Employee Benefit Plans

Retirement Plans

Profit Sharing Plans. The profit-sharing plan is a defined contribution retirement plan that covers employees who have completed at least one year of service and are age 21 or older. All contributions to the plan are made at the discretion of the Corporation and may be made without regard to current or accumulated profits. Contributions are allocated to eligible participants pro rata, based upon compensation, age and other factors. Plan participants self-direct the investment of allocated contributions by choosing from a menu of investment options. Account assets are subject to withdrawal restrictions and participants vest in their accounts after three years of service. The Corporation also maintains a separate non-qualified profit sharing plan for certain employees whose participation in the qualified profit sharing plan is limited. The plan offers such employees an alternative means of receiving comparable benefits. Expense related to these plans totaled $10.8 million in 2014, $11.4 million in 2013 and $9.2 million in 2012.

Retirement Plan and Restoration Plan. The Corporation maintains a non-contributory defined benefit plan (the “Retirement Plan”) that was frozen as of December 31, 2001. The plan provides pension and death benefits to substantially all employees who were at least 21 years of age and had completed at least one year of service prior to December 31, 2001. Defined benefits are provided based on an employee’s final average compensation and years of service at the time the plan was frozen and age at retirement. The freezing of the plan provides that future salary increases will not be considered. The Corporation’s funding policy is to contribute yearly, at least the amount necessary to satisfy the funding standards of the Employee Retirement Income Security Act (“ERISA”).

The Corporation’s Restoration of Retirement Income Plan (the “Restoration Plan”) provides benefits for eligible employees that are in excess of the limits under Section 415 of the Internal Revenue Code of 1986, as amended, that apply to the Retirement Plan. The Restoration Plan is designed to comply with the requirements of ERISA. The entire cost of the plan, which was also frozen as of December 31, 2001, is supported by contributions from the Corporation.

The Corporation uses a December 31 measurement date for its defined benefit plans. Combined activity in the Corporation’s defined benefit pension plans was as follows:



	2014			2013			2012
Change in benefit obligation:
Benefit obligation at beginning of year	$	163,876		$	178,158		$	157,855
Interest cost	8,002			7,341			7,801
Actuarial (gain) loss	34,438			(15,333		)	18,436
Benefits paid	(6,679		)	(6,290		)	(5,934		)
Benefit obligation at end of year	199,637			163,876			178,158
Change in plan assets:
Fair value of plan assets at beginning of year	164,769			145,901			137,253
Actual return on plan assets	9,428			24,489			13,931
Employer contributions	667			669			651
Benefits paid	(6,679		)	(6,290		)	(5,934		)
Fair value of plan assets at end of year	168,185			164,769			145,901
Funded status of the plan at end of year and accrued (benefit) liability recognized	$	31,452		$	(893	)	$	32,257
Accumulated benefit obligation at end of year	$	199,637		$	163,876		$	178,158

Certain disaggregated information related to the Corporation’s defined benefit pension plans as of year-end was as follows:



	Retirement Plan					Restoration Plan
	2014		2013			2014		2013
Projected benefit obligation	$	179,970	$	147,403		$	19,667	$	16,473
Accumulated benefit obligation	179,970		147,403			19,667		16,473
Fair value of plan assets	168,185		164,769			—		—
Funded status of the plan at end of year and accrued (benefit) liability recognized	11,785		(17,366		)	19,667		16,473

The components of the combined net periodic cost (benefit) for the Corporation’s defined benefit pension plans were as follows:



	2014			2013			2012
Expected return on plan assets, net of expenses	$	(12,514	)	$	(11,087	)	$	(10,412	)
Interest cost on projected benefit obligation	8,002			7,341			7,801
Net amortization and deferral	2,687			6,558			5,709
Net periodic cost (benefit)	$	(1,825	)	$	2,812		$	3,098

Amounts related to the Corporation’s defined benefit pension plans recognized as a component of other comprehensive income were as follows:



	2014			2013			2012
Net actuarial gain (loss)	$	(34,837	)	$	35,293		$	(9,405	)
Deferred tax (expense) benefit	12,193			(12,353		)	3,292
Other comprehensive income (loss), net of tax	$	(22,644	)	$	22,940		$	(6,113	)

Amounts recognized as a component of accumulated other comprehensive loss as of year-end that have not been recognized as a component of the combined net period benefit cost of the Corporation’s defined benefit pension plans are presented in the following table. The Corporation expects to recognize approximately $7.0 million of the net actuarial loss reported in the following table as of December 31, 2014 as a component of net periodic benefit cost during 2015.



