 12.5% 13.0%
SHORT-TERM BORROWINGS
The Corporation's primary source of short-term borrowings is Federal funds
purchased from correspondent banks and securities sold under repurchase
agreements in the natural trade territories of the Cullen/Frost subsidiary
banks, as well as from upstream banks. The net purchase position experienced in
1998 was primarily the result of growth in earning assets over core deposit
growth. In 1997, the increase in the net funds position is a direct result of
the Corporation's use of funds acquired from the issuance of the $100 million
Trust Preferred Capital Securities. The weighted-average interest rate on
Federal funds purchased at December 31, 1998 and 1997 was 4.69 percent and 5.81
percent, respectively. Generally, securities sold under repurchase agreements
are at 80 percent of Federal funds.
1998 1997 1996
--------------------- -------------------- --------------------
AVERAGE AVERAGE Average Average Average Average
FEDERAL FUNDS BALANCE RATE Balance Rate Balance Rate
- -------------------------------------------------------------------------------------------------------------
Federal funds sold................... $ 127,273 5.59% $228,245 5.44% $143,401 5.21%
Federal funds purchased and
securities sold under repurchase
agreements......................... 252,977 4.59 189,468 4.61 204,515 4.77
--------- -------- --------
Net funds position................... $(125,704) $ 38,777 $(61,114)
========= ======== ========
FEDERAL FUNDS PURCHASED AND Year Ended December 31
SECURITIES ----------------------------------
SOLD UNDER REPURCHASE AGREEMENTS 1998 1997 1996
- -------------------------------------------------------------------------
Balance at year end.................. $ 305,564 $ 200,774 $ 232,690
Maximum month-end balance............ 523,178 231,418 272,489
Other funding sources include a $7.5 million short-term line of credit to
the parent Corporation used for short-term liquidity needs. There were no
borrowings outstanding from this source at December 31, 1998 and 1997.
GUARANTEED PREFERRED BENEFICIAL INTEREST IN THE CORPORATION'S JUNIOR
SUBORDINATED DEFERRABLE INTEREST DEBENTURES
During February 1997, the Corporation issued $100 million of its 8.42
percent Capital Securities, Series A which represent a beneficial interest in
Cullen/Frost Capital Trust I, a Delaware statutory business trust and
wholly-owned subsidiary of the Corporation. The Issuer Trust used the proceeds
of the sale of the Capital Securities to purchase Junior Subordinated Debentures
of Cullen/Frost. Of these proceeds, the Corporation used $55.3 million for the
acquisition of Harrisburg Bancshares, Inc. and $17.8 million for the repurchase
of shares of the Corporation. The $100 million Trust Preferred Capital
Securities are included in the Tier 1 capital of Cullen/Frost for regulatory
capital purposes and are reported as debt on the balance sheet. See Note I
"Borrowed Funds" on page 44.
29
CAPITAL
At December 31, 1998, shareholders' equity reached the highest level in the
Corporation's history, $512.9 million, an increase of 10.8 percent from $462.9
million at December 31, 1997. The increase in 1998 was due primarily to earnings
growth partially offset by $30.5 million of dividends paid and $3.5 million paid
for the repurchase of shares of the Corporation. The Corporation had an
unrealized gain on securities available for sale, net of deferred taxes, of $7.7
million as of December 31, 1998 compared to $8.9 million as of December 31,
1997. Currently, under regulatory requirements, the unrealized gain or loss on
securities available for sale is not included in the calculation of risk-based
capital and leverage ratios.
The Corporation paid a quarterly dividend of $.25 per common share during
the first quarter of 1998 increasing to $.30 per common share during the second,
third and fourth quarters of 1998. The Corporation paid a quarterly dividend of
$.21 per common share during the first quarter of 1997 increasing to $.25 per
common share during the second, third and fourth quarters of 1997. The dividend
payout ratio excluding the merger related charge was 35.8 percent for 1998.
Cullen/Frost dividend payout ratio for 1997 (including income and dividends for
Overton) was 30.5 percent.
The Federal Reserve Board utilizes capital guidelines designed to measure
Tier 1 and Total Capital and take into consideration the risk inherent in both
on-balance sheet and off-balance sheet items. For the Corporation's capital
ratios at December 31, 1998 and 1997, see Note L "Capital" on page 46.
FORWARD-LOOKING STATEMENTS
The Corporation may from time to time make forward-looking statements
(within the meaning of the Private Securities Litigation Reform Act of 1995)
with respect to earnings per share, credit quality, its Year 2000 compliance
program, corporate objectives and other financial and business matters. The
Corporation cautions the reader that these forward-looking statements are
subject to numerous assumptions, risks and uncertainties, including economic
conditions, actions taken by the Federal Reserve Board, legislative and
regulatory actions and reforms, competition, as well as other reasons, all of
which change over time. Actual results may differ materially from
forward-looking statements.
PARENT CORPORATION
Historically, a large portion of the parent Corporation's income, which
provides funds for the payment of dividends to shareholders and for other
corporate purposes, has been derived from Cullen/Frost's investments in
subsidiaries. Dividends received from the subsidiaries are based upon each
bank's earnings and capital position. See Note K "Dividends" on page 46.
Management fees are not assessed.
NON-BANKING SUBSIDIARIES
The New Galveston Company is a wholly-owned second tier bank holding
company subsidiary which holds all shares of each banking and non-banking
subsidiary with the exception of Cullen/Frost Capital Trust I. Cullen/Frost has
three principal non-banking subsidiaries. Main Plaza Corporation occasionally
makes loans to qualified borrowers. Such loans are typically funded with
borrowings against Cullen/Frost's current cash or borrowing against credit
lines. Daltex General Agency, Inc., a managing general insurance agency,
provides vendor's single interest insurance for Cullen/Frost subsidiary banks.
Cullen/Frost Capital Trust I, a wholly-owned non-banking subsidiary, is a
Delaware statutory trust. The sole purpose of the trust was to sell Capital
Securities and to purchase Junior Debentures of the Corporation.
The Corporation formed a new subsidiary, Frost Insurance Agency, Inc., a
wholly owned subsidiary of The Frost National Bank on April 16, 1998. Frost
Insurance Agency will offer corporate and personal property and casualty
insurance as well as group, health and life insurance products to individuals
and businesses.
30
SUBSEQUENT EVENTS
PENDING ACQUISITIONS
On March 3, 1999, Frost Insurance Agency, a subsidiary of The Frost
National Bank, signed a letter of intent to acquire Professional Insurance
Agents, Inc. (PIA), a mid-sized independent insurance agency based in Victoria,
Texas, with additional locations in San Antonio, New Braunfels and Refugio. PIA
offers corporate and personal property and casualty insurance as well as group,
health and life insurance products to individuals and businesses. The
transaction is subject to regulatory approval, and is expected to close in the
second quarter of 1999. The purchase method of accounting will be used to record
the transaction.
On February 17, 1999, the Corporation entered into a definitive agreement
to acquire Commerce Financial Corporation of Fort Worth, Texas which has
deposits of approximately $174 million. The Corporation agreed to pay $42.25
million. The acquisition is expected to be completed in the second quarter of
1999 following shareholder and regulatory approval. This transaction will be
accounted for as a purchase with total cash consideration being funded through
internal sources.
INVESTMENT BANKING SUBSIDIARY
On January 26, 1999, the Corporation announced its intent to seek Federal
Reserve Bank approval to form a Section 20 investment banking subsidiary. The
new subsidiary, to be named Frost Securities, Inc., is expected to be
operational by July 1 and will offer a full range of services including equity
research, institutional sales, trading and investment banking services to
institutional investors and corporate customers who need access to the capital
markets.
COMPLETED ACQUISITION
On January 15, 1999, the Corporation paid approximately $18.7 million to
acquire Keller State Bank, of Keller, Texas. The total cash consideration was
funded through internal sources. The purchase method of accounting has been used
to record the transaction and as such the purchase price has been allocated to
the underlying assets and liabilities based on estimated fair values at the date
of acquisition. Such estimates may be subsequently revised. The Corporation
acquired loans of approximately $38 million and deposits of approximately $62
million. Total intangibles associated with the acquisition amounted to
approximately $11.8 million. This acquisition is not expected to have a material
impact on the Corporation's 1999 net income.
31
MANAGEMENT'S RESPONSIBILITY FOR FINANCIAL REPORTING
The management of Cullen/Frost Bankers, Inc. is responsible for the
preparation of the financial statements, related financial data and other
information in this annual report. The consolidated financial statements have
been prepared in accordance with generally accepted accounting principles and
include amounts based on management's estimates and judgment where appropriate.
Financial information appearing throughout this annual report is consistent with
the financial statements.
In meeting its responsibility both for the integrity and fairness of these
financial statements and information, management depends on the accounting
systems and related internal accounting controls that are designed to provide
reasonable assurances that transactions are authorized and recorded in
accordance with established procedures and that assets are safeguarded and that
proper and reliable records are maintained.
The concept of reasonable assurance is based on the recognition that the
cost of a system of internal controls should not exceed the related benefits. As
an integral part of the system of internal controls, Cullen/Frost maintains an
internal audit staff which monitors compliance with and evaluates the
effectiveness of the system of internal controls and coordinates audit coverage
with the independent auditors.
The Audit Committee of Cullen/Frost's Board of Directors, which is composed
entirely of directors independent of management, meets regularly with
management, regulatory examiners, internal auditors, the asset review staff and
independent auditors to discuss financial reporting matters, internal controls,
regulatory reports, internal auditing and the nature, scope and results of the
audit efforts. Internal Audit and Asset Review report directly to the Audit
Committee. The banking regulators, internal auditors and independent auditors
have direct access to the Audit Committee.
The consolidated financial statements have been audited by Ernst & Young
LLP, independent auditors, who render an independent opinion on management's
financial statements. Their appointment was recommended by the Audit Committee
and approved by the Board of Directors and by the shareholders. The audit by the
independent auditors provides an additional assessment of the degree to which
Cullen/Frost's management meets its responsibility for financial reporting.
Their opinion on the financial statements is based on auditing procedures, which
include their consideration of internal controls and performance of selected
tests of transactions and records, as they deem appropriate. These auditing
procedures are designed to provide an additional reasonable level of assurance
that the financial statements are fairly presented in accordance with generally
accepted accounting principles in all material respects.
Richard W. Evans, Jr. Phillip D. Green
Chairman and Chief Senior Executive Vice President
Executive Officer and Chief Financial Officer
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The information required by this Item is set forth in the section entitled
"Market Risk -- Interest Rate Sensitivity" included under Item 7 of this
document and is incorporated herein by reference.
32
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
CONSOLIDATED STATEMENTS OF OPERATIONS
(dollars in thousands, except per share amounts)
Year Ended December 31
--------------------------------
1998 1997 1996
- ------------------------------------------------------------------------
INTEREST INCOME:
Loans, including fees........... $300,721 $261,607 $219,279
Securities:
Taxable....................... 117,261 108,249 111,334
Tax-exempt.................... 2,998 1,821 1,587
--------------------------------
Total securities........... 120,259 110,070 112,921
Federal funds sold and
securities purchased under
resale agreements............. 7,111 12,423 7,506
--------------------------------
TOTAL INTEREST INCOME... 428,091 384,100 339,706
INTEREST EXPENSE:
Deposits........................ 138,283 131,140 117,179
Federal funds purchased and
securities sold under
repurchase agreements......... 11,606 8,739 9,773
Guaranteed preferred beneficial
interests in the Corporation's
subordinated debentures....... 8,475 7,652
Other borrowings................ 1,754 1,434 1,037
--------------------------------
TOTAL INTEREST
EXPENSE............... 160,118 148,965 127,989
--------------------------------
NET INTEREST INCOME..... 267,973 235,135 211,717
Provision for possible loan losses... 10,393 9,174 8,494
--------------------------------
NET INTEREST INCOME
AFTER PROVISION FOR
POSSIBLE LOAN
LOSSES................ 257,580 225,961 203,223
NON-INTEREST INCOME:
Trust fees...................... 46,863 43,275 36,898
Service charges on deposit
accounts...................... 53,601 47,627 41,570
Other service charges,
collection and exchange
charges, commissions and
fees.......................... 15,482 11,349 9,199
Net gain (loss) on securities
transactions.................. 359 498 (892)
Other........................... 22,361 18,953 17,403
--------------------------------
TOTAL NON-INTEREST
INCOME................ 138,666 121,702 104,178
NON-INTEREST EXPENSE:
Salaries and wages.............. 111,423 98,874 85,646
Pension and other employee
benefits...................... 21,295 19,874 18,224
Net occupancy of banking
premises...................... 25,486 22,812 21,486
Furniture and equipment......... 18,921 16,147 14,697
Intangible amortization......... 13,293 11,920 11,306
Merger related charge........... 12,244
Other........................... 75,844 65,514 58,695
--------------------------------
TOTAL NON-INTEREST
EXPENSE............... 278,506 235,141 210,054
--------------------------------
INCOME BEFORE INCOME
TAXES................. 117,740 112,522 97,347
Income taxes......................... 42,095 39,555 34,409
--------------------------------
NET INCOME.............. $ 75,645 $ 72,967 $ 62,938
================================
Net income per share:
Basic........................... $ 2.85 $ 2.75 $ 2.37
Diluted......................... 2.77 2.67 2.31
Dividends per share.................. 1.15 .96 .81
See notes to consolidated financial statements.
33
CONSOLIDATED BALANCE SHEETS
(dollars in thousands, except per share amounts)
December 31
--------------------------
1998 1997
- -----------------------------------------------------------------
ASSETS
Cash and due from banks.............. $ 684,941 $ 637,613
Securities held to maturity (market
value: 1998 -- $113,682;
1997 -- $261,225).................. 111,439 255,428
Securities available for sale........ 1,979,555 1,514,050
Trading account securities........... 709 1,940
Federal funds sold................... 102,900 190,000
Loans, net of unearned discount of
$3,357 in 1998 and $3,194 in
1997............................... 3,646,603 3,116,895
Less: Allowance for possible loan
losses.......................... (53,616) (48,073)
--------------------------
Net loans....................... 3,592,987 3,068,822
Banking premises and equipment....... 137,290 128,710
Accrued interest and other assets.... 259,784 249,010
--------------------------
TOTAL ASSETS.................. $ 6,869,605 $ 6,045,573
==========================
LIABILITIES
Demand deposits:
Commercial and individual.......... $ 1,585,891 $ 1,353,242
Correspondent banks................ 201,355 140,443
Public funds....................... 56,253 54,880
--------------------------
Total demand deposits......... 1,843,499 1,548,565
Time deposits:
Savings and Interest-on-Checking... 961,597 855,783
Money market deposit accounts...... 1,493,778 1,255,237
Time accounts...................... 1,264,121 1,216,145
Public funds....................... 282,492 293,360
--------------------------
Total time deposits........... 4,001,988 3,620,525
--------------------------
Total deposits................ 5,845,487 5,169,090
Federal funds purchased and
securities sold under repurchase
agreements......................... 305,564 200,774
Accrued interest and other
liabilities........................ 107,177 114,377
Guaranteed preferred beneficial
interest in the Corporation's
junior subordinated deferrable
interest debentures, net........... 98,458 98,403
--------------------------
TOTAL LIABILITIES............. 6,356,686 5,582,644
SHAREHOLDERS' EQUITY
Common stock, par value per share:
$.01; $5........................... 267 133,775
Shares authorized:
1998 -- 90,000,000;
1997 -- 60,000,000
Shares issued:
1998 -- 26,712,648;
1997 -- 26,754,960
Surplus.............................. 183,151 53,647
Retained earnings.................... 321,754 278,994
Accumulated other comprehensive
income, net of tax................. 7,747 8,917
Treasury stock at cost (284,887)..... (12,404)
--------------------------
TOTAL SHAREHOLDERS' EQUITY.... 512,919 462,929
--------------------------
TOTAL LIABILITIES AND
SHAREHOLDERS' EQUITY......... $ 6,869,605 $ 6,045,573
==========================
See notes to consolidated financial statements.
