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 our discretion and may be made without regard to current or accumulated profits. Contributions are allocated to eligible participants uniformly, 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. We also maintain 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 $12.7 million in 2017, $11.6 million in 2016 and $11.3 million in 2015.

Retirement Plan and Restoration Plan. We maintain 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. Our funding policy is to contribute yearly, at least the amount necessary to satisfy the funding standards of the Employee Retirement Income Security Act (“ERISA”).

Our 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 our contributions.

We use a December 31 measurement date for our defined benefit plans. Combined activity in our defined benefit pension plans was as follows:



	2017			2016			2015
Change in plan assets:
Fair value of plan assets at beginning of year	$	157,214		$	163,270		$	168,185
Actual return on plan assets	23,518			5,174			1,567
Employer contributions	1,049			4,819			736
Benefits paid	(13,331		)	(16,049		)	(7,218		)
Fair value of plan assets at end of year	168,450			157,214			163,270
Change in benefit obligation:
Benefit obligation at beginning of year	176,751			194,140			199,637
Interest cost	6,189			6,958			8,210
Actuarial (gain) loss	12,998			(8,298		)	(6,489		)
Benefits paid	(13,331		)	(16,049		)	(7,218		)
Benefit obligation at end of year	182,607			176,751			194,140
Funded status of the plan at end of year and accrued benefit (liability) recognized	$	(14,157	)	$	(19,537	)	$	(30,870	)
Accumulated benefit obligation at end of year	$	182,607		$	176,751		$	194,140

Certain disaggregated information related to our defined benefit pension plans as of year-end was as follows:



	Retirement Plan					Restoration Plan
	2017		2016			2017			2016
Projected benefit obligation	$	166,191	$	160,778		$	16,416		$	15,973
Accumulated benefit obligation	166,191		160,778			16,416			15,973
Fair value of plan assets	168,450		157,214			—			—
Funded status of the plan at end of year and accrued benefit (liability) recognized	2,259		(3,564		)	(16,416		)	(15,973		)

The components of the combined net periodic cost (benefit) for our defined benefit pension plans are presented in the table below. Supplemental executive retirement plan (“SERP”) settlement costs were related to the retirement of a former executive officer.



	2017			2016			2015
Expected return on plan assets, net of expenses	$	(11,117	)	$	(11,558	)	$	(11,932	)
Interest cost on projected benefit obligation	6,189			6,958			8,210
Net amortization and deferral	5,429			6,247			6,995
SERP settlement costs	—			1,027			—
Net periodic expense (benefit)	$	501		$	2,674		$	3,273

As of December 31, 2015, we changed the method we use to estimate the interest cost component of net periodic benefit cost for our defined benefit pension and other post-retirement benefit plans. Prior to the change, we estimated the interest cost component utilizing a single weighted-average discount rate derived from the yield curve used to measure our projected benefit obligation. Under the new method, we utilize a full yield curve approach in the estimation of the interest cost component by applying the specific annual spot rates along the yield curve used in the measurement of our projected benefit obligation to the relevant projected cash flows. We view the full yield curve method as more representationally faithful of effective settlement rates as the interest cost component of the net periodic cost is measured more precisely, reflecting the difference in the timing of future benefit payment cash flows. This new method constituted a change in an accounting estimate that was inseparable from a change in accounting principle and was accounted for prospectively, with the resulting change impacting the recognition of net periodic benefit cost beginning January 1, 2016.

Amounts related to our defined benefit pension plans recognized as a component of other comprehensive income were as follows:



	2017			2016			2015
Net actuarial gain (loss)	$	4,832		$	9,188		$	3,118
Deferred tax (expense) benefit	(1,774		)	(3,216		)	(1,091		)
Other comprehensive income (loss), net of tax	$	3,058		$	5,972		$	2,027

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 our defined benefit pension plans are presented in the following table. We expect to recognize approximately $5.0 million of the net actuarial loss reported in the following table as of December 31, 2017 as a component of net periodic benefit cost during 2018.



	2017			2016
Net actuarial loss	$	(57,900	)	$	(62,732	)
Deferred tax benefit	12,160			21,956
Amounts included in accumulated other comprehensive income/loss, net of tax	(37,718		)	(40,776		)

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.



	2017		2016		2015
Benefit obligations:
Discount rate	3.68	%	4.24	%	4.55	%
Net periodic benefit cost:
Discount rate	4.24	%	4.55	%	4.20	%
Expected return on plan assets	7.25		7.25		7.25

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, 2017, management’s investment objective for our 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 our 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 17 - Fair Value Measurements). Our Restoration Plan is unfunded.



	2017		2016
Level 1:
Mutual funds	$	165,322	$	153,765
Cash and cash equivalents	3,128		3,208
Level 2:
U.S. government agency securities	—		241
Total fair value of plan assets	$	168,450	$	157,214

Mutual funds include various equity, fixed-income and blended funds with varying investment strategies. Approximately 65% of mutual fund investments consist of equity investments as of December 31, 2017. 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. U.S. government agency securities include obligations of Ginnie Mae. Our investment strategies prohibit selling assets short and the use of derivatives. Additionally, our 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 7.25% in the determination of the net periodic benefit cost for 2017. 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, 2017, expected future benefit payments related to our defined benefit plans were as follows:



2018	$	9,395
2019	9,837
2020	10,230
2021	10,524
2022	10,770
2023 through 2026	55,927
	$	106,683

We expect to contribute $1.1 million to the defined benefit plans during 2018.