	2014			2013
Net actuarial loss	$	(75,038	)	$	(40,201	)
Deferred tax benefit	26,263			14,070
Amounts included in accumulated other comprehensive loss, net of tax	$	(48,775	)	$	(26,131	)

The weighted-average assumptions used to determine the benefit obligations as of the end of the years indicated and the net periodic benefit cost for the years indicated are presented in the table below. Because the plans were frozen, increases in compensation are not considered after 2001.



	2014		2013		2012
Benefit obligations:
Discount rate	4.20	%	5.00	%	4.20	%
Net periodic benefit cost:
Discount rate	5.00	%	4.20	%	5.05	%
Expected return on plan assets	7.75		7.75		7.75

Management uses an asset allocation optimization model to analyze the potential risks and rewards associated with various asset allocation strategies on a quarterly basis. As of December 31, 2014, management’s investment objective for the Corporation’s defined benefit plans is to achieve long-term growth. This strategy provides for a target asset allocation of approximately 65% invested in equity securities, approximately 32% invested in fixed income debt securities with any remainder invested in cash or short-term cash equivalents. The modeling process calculates, with a 90% confidence ratio, the potential risk associated with a given asset allocation and helps achieve adequate diversification of investment assets. The plan assets are reviewed annually to determine if the obligations can be met with the current investment mix and funding strategy.

The major categories of assets in the Corporation’s Retirement Plan as of year-end are presented in the following table. Assets are segregated by the level of the valuation inputs within the fair value hierarchy established by ASC Topic 820 “Fair Value Measurements and Disclosures,” utilized to measure fair value (see Note 18 - Fair Value Measurements). The Corporation’s Restoration Plan is unfunded.



	2014		2013
Level 1:
Mutual funds	$	165,429	$	163,046
Cash and cash equivalents	1,447		91
Level 2:
Corporate bonds and notes	653		893
U.S. government agency securities	394		473
States and political subdivisions	262		266
Total fair value of plan assets	$	168,185	$	164,769

Mutual funds include various equity, fixed-income and blended funds with varying investment strategies. Approximately 71% of mutual fund investments consist of equity investments as of December 31, 2014. The investment objective of equity funds is long-term capital appreciation with current income. The remaining mutual fund investments consist of U.S. fixed-income securities, including investment-grade U.S. Treasury securities, U.S. government agency securities and mortgage-backed securities, corporate bonds and notes and collateralized mortgage obligations. The investment objective of fixed-income funds is to maximize investment return while preserving investment principal. Corporate bonds and notes include investment-grade bonds and notes of U.S. companies from diversified industries. U.S. government agency securities include obligations of Ginnie Mae. States and political subdivisions include fixed income municipal securities. The Corporation’s investment strategies prohibit selling assets short and the use of derivatives. Additionally, the Corporation’s defined benefit plans do not directly invest in real estate, commodities, or private investments.

The asset allocation optimization model is used to estimate the expected long-term rate of return for a given asset allocation strategy. Expectations of returns for each asset class are based on comprehensive reviews of historical data and economic/financial market theory. During periods with volatile interest rates and equity security prices, the model may call for changes in the allocation of plan investments to achieve desired returns. Management assumed a long-term rate of return of 7.75% in the determination of the net periodic benefit cost for 2014. The expected long-term rate of return on assets was selected from within the reasonable range of rates determined by historical real returns, net of inflation, for the asset classes covered by the plan’s investment policy and projections of inflation over the long-term period during which benefits are payable to plan participants.

As of December 31, 2014, expected future benefit payments related to the Corporation’s defined benefit plans were as follows:



2015	$	8,429
2016	11,991
2017	9,532
2018	9,988
2019	10,413
2020 through 2024	57,255
	$	107,608

The Corporation expects to contribute $1.1 million to the defined benefit plans during 2015.

Supplemental Executive Retirement Plan. The Corporation maintains a supplemental executive retirement plan (“SERP”) for one active key executive. 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 profit sharing, non-qualified profit sharing, defined benefit retirement and restoration plans, described above, and any social security benefits. Expense related to this plan was not significant during 2014, 2013 and 2012.

Savings Plans

401(k) Plan and Thrift Incentive Plan. The Corporation maintains a 401(k) stock purchase plan that permits each participant to make before- or after-tax contributions in an amount not less than 2% and not exceeding 50% of eligible compensation and subject to dollar limits from Internal Revenue Service regulations. The Corporation matches 100% of the employee’s contributions to the plan based on the amount of each participant’s contributions up to a maximum of 6% of eligible compensation. Eligible employees must complete 90 days of service in order to enroll and vest in the Corporation’s matching contributions immediately. Expense related to the plan totaled $12.3 million in 2014, $11.5 million in 2013, and $10.8 million in 2012. The Corporation’s matching contribution is initially invested in the Cullen/Frost common stock fund. However, employees may immediately reallocate the Corporation’s matching portion, as well as invest their individual contribution, to any of a variety of investment alternatives offered under the 401(k) Plan.