34
CONSOLIDATED STATEMENTS OF CASH FLOWS
(dollars in thousands)
Year Ended December 31
---------------------------------------
1998 1997 1996
- ------------------------------------------------------------------------------
OPERATING ACTIVITIES
Net income........................... $ 75,645 $ 72,967 $ 62,938
Adjustments to reconcile net income
to net cash provided by operating
activities:
Provision for possible loan
losses........................ 10,393 9,174 8,494
Provision for real estate
losses........................ 161 43 55
Credit for deferred taxes....... (5,574) (6,703) (3,865)
Accretion of discounts on
loans......................... (2,841) (1,212) (970)
Accretion of securities'
discounts..................... (3,911) (11,960) (15,568)
Amortization of securities'
premiums...................... 5,824 3,847 2,827
Decrease (increase) in trading
account securities............ 1,231 (1,153) (351)
Net realized (gain) loss on
securities transactions....... (359) (498) 892
Net gain on sale of assets...... (773) (654) (1,406)
Depreciation and amortization... 30,024 26,459 24,923
Decrease (increase) in accrued
interest receivable........... 660 (6,374) (3,507)
(Decrease) increase in accrued
interest payable.............. (4,072) 4,453 1,051
Originations of mortgages
held-for-sale................. (181,219) (104,271) (79,392)
Proceeds from sales of mortgages
held-for-sale................. 177,160 102,728 79,404
Net change in other assets and
liabilities................... 13,000 (38,614) 1,069
---------------------------------------
NET CASH PROVIDED BY OPERATING
ACTIVITIES.................... 115,349 48,232 76,594
INVESTING ACTIVITIES
Proceeds from maturities of
securities held to maturity........ 36,906 40,606 41,938
Purchases of securities held to maturity (9,650) (32,040) (21,153)
Proceeds from sales of securities
available for sale................. 900,398 434,488 240,078
Proceeds from maturities of
securities available for sale...... 1,145,806 908,197 574,360
Purchases of securities available for
sale............................... (2,314,252) (1,354,280) (717,162)
Net increase in loan portfolio....... (407,212) (342,559) (335,832)
Proceeds from sales of equipment..... 30 49 2,768
Purchases of premises and equipment.. (18,798) (18,104) (21,380)
Proceeds from sales of repossessed
properties......................... 2,982 2,038 1,331
Net cash and cash equivalents (paid)
received from bank acquisitions.... (8,899) 14,277 19,198
---------------------------------------
NET CASH USED BY INVESTING
ACTIVITIES.................... (672,689) (347,328) (215,854)
FINANCING ACTIVITIES
Net increase in demand deposits, IOC
accounts, and savings accounts..... 566,136 159,070 518,195
Net decrease in certificates of
deposit............................ (111,941) (16,532) (144,254)
Net increase (decrease) in Federal
funds purchased and securities sold
under repurchase agreements........ 89,361 (31,916) 76,326
Net proceeds from issuance of
guaranteed preferred beneficial
interest in the Corporation's
subordinated debentures............ 98,353
Net proceeds from issuance of common
stock.............................. 7,983 3,735 1,182
Purchase of treasury stock........... (3,495) (17,834) (1,164)
Dividends paid....................... (30,476) (22,256) (18,754)
---------------------------------------
NET CASH PROVIDED BY FINANCING
ACTIVITIES.................... 517,568 172,620 431,531
---------------------------------------
(DECREASE) INCREASE IN CASH AND
CASH EQUIVALENTS.............. (39,772) (126,476) 292,271
Cash and cash equivalents at
beginning of year.................. 827,613 954,089 661,818
---------------------------------------
CASH AND CASH EQUIVALENTS AT END
OF YEAR....................... $ 787,841 $ 827,613 $ 954,089
=======================================
See notes to consolidated financial statements.
35
CONSOLIDATED STATEMENT OF CHANGES IN SHAREHOLDERS' EQUITY
(dollars in thousands)
Accumulated
Other
Comprehensive
Common Retained Income Treasury
Stock Surplus Earnings net of tax Stock Total
- ----------------------------------------------------------------------------------------------------------------
BALANCE AT JANUARY 1, 1996.............. $ 77,062 $106,069 $188,835 $ 10,037 $382,003
Net Income for 1996................... 62,938 62,938
Unrealized loss on securities
available for sale of $2,333, net of
tax and reclassification adjustment
for after-tax losses included in net
income of $410...................... (1,923) (1,923)
--------
Total comprehensive income..... 61,015
--------
Proceeds from employee stock purchase
plan and
options............................. 300 434 (409) 325
Tax benefit related to exercise of
stock options....................... 661 661
Issuance of restricted stock.......... 15 65 80
Restricted stock plan deferred
compensation, net................... 392 392
Cash dividend......................... (18,073) (18,073)
Two-for-one stock split............... 56,098 (56,098)
Pre-merger transaction of pooled
company:
Release of unearned ESOP shares..... 199 199
Cash dividend....................... (681) (681)
Purchase of treasury stock.......... $ (1,164) (1,164)
Sale of treasury stock.............. 1 28 29
Transfer of treasury stock of
ESOP................................ (1,000) 1,000
----------------------------------------------------------------------
BALANCE AT DECEMBER 31, 1996............ 133,475 51,132 232,201 8,114 (136) 424,786
Net Income for 1997................... 72,967 72,967
Unrealized gain on securities
available for sale of $1,127, net of
tax and reclassification adjustment
for after-tax gains included in net
income of $324...................... 803 803
--------
Total comprehensive income..... 73,770
--------
Proceeds from employee stock purchase
plan and
options............................. 300 437 (1,949) 3,201 1,989
Tax benefit related to exercise of
stock options....................... 1,492 1,492
Purchase of treasury stock............ (17,814) (17,814)
Issuance of restricted stock.......... 522 2,297 2,819
Restricted stock plan deferred
compensation, net................... (2,112) (2,112)
Cash dividend......................... (21,463) (21,463)
Pre-merger transaction of pooled
company:
Release of unearned ESOP shares..... 64 143 207
Cash dividend....................... (793) (793)
Purchase of treasury stock.......... (20) (20)
Sale of treasury stock.............. 68 68
----------------------------------------------------------------------
BALANCE AT DECEMBER 31, 1997............ 133,775 53,647 278,994 8,917 (12,404) 462,929
Net Income for 1998................... 75,645 75,645
Unrealized loss on securities
available for sale of $937, net of
tax and reclassification adjustment
for after-tax gains included in net
income of $233...................... (1,170) (1,170)
--------
Total comprehensive income..... 74,475
--------
Proceeds from employee stock purchase
plan and
options............................. 390 (2,014) 2,802 1,178
Tax benefit related to exercise of
stock options....................... 1,771 1,771
Purchase of treasury stock............ (3,495) (3,495)
Issuance of restricted stock.......... 1 1,889 126 2,016
Restricted stock plan deferred
compensation, net................... (514) (514)
Cash dividend......................... (29,567) (29,567)
ESOP shares released.................. 2,820 658 3,478
Constructive retirement of treasury
stock issued in connection with a
business combination................ (1,382) (11,023) 12,883 478
Change in par value................... (132,974) 132,974
Pre-merger transactions of pooled
company:
Proceeds from employee stock
purchase plan and options......... 847 683 (539) 88 1,079
Cash dividend....................... (909) (909)
----------------------------------------------------------------------
BALANCE AT DECEMBER 31, 1998............ $ 267 $183,151 $321,754 $ 7,747 $ -- $512,919
======================================================================
See notes to consolidated financial statements.
36
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE A -- SUMMARY OF ACCOUNTING POLICIES
Cullen/Frost Bankers, Inc., ("Cullen/Frost" or "the Corporation")
through its wholly-owned subsidiary banks provides a broad array of products and
services throughout 10 Texas markets. In addition to general commercial banking,
other products and services offered include trust and investment management,
mortgage banking, leasing, asset-based lending, treasury management and item
processing.
The accounting and reporting policies followed by Cullen/Frost are in
accordance with generally accepted accounting principles and conform to general
practices within the banking industry. The more significant accounting and
reporting policies are summarized below.
BASIS OF PRESENTATION -- The consolidated financial statements include the
accounts of Cullen/Frost and its wholly-owned subsidiaries. Condensed parent
company financial statements reflect investments in subsidiaries using the
equity method of accounting. All significant intercompany balances and
transactions have been eliminated in consolidation. The consolidated financial
statements have been prepared to give retroactive effect to the May 29, 1998
merger with Overton Bancshares, Inc. which was accounted for as a pooling of
interests. Certain reclassifications have been made to make prior years
comparable.
USE OF ESTIMATES -- The preparation of financial statements in conformity
with generally accepted accounting principles requires management to make
estimates and assumptions that affect the amounts reported in the consolidated
financial statements and accompanying notes. Actual results could differ from
those estimates.
SECURITIES -- Securities are classified as held to maturity and carried at
amortized cost when the Corporation has the intent and ability to hold the
securities until maturity. Securities held for resale in anticipation of
short-term market movements are classified as trading and are carried at market
value with both net realized and unrealized gains and losses included in other
income during the period. Securities to be held for indefinite periods of time
are classified as available for sale and stated at fair value, with the
unrealized gains and losses, net of tax, reported as a separate component of
shareholders' equity. The adjusted carrying value of the specific security sold
is used to compute gain or loss on the sale of securities. Declines in value
other than temporary declines are adjusted against the security with a charge to
operations.
LOANS -- Interest on loans is accrued and accreted to operations based on
the principal amount outstanding. Interest on certain consumer loans is
recognized over their respective terms using a method which approximates the
interest method. Generally, loans are placed on a non-accrual status if
principal or interest payments become 90 days past due and/or management deems
the collectability of the principal and/or interest to be in question as well as
when required by regulatory regulations. Once interest accruals are
discontinued, uncollected but accrued interest is charged to current year
operations. Subsequent receipts on nonaccrual loans are recorded as a reduction
of principal, and interest income is recorded once principal recovery is
reasonably assured. Loans which are determined to be uncollectible are charged
to the allowance for possible loan losses. The collectability of loans is
continually reviewed by management.
ALLOWANCE FOR POSSIBLE LOAN LOSSES -- The allowance for possible loan
losses is established through a provision for possible loan losses charged to
current operations. The amount maintained in the allowance reflects management's
continuing assessment of the potential losses inherent in the portfolio based on
evaluations of industry concentrations, specific credit risks, loan loss
experience, current loan portfolio quality, present economic, political and
regulatory conditions and unidentified losses inherent in the current loan
portfolio. The methodolgy used by the company to determine the level and
adequacy of the allowance is consistent with the requirements and
recommendations of the primary regulator. Certain loans are accounted for under
the provisions of SFAS No. 114, "Accounting by Creditors for Impairment of a
Loan," as amended by SFAS No. 118, "Accounting by Creditors for Impairment of
a Loan -- Income Recognition and Disclosure." These standards require an
allowance to be established as a component of the allowance for loan losses for
certain loans when its is probable that all amounts due pursuant to the
37
contractual terms of the loan will not be collected and the recorded investment
in the loan exceeds the fair value. The allowance for possible loan losses
related to loans that are impaired as defined by SFAS No. 114 and SFAS No. 118
is based on discounted cash flows using the loan's initial effective interest
rate or the fair value of the collateral for certain collateral dependent loans.
Income on impaired loans is recognized in accordance with SFAS No. 118 which is
based on the collectability of the principal amount.
FORECLOSED ASSETS -- Foreclosed assets consist of property which has been
formally repossessed. Collateral obtained through foreclosure is recorded at the
lower of fair value less estimated selling costs or the underlying loan amounts.
Write-downs are provided for subsequent declines in value. A loan is classified
as in-substance foreclosure when the Corporation has taken possession of the
collateral regardless of whether formal foreclosure proceedings have taken
place.
BANKING PREMISES AND EQUIPMENT -- Banking premises and equipment are stated
at cost, less accumulated depreciation and amortization. Depreciation and
amortization are generally computed on a straight-line basis over the estimated
useful lives of the assets. Leasehold improvements are generally amortized over
the lesser of the term of the respective leases or the estimated useful lives of
the improvements.
On January 1, 1996, the Company adopted SFAS No. 121, "Accounting for the
Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed Of."
This statement requires that long-lived assets and certain identifiable
intangibles be reviewed for impairment whenever events or changes in
circumstances indicate that the carrying amount of an asset may not be
recoverable on an undiscounted basis. If impairment is indicated the present
value of expected future cash flows from the use of the asset and its eventual
disposition are less than the carrying amount of the asset, an impairment loss
is recognized. The adoption did not have a material impact on financial position
or results of operations.
INTANGIBLE ASSETS -- The excess of cost over fair value of net assets of
businesses acquired (goodwill) is amortized on a straight-line and accelerated
basis (as appropriate) over periods generally not exceeding twenty-five years.
Core deposit and other intangibles are amortized on an accelerated basis over
their estimated lives ranging from five to ten years. Intangible assets are
included in other assets. All such intangible assets are periodically evaluated
as to the recoverability of their carrying value.
FEDERAL INCOME TAXES -- Cullen/Frost files a consolidated federal income
tax return which includes the taxable income of all of its principal
subsidiaries. Applicable federal income taxes of the individual subsidiaries are
generally determined on a separate return basis. Deferred tax assets and
liabilities are recognized for the expected future tax consequences of temporary
differences between the financial reporting bases and the tax bases of assets
and liabilities. If it is more likely than not that some portion or all of a
deferred tax asset will not be realized, a valuation allowance is recognized.
STOCK OPTION PLANS -- On January 1, 1996 the Corporation adopted SFAS No.
123, "Accounting for Stock Based Compensation." The Statement allows the
continued use of Accounting Principles Board Opinion No. 25, "Accounting for
Stock Issued to Employees," (APB No. 25) and related Interpretations. The
Corporation continues to account for its stock option plans in accordance with
APB No. 25. Under APB No. 25, because the exercise price of the Corporation's
employee stock options equals the market price of the underlying stock on the
date of grant, no compensation expense is recognized. SFAS No. 123 also allows
for the fair value method of accounting for employees stock options. The
continued use of APB No. 25 requires pro forma disclosures of net income and
earnings per share as if the fair value method of accounting had been applied.