Supplemental Executive Retirement Plan. We maintained a supplemental executive retirement plan (“SERP”) for one key executive who retired in 2016. The plan provided for target retirement benefits, as a percentage of pay, beginning at age 55. The target percentage was 45 percent of pay at age 55, increasing to 60 percent at age 60 and later. Benefits under the SERP were 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. Settlement costs related to the SERP during 2016 are reported as a component of net periodic pension expense, detailed above.

Savings Plans

401(k) Plan and Thrift Incentive Plan. We maintain 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. We match 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 our matching contributions immediately. Expense related to the plan totaled $14.3 million in 2017, $13.6 million in 2016, and $13.3 million in 2015. Our matching contribution is initially invested in the Cullen/Frost common stock fund. However, employees may immediately reallocate our matching portion, as well as invest their individual contribution, to any of a variety of investment alternatives offered under the 401(k) Plan.

We maintain 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 2017, 2016 and 2015.

Stock Compensation Plans

We have three active stock compensation plans (the 2005 Omnibus Incentive Plan, the 2007 Outside Directors Incentive Plan and the 2015 Omnibus Incentive Plan). All of the plans have been approved by our shareholders. During 2015, the 2015 Omnibus Incentive Plan (“2015 Plan”) was established to replace both the 2005 Omnibus Incentive Plan (“2005 Plan”) and the 2007 Outside Directors Incentive Plan (the “2007 Directors Plan”). All remaining shares authorized for grant under the superseded 2005 Plan and 2007 Directors Plan were transferred to the 2015 Plan. Our stock compensation plans were established to (i) motivate superior performance by means of performance-related incentives, (ii) encourage and provide for the acquisition of an ownership interest in our company by employees and non-employee directors and (iii) enable us to attract and retain qualified and competent persons as employees and to serve as members of our board of directors.

Under the 2015 Plan, we may grant, among other things, nonqualified stock options, incentive stock options, stock awards, stock appreciation rights, restricted stock units, performance share units or any combination thereof to certain employees and non-employee directors. Any of the authorized shares may be used for any type of award allowable under the Plan. The Compensation and Benefits Committee (“Committee”) of our Board of Directors has sole authority to (i) establish the awards to be issued, (ii) select the employees and non-employee directors to receive awards, and (iii) approve the terms and conditions of each award contract. Each award under the stock plans is evidenced by an award agreement that specifies the award price, the duration of the award, the number of shares to which the award pertains, and such other provisions as the Committee determines. For stock options, 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. As defined in the plans, outstanding awards may immediately vest upon a change-in-control of Cullen/Frost and, in the case of awards granted under the 2015 Plan, subsequent termination resulting from the change in control.

A combined summary of activity in our active stock plans is presented in the table. Performance stock units outstanding are presented assuming attainment of the maximum payout rate as set forth by the performance criteria. The target award level for performance stock units granted in 2017 and 2016 was 24,162 and 29,240, respectively. As of December 31, 2017, there were 1,367,750 shares remaining available for grant for future awards.



	Director Deferred Stock Units Outstanding				Non-Vested Stock Awards/Stock Units Outstanding				Performance Stock Units Outstanding			Stock Options Outstanding
	Number of Units		Weighted- Average Fair Value at Grant		Number of Shares/Units		Weighted- Average Fair Value at Grant		Number of Units	Weighted- Average Fair Value at Grant		Number of Shares		Weighted- Average Exercise Price
January 1, 2015	38,867		$	59.39	175,490		$	60.55	—	$	—	5,029,882		$	58.99
Authorized	—		—		—		—		—	—		—		—
Granted	6,576		72.94		53,990		65.11		—	—		890,940		65.11
Exercised/vested	—		—		(56,300	)	48.00		—	—		(287,326	)	51.70
Forfeited/expired	—		—		—		—		—	—		(21,256	)	66.72
December 31, 2015	45,443		61.35		173,180		66.05		—	—		5,612,240		60.30
Authorized	—		—		—		—		—	—		—		—
Granted	8,216		63.25		132,800		76.07		43,860	69.70		—		—
Exercised/vested	—		—		(49,130	)	54.56		—	—		(1,476,841	)	53.40
Forfeited/expired	—		—		—		—		—	—		(46,371	)	71.04
December 31, 2016	53,659		61.48		256,850		73.43		43,860	69.70		4,089,028		62.67
Authorized	—		—		—		—		—	—		—		—
Granted	5,447		95.37		99,833		98.90		36,243	92.27		—		—
Exercised/vested	(6,098	)	62.29		(39,740	)	71.59		—	—		(1,118,122	)	60.59
Forfeited/expired	—		—		(4,287	)	79.52		—	—		(53,764	)	69.78
December 31, 2017	53,008		$	64.87	312,656		$	81.71	80,103	$	79.91	2,917,142		$	63.34