The Corporation maintains a thrift incentive stock purchase plan to offer certain employees whose participation in the 401(k) plan is limited an alternative means of receiving comparable benefits. Expense related to this plan was not significant during 2014, 2013 and 2012.

Stock Compensation Plans

The Corporation has one active executive stock plan (the 2005 Omnibus Incentive Plan) and one active outside director stock plan (the 2007 Outside Directors Incentive Plan). The executive stock plan was established to help the Corporation retain and motivate key employees, while the outside director stock plan was established as a means to compensate outside directors for their service to the Corporation. Both of the plans have been approved by the Corporation’s shareholders. The Compensation and Benefits Committee (“Committee”) of the Corporation’s Board of Directors has sole authority to select the employees, establish the awards to be issued, and approve the terms and conditions of each award contract under the executive stock plans.

During 2005, the 2005 Omnibus Incentive Plan (“2005 Plan”) was established to replace all other previously approved executive stock plans and the remaining shares authorized for grant under the previous plan were canceled. Under the 2005 Plan, the Corporation may grant, among other things, nonqualified stock options, incentive stock options, stock awards, stock award units, stock appreciation rights, or any combination thereof to certain employees.

During 2007, the 2007 Outside Directors Incentive Plan (the “2007 Directors Plan”) was established to replace the previous plan. The 2007 Directors Plan allows the Corporation to grant nonqualified stock options, stock awards and stock award units to outside directors. Subject to the terms of the plan, stock options, stock awards and/or stock award units may be awarded in such number, and upon such terms, and at any time and from time to time as determined by the Committee.

Options awarded under the 2005 Plan during the periods presented have a ten-year life and generally vest in equal annual installments over a four-year period. Non-vested stock awards/stock units awarded under the 2005 Plan generally have a four-year-cliff vesting period. No options were awarded under the 2007 Directors Plan during the reported periods. Director deferred stock units awarded under the 2007 Directors Plan have immediate vesting. Upon retirement from the Corporation’s board of directors, non-employee directors will receive one share of the Corporation’s common stock for each deferred stock unit held. Outstanding non-vested stock units and director deferred stock units receive equivalent dividend payments as such dividends are declared on the Corporation’s common stock.

Each award from both plans 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 of Cullen/Frost’s common stock 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. Upon a change-in-control of Cullen/Frost, as defined in the plans, all outstanding options and non-vested stock awards/units immediately vest.

A combined summary of activity in the Corporation’s active stock plans is presented in the following table.



				Non-Vested Stock Awards/Stock Units Outstanding				Stock Options Outstanding
	Shares Available for Grant		Director Deferred Stock Units Outstanding	Number of Shares		Weighted- Average Grant-Date Fair Value		Number of Shares		Weighted- Average Exercise Price
Balance, January 1, 2012	1,963,455		22,092	169,530		$	50.33	4,968,822		$	51.49
Granted	(825,542	)	5,632	49,130		54.56		770,780		54.56
Stock options exercised	—		—	—		—		(206,336	)	50.96
Stock awards vested	—		—	(30,100	)	52.44		—		—
Forfeited	19,750		—	—		—		(19,750	)	50.49
Canceled/expired	(250	)	—	—		—		—		—
Balance, December 31, 2012	1,157,413		27,724	188,560		51.67		5,513,516		51.94
Authorized	2,293,660		—	—		—		—		—
Granted	(635,360	)	5,500	38,010		71.39		591,850		71.38
Stock options exercised	—		—	—		—		(1,319,786	)	52.02
Stock awards vested	—		—	(26,830	)	50.64		—		—
Forfeited	46,890		—	—		—		(46,890	)	46.05
Canceled/expired	—		—	—		—		—		—
Balance, December 31, 2013	2,862,603		33,224	199,740		55.32		4,738,690		54.35
Authorized	—		—	—		—		—		—
Granted	(955,443	)	5,643	32,050		78.92		917,750		78.93
Stock options exercised	—		—	—		—		(560,291	)	52.04
Stock awards/units vested	—		—	(56,300	)	52.46		—		—
Forfeited	66,267		—	—		—		(66,267	)	62.21
Canceled/expired	—		—	—		—		—		—
Balance, December 31, 2014	1,973,427		38,867	175,490		$	60.55	5,029,882		$	58.99

Of the shares available for grant included in the above table as of December 31, 2014, a total of 281,840 shares may be granted as full value awards, meaning awards other than in the form of stock options or stock appreciation rights, and which are settled by the issuance of shares.