FINANCIAL DERIVATIVES -- Derivatives are used to hedge interest rate
exposure by modifying the interest rate characteristics of related balance sheet
instruments. The specific criteria required for derivatives used for these
purposes are described below. Derivatives that do not meet these criteria are
carried at market value with changes in value recognized currently in earnings.
Derivatives used as hedges must be effective at reducing the risk
associated with the exposure being hedged and must be designated as a hedge at
the inception of the derivative contract. Derivatives currently used for hedging
purposes include interest rate swaps. These swap transactions allow management
to
38
structure the interest rate sensitivity of the asset side of the Corporation's
balance sheet to more closely match its view of the interest rate sensitivity of
the Corporation's funding sources. The fair value of derivative contracts are
carried off-balance sheet and the unrealized gains and losses on derivative
contracts are generally deferred. The interest component associated with
derivatives used as hedges or to modify the interest rate characteristics of
assets and liabilities is recognized over the life of the contract in net
interest income. Upon contract settlement or early termination, the cumulative
change in the market value of such derivatives is recorded as an adjustment to
the carrying value of the underlying asset or liability and recognized in net
interest income over the expected remaining life of the derivative contract. In
instances where the underlying instrument is repaid, the cumulative change in
the value of the associated derivative is recognized immediately in earnings.
ACCOUNTING CHANGES -- The following is a brief discussion of the SFAS
pronouncements issued by the FASB in 1997, and 1998 which apply to the
Corporation.
As of January 1, 1998, the Corporation adopted SFAS No. 130, "Reporting
Comprehensive Income" (SFAS No. 130). SFAS No. 130 establishes new rules for
the reporting and display of comprehensive income and its components; however,
the adoption of this statement had no impact on the Corporation's net income or
shareholders' equity. SFAS No. 130 requires unrealized gains and losses on the
Corporation's available-for-sale securities, which prior to adoption were
reported separately in shareholders' equity to be included in other
comprehensive income. Prior year financial statements have been reclassified to
conform to the requirements of SFAS No. 130.
In June 1997, the FASB issued SFAS No. 131, "Disclosures about Segments of
an Enterprise and Related Information." The statement establishes standards for
the method that public entities use to report information about operating
segments in annual financial statements and requires that those enterprises
report selected information about operating segments in interim financial
reports issued to shareholders. The Corporation adopted the provisions of this
statement in this annual report. These disclosure requirements had no impact on
the financial position or operating results of the Corporation.
In February 1998, the FASB issued SFAS No. 132, "Employer's Disclosures
about Pensions and Other Post Retirement Benefits." This statement revises
employer's disclosures about pension and other post retirement benefit plans but
does not change the measure of recognition of those plans. The statement
standardizes the disclosure requirements to the extent practicable, requires
additional information on changes in the benefit obligation and the fair value
of plan assets that will aid financial analysis, and eliminates certain
disclosures that are no longer useful. The Corporation adopted the provisions of
this statement in this annual report. These disclosure requirements had no
impact on the financial position or operating results of the Corporation.
In June 1998, the FASB issued SFAS No. 133, "Accounting for Derivative
Instruments and Hedging Activities." This statement requires that all
derivatives be marked-to-market on an on-going basis. The statement continues to
allow derivatives to be used to hedge various risks and provides for specific
criteria to be used to determine when hedge accounting can be used. It also
provides for offsetting changes in fair value or cash flows of both the
derivative and the hedged asset or liability to be recognized in earnings in the
same period. In addition, any changes in fair value or cash flow that represent
the ineffective portion of a hedge are required to be recognized in earnings and
cannot be deferred. For derivatives not accounted for as hedges, changes in fair
value are required to be recognized in earnings. SFAS No. 133 is effective for
fiscal years beginning after June 15, 1999. Even though early adoption is
allowed, the Corporation has no plans to adopt this statement prior to the
effective date. The impact on future results will depend on the financial
position of the Corporation and the nature and purpose of the derivatives in use
by the Corporation at that time.
NOTE B -- ACQUISITIONS
The transactions listed below, with the exception of the merger with
Overton, have been accounted for as purchase transactions with the total cash
consideration funded through internal sources. The purchase price has been
allocated to the underlying assets and liabilities based on estimated fair value
at the date of
39
acquisition. Results of operations are included from the date of acquisition.
The Overton acquisition has been accounted for under the pooling-of-interests
method of accounting which requires the assets, liabilities and shareholders'
equity of the merged entity to be retroactively combined with the Corporation's
respective accounts at recorded value. Prior period financial statements have
been restated to give effect to the pooling-of-interests method.
1998 MERGERS AND ACQUISITIONS
OVERTON BANCSHARES, INC. -- FORT WORTH
On May 29, 1998, the Corporation completed the merger of Overton
Bancshares, Inc., in Fort Worth, Texas, and its wholly-owned subsidiary Overton
Bank & Trust, N.A. The merger, which was accounted for as a
"pooling-of-interests" transaction, was the Corporation's first entry into the
Fort Worth market. With the merger, the Corporation had twelve locations in Fort
Worth/Arlington and two in Dallas. The Corporation issued approximately 4.38
million common shares as part of this transaction. As a result of the
transaction, the Corporation recorded a merger related charge of $12.2 million
primarily consisting of severance payments and other employee benefits, and
investment banking fees. In addition, shortly after the merger was consummated
the Corporation reclassified approximately $116 million of held to maturity
securities of Overton Bancshares, Inc. to available for sale securities.
HARRISBURG BANCSHARES, INC. -- HOUSTON
On January 2, 1998, the Corporation paid approximately $55.3 million to
acquire Harrisburg Bancshares, Inc., including its subsidiary Harrisburg Bank in
Houston, Texas. Goodwill associated with the transaction amounted to
approximately $24.5 million and approximately $10.6 million of other intangibles
associated with the acquisition were recorded. The Corporation acquired loans of
approximately $125 million and deposits of approximately $222 million. This
acquisition did not have a material impact on the Corporation's 1998 net income.
1997 ACQUISITION
CORPUS CHRISTI BANCSHARES, INC. -- CORPUS CHRISTI
On March 7, 1997, the Corporation paid approximately $32.2 million to
acquire Corpus Christi Bancshares, Inc., including its subsidiary Citizens State
Bank, in Corpus Christi, Texas. Goodwill associated with the transaction
amounted to approximately $13.8 million and approximately $7.1 million of other
intangibles associated with the acquisition were recorded. The Corporation
acquired loans of approximately $108 million and deposits of approximately $184
million. Cullen/Frost's results of operations would not have been materially
impacted if the Corpus Christi Bancshares acquisition had occurred at the
beginning of 1997 or 1996.
1996 ACQUISITIONS
S.B.T. BANCSHARES, INC. -- SAN MARCOS
On January 5, 1996, the Corporation paid approximately $17.7 million to
acquire S.B.T. Bancshares, Inc., including its subsidiary, State Bank and Trust
Company in San Marcos, Texas. Goodwill associated with the transaction amounted
to approximately $6.5 million and approximately $4.5 million of other
intangibles associated with the acquisition were recorded. The Corporation
acquired loans of approximately $51 million and deposits of approximately $112
million.
PARK NATIONAL BANK -- HOUSTON
On February 15, 1996, the Corporation paid approximately $33.5 million to
acquire Park National Bank in Houston, Texas. Goodwill associated with the
transaction amounted to approximately $8.4 million and approximately $7.6
million of other intangibles associated with the acquisition were recorded. The
Corporation acquired loans of approximately $157 million and deposits of
approximately $225 million. Cullen/Frost's results of operations would not have
been materially impacted if the Park National Bank acquisition had occurred at
the beginning of 1996.
40
NOTE C -- CASH AND DUE FROM BANKS
Cullen/Frost subsidiary banks are required to maintain cash or non-interest
bearing reserves with the Federal Reserve Bank which are equal to specified
percentages of deposits. The average amounts of reserve and contractual balances
were $75.1 million for 1998 and $78.3 million for 1997.
NOTE D -- SECURITIES
A summary of the amortized cost and estimated fair value of securities is
presented below.
DECEMBER 31, 1998
------------------------------------------------
AMORTIZED UNREALIZED UNREALIZED ESTIMATED
(in thousands) COST GAINS LOSSES FAIR VALUE
- -----------------------------------------------------------------------------------------
Securities Held to Maturity:
U.S. Government agencies and
corporations..................... $ 107,182 $ 1,939 $ 12 $ 109,109
States and political
subdivisions..................... 4,232 316 4,548
Other.............................. 25 25
--------------------------------------------------
Total............................ $ 111,439 $ 2,255 $ 12 $ 113,682
==================================================
Securities Available for Sale:
U.S. Treasury...................... $ 189,240 $ 357 $ 23 $ 189,574
U.S. Government agencies and
corporations..................... 1,601,930 13,448 2,980 1,612,398
State and political subdivisions... 119,962 1,943 907 120,998
Other.............................. 56,504 97 16 56,585
--------------------------------------------------
Total............................ $1,967,636 $ 15,845 $3,926 $1,979,555
==================================================
December 31,1997
--------------------------------------------------
Amortized Unrealized Unrealized Estimated
(in thousands) Cost Gains Losses Fair Value
- ------------------------------------------------------------------------------------------
Securities Held to Maturity:
U.S. Government agencies and
corporations..................... $ 205,229 $ 5,881 $ 1,622 $ 209,488
States and political
subdivisions..................... 44,181 2,563 1,032 45,712
Other.............................. 6,018 17 10 6,025
Total............................ $ 255,428 $ 8,461 $ 2,664 $ 261,225
Securities Available for Sale:
U.S. Treasury...................... $ 341,516 $ 2,112 $ 1,947 $ 341,681
U.S. Government agencies and
corporations..................... 1,148,723 23,386 9,838 1,162,271
State and political subdivisions... 50 50
Other.............................. 10,048 10,048
Total............................ $ 1,500,337 $ 25,498 $ 11,785 $1,514,050
The amortized cost and estimated fair value of securities at December 31,
1998 are presented below by contractual maturity. Actual maturities will differ
from contractual maturities because borrowers may have the right to call or
prepay obligations with or without prepayment penalties.
DECEMBER 31, 1998
-------------------------------------------------------
SECURITIES HELD TO SECURITIES AVAILABLE FOR
MATURITY SALE
------------------------- --------------------------
AMORTIZED ESTIMATED AMORTIZED ESTIMATED
(in thousands) COST FAIR VALUE COST FAIR VALUE
- -----------------------------------------------------------------------------------------------
Due in one year or less.............. $ 55 $ 55 $ 192,788 $ 192,978
Due after one year through five
years................................ 565 578 50,755 51,564
Due after five years through ten
years................................ 1,670 1,782 37,707 38,264
Due after ten years.................. 1,967 2,157 84,456 84,351
------------------------- --------------------------
4,257 4,572 365,706 367,157
Mortgage-backed securities and
collateralized mortgage
obligations........................ 107,182 109,110 1,601,930 1,612,398
------------------------- --------------------------
Total........................... $ 111,439 $ 113,682 $1,967,636 $1,979,555
========================= ==========================
Proceeds from sales of securities available for sale during 1998 were
$900.4 million. During 1998, gross gains of $1,064,000 and gross losses of
$705,000 were realized on those sales. Proceeds from sales of securities
available for sale during 1997 were $434.5 million. During 1997, gross gains of
$556,000 and gross losses of $58,000 were realized on those sales. Proceeds from
sales of securities available for sale during 1996 were $240.1 million. During
1996, gross gains of $152,000 and gross losses of $1,044,000 were realized on
those sales.
The carrying value of securities pledged to secure public funds, trust
deposits, securities sold under repurchase agreements and for other purposes as
required or permitted by law amounted to $1.2 billion at December 31, 1998 and
1997.
41
NOTE E -- LOANS AND ALLOWANCE FOR POSSIBLE LOAN LOSSES
A summary of loans outstanding follows:
December 31
--------------------------
(in thousands) 1998 1997
- -----------------------------------------------------------------
Real estate:
Construction.................... $ 292,789 $ 179,201
Land............................ 75,397 60,339
Permanent mortgages:
Commercial................. 346,479 259,320
Residential................ 655,484 516,345
Other........................... 349,255 355,475
Commercial and industrial............ 1,211,180 989,355
Consumer............................. 625,018 645,988
Financial institutions............... 7,416 3,767
Foreign.............................. 45,187 72,911
Other................................ 41,755 37,388
Unearned discount.................... (3,357) (3,194)
--------------------------
Total loans..................... $ 3,646,603 $ 3,116,895
==========================
In the normal course of business, in order to meet the financial needs of
its customers, the Corporation is a party to financial instruments with
off-balance sheet risk. These include commitments to extend credit and standby
letters of credit which commit the Corporation to make payments on behalf of
customers when certain specified future events occur. Both arrangements have
credit risk essentially the same as that involved in extending loans to
customers and are subject to the Corporation's normal credit policies.
Collateral is obtained based on management's credit assessment of the customer.
No material losses are anticipated as a result of these commitments. Commitments
to extend credit and standby letters of credit amounted to $1.2 billion and
$53.0 million, respectively, at December 31, 1998. Commitments to extend credit
and standby letters of credit amounted to $1.2 billion and $59.4 million,
respectively, at December 31, 1997. Commercial and industrial loan commitments
represent approximately 71 percent and 74 percent of the total loan commitments
outstanding at December 31, 1998 and 1997, respectively.
The majority of the Corporation's real estate loans are secured by real
estate in San Antonio, Houston and Fort Worth. Mortgage loans of approximately
$14.0 million and $10.0 million were held for sale by the Corporation and are
included in residential permanent mortgages at December 31, 1998 and 1997,
respectively. These loans are valued at the lower of cost or market, on an
aggregate basis.
In the normal course of business, Cullen/Frost subsidiary banks make loans
to directors and officers of both Cullen/Frost and its subsidiaries. These loans
are made on substantially the same terms, including interest rates and
collateral, as those prevailing at the time for comparable transactions with
other persons. Loans made to directors and executive officers of Cullen/Frost
and its significant subsidiaries, including loans made to their associates,
amounted to $45.3 million and $51.9 million at December 31, 1998 and 1997,
respectively. During 1998, additions to these loans amounted to $47.4 million,
repayments totaled $53.7 million and other changes totaled $335,000. These other
changes consist primarily of changes in related-party status. Standby letters of
credit extended to directors and executive officers of Cullen/Frost and its
significant subsidiaries and their associates amounted to $614,000 and $692,000
at December 31, 1998 and 1997, respectively.
42
A summary of the changes in the allowance for possible loan losses follows:
Year Ended December 31
-------------------------------
(in thousands) 1998 1997 1996
- -------------------------------------------------------------------------
Balance at the beginning of the year.... $ 48,073 $ 42,821 $ 36,525
Provision for possible loan losses...... 10,393 9,174 8,494
Loan loss reserve of acquired
institutions.......................... 1,250 2,105 627
Net charge-offs:
Losses charged to the allowance.... (12,548) (9,927) (10,621)
Recoveries......................... 6,448 3,900 7,796
-------------------------------
Net charge-offs............... (6,100) (6,027) (2,825)
-------------------------------
Balance at the end of the year.......... $ 53,616 $ 48,073 $ 42,821
===============================
A loan within the scope of SFAS No. 114 is considered impaired when, based
on current information and events, it is probable that the Corporation will be
unable to collect all amounts due according to the contractual terms of the loan
agreement, including scheduled principal and interest payments. All impaired
loans are included in non-performing assets. At December 31, 1998, the majority
of the impaired loans were real estate loans and collectability was measured
based on the fair value of the collateral. Interest payments on impaired loans
are typically applied to principal unless collectability of the principal amount
is fully assured, in which case interest is recognized on the cash basis.