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

Performance stock units represent shares potentially issuable in the future. Issuance is based upon the measure of our achievement of relative return on assets over a three-year performance period compared to an identified peer group's achievement of relative return on assets over the same three-year performance period. The ultimate number of shares issuable under each performance award is the product of the award target and the award payout percentage for the given level of achievement. The level of achievement is measured as the percentile rank of relative return on assets among the peer group. The award payout percentages by level of achievement are as follows: (i) less than 25th percentile pays out at 0% of target, (ii) 25th percentile pays out at 50% of target, (iii) 50th percentile pays out at 100% of target and (iv) 75th percentile or more pays out at 150% of target. Achievement between the aforementioned percentiles will result in an award payout percentage determined based on straight-line interpolation between the percentiles. Performance stock units are eligible to receive equivalent dividend payments as such dividends are declared on our common stock during the performance period. Equivalent dividend payments are based upon the ultimate number of shares issued under each performance award and are deferred until such time that the units vest and shares are issued.

Other information regarding options outstanding and exercisable as of December 31, 2017 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	294,230	$	48.00	3.82	294,230	$	48.00
50.01		to	55.00		915,923	52.79		3.04	915,923	52.79
65.01		to	70.00		711,477	65.11		7.49	294,507	65.11
70.01		to	75.00		345,195	71.39		5.78	345,195	71.39
75.01		to	80.00		650,317	78.94		6.58	445,131	78.94
			Total		2,917,142	63.34		5.32	2,294,986	61.63

The total intrinsic value of outstanding in-the-money stock options and outstanding in-the-money exercisable stock options was $91.3 million and $75.8 million at December 31, 2017.

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:



	2017		2016		2015
New shares issued from available authorized shares	603,842		—		—
Issued from available treasury stock	547,078		1,509,121		337,056
Total	1,150,920		1,509,121		337,056
Proceeds from stock option exercises	$	67,746	$	78,866	$	14,853
Intrinsic value of stock options exercised	38,275		30,935		5,766
Fair value of stock awards/units vested	4,578		3,679		3,728

Stock-based Compensation Expense. Stock-based compensation expense is recognized ratably over the requisite service period for all awards. For most stock option awards, the service period generally matches the vesting period. For stock options granted to certain executive officers and for non-vested stock units granted to all participants, the service period does not extend past the date the participant reaches 65 years of age. Deferred stock units granted to non-employee directors generally have immediate vesting and the related expense is fully recognized on the date of grant. For performance stock units, the service period generally matches the three-year performance period specified by the award, however, the service period does not extend past the date the participant reaches 65 years of age. Expense recognized each period is dependent upon our estimate of the number of shares that will ultimately be issued.

Stock-based compensation expense and the related income tax benefit is presented in the following table. The service period for performance stock units granted each year begins on January 1 of the following year.



	2017		2016		2015
Stock options	$	6,230	$	8,235	$	9,660
Non-vested stock awards/stock units	4,992		3,044		2,597
Deferred stock-units	519		520		480
Performance stock units	1,272		—		—
Total	$	13,013	$	11,799	$	12,737
Income tax benefit	$	4,555	$	4,130	$	4,458

Unrecognized stock-based compensation expense and the weighted-average period over which the expense is expected to be recognized at December 31, 2017 is presented in the table below. Unrecognized stock-based compensation expense related to performance stock units is presented assuming attainment of the maximum payout rate as set forth by the performance criteria.



	Unrecognized Expense		Weighted-Average Number of Years for Expense Recognition
Stock options	$	5,575	1.4
Non-vested stock awards/stock units	14,953		3.0
Performance stock units	5,129		2.1
Total	$	25,657

Valuation of Stock-Based Compensation. For the purposes of recognizing stock-based compensation expense, the fair value of non-vested stock awards/stock units and deferred stock units is the market price of the stock on the measurement date, which, for us, is the date of the award. The fair value of performance stock units is determined in a similar manner except that the market price of the stock on the measurement date is discounted by the present value of the dividends expected to be paid on our common stock during the service period of the award because dividend equivalent payments on performance stock units are deferred until such time that the units vest and shares are issued. In applying this discount to the market price of our stock on the measurement date, we assumed we would pay a flat quarterly dividend during the service period equal to our most recent dividend payment, which was $0.57 in 2017 and $0.54 in 2016, discounted at a weighted-average risk-free rate of 1.7% in 2017 and 1.0% in 2016.

The fair value of employee stock options granted is estimated on the measurement date, which, for us, 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 our stock price and other variables, and allows for the use of dynamic assumptions about interest rates and expected volatility.

No stock options were granted during 2017 or 2016. The weighted-average fair value of stock options granted during 2015, estimated using a binomial lattice-based valuation model, was $10.23. The assumptions used to determine the fair value of options granted in 2015 included (i) weighted-average risk free rate of 2.05%, (ii) dividend yield of 3.02%, (iii) weighted-average expected market price volatility of 26.48% and (iv) weighted-average expected term of 5.7 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 our 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.