Other information regarding options outstanding and exercisable as of December 31, 2014 is as follows:



					Options Outstanding				Options Exercisable
Range of Exercise Prices					Number of Shares	Weighted- Average Exercise Price		Weighted- Average Remaining Contractual Life in Years	Number of Shares	Weighted- Average Exercise Price
$	45.01	to	$	50.00	946,265	$	48.26	5.58	760,240	$	49.91
50.01		to	55.00		2,273,190	52.61		5.58	1,907,700	52.24
55.01		to	60.00		334,075	57.63		1.88	334,075	57.63
70.01		to	75.00		576,602	71.38		8.84	140,613	71.38
75.01		to	80.00		899,750	78.94		9.80	—	—
			Total		5,029,882	58.99		6.46	3,142,628	53.11

The total intrinsic value of outstanding in-the-money stock options and outstanding in-the-money exercisable stock options was $66.5 million and $56.4 million at December 31, 2014.

Shares issued in connection with stock compensation awards are issued from available treasury shares. If no treasury shares are available, new shares are issued from available authorized shares. Shares issued in connection with stock compensation awards along with other related information were as follows:



	2014		2013		2012
New shares issued from available authorized shares	—		153,275		207,586
Issued from available treasury stock	601,851		1,179,551		15,600
Total	601,851		1,332,826		223,186
Proceeds from stock option exercises	$	29,158	$	68,653	$	10,516
Intrinsic value of stock options exercised	13,714		20,506		1,538
Fair value of stock awards/units vested	4,346		1,918		1,649

Stock-based Compensation Expense. Stock-based compensation expense is recognized ratably over the requisite service period for all awards. The service period generally matches the vesting period for most awards; however, the service period for certain executive officers does not extend past the date they reach 65 years of age. Stock-based compensation expense and the related income tax benefit was as follows:



	2014		2013		2012
Stock options	$	9,142	$	8,814	$	9,663
Non-vested stock awards/stock units	2,920		2,819		2,843
Deferred stock-units	441		330		330
Total	$	12,503	$	11,963	$	12,836
Income tax benefit	$	4,376	$	4,187	$	4,493

Unrecognized stock-based compensation expense at December 31, 2014 was as follows:



Stock options	$	22,066
Non-vested stock awards/stock units	2,437
Total	$	24,503

The weighted-average period over which the remaining unrecognized stock-based compensation expense related to stock options is expected to be recognized was 3.1 years as of December 31, 2014. The weighted-average period over which the remaining unrecognized stock-based compensation expense related to non-vested stock awards/stock units is expected to be recognized was 2.5 years as of December 31, 2014 .

Valuation of Stock-Based Compensation. The fair value of the Corporation’s employee stock options granted is estimated on the measurement date, which, for the Corporation, is the date of grant. The fair value of stock options is estimated using a binomial lattice-based valuation model that takes into account employee exercise patterns based on changes in the Corporation’s stock price and other variables, and allows for the use of dynamic assumptions about interest rates and expected volatility. The fair value of stock options granted prior to the fourth quarter of 2006 was estimated using the Black-Scholes option-pricing model.

The weighted-average fair value of stock options granted during 2014, 2013 and 2012 estimated using a binomial lattice-based valuation model, was $16.97, $13.74, and $11.07. The assumptions used to determine the fair value of options granted are detailed in the table below.



	2014		2013		2012
Weighted-average risk-free interest rate	2.33	%	2.65	%	1.85	%
Dividend yield	2.71		2.92		3.28
Weighted-average expected market price volatility	26.66		24.20		28.06
Weighted-average expected term	7.1 years		6.7 years		6.2 years

Expected volatility is based on the short-term historical volatility (estimated over the most recent two years) and the long-term historical volatility (estimated over a period at least equal to the contractual term of the options) of the Corporation’s stock, and other factors. A variance targeting methodology is utilized to estimate the convergence, or mean reversion, from short-term to long-term volatility within the model. In estimating the fair value of stock options under the binomial lattice-based valuation model, separate groups of employees that have similar historical exercise behavior are considered separately. The expected term of options granted is derived using a regression model and represents the period of time that options granted are expected to be outstanding. Certain groups of employees exhibit different behavior.

The fair value of non-vested stock awards/stock units and deferred stock units for the purposes of recognizing stock-based compensation expense is the market price of the stock on the measurement date, which, for the Corporation, is the date of the award.