Interest revenue recognized on impaired loans for 1998 and 1997 was $70,000 and
$82,000, respectively. The total allowance for possible loan losses includes
activity related to allowances calculated in accordance with SFAS No. 114 and
activity related to other loan loss allowances determined in accordance with
SFAS No. 5.
The following is a summary of loans considered to be impaired:
December 31
--------------------
(in thousands) 1998 1997
- --------------------------------------------------------------
Impaired loans with no valuation
reserve............................... $ 1,924 $ 1,940
Impaired loans with a valuation
reserve............................... 2,779 3,265
--------------------
Total recorded investment in impaired
loans................................. $ 4,703 $ 5,205
====================
Valuation reserve....................... $ 1,834 $ 2,199
The average recorded investment in impaired loans was $5.7 million and $5.5
million for the years ended December 31, 1998 and 1997, respectively.
NOTE F -- NON-PERFORMING ASSETS
A summary of non-performing assets follows:
December 31
--------------------
(in thousands) 1998 1997
- --------------------------------------------------------------
Non-accrual............................. $ 12,997 $ 13,077
Foreclosed assets....................... 4,107 5,011
--------------------
$ 17,104 $ 18,088
====================
The Corporation did not have any restructured loans for the years ended December
31, 1998 and 1997, respectively.
Cullen/Frost recognized interest income on non-accrual and restructured
loans of approximately $742,000, $594,000 and $302,000 in 1998, 1997 and 1996,
respectively. Had these reduced earning and non-earning loans performed
according to their original contract terms, Cullen/Frost would have recognized
additional interest income of approximately $1,262,000 in 1998, $1,167,000 in
1997 and $1,239,000 in 1996.
43
NOTE G -- BANKING PREMISES AND EQUIPMENT
A summary of banking premises and equipment follows:
December 31
-----------------------------------------------------------------------------
1998 1997
------------------------------------- -------------------------------------
ACCUMULATED Accumulated
DEPRECIATION NET Depreciation Net
AND CARRYING and Carrying
(in thousands) COST AMORTIZATION VALUE Cost Amortization Value
- --------------------------------------------------------------------------------------------------------------------
Land................................. $ 44,528 $ 44,528 $ 43,257 $ 43,257
Buildings............................ 64,103 $ 22,012 42,091 58,178 $ 20,503 37,675
Furniture and equipment.............. 104,200 79,730 24,470 98,926 73,727 25,199
Leasehold improvements............... 37,881 19,519 18,362 35,721 16,519 19,202
Construction in progress............. 7,839 7,839 3,377 3,377
-----------------------------------------------------------------------------
Total banking premises and
equipment..................... $ 258,551 $121,261 $137,290 $ 239,459 $110,749 $128,710
=============================================================================
NOTE H -- DEPOSITS
A summary of deposits outstanding by category follows:
December 31
--------------------------
(in thousands) 1998 1997
- -----------------------------------------------------------------
Demand deposits...................... $ 1,843,499 $ 1,548,565
Savings and Interest-on-Checking..... 961,597 855,783
Money market deposit accounts........ 1,493,778 1,255,237
Time accounts of $100,000 or more.... 662,923 599,953
Time accounts under $100,000......... 601,198 616,192
Other................................ 282,492 293,360
--------------------------
Total deposits.................. $ 5,845,487 $ 5,169,090
==========================
At December 31, 1999, the Corporation's aggregate amount of maturities of
public and private time accounts are as follows: 1999 -- $1,295,565,000;
2000 -- $66,700,000; 2001 -- $6,466,000; 2002 -- $4,464,000; 2003 -- $2,303,000;
and thereafter $217,000. Foreign deposits totaled $672,607,000 and $632,477,000
at December 31, 1998 and 1997, respectively.
NOTE I -- BORROWED FUNDS
Cullen/Frost has a $7.5 million revolving credit facility with another
financial institution. The line of credit bears interest at prime. There were no
borrowings outstanding on this line at December 31, 1998 and 1997.
The Corporation has received advances totaling $13,295,000 from the Federal
Home Loan Bank (FHLB) under provisions of a credit facility designed to enable
the Corporation to fund long-term loans. The advances mature on November 1, 2002
through July 2, 2018, bear interest at the FHLB's floating rate (average 6.11%
at December 31, 1998), and are collateralized by a blanket floating lien on all
first mortgage loans, the FHLB capital stock owned by the Corporation, and any
Bank funds on deposit with the FHLB.
44
Scheduled payments and maturity due under terms of the advances are as
follows:
(in thousands) FHLB Advances
- ------------------------------------------------------
1999................................. $ 3,775
2000................................. 568
2001................................. 604
2002................................. 749
2003................................. 6,021
Subsequent to 2003................... 1,578
--------------
Total........................... $ 13,295
==============
The following table represents balances as they relate to securities sold
under repurchase agreements:
Year Ended December 31
----------------------
(in thousands) 1998 1997
- -------------------------------------------------------------
Balance at year end.................. $ 209,526 $ 175,839
Maximum month-end balance............ 209,526 175,839
For the year:
Average daily balance.............. 175,699 153,586
Cullen/Frost Capital Trust I, a Delaware statutory business trust (the
"Issuer Trust") and wholly-owned subsidiary of the Corporation, issued on
February 6, 1997, $100 million of its 8.42 percent Capital Securities, Series A
(the "Capital Securities"), which represent beneficial interests in the Issuer
Trust, in an offering exempt from registration under the Securities Act of 1933
pursuant to Rule 144A. The Capital Securities will mature on February 1, 2027
and are redeemable in whole or in part at the option of the Corporation at any
time after February 1, 2007 with the approval of the Federal Reserve and in
whole at any time upon the occurrence of certain events affecting their tax or
regulatory capital treatment. The Issuer Trust used the proceeds of the offering
of the Capital Securities to purchase Junior Subordinated Debentures of the
Corporation which constitute its only assets and which have terms substantially
similar to the Capital Securities. Payments of distributions on the Capital
Securities and payments on liquidation or redemption of the Capital Securities
are guaranteed by the Corporation on a limited basis pursuant to a Guarantee.
The Corporation has also entered into an Agreement as to Expenses and
Liabilities with the Issuer Trust pursuant to which it has agreed on a
subordinated basis to pay any costs, expenses or liabilities of the Issuer Trust
other than those arising under the Capital Securities. The obligations of the
Corporation under the Junior Subordinated Debentures, the related Indenture, the
trust agreement establishing the Issuer Trust, the Guarantee and the Agreement
as to Expenses and Liabilities, in the aggregate, constitute a full and
unconditional guarantee by the Corporation of the Issuer Trust's obligations
under the Capital Securities.
The Corporation used the majority of the proceeds of the sale of the Junior
Subordinated Debentures for acquisitions and the repurchase of the Corporation's
common stock. The Capital Securities are included in the Tier 1 capital of the
Corporation for regulatory capital purposes and are reported as debt on the
balance sheet, net of deferred issuance costs. The Corporation records
distributions payable on the Capital Securities as interest expense. The
Corporation has the right to defer payments of interest on the Junior
Subordinated Debentures at any time or from time to time for a period of up to
ten consecutive semi-annual periods with respect to each deferral period. Under
the terms of the Junior Subordinated Debentures, in the event that under certain
circumstances there is an event of default under the Junior Subordinated
Debentures or the Corporation has elected to defer interest on the Junior
Subordinated Debentures, the Corporation may not, with certain exceptions,
declare or pay any dividends or distributions on its capital stock or purchase
or acquire any of its capital stock.
On March 13, 1997, the Corporation and the Issuer Trust, filed a
Registration Statement on Form S-4 with the Securities and Exchange Commission
to register under the Securities Act of 1933 the exchange of up to $100 million
aggregate Liquidation Amount of "new" 8.42 percent Capital Securities, Series
A for
45
the then outstanding Capital Securities. On April 25, 1997, the Corporation
exchanged all of the outstanding Capital Securities for registered Capital
Securities. The "new" Capital Securities have the same terms as the "old"
Capital Securities. This exchange enhanced the transferability of the Capital
Securities and had no impact on redemption of the Capital Securities, the Junior
subordinated Debentures issued by the Company, the Company's guarantee of the
Capital Securities, or other matters described above.
NOTE J -- COMMON STOCK AND EARNINGS PER COMMON SHARE
In accordance with SFAS 128, the reconciliation of earnings per share for
1998, 1997 and 1996 follows:
December 31
-------------------------------
(in thousands, except per share amounts) 1998 1997 1996
- -------------------------------------------------------------------------
Numerators for both basic and diluted
earnings per share, net income........ $ 75,645 $ 72,967 $ 62,938
===============================
Denominators:
Denominators for basic earnings per
share, average outstanding common
shares................................ 26,575 26,499 26,597
Dilutive effect of stock options........ 764 877 629
===============================
Denominator for diluted earnings per
share................................. 27,339 27,376 27,226
===============================
Earnings per share:
Basic................................... $ 2.85 $ 2.75 $ 2.37
Diluted................................. 2.77 2.67 2.31
NOTE K -- DIVIDENDS
In the ordinary course of business Cullen/Frost is dependent upon dividends
from its subsidiary banks to provide funds for the payment of dividends to
shareholders and to provide for other cash requirements. The amount of dividends
that subsidiary banks may declare is subject to regulations. Without prior
regulatory approval, the subsidiary banks had approximately $53.3 million
available for the payment of dividends to Cullen/Frost at December 31, 1998.
NOTE L -- CAPITAL
The table below reflects various measures of regulatory capital at year end
1998 and 1997 for the Corporation.
DECEMBER 31, 1998 December 31, 1997
-------------------- --------------------
(in thousands) AMOUNT RATIO Amount Ratio
- ----------------------------------------------------------------------------------
Risk-Based
Tier 1 Capital.................. $ 512,125 12.23% $ 480,755 13.21%
Tier 1 Capital Minimum
requirement................... 167,470 4.00 145,602 4.00
Total Capital................... $ 564,477 13.48% $ 526,287 14.46%
Total Capital Minimum
requirement................... 334,940 8.00 291,204 8.00
Risk-adjusted assets, net of
goodwill...................... $ 4,186,744 $ 3,640,055
Leverage ratio....................... 7.71% 8.22%
Average equity as a percentage of
average assets..................... 7.63 7.83
At December 31, 1998 and 1997, the Corporation's subsidiary banks were
considered "well capitalized" as defined by the FDIC Improvement Act of 1991,
the highest rating, and the Corporation's capital ratios were in excess of
"well capitalized" levels. A financial institution is deemed to be well
capitalized if the institution has a total risk-based capital ratio of 10.0
percent or greater, a Tier 1 risk-based capital ratio of 6.0 percent or greater,
and a Tier 1 leverage ratio of 5.0 percent or greater and the institution is not
subject to an order, written agreement, capital directive or prompt corrective
action directive to meet and
46
maintain a specific capital level for any capital measure. The Corporation and
its subsidiary banks currently exceed all minimum capital requirements.
Management is not aware of any conditions or events that would have changed the
Corporation's capital rating since December 31, 1998.
The Corporation is subject to the regulatory capital requirements
administered by the Federal Reserve Bank. Regulators can initiate certain
mandatory actions, if the Corporation fails to meet the minimum requirements,
that could have a direct material effect on the Corporation's financial
statements.
NOTE M -- LEASES AND RENTAL AGREEMENTS
Rental expense for all leases amounted to $13.9 million, $12.8 million and
$12.1 million for the years ended December 31, 1998, 1997 and 1996,
respectively.
In June 1987, Frost Bank consummated the sale of its office tower and
leased back a portion of the premises under a 13-year primary lease term with
options allowing for occupancy up to 50 years. The Bank also sold its related
parking garage facility and leased back space in that structure under a 12-year
primary lease term with options allowing for occupancy up to 50 years. Both
leases allow for purchase of the related asset under specific terms.
A summary of the total future minimum rental commitments due under
non-cancelable equipment leases and long-term agreements on banking premises at
December 31, 1998 follows:
Total
(in thousands) Commitments
- ---------------------------------------------------
1999................................. $13,802
2000................................. 13,273
2001................................. 12,668
2002................................. 11,809
2003................................. 10,651
Subsequent to 2003................... 34,800
-----------
Total future minimum rental
commitments.................... $97,003
===========
It is expected that certain leases will be renewed, or equipment replaced
with new leased equipment, as these leases expire.
NOTE N -- EMPLOYEE BENEFIT PLANS
RETIREMENT PLANS --
Cullen/Frost has a non-contributory defined benefit plan which covers
substantially all employees who have completed at least one year of service and
have attained the age of 21. Defined benefits are provided based on an
employee's final average compensation, age at retirement and years of service.
Cullen/Frost's funding policy is to contribute quarterly an amount necessary to
satisfy the Employee Retirement Income Security Act (ERISA) funding standards.
An eligible employee's right to receive benefits under the plan becomes fully
vested upon the earlier of the date on which such employee has completed five
years of service or the date on which such employee attains 65 years of age.
Retirement benefits under the plan are paid to vested employees upon their (i)
normal retirement at age 65 or later or (ii) early retirement at or after age
55, but before age 65. In addition, Cullen/Frost has a Restoration of Retirement
Income Plan (providing benefits in excess of the limits under Section 415 of the
Internal Revenue Code of 1986, as amended) for eligible employees which is
designed to comply with the requirements of ERISA and the entire cost of which
is provided by Cullen/Frost contributions. Both plans, as amended, provide for
the payment of monthly retirement income pursuant to a formula based on an
eligible employee's highest three consecutive years of final average
compensation during the last ten consecutive years of employment.
47
The following table summarizes benefit obligation and plan asset activity
for the plans.
(in thousands) 1998 1997
- --------------------------------------------------------------
CHANGE IN BENEFIT OBLIGATION:
Benefit obligation at beginning of
year............................... $ 51,776 $ 44,796
Service cost.......................... 2,915 2,741
Interest cost......................... 3,711 3,319
Plan Amendments....................... 6,071
Actuarial loss........................ 2,545 2,103
Benefits paid......................... (1,352) (1,183)
--------------------
Benefit obligation at end of year..... $ 65,666 $ 51,776
CHANGE IN PLAN ASSETS:
Fair value of plan assets at beginning
of year............................... $ 42,357 $ 31,676
Actual return on plan assets.......... 6,601 4,550
Employer contributions................ 154 7,313
Benefits paid......................... (1,352) (1,183)
--------------------
Fair value of plan assets at end of
year.................................. $ 47,760 $ 42,356
Funded status of the plan............. $ 17,906 $ 9,420
Unrecognized net actuarial loss....... (7,329) (7,876)
Unrecognized prior service cost....... (9,805) (4,292)
Unrecognized net transition asset..... 490 590
--------------------
(Prepaid) accrued benefit cost........ $ 1,262 $ (2,158)
====================
WEIGHTED-AVERAGE ASSUMPTIONS AS OF
DECEMBER 31
Discount rate......................... 6.75% 7.25%
Expected return on plan assets........ 9.00 9.00
Rate of compensation increase......... 5.00 5.00
Net pension cost included the following components:
(in thousands) 1998 1997 1996
- -------------------------------------------------------------------------
Service cost for benefits earned during
the year.............................. $ 2,915 $ 2,741 $ 2,035
Expected return on plan assets, net of
expenses.............................. (3,765) (3,000) (2,401)
Interest cost on projected benefit
obligation............................ 3,711 3,319 2,947
Net amortization and deferral........... 714 742 1,361
-------------------------------
Net pension cost................... $ 3,575 $ 3,802 $ 3,942
===============================
The Corporation has a supplemental executive retirement plan ("SERP") for
certain key executives. The plan provides for target retirement benefits, as a
percentage of pay, beginning at age 55. The target percentage is 45 percent of
pay at age 55, increasing to 60 percent at age 60 and later. Benefits under the
SERP are reduced, dollar-for-dollar, by benefits received under the Retirement
and Restoration Plans, described above, and any social security benefits.
48
SAVINGS PLANS --
The Corporation maintains a 401(k) stock purchase plan (the "401(k)
Plan"). The 401(k) Plan permits each participant to make before- or after-tax
contributions up to 16 percent of eligible compensation. Cullen/Frost makes
matching contributions to the 401(k) Plan based on the amount of each
participant's contributions up to a maximum of six percent of eligible
compensation. Eligible employees must complete 90 days of service to be eligible
for enrollment and beginning on January 1, 1999, vest in the Corporation's
matching contributions immediately. The Corporation's gross expenses related to
the 401(k) Plan were $2.8 million, $2.3 million and $2.0 million for 1998, 1997
and 1996, respectively. During 1998, 1997 and 1996, the Corporation utilized
forfeitures with a value of $199,000, $308,000 and $449,000, respectively, to
offset this expense.
The 1991 Thrift Incentive Stock Purchase Plan ("1991 Stock Purchase
Plan") was adopted to offer those employees whose participation in the 401(k)
Plan is limited an alternative means of receiving comparable benefits. The
Corporation's expenses related to the 1991 Stock Purchase Plan were $861,000,
$743,000 and $754,000 for 1998, 1997 and 1996, respectively.
EXECUTIVE STOCK PLANS --
The Corporation has four executive stock plans and one outside director
stock plan; the 1983 Nonqualified Stock Option Plan ("1983 Plan"), the 1988
Nonqualified Stock Option Plan ("1988 Plan"), the Restricted Stock Plan, the
1992 Stock Plan and the 1997 Outside Directors Stock plan ("1997 Plan"). The
1992 Stock Plan is an all-inclusive plan, with an aggregate of 2,805,029 shares
of common stock authorized for award. The 1992 Stock Plan has replaced all other
previously approved executive stock plans.
The 1992 Stock Plan allows the Corporation to grant restricted stock,
incentive stock options, nonqualified stock options, stock appreciation rights,
or any combination thereof to certain key executives of the Corporation.
The 1997 Outside Directors Plan allows the Corporation to grant
nonqualified stock options to outside directors. The options may be awarded to
outside directors in such number, and upon such terms, and at any time and from
time to time as determined by the Compensation and Benefits Committee
("Committee"). Each award is evidenced by an award agreement that specifies
the option price, the duration of the option, the number of shares to which the
option pertains, and such other provisions as the Committee determines. The
option price for each grant is at least equal to the fair market value of a
share on the date of grant. Options granted expire at such time as the Committee
determines at the date of grant and in no event does the exercise period exceed
a maximum of ten years.
49
The following is a summary of option transactions in each of the last three
years.
1983 Plan 1988 Plan 1992 Plan
---------------------- ---------------------- ----------------------------------
Weighted Weighted Shares Weighted
Options Average Options Average Available Options Average
Outstanding Price Outstanding Price For Grant Outstanding Price
- -----------------------------------------------------------------------------------------------------------------------------
Balance, Dec. 31, 1995.................. 55,534 $ 4.73 232,794 $ 5.18 740,456 828,066 $18.55
Granted................................. (403,000) 403,000 30.34
Exercised............................... (13,036) 4.14 (53,958) 5.14 (38,906) 17.73
Canceled................................ (5,868) 5.46 (788) 5.46 21,234 (21,234) 19.05
------------------------------------------------------------------------------------
Balance, Dec. 31, 1996.................. 36,630 4.83 178,048 5.20 358,690 1,170,926 22.56
Authorized.............................. 1,000,000
Granted................................. (176,000) 176,000 48.19
Exercised............................... (10,248) 5.46 (35,715) 5.05 (95,838) 18.30
Canceled................................ 9,380 (9,380) 22.66
------------------------------------------------------------------------------------
Balance, Dec. 31, 1997.................. 26,382 4.58 142,333 5.24 1,192,070 1,241,708 26.52
Granted................................. (420,900) 420,900 49.40
Exercised............................... (16,246) 4.04 (13,082) 4.41 (63,035) 20.49
Canceled................................ 7,540 (7,540) 52.52
------------------------------------------------------------------------------------
Balance, Dec. 31, 1998.................. 10,136 $ 5.46 129,251 $ 5.32 778,710 1,592,033 $32.69
====================================================================================
At Dec. 31, 1998
$12.73-$18.13*
Per Share Price Range................... $5.46 $3.01-$5.46
22.88-*30.25*
48.19-*60.63**
Weighted-Average Remaining Contractual * 5.2 Years
Life.................................. 2.8 Years 2.7 Years
** 7.3 Years
***9.4 Years
1997 Plan
----------------------------------
Shares Weighted
Available Options Average
For Grant Outstanding Price
- ----------------------------------------------------------------------------
Balance, Dec. 31, 1995..................
Granted.................................
Exercised...............................
Canceled................................
Balance, Dec. 31, 1996..................
Authorized.............................. 150,000
Granted................................. (18,000) 18,000 $45.1
Exercised...............................
Canceled................................
----------------------------------
Balance, Dec. 31, 1997.................. 132,000 18,000 45.13
Granted................................. (36,000) 36,000 53.75
Exercised...............................
Canceled................................
----------------------------------
Balance, Dec. 31, 1998.................. 96,000 54,000 $50.88
==================================
At Dec. 31, 1998
Per Share Price Range................... $45.13-$53.75
Weighted-Average Remaining Contractual
Life.................................. 9.2 Years
*Includes 453,113 options of which 391,753 are exercisable both with a
weighted-average exercise price of $17.25.
**Includes 549,320 options of which 231,196 are exercisable both with a
weighted-average exercise price of $27.92.
***Includes 589,600 options of which 34,800 are exercisable both with a
weighted-average exercise price of $48.99.
There were 851,136, 649,978 and 533,473 options exercisable for 1998, 1997,
and 1996 with a weighted-average exercise price of $21.37, $16.66 and $12.43,
respectively. The 1998 options were awarded having a ten-year life with a
three-year cliff vesting period. In general, options awarded prior to 1998 had a
ten-year life with a five-year vesting period. These plans which were approved
by shareholders were established to enable the Corporation to retain and
motivate key employees. A committee of non-participating directors has sole
authority to select the employees, establish the awards to be issued, and
approve the terms and conditions of each award contract. The Corporation has
common stock reserved for future issuance upon the grant and exercise of options
of 2,660,130 shares.
In accounting for the impact of issuing stock options, the Corporation has
elected to continue to follow the requirements of Accounting Principles Board
Opinion No. 25, "Accounting for Stock Issued to Employees" (APB 25) and
Related Interpretation as allowed by SFAS No. 123, rather than to follow the
recognition requirements of SFAS No. 123, which requires fair value accounting.
SFAS No. 123 requires disclosure of pro forma net income and earnings per share
information assuming that stock options granted in 1996, 1997 and 1998 have been
accounted for in accordance with the fair value requirements of SFAS No. 123.
50
The fair value for these options was estimated at the date of grant using a
Black-Scholes option pricing model. The Black-Scholes option valuation model was
developed for use in estimating the fair value of traded options which have
characteristics which are different from the Corporation's employee stock
options. In addition, option valuation models require the input of highly
subjective assumptions which can significantly impact the estimated fair value.
As such, in management's opinion, the existing models do not necessarily provide
a reliable single measure of the fair value of employee/outside director stock
options.
The following weighted-average assumptions were used for 1998, 1997 and
1996, respectively: risk-free interest rates of 4.87 percent, 5.37 percent and
6.50 percent; dividend yield of 2.25 percent, 2.00 percent and 2.50 percent;
volatility factors of the expected market price of the Corporation's common
stock of 23 percent, 19 percent and 21 percent; and weighted-average expected
lives of the options of 8 years. The weighted-average grant-date fair value of
options granted during 1998, 1997 and 1996 was $16.71, $13.18, and $9.48,
respectively. For purposes of proforma disclosures, the estimated fair value of
the options is amortized to expense over the options' vesting period.
The Corporation's proforma information as if compensation expense had been
recognized in accordance with SFAS 123 is summarized below:
(in thousands except per share amounts) 1998 1997 1996
- ----------------------------------------------------------------------
Proforma net income*................. $ 74,345 $ 72,265 $ 65,652
Proforma earnings per common share
Basic........................... $ 2.80 $ 2.73 $ 2.36
Diluted......................... 2.79 2.72 2.36
*Because SFAS No. 123 is applicable only to options granted subsequent to
December 31, 1994, its proforma effect is not necessarily indicative of its
impact on future years.
In 1998, restricted stock grants of 41,500 were awarded under the 1992
Stock Plan. Restricted stock grants awarded under the 1992 Stock Plan totaled
58,500 and 3,000 shares for 1997 and 1996, respectively. The weighted-average
price for these awards equaled the market price at the date of grant and was
$49.30, $48.19, and $26.75 for 1998, 1997 and 1996, respectively. Deferred
compensation expense related to the restricted stock was $1.5 million in 1998,
$707,000 in 1997, and $472,000 in 1996. Restricted shares are generally awarded
under a three- to four-year cliff vesting period. The market value of restricted
shares at the date of grant is expensed over the restriction period.
The Corporation has change-in-control agreements with 19 of its executives.
Under seven of these agreements, as revised, each covered person could receive,
in the event of a change in control, one-half of his base compensation upon the
effectiveness of the change in control, and from one and one-half times up to
2.49 times (depending on the executive) of his average annual W-2 compensation
during the previous five years if such person is constructively terminated or
discharged for reasons other than cause within two years following the change in
control. Under the remaining 12 agreements, each covered person could receive
from two times up to 2.99 times (depending on the executive) of his average W-2
compensation during the previous five years if such person is constructively
terminated or discharged for reasons other than cause within two years following
the change in control. These agreements, other than certain instances of stock
appreciation and SERPS, limit payments to avoid being considered "parachute
payments" as defined by the Internal Revenue Code. The maximum contingent
liability under these agreements approximated $12 million at December 31, 1998.
The Corporation has no material liability for post-retirement or
post-employment benefits other than pensions.
51
NOTE O -- INCOME TAXES
The following is an analysis of the Corporation's income taxes included in
the consolidated statements of operations for the years ended December 31, 1998,
1997, and 1996.
(in thousands) 1998 1997 1996
- ----------------------------------------------------------------------
Current income tax expense........... $ 47,669 $ 46,236 $ 38,274
Deferred income tax.................. (5,574) (6,681) (3,865)
-------------------------------
Income tax expense as reported....... $ 42,095 $ 39,555 $ 34,409
===============================
The following is a reconciliation of the difference between income tax
expense as reported and the amount computed by applying the statutory income tax
rate to income before income taxes:
Year Ended December 31
---------------------------------
(in thousands) 1998 1997 1996
- ------------------------------------------------------------------------
Income before income taxes........... $ 117,740 $ 112,522 $ 97,347
Statutory rate....................... 35% 35% 35%
---------------------------------
Income tax expense at the statutory
rate............................... 41,209 39,383 34,071
Effect of tax-exempt interest........ (1,820) (1,298) (1,145)
Amortization of goodwill............. 1,410 1,027 778
Acquisition costs.................... 931
Other................................ 365 443 705
---------------------------------
Income tax expense as reported....... $ 42,095 $ 39,555 $ 34,409
=================================
Tax (expense) benefits related to
security transactions.............. $ (126) $ (174) $ 312
=================================
The tax effects of temporary differences that give rise to significant
portions of deferred tax assets and liabilities at December 31, 1998, and 1997
are presented below:
(in thousands) 1998 1997
- -----------------------------------------------------------
Deferred tax assets:
Allowance for possible loan
losses......................... $ 18,766 $ 16,769
Building modification reserve... 1,592 1,592
Gain on sale of assets.......... 1,079 1,101
Net occupancy restructuring..... 211
Other........................... 1,601 1,076
--------------------
Total gross deferred tax
assets.................. 23,038 20,749
Deferred tax liabilities:
Prepaid expenses................ $ (569) $ (598)
Unrealized gain on securities
available for sale............. (4,172) (4,795)
Intangibles..................... (3,896) (2,203)
Bank premises and equipment..... (351) (446)
Other........................... (500) (1,427)
--------------------
Total gross deferred tax
liabilities............. (9,488) (9,469)
--------------------
Net deferred tax asset..... $ 13,550 $ 11,280
====================
At December 31, 1998 and 1997, no valuation allowance for deferred tax
assets was necessary because they were supported by recoverable taxes paid in
prior years.
52
NOTE P -- NON-INTEREST EXPENSE
Significant components of other non-interest expense for the years ended
December 31, 1998, 1997, and 1996 are presented below:
Year Ended December 31
-------------------------------
(in thousands) 1998 1997 1996
- ----------------------------------------------------------------------
Outside computer service............. $ 9,380 $ 7,936 $ 9,823
Other professional expenses.......... 6,327 5,793 10,425
Stationery, printing and supplies.... 6,024 5,850 7,199
Armored motor service................ 3,946 3,497 4,091
Postage and express.................. 3,830 3,558 4,204
Other................................ 46,337 38,880 22,953
-------------------------------
Total........................... $ 75,844 $ 65,514 $ 58,695
===============================
NOTE Q -- CASH FLOW DATA
For purposes of reporting cash flow, cash and cash equivalents include the
following:
December 31
----------------------------------
(in thousands) 1998 1997 1996
- ----------------------------------------------------------------------------
Cash and due from banks................. $ 684,941 $ 637,613 $ 901,239
Federal funds sold...................... 102,900 190,000 52,850
----------------------------------
Total.............................. $ 787,841 $ 827,613 $ 954,089
==================================
Generally, Federal funds are sold for one-day periods and securities
purchased under resale agreements are held for less than thirty-five days.
Supplemental cash flow information is as follows:
Year Ended December 31
----------------------------------
(in thousands) 1998 1997 1996
- ----------------------------------------------------------------------------
Cash paid:
Interest........................... $ 164,150 $ 144,512 $ 126,982
Income Taxes....................... 45,968 39,391 36,796
Non-cash items:
Loans originated to facilitate the
sale of foreclosed assets........ 269 1,690 848
Loan foreclosures.................. 1,995 4,240 3,449
NOTE R -- FAIR VALUES OF FINANCIAL INSTRUMENTS
Fair Values of Financial Instruments -- SFAS No. 107, "Disclosures about
Fair Value of Financial Instruments" requires disclosure of fair value
information about financial instruments, whether or not recognized in the
balance sheet, for which it is practicable to estimate that value. In cases
where quoted market prices are not available, fair values are based on estimates
using present value or other valuation techniques. Those techniques are
significantly affected by the assumptions used, including the discount rate and
estimates of future cash flows. SFAS No. 107 excludes certain financial
instruments and all non-financial instruments from its disclosure requirements.
This disclosure does not and is not intended to represent the fair value of the
Corporation.
The following methods and assumptions were used by the Corporation in
estimating its fair value disclosures for financial instruments:
CASH AND CASH EQUIVALENTS: The carrying amounts reported in the
consolidated balance sheet for cash and due from banks and Federal funds sold
approximate their fair value.
53
SECURITIES: Estimated fair values are based on quoted market prices, if
available. If a quoted market price is not available, fair value is estimated
using quoted market prices for similar instruments.
LOANS: For variable-rate loans that reprice frequently and with no
significant change in credit risk, fair values are based on carrying values. The
fair values for certain mortgage loans are based on quoted market prices of
similar loans sold, adjusted for differences in loan characteristics. The fair
value for other loans is estimated using discounted cash flow analyses, using
interest rates currently being offered for loans with similar terms to borrowers
of similar credit quality. The carrying amount of accrued interest approximated
its fair value.
DEPOSITS: SFAS No. 107 defines the fair value of demand deposits as the
amount payable on demand, and prohibits adjusting fair value for any deposit
base intangible. The deposit base intangible is not considered in the fair value
amounts. The carrying amounts for variable-rate money market accounts
approximate their fair value. The fair value of fixed-term certificates of
deposit are estimated using a discounted cash flow calculation that applies
interest rates currently being offered on certificates to a schedule of
aggregated expected monthly maturities.
SHORT-TERM BORROWINGS: The carrying amount reported in the consolidated
balance sheet approximates the estimated fair value.
LOAN COMMITMENTS, STANDBY AND COMMERCIAL LETTERS OF CREDIT: The
Corporation's lending commitments have variable interest rates and "escape"
clauses if the customer's credit quality deteriorates. Therefore the amounts
committed approximate fair value.
GUARANTEED PREFERRED BENEFICIAL INTEREST IN CORPORATION'S JUNIOR
SUBORDINATED DEFERRABLE INTEREST DEBENTURES: The fair value of the Trust
Preferred Capital Securities is estimated based on the quoted market prices of
the instruments.
INTEREST RATE SWAPS/FLOORS: The estimated fair value of the existing
agreements are based on quoted market prices.
The estimated fair values of the Corporation's financial instruments are as
follows:
December 31
----------------------------------------------------
1998 1997
----------------------------------------------------
ESTIMATED ESTIMATED
CARRYING FAIR CARRYING FAIR
(IN THOUSANDS) AMOUNT VALUE AMOUNT VALUE
- --------------------------------------------------------------------------------------------
Financial assets:
Cash and cash equivalents....... $ 787,841 $ 787,841 $ 827,613 $ 827,613
Securities...................... 2,091,703 2,093,946 1,771,418 1,777,215
Loans........................... 3,646,603 3,678,077 3,116,895 3,130,065
Allowance for loan losses....... (53,616) (48,073)
----------------------------------------------------
Net loans.................. 3,592,987 3,678,077 3,068,822 3,130,065
Financial liabilities:
Deposits........................ 5,845,487 5,845,859 5,169,090 5,169,114
Short-term borrowings........... 305,564 305,564 230,774 230,774
Guaranteed preferred beneficial
interest in the Corporation's
junior subordinated deferrable
interest debentures, net...... 98,458 108,340 98,403 107,420
Off-balance sheet instruments:
Interest rate swaps............. (2,505) (1,836)
Interest rate floors............ 692
54
NOTE S -- DERIVATIVE FINANCIAL INSTRUMENTS
The Corporation has off-balance sheet interest rate swaps to hedge its
interest rate risk by essentially converting fixed-rate loans into synthetic
variable-rate instruments. These swap transactions allow management to structure
the interest rate sensitivity of the asset side of the Corporation's balance
sheet to more closely match its view of the interest rate sensitivity of the
Corporation's funding sources. The Corporation had 22 interest rate swaps at
December 31, 1998 with a notional amount of $75 million compared to 42 interest
rate swaps at December 31, 1997 with a notional amount of $267 million. Each
swap was a hedge against a specific commercial fixed-rate loan or against a
specific pool of consumer fixed-rate loans with lives ranging from two to ten
years where the Corporation pays a fixed rate and receives a floating rate. In
each case, the amortization of the interest rate swap generally matches the
expected amortization of the underlying loan or pool of loans. These interest
rate contracts involve the risk of dealing with counterparties and their ability
to meet contractual terms. Each counterparty to a swap transaction has a credit
rating that is investment grade. The net amount payable or receivable under
interest rate swaps\floors is accrued as an adjustment to interest income and
was not material in 1998 or 1997. In the third quarter of 1998, the Corporation
terminated interest rate swaps hedging fixed rate consumer loans. The
Corporation is amortizing the loss on the transaction of $1.9 million over the
remaining term of the interest swaps ending in the second quarter of 2002.
During 1998, the Corporation terminated all three of its interest rate floor
agreements with a notional amount totaling $500 million and an original term of
three years. These interest rate floors were purchased in 1997 for the purpose
of hedging floating interest rate exposure in commercial loan accounts in an
environment of falling interest rates. The Corporation is amortizing the gain on
the transaction of $2.8 million over the remaining term of the interest rate
floors.
The Corporation's credit exposure on interest rate swaps\floors is limited
to the net favorable value of all swaps\floors to each counterparty. In such
cases collateral is required from the counterparties involved if the net value
of the swaps\floors exceeds a nominal amount considered to be immaterial. At
December 31, 1998, the Corporation's credit exposure relating to interest rate
swaps\floors was immaterial. The fair value and related carrying amounts of the
interest rate swaps can be found in footnote R on page 53.
Activity in the notional amounts of end-user derivatives for each of the
three years ended December 31, 1998, 1997 and 1996, is summarized as follows:
Swaps
Amortizing Interest Rate Total
(in millions) Receive Floating Floors Derivatives
- -------------------------------------------------------------------------------------------
Balance, December 31, 1995........... $ 142 $142
Additions....................... 168 168
Amortization and maturities..... (48) (48)
Terminations.................... (11) (11)
---------------------------------------------------
Balance, December 31, 1996........... 251 251
Additions....................... 125 $500 625
Amortization and maturities..... (89) (89)
Terminations.................... (20) (20)
---------------------------------------------------
Balance, December 31, 1997........... 267 500 767
Additions....................... 19 19
Amortization and maturities..... (55) (55)
Terminations.................... (156) (500) (656)
---------------------------------------------------
Balance, December 31, 1998........... $ 75 $ -- $ 75
===================================================
55
NOTE T -- CONTINGENCIES
Certain subsidiaries of Cullen/Frost are defendants in various matters of
litigation which have arisen in the normal course of conducting a commercial
banking business. In the opinion of management, the disposition of such pending
litigation will not have a material effect on Cullen/Frost's consolidated
financial position.
NOTE U -- SUBSEQUENT EVENTS (UNAUDITED)
1999 ACQUISITION
KELLER STATE BANK -- KELLER
On January 15, 1999, the Corporation paid approximately $18.7 million to
acquire Keller State Bank, of Keller, Texas. The total cash consideration was
funded through internal sources. The purchase method of accounting has been used
to record the transaction and as such the purchase price has been allocated to
the underlying assets and liabilities based on estimated fair values at the date
of acquisition. Such estimates may be subsequently revised. The Corporation
acquired loans of approximately $38 million and deposits of approximately $62
million. Total intangibles associated with the acquisition amounted to
approximately $11.8 million. This acquisition is not expected to have a material
impact on the Corporation's 1999 net income.
INVESTMENT BANKING SUBSIDIARY
On January 26, 1999 the Corporation announced its intent to seek Federal
Reserve Bank approval to form a Section 20 investment banking subsidiary to be
based in Dallas, Texas. The new subsidiary, to be named Frost Securities, Inc.
is expected to be operational by July 1 and will offer a full range of services
including equity research, institutional sales, trading and investment banking
services to institutional investors and corporate customers who need access to
the capital markets.
PENDING ACQUISITIONS
COMMERCE FINANCIAL CORPORATION
On February 17, 1999, the Corporation entered into a definitive agreement
to acquire Commerce Financial Corporation of Fort Worth, Texas which had
deposits of $174 million and loans of $76 million at December 31, 1998. The
Corporation agreed to pay approximately $42.25 million. The acquisition is
expected to be completed in the second quarter of 1999 following shareholder and
regulatory approval. This transaction will be accounted for as a purchase with
total cash consideration being funded through internal sources.
PROFESSIONAL INSURANCE AGENTS, INC.
On March 3, 1999, Frost Insurance Agency, a subsidiary of The Frost
National Bank, signed a letter of intent to acquire Professional Insurance
Agents, Inc. (PIA), a mid-sized independent insurance agency based in Victoria,
Texas, with additional locations in San Antonio, New Braunfels and Refugio. PIA
offers corporate and personal property and casualty insurance as well as group,
health and life insurance products to individuals and businesses. The
transaction is subject to regulatory approval, and is expected to close in the
second quarter of 1999. The purchase method of accounting will be used to record
the transaction.
56
NOTE V -- OPERATING SEGMENTS
The Corporation has two reportable operating segments: Banking and the
Financial Management Group. Banking includes both commercial and consumer
banking services. Commercial services are provided to corporations and other
business clients and include a wide array of lending and cash management
products. Consumer banking services include direct and indirect lending,
mortgage lending and depository services. The Financial Management Group
includes fee based services within private trust, retirement services, and
financial management services including personal wealth management and brokerage
services. These business units were identified through the products and services
that are offered within each unit.
The accounting policies of each reportable segment are the same as those of
the Corporation described in Note A, except for the following items. The
Corporation uses a match-funded transfer pricing process to assess operating
segment performance. Expenses for consolidated back-office operations are
allocated to operating segments based on estimated uses of those services.
General overhead type expenses such as executive administration, accounting,
internal audit, and personnel are allocated based on the direct expense level of
the operating segment. Income tax expense for the individual segments is
calculated basically at the statutory rate. Parent Company (included in
Non-Banks) records the tax expense or benefit necessary to reconcile to the
consolidated total.
Financial
Management Consolidated
(in thousands) Banking Group Non-Banks Total
- -------------------------------------------------------------------------------------------------------
1998:
NET INTEREST INCOME (EXPENSE)........ $270,261 $ 6,456 $ (8,744) $ 267,973
PROVISION FOR POSSIBLE LOAN LOSSES... 10,337 56 10,393
NON-INTEREST INCOME.................. 84,820 53,162 684 138,666
NON-INTEREST EXPENSE................. 223,473 37,282 5,507 266,262
---------------------------------------------------------------
EARNINGS (LOSS) BEFORE INCOME
TAXES.............................. 121,271 22,280 (13,567) 129,984*
INCOME TAX EXPENSE (CREDIT).......... 42,445 7,783 (5,400) 44,828
---------------------------------------------------------------
OPERATING EARNINGS (LOSS)............ $ 78,826 $14,497 $ (8,167) $ 85,156*
===============================================================
AVERAGE ASSETS (IN MILLIONS)......... $ 6,413 $ 31 $ N/M $ 6,418
=======================================================================================================
1997
Net interest income (expense)........ $236,998 $ 6,100 $ (7,963) $ 235,135
Provision for possible loan losses... 9,169 5 9,174
Non-interest income.................. 73,136 48,220 346 121,702
Non-interest expense................. 195,870 34,507 4,764 235,141
---------------------------------------------------------------
Income (loss) before income taxes.... 105,095 19,808 (12,381) 112,522
Income tax expense (credit).......... 36,783 6,930 (4,158) 39,555
---------------------------------------------------------------
Net income (loss).................... $ 68,312 $12,878 $ (8,223) $ 72,967
===============================================================
Average assets (in millions)......... $ 5,654 $ 24 $ N/M $ 5,688
=======================================================================================================
1996
Net interest income (expense)........ $206,662 $ 5,143 $ (88) $ 211,717
Provision for possible loan losses... 8,487 7 8,494
Non-interest income.................. 63,433 40,712 33 104,178
Non-interest expense................. 172,683 31,668 5,703 210,054
---------------------------------------------------------------
Income (loss) before income taxes.... 88,925 14,180 (5,758) 97,347
Income tax expense (credit).......... 31,124 4,936 (1,651) 34,409
---------------------------------------------------------------
Net income (loss).................... $ 57,801 $ 9,244 $ (4,107) $ 62,938
===============================================================
Average assets (in millions)......... $ 5,270 $ 14 $ N/M $ 5,113
=======================================================================================================
* Excludes the after-tax impact of the $12.2 million Overton merger related
charge. See discussion on page 13.
57
NOTE W -- CONDENSED PARENT CORPORATION FINANCIAL STATEMENTS
Condensed financial information of the parent Corporation as of December
31, 1998 and 1997 and for each of the three years in the period ended December
31, 1998 follows:
Year Ended December 31
-------------------------------
STATEMENT OF OPERATIONS (in thousands) 1998 1997 1996
- ----------------------------------------------------------------------
INCOME:
Dividends from second tier bank
holding company subsidiary..... $ 91,673 $ 23,514 $ 66,137
Interest and other............... 2,943 5,075 713
-------------------------------
TOTAL INCOME................. 94,616 28,589 66,850
EXPENSES:
Salaries and employee benefits... 6,698 3,350 4,504
Interest expense................. 8,761 7,962 56
Other............................ 6,635 1,414 1,197
-------------------------------
TOTAL EXPENSES............... 22,094 12,726 5,757
-------------------------------
INCOME BEFORE INCOME TAX
CREDITS AND EQUITY IN
UNDISTRIBUTED NET INCOME OF
SUBSIDIARIES............... 72,522 15,863 61,093
Income tax credits................... 4,812 2,326 1,439
Equity in undistributed net income of
subsidiaries....................... (1,689) 54,778 406
-------------------------------
NET INCOME................... $ 75,645 $ 72,967 $ 62,938
===============================
December 31
--------------------
BALANCE SHEETS (in thousands) 1998 1997
- -----------------------------------------------------------
ASSETS
Cash................................. $ 304 $ 241
Securities purchased under resale
agreements......................... 100,830 43,990
Loans to non-bank subsidiaries....... 52 52
Investments in second tier bank
holding company subsidiary......... 527,124 529,982
Other................................ 2,370 2,646
--------------------
TOTAL ASSETS................. $ 630,680 $ 576,911
====================
LIABILITIES
Other................................ $ 16,210 $ 12,486
Guaranteed preferred beneficial
interest in the Corporation's
junior subordinated deferrable
interest debentures................ 101,551 101,496
--------------------
TOTAL LIABILITIES............ 117,761 113,982
SHAREHOLDERS' EQUITY................. 512,919 462,929
--------------------
TOTAL LIABILITIES AND
SHAREHOLDERS' EQUITY......... $ 630,680 $ 576,911
====================
Year Ended December 31
-------------------------------
STATEMENTS OF CASH FLOWS (in thousands) 1998 1997 1996
- ----------------------------------------------------------------------
OPERATING ACTIVITIES
Net income........................... $ 75,645 $ 72,967 $ 62,938
Adjustments to reconcile net income
to net cash provided by operating
activities:
Net income of subsidiaries....... (89,984) (78,292) (66,543)
Dividends from subsidiaries...... 91,673 23,514 66,137
Net change in other liabilities
and assets..................... 5,557 1,523 1,427
-------------------------------
NET CASH PROVIDED BY
OPERATING ACTIVITIES....... 82,891 19,712 63,959
INVESTING ACTIVITIES
Capital contributions to
subsidiaries....................... (88,211) (53,386)
Net decrease in loans................ 160 986
-------------------------------
NET CASH USED BY INVESTING
ACTIVITIES................. (88,051) (52,400)
FINANCING ACTIVITIES
Proceeds from issuance of guaranteed
preferred beneficial interest in
the Corporation's junior
subordinated deferrable interest
debentures......................... 101,446
Purchase of treasury stock........... (3,495) (17,834) (1,164)
Net proceeds from issuance of common
stock.............................. 7,983 3,735 1,182
Cash dividends....................... (30,476) (22,256) (18,754)
-------------------------------
NET CASH PROVIDED (USED) BY
FINANCING ACTIVITIES....... (25,988) 65,091 (18,736)
-------------------------------
INCREASE (DECREASE) IN CASH
AND CASH EQUIVALENTS....... 56,903 (3,248) (7,177)
Cash and cash equivalents at
beginning of year.................. 44,231 47,479 54,656
-------------------------------
CASH AND CASH EQUIVALENTS AT
END OF YEAR................ $ 101,134 $ 44,231 $ 47,479
===============================
58
Report of Ernst & Young LLP
Independent Auditors
SHAREHOLDERS AND BOARD OF DIRECTORS
CULLEN/FROST BANKERS, INC.
We have audited the accompanying consolidated balance sheets of
Cullen/Frost Bankers, Inc. and Subsidiaries (Cullen/Frost) as of December 31,
1998 and 1997, and the related consolidated statements of operations, changes in
shareholders' equity, and cash flows for each of the three years in the period
ended December 31, 1998. These financial statements are the responsibility of
the Corporation's management. Our responsibility is to express an opinion on
these financial statements based on our audits. The consolidated financial
statements give retroactive effect to the merger of Cullen/Frost and Overton
Bancshares, Inc. and Subsidiaries (Overton) on May 29, 1998, which has been
accounted for using the pooling of interests method as described in Note B to
the consolidated financial statements. We did not audit the consolidated
financial statements of Overton for the years ended December 31, 1997 and 1996,
which statements reflect total assets constituting 14 percent in 1997 and net
interest income of 16 percent in 1997 and 1996 of the related Cullen/Frost's
consolidated totals. Those Overton statements were audited by other auditors
whose report has been furnished to us, and our opinion, insofar as it relates to
data included for Overton, is based solely on the report of other auditors.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits and the report of other auditors provide a reasonable
basis for our opinion.
In our opinion, based on our audit and the report of other auditors, the
financial statements referred to above present fairly, in all material respects,
the consolidated financial position of Cullen/Frost Bankers, Inc. and
Subsidiaries at December 31, 1998 and 1997, and the consolidated results of
their operations and their cash flows for each of the three years in the period
ended December 31, 1998 in conformity with generally accepted accounting
principles.
ERNST & YOUNG LLP
San Antonio, Texas
February 12, 1999
59
CONSOLIDATED AVERAGE BALANCE SHEETS
(dollars in thousands -- taxable-equivalent basis)
Year Ended December 31
---------------------------------------------------------------
1998 1997
------------------------------ ------------------------------
INTEREST Interest
AVERAGE INCOME/ YIELD/ Average Income/ Yield/
BALANCE EXPENSE COST Balance Expense Cost
- ------------------------------------------------------------------------------------------------------
ASSETS:
Securities:
U.S. Treasury.................... $ 262,098 $ 14,339 5.47% $ 301,133 $ 16,596 5.51%
U.S. Government agencies and
corporations................... 1,557,489 99,971 6.42 1,374,202 90,688 6.60
States and political
subdivisions:
Tax-exempt................... 68,507 5,101 7.45 36,888 2,850 7.73
Taxable...................... 3,185 239 7.50
Other............................ 42,025 2,579 6.14 11,317 686 6.06
--------- -------- --------- --------
Total securities......... 1,930,119 121,990 6.32 1,726,725 111,059 6.43
Federal funds sold................... 127,273 7,111 5.59 228,245 12,423 5.44
Loans, net of unearned discount...... 3,437,510 301,789 8.78 2,917,371 262,569 9.00
--------- -------- --------- --------
TOTAL EARNING ASSETS AND AVERAGE
RATE EARNED.................... 5,494,902 430,890 7.84 4,872,341 386,051 7.92
Cash and due from banks.............. 577,489 527,924
Allowance for possible loan losses... (51,230) (44,837)
Banking premises and equipment...... 135,577 124,629
Accrued interest and other assets.... 260,831 207,520
--------- ---------
TOTAL ASSETS..................... $6,417,569 $5,687,577
========= =========
LIABILITIES:
Demand deposits:
Commercial and individual........ $1,387,824 $1,143,828
Correspondent banks.............. 195,555 192,231
Public funds..................... 43,507 44,183
--------- ---------
Total demand deposits........ 1,626,886 1,380,242
Time deposits:
Savings and
Interest-on-Checking........... 901,960 10,958 1.21 818,216 10,764 1.32
Money market deposit accounts.... 1,387,994 54,326 3.91 1,195,773 48,816 4.08
Time accounts.................... 1,286,036 63,621 4.95 1,205,261 59,867 4.97
Public funds..................... 251,570 9,378 3.73 269,027 11,693 4.35
--------- -------- --------- --------
Total time deposits...... 3,827,560 138,283 3.61 3,488,277 131,140 3.76
--------- ---------
Total deposits........... 5,454,446 4,868,519
Federal funds purchased and
securities sold
under repurchase agreements........ 252,977 11,606 4.59 189,468 8,739 4.61
Guaranteed preferred beneficial
interests in the Corporation's
junior subordinated deferrable
interest debentures, net........... 98,429 8,475 8.61 88,745 7,652 8.62
Long-term notes payable..............
Other borrowings..................... 30,666 1,754 5.72 25,794 1,434 5.56
--------- -------- --------- --------
TOTAL INTEREST-BEARING FUNDS AND
AVERAGE RATE PAID.............. 4,209,632 160,118 3.80 3,792,284 148,965 3.93
-------- ------ -------- ------
Accrued interest and other
liabilities........................ 91,093 69,601
--------- ---------
TOTAL LIABILITIES................ 5,927,611 5,242,127
SHAREHOLDERS' EQUITY................. 489,958 445,450
--------- ---------
TOTAL LIABILITIES AND
SHAREHOLDERS' EQUITY........... $6,417,569 $5,687,577
========= =========
Net interest income.................. $270,772 $237,086
======== ========
Net interest spread.................. 4.04% 3.99%
====== ======
Net interest income to total average
earning assets..................... 4.93% 4.87%
====== ======
The above information is shown on a taxable-equivalent basis assuming a 35
percent tax rate. Non-accrual loans are included in the average loan amounts
outstanding for these computations.
60
Year Ended December 31
- -----------------------------------------------------------------------------------------------------------------------------
1996 1995 1994 1993
- ----------------------------- ----------------------------- ----------------------------- -----------------------------
Interest Interest Interest Interest
Average Income/ Yield/ Average Income/ Yield/ Average Income/ Yield/ Average Income/ Yield/
Balance Expense Cost Balance Expense Cost Balance Expense Cost Balance Expense Cost
- -----------------------------------------------------------------------------------------------------------------------------
$ 282,692 $ 15,049 5.32% $ 238,968 $ 14,142 5.92% $ 362,881 $ 16,616 4.58% $ 602,603 $ 28,111 4.66%
1,439,744 95,838 6.66 1,447,288 93,373 6.45 1,438,632 85,507 5.94 1,118,308 71,302 6.38
29,863 2,340 7.84 27,128 2,211 8.15 20,555 1,729 8.41 21,924 1,679 7.66
1,783 118 6.69 605 39 6.45 320 20 6.25 1,148 95 8.28
6,723 389 5.79 9,314 593 6.37 30,908 1,711 5.54 54,649 2,811 5.14
- ---------- -------- ---------- -------- ----------- -------- ---------- --------
1,760,805 113,734 6.46 1,723,303 110,358 6.40 1,853,296 105,583 5.70 1,798,632 103,998 5.78
143,401 7,476 5.21 121,122 6,957 5.74 109,563 4,217 3.85 270,463 8,157 3.02
2,445,777 220,417 9.01 1,971,681 181,597 9.21 1,552,249 126,039 8.12 1,333,085 104,376 7.83
- ---------- -------- ---------- -------- ----------- -------- ---------- --------
4,349,983 341,627 7.85 3,816,106 298,912 7.83 3,515,108 235,839 6.71 3,402,180 216,531 6.36
508,934 400,270 358,927 343,613
(39,814) (31,969) (29,214) (33,879)
117,352 102,920 99,518 93,672
177,040 156,229 144,359 140,141
- ---------- ---------- ----------- ----------
$5,113,495 $ 4,443,556 $ 4,088,698 $3,945,727
========== =========== =========== ==========
$ 979,757 $ 814,169 $ 773,912 $ 718,571
199,983 131,295 124,416 143,008
45,200 42,033 40,293 42,516
- --------- ----------- ----------- ----------
1,224,940 987,497 938,621 904,095
741,102 10,176 1.37 741,003 13,195 1.78 880,969 15,923 1.81 827,380 16,418 1.98
1,053,819 40,208 3.82 801,081 29,631 3.70 638,277 18,294 2.87 613,650 15,345 2.50
1,145,194 56,110 4.90 1,057,100 52,509 4.97 939,493 32,273 3.44 990,081 30,268 3.06
245,266 10,685 4.36 125,971 5,450 4.33 92,092 2,705 2.94 83,062 2,426 2.92
- ---------- -------- ----------- -------- ----------- -------- ---------- --------
3,185,381 117,179 3.68 2,725,155 100,785 3.70 2,550,831 69,195 2.71 2,514,173 64,457 2.56
- ---------- ----------- ----------- ----------
4,410,321 3,712,652 3,489,452 3,418,268
204,515 9,761 4.77 290,636 15,150 5.21 220,367 8,177 3.71 201,268 5,253 2.61
4,331 397 9.17
19,389 1,019 5.26 12,514 733 5.86 508 30 5.91
- ---------- -------- ----------- -------- ----------- -------- ---------- --------
3,409,285 127,959 3.75 3,028,305 116,668 3.85 2,771,198 77,372 2.79 2,720,280 70,137 2.58
-------- ----- -------- ----- -------- ----- -------- -----
76,583 67,940 61,579 46,766
- ---------- ----------- ----------- ----------
4,710,808 4,083,742 3,771,398 3,671,141
402,687 359,814 317,300 274,586
- ---------- ----------- ----------- ----------
$5,113,495 $ 4,443,556 $ 4,088,698 $3,945,727
========== =========== =========== ==========
$ 213,668 $ 182,244 $158,467 $146,394
========= ========= ======== ========
4.10% 3.98% 3.92% 3.78%
====== ====== ====== ======
4.91% 4.78% 4.51% 4.30%
====== ====== ====== ======
61
FINANCIAL STATISTICS
(dollars in thousands)
The following unaudited schedules and statistics are presented for
additional information and analysis.
RATE/VOLUME ANALYSIS
1998/1997 1997/1996
------------------------------- -------------------------------
INCREASE Increase
(DECREASE) (Decrease)
DUE TO CHANGE IN TOTAL Due to Change in Total
------------------ OR NET ------------------ or Net
AVERAGE AVERAGE INCREASE Average Average Increase
RATE BALANCE (DECREASE) Rate Balance (Decrease)
- --------------------------------------------------------------------------------------------------------
Changes in interest earned on:
Securities:
U.S. Treasury.............. $ (121) $ (2,136) $ (2,257) 543 1,004 1,547
U.S. Government agencies
and corporations........ (2,538) 11,821 9,283 (819) (4,331) (5,150)
States and political subdivisions
Tax-exempt...................... (107) 2,358 2,251 (33) 543 510
Taxable......................... (119) (120) (239) 18 103 121
Other................................ 9 1,884 1,893 19 278 297
Federal funds sold................... 321 (5,633) (5,312) 343 4,604 4,947
Loans................................ (6,584) 45,804 39,220 (293) 42,445 42,152
-----------------------------------------------------------------
Total...................... (9,139) 53,978 44,839 (222) 44,646 44,424
Changes in interest paid on:
Savings, Interest-on-Checking... 859 (1,053) (194) 439 (1,027) (588)
Money market deposits
accounts...................... 2,080 (7,590) (5,510) (2,942) (5,666) (8,608)
Time accounts and public
funds......................... 1,833 (3,272) (1,439) (757) (4,008) (4,765)
Federal funds purchased and
securities sold under
repurchase agreements......... 47 (2,914) (2,867) 320 702 1,022
Long-term notes payable and other
borrowings......................... (31) (1,112) (1,143) (60) (8,007) (8,067)
-----------------------------------------------------------------
Total...................... 4,788 (15,941) (11,153) (3,000) (18,006) (21,006)
-----------------------------------------------------------------
Changes in net interest income....... $(4,351) $ 38,037 $ 33,686 $(3,222) $ 26,640 $ 23,418
=================================================================
The allocation of the rate/volume variance has been made on a pro-rata basis
assuming absolute values. The above information is shown on a taxable-equivalent
basis assuming a 35 percent tax rate.
LOAN MATURITY AND SENSITIVITY
DECEMBER 31, 1998
---------------------------------------------------
DUE IN AFTER ONE, AFTER
ONE YEAR BUT WITHIN FIVE
OR LESS FIVE YEARS YEARS TOTAL
- -------------------------------------------------------------------------------------------
Real estate construction and land
loans.............................. $ 243,645 $ 85,605 $ 33,658 $ 362,908
Other real estate loans.............. 162,040 194,603 356,969 713,612
All other loans...................... 838,037 387,691 110,935 1,336,663
---------------------------------------------------
Total........................... $1,243,722 $ 667,899 $501,562 $2,413,183
===================================================
Loans with fixed interest rates...... $ 486,913 $ 301,326 $215,287 $1,003,526
Loans with floating interest rates... 756,809 366,573 286,275 1,409,657
---------------------------------------------------
Total........................... $1,243,722 $ 667,899 $501,562 $2,413,183
===================================================
Loans for 1-4 family housing totaling $611,759,000 and consumer loans totaling
$625,018,000 and unearned income of $3,357,000 are not included in the amounts
in the table.
62
MATURITY DISTRIBUTION AND SECURITIES PORTFOLIO YIELDS
DECEMBER 31, 1998
---------------------------------------------------------------------------------------------
MATURITY
---------------------------------------------------------------------------------------------
Within 1 Year 1-5 Years 5-10 Years After 10 Years
--------------------- --------------------- --------------------- ---------------------
Weighted Weighted Weighted Weighted
Average Average Average Average
(in thousands) Amount Yield Amount Yield Amount Yield Amount Yield
- ------------------------------------------------------------------------------------------------------------------------------------
Held to maturity:
U.S. Government agencies and
corporations........................ $ 13,533 8.31% $ 93,649 9.87%
States and political subdivisions.... $ 55 4.42% $ 540 4.77% 1,670 6.09 1,967 6.44
Other................................ 25 8.00
---------------------------------------------------------------------------------------------
Total securities held to maturity... $ 55 4.42% $ 565 4.91% $ 15,203 8.07% $ 95,616 9.80%
=============================================================================================
Available for sale:
U.S. Treasury........................ $ 180,398 5.16% $ 9,176 6.17%
U.S. Government agencies and
corporations........................ 103,216 5.93 268,669 6.24 $ 49,595 6.52% $1,190,918 6.53%
States and political subdivisions.... 3,353 4.90 27,353 5.03 34,264 4.52 56,028 4.44
Other................................ 9,227 9.51 15,035 6.35 4,000 6.37 28,323 6.05
---------------------------------------------------------------------------------------------
Total securities available for
sale.............................. $ 296,194 5.56% $ 320,233 6.14% $ 87,859 5.73% $1,275,269 6.43%
=============================================================================================
December 31,1998
---------------------
Total Carrying Amount
---------------------
Weighted
Average
(in thousands) Amount Yield
- ------------------------------------------------------------
Held to maturity:
U.S. Government agencies and
corporations........................ $ 107,182 9.68%
States and political subdivisions.... 4,232 6.06
Other................................ 25 8.00
--------------------
Total securities held to maturity... $ 111,439* 9.54%
====================
Available for sale:
U.S. Treasury........................ $ 189,574 5.21%
U.S. Government agencies and
corporations........................ 1,612,398 6.44
States and political subdivisions.... 120,998 4.61
Other................................ 56,585 6.72
--------------------
Total securities available for
sale.............................. $1,979,555* 6.22%
====================
Weighted average yields have been computed on a fully taxable-equivalent basis
assuming a tax rate of 35 percent.
* Included in the totals are mortgage-backed securities and collateralized
mortgage obligations of $1.7 billion which are included in maturity categories
based on their stated maturity date.
QUARTERLY RESULTS OF OPERATIONS*
THREE MONTHS ENDED 1998 Three Months Ended 1997
(in thousands, except per share -------------------------------------------- -----------------------------------------
amounts) MAR 31 JUNE 30 SEPT 30 DEC 31 Mar 31 June 30 Sept 30 Dec 31
- --------------------------------------------------------------------------------------------------------------------------------
Interest income...................... $104,072 $106,240 $107,920 $ 109,859 $90,338 $96,002 $97,643 $ 100,117
Interest expense..................... 40,014 40,018 40,250 39,836 34,741 37,425 37,941 38,858
Net interest income.................. 64,058 66,222 67,670 70,023 55,597 58,577 59,702 61,259
Provision for possible loan losses... 2,579 2,600 2,555 2,659 1,967 2,599 2,303 2,305
Gain on securities transactions...... 73 71 67 148 1 15 6 476
Non-interest income**................ 33,462 35,004 36,009 34,191 28,155 30,898 30,861 31,788
Non-interest expense***.............. 64,853 79,028 67,398 67,227 55,511 58,715 59,258 61,657
Income before income taxes........... 30,088 19,598 33,726 34,328 26,274 28,161 29,002 29,085
Income taxes......................... 10,675 8,142 11,728 11,550 9,277 10,033 10,107 10,138
Net income........................... 19,413 11,456 21,998 22,778 16,997 18,128 18,895 18,947
Net income per diluted common share.. .71 .42 .80 .83 .62 .66 .69 .69
* All financial information has been restated for the merger with Overton
Bancshares, Inc. accounted for as a pooling of interests.
** Includes net gain on securities transactions.
*** Includes a merger related charge of $12.2 million associated with the second
quarter 1998 merger with Overton Bancshares, Inc. Without the merger related
charge after-tax operating earnings per diluted common share for the second
quarter of 1998 were $.77.
63
CULLEN/FROST BANKERS, INC. AND SUBSIDIARIES
BANK SUBSIDIARIES
(in thousands)
- -------------------------------------------------------------------------------
DECEMBER 31, 1998
-------------------------------------
TOTAL TOTAL TOTAL
ASSETS LOANS DEPOSITS
-------------------------------------
Frost National Bank..................... $ 6,748,283 $ 3,580,240 $ 5,716,427
San Antonio, Austin, Corpus Christi,
Dallas, Fort Worth, Houston,
McAllen, New Braunfels and San
Marcos
Main Office:
P. O. Box 1600, 100 West Houston
Street
San Antonio, Texas 78296
(210)220-4011
United States National Bank............. 150,773 66,118 138,109
P. O. Box 179, 2201 Market Street
Galveston, Texas 77553 (409)763-1151
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
None.
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The information regarding directors and executive officers called for by
Item 10 is incorporated herein by reference to Cullen/Frost's Proxy Statement
for its Annual Meeting of Shareholders to be held May 26, 1999.
The additional information regarding executive officers called for by Item
10 is included in Part I, Item 1 of this document under the heading "Executive
Officers of the Registrant".
ITEM 11. EXECUTIVE COMPENSATION
The information called for by Item 11 is incorporated herein by reference
to Cullen/Frost's Proxy Statement for its Annual Meeting of Shareholders to be
held May 26, 1999.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The information called for by Item 12 is incorporated herein by reference
to Cullen/Frost's Proxy Statement for its Annual Meeting of Shareholders to be
held May 26, 1999.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The information called for by Item 13 is incorporated herein by reference
to Cullen/Frost's Proxy Statement for its Annual Meeting of Shareholders to be
held May 26, 1999.
64
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K
(a) The following documents are filed as part of this Annual Report on
Form 10-K:
1. Financial Statements -- Reference is made to Part II, Item 8, of
this Annual Report on Form 10-K.
2. The Financial Statement Schedules are omitted, as the required
information is not applicable. 3. Exhibits -- The following
exhibits are filed as a part of this Annual Report on Form 10-K:
EXHIBIT
NUMBER
---------
3.1 -- Articles of Incorporation, of
Cullen/Frost Bankers, Inc. as amended
(11)
3.2 -- Amended By-Laws of Cullen/Frost
Bankers, Inc. (8)
4.1 -- Shareholder Protection Rights
Agreement dated as of February 1,
1999 between Cullen/Frost Bankers,
Inc. and The Frost National Bank, as
Rights Agent (12)
10.1 -- Restoration of Retirement Income Plan
for Participants in the Retirement
Plan for Employees of Cullen/Frost
Bankers, Inc. and its Affiliates (as
amended and restated)*
10.2 -- Change-In-Control Agreement with one
Executive Officer*
10.3 -- 1983 Non-qualified Stock Option Plan,
as amended (1)
10.4 -- Form of Revised Change-In-Control
Agreements with four Executive
Officers (3)*
10.5 -- 1988 Non-qualified Stock Option Plan (2)*
10.6 -- The 401(k) Stock Purchase Plan for
employees of Cullen/Frost Bankers,
Inc. and its Affiliates (4)*
10.7 -- 1991 Thrift Incentive Stock Purchase
Plan for Employees of Cullen/Frost
Bankers, Inc. and its Affiliates (5)*
10.8 -- Cullen/Frost Bankers, Inc. Restricted
Stock Plan (6)*
10.9 -- Cullen/Frost Bankers, Inc.
Supplemental Executive Retirement
Plan (7)*
10.10 -- Form of Revised Change-In-Control
Agreements with one Executive Officer (7)*
10.11 -- Retirement agreement with one
Executive Officer (9)*
10.12 -- Cullen/Frost Bankers, Inc. 1997
Directors Stock Plan (10)
10.13 -- Cullen/Frost Bankers, Inc. 1992 Stock
Plan, as amended (10)
19.1 -- Annual Report on Form 11-K for the
Year Ended December 31, 1998, for the
1991 Thrift Incentive Stock Purchase
Plan (filed pursuant to Rule 15d-21
of the Securities and Exchange Act of
1934)(13)
19.2 -- Annual Report on Form 11-K for the
Year Ended December 31, 1998, for the
401(k) Stock Purchase Plan (filed
pursuant to Rule 15d-21 of the
Securities and Exchange Act of 1934)(13)
21 -- Subsidiaries of Cullen/Frost
23.1 -- Consent of Independent Auditors
23.2 -- Consent of PricewaterhouseCoopers LLP
Independent Auditors for Overton
Bancshares, Inc.
24 -- Power of Attorney
27 -- Financial Date Schedule (EDGAR Version)
99 -- Report of PricewaterhouseCoopers LLP
on Overton Bancshares, Inc. financial
statements as of December 31, 1997
and for each of the years in the two
year period ended December 31, 1997.
* Management contract or compensatory plan or arrangement required to be filed
as an exhibit pursuant to Item 601 of Regulation S-K.
(b) Reports on Form 8-K -- No such reports were filed during the quarter ended
December 31, 1998.
65
- ------------
(1) Incorporated herein by reference to the designated Exhibits to
Cullen/Frost's Report on Form S-8 filed September 5, 1989 (File No.
33-30776)
(2) Incorporated herein by reference to the designated Exhibits to
Cullen/Frost's Report on Form S-8 filed September 5, 1989 (File No.
33-30777)
(3) Incorporated herein by reference to the designated Exhibits to the
Cullen/Frost Annual Report on Form 10-K for the Year Ended December 31,
1989 (File No. 0-7275)
(4) Incorporated herein by reference to the designated Exhibits to
Cullen/Frost's Report on Form S-8 filed October 31, 1990 (File No.
33-37500)
(5) Incorporated herein by reference to the designated Exhibits to
Cullen/Frost's Report on Form S-8 filed March 18, 1991 (File No. 33-39478)
(6) Incorporated herein by reference to the designated Exhibits to
Cullen/Frost's Report on Form S-8 filed October 20, 1992 (File No.
33-53492)
(7) Incorporated herein by reference to the designated Exhibits to
Cullen/Frost's Annual Report on Form 10-K for the Year Ended December 31,
1994 (File No. 0-7275)
(8) Incorporated herein by reference to the designated Exhibits to
Cullen/Frost's Annual Report on Form 10-K/A for the Year Ended December 31,
1995 (File No. 0-7275)
(9) Incorporated herein by reference to the designated Exhibits to
Cullen/Frost's Annual Report on Form 10-K for the Year Ended December 31,
1996 (File No. 0-7275)
(10) Incorporated herein by reference to the designated Exhibits to
Cullen/Frost's Annual Report on Form 10-K for the Year Ended December 31,
1997 (File No. 0-7275)
(11) Incorporated herein by reference to the designated Exhibits to
Cullen/Frost's Report on Form 8-A12B/A filed on August 31, 1998 (File No.
0-7275)
(12) Incorporated herein by reference to the designated Exhibits to
Cullen/Frost's Current Report on Form 8-A12G/A dated February 1, 1999 (File
No. 0-7275)
(13) To be filed as an amendment.
66
SIGNATURES
PURSUANT TO THE REQUIREMENTS OF SECTION 13 OR 15(D) OF THE SECURITIES
EXCHANGE ACT OF 1934, THE REGISTRANT HAS DULY CAUSED THIS REPORT TO BE SIGNED ON
ITS BEHALF BY THE UNDERSIGNED, THEREUNTO DULY AUTHORIZED.
Date: March 31, 1999 CULLEN/FROST BANKERS, INC.
(Registrant)
By: /s/ PHILLIP D. GREEN
--------------------
PHILLIP D. GREEN
SENIOR EXECUTIVE VICE PRESIDENT AND
CHIEF FINANCIAL OFFICER
PURSUANT TO THE REQUIREMENTS OF THE SECURITIES EXCHANGE ACT OF 1934, THIS
REPORT HAS BEEN SIGNED BELOW BY THE FOLLOWING PERSONS ON BEHALF OF THE
REGISTRANT AND IN THE CAPACITIES INDICATED ON MARCH 31, 1999.
SIGNATURES TITLE DATE
- ------------------------------------------------------ ------------------------------------- ---------------
T.C. FROST* Senior Chairman of the Board and
------------- Director
T.C. FROST
RICHARD W. EVANS, JR.* Chairman of the Board and Director
----------------------- (Principal Executive Officer)
RICHARD W. EVANS, JR.
R. DENNY ALEXANDER* Director
-------------------
R. DENNY ALEXANDER
ISAAC ARNOLD, JR.* Director
-------------------
ISAAC ARNOLD, JR.
ROYCE S. CALDWELL* Director
-------------------
ROYCE S. CALDWELL
RUBEN R. CARDENAS* Director
-------------------
RUBEN R. CARDENAS
HENRY E. CATTO* Director
-------------------
HENRY E. CATTO
BOB W. COLEMAN* Director
-------------------
BOB W. COLEMAN
HARRY H. CULLEN* Director
-------------------
HARRY H. CULLEN
------------------- Director
ROY H. CULLEN
EUGENE H. DAWSON, Sr.* Director
--------------------
EUGENE H. DAWSON, SR.
67
SIGNATURES -- (CONTINUED)
SIGNATURES TITLE DATE
- ------------------------------------------------------ ------------------------------------- ---------------
CASS EDWARDS* Director
-------------------
CASS EDWARDS
RUBEN M. ESCOBEDO* Director
-------------------
RUBEN M. ESCOBEDO
W.N. FINNEGAN, III* Director
-------------------
W.N. FINNEGAN, III
PATRICK B. FROST* Director
-------------------
PATRICK B. FROST
JOE FULTON* Director
-------------------
JOE FULTON
JAMES W. GORMAN, Jr.* Director
--------------------
JAMES W. GORMAN, JR.
JAMES L. HAYNE* Director
-------------------
JAMES L. HAYNE
RICHARD M. KLEBERG, III* Director
------------------------
RICHARD M. KLEBERG, III
ROBERT S. McCLANE* Director
-------------------
ROBERT S. MCCLANE
IDA CLEMENT STEEN* Director
-------------------
IDA CLEMENT STEEN
CURTIS VAUGHAN, JR.* Director
-------------------
CURTIS VAUGHAN, JR.
HORACE WILKINS* Director
-------------------
HORACE WILKINS
MARY BETH WILLIAMSON* Director
-------------------
MARY BETH WILLIAMSON
*By: /s/PHILLIP D. GREEN Senior Executive Vice President and March 31, 1999
----------------------
PHILLIP D. GREEN Chief Financial Officer
(AS ATTORNEY-IN-FACT FOR
THE PERSONS INDICATED)
68