10-K 1 a20171231-10k.htm 10-K Document

UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
ý Annual Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
For the fiscal year ended:    December 31, 2017
Or
¨ 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:    001-13221
CULLEN/FROST BANKERS, INC.
(Exact name of registrant as specified in its charter)
Texas
74-1751768
(State or other jurisdiction of
incorporation or organization)
(I.R.S. Employer
Identification No.)
100 W. Houston Street, San Antonio, Texas
78205
(Address of principal executive offices)
(Zip code)
(210) 220-4011
(Registrant’s telephone number, including area code)
Securities registered pursuant to Section 12(b) of the Act:
Common Stock, $.01 Par Value
The New York Stock Exchange, Inc.
5.375% Non-Cumulative Perpetual Preferred Stock, Series A
The New York Stock Exchange, Inc.
(Title of each class)
(Name of each exchange on which registered)
Securities registered pursuant to Section 12(g) of the Act: None
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes  ý    No  ¨
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes ¨    No  ý
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  ý    No  ¨
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Website, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes  ý    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. ý
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act.
Large accelerated filer
ý
Accelerated filer
¨
Non-accelerated filer
¨ (Do not check if a smaller reporting company)
Smaller reporting company
¨
 
 
Emerging growth company
¨
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act.    ¨
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act.) Yes ¨    No  ý
As of June 30, 2017, the last business day of the registrant’s most recently completed second fiscal quarter, the aggregate market value of the shares of common stock held by non-affiliates, based upon the closing price per share of the registrant’s common stock as reported on The New York Stock Exchange, Inc., was approximately $5.8 billion.
As of January 30, 2018, there were 63,682,137 shares of the registrant’s common stock, $.01 par value, outstanding.



DOCUMENTS INCORPORATED BY REFERENCE
Portions of the Proxy Statement for the 2018 Annual Meeting of Shareholders of Cullen/Frost Bankers, Inc. to be held on April 25, 2018 are incorporated by reference in this Form 10-K in response to Part III, Items 10, 11, 12, 13 and 14.



CULLEN/FROST BANKERS, INC.
ANNUAL REPORT ON FORM 10-K
TABLE OF CONTENTS
 
 
 
Page
PART I
 
 
 
 
 
Item 1.
 
 
 
Item 1A.
 
 
 
Item 1B.
 
 
 
Item 2.
 
 
 
Item 3.
 
 
 
Item 4.
 
 
 
PART II
 
 
 
 
 
Item 5.
 
 
 
Item 6.
 
 
 
Item 7.
 
 
 
Item 7A.
 
 
 
Item 8.
 
 
 
Item 9.
 
 
 
Item 9A.
 
 
 
Item 9B.
 
 
 
PART III
 
 
 
 
 
Item 10.
 
 
 
Item 11.
 
 
 
Item 12.
 
 
 
Item 13.
 
 
 
Item 14.
 
 
 
PART IV
 
 
 
 
 
Item 15.
 
 
 
Item 16.
 
 
 
SIGNATURES
 

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PART I
ITEM 1. BUSINESS
The disclosures set forth in this item are qualified by Item 1A. Risk Factors and the section captioned “Forward-Looking Statements and Factors that Could Affect Future Results” in Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations of this report and other cautionary statements set forth elsewhere in this report.
The Corporation
Cullen/Frost Bankers, Inc., a Texas business corporation incorporated in 1977, is a financial holding company and a bank holding company headquartered in San Antonio, Texas that provides, through its subsidiaries, a broad array of products and services throughout numerous Texas markets. The terms “Cullen/Frost,” “the Corporation,” “we,” “us” and “our” mean Cullen/Frost Bankers, Inc. and its subsidiaries, when appropriate. We offer commercial and consumer banking services, as well as trust and investment management, insurance, brokerage, mutual funds, leasing, treasury management, capital markets advisory and item processing services. At December 31, 2017, Cullen/Frost had consolidated total assets of $31.7 billion and was one of the largest independent bank holding companies headquartered in the State of Texas.
Our philosophy is to grow and prosper, building long-term relationships based on top quality service, high ethical standards, and safe, sound assets. We operate as a locally-oriented, community-based financial services organization, augmented by experienced, centralized support in select critical areas. Our local market orientation is reflected in our regional management and regional advisory boards, which are comprised of local business persons, professionals and other community representatives that assist our regional management in responding to local banking needs. Despite this local market, community-based focus, we offer many of the products available at much larger money-center financial institutions.
We serve a wide variety of industries including, among others, energy, manufacturing, services, construction, retail, telecommunications, healthcare, military and transportation. Our customer base is similarly diverse. While our loan portfolio has a significant concentration of energy-related loans totaling approximately 11.4% of total loans at December 31, 2017, we are not dependent upon any single industry or customer.
Our operating objectives include expansion, diversification within our markets, growth of our fee-based income, and growth internally and through acquisitions of financial institutions, branches and financial services businesses. We generally seek merger or acquisition partners that are culturally similar and have experienced management and possess either significant market presence or have potential for improved profitability through financial management, economies of scale and expanded services. We regularly evaluate merger and acquisition opportunities and conduct due diligence activities related to possible transactions with other financial institutions and financial services companies. As a result, merger or acquisition discussions and, in some cases, negotiations may take place and future mergers or acquisitions involving cash, debt or equity securities may occur. Acquisitions typically involve the payment of a premium over book and market values, and, therefore, some dilution of our tangible book value and net income per common share may occur in connection with any future transaction. Our ability to engage in certain merger or acquisition transactions, whether or not any regulatory approval is required, will be dependent upon our bank regulators’ views at the time as to the capital levels, quality of management and our overall condition and their assessment of a variety of other factors. Certain merger or acquisition transactions, including those involving the acquisition of a depository institution or the assumption of the deposits of any depository institution, require formal approval from various bank regulatory authorities, which will be subject to a variety of factors and considerations.
Although Cullen/Frost is a corporate entity, legally separate and distinct from its affiliates, bank holding companies such as Cullen/Frost are required to act as a source of financial strength for their subsidiary banks. The principal source of Cullen/Frost’s income is dividends from its subsidiaries. There are certain regulatory restrictions on the extent to which these subsidiaries can pay dividends or otherwise supply funds to Cullen/Frost. See the section captioned “Supervision and Regulation” included elsewhere in this item for further discussion of these matters.
Cullen/Frost’s executive offices are located at 100 W. Houston Street, San Antonio, Texas 78205, and its telephone number is (210) 220-4011.

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Subsidiaries of Cullen/Frost
Frost Bank
Frost Bank, the principal operating subsidiary and sole banking subsidiary of Cullen/Frost, is a Texas-chartered bank primarily engaged in the business of commercial and consumer banking through approximately 134 financial centers across Texas in the Austin, Corpus Christi, Dallas, Fort Worth, Houston, Permian Basin, Rio Grande Valley and San Antonio regions. Frost Bank also operates over 1,300 automated-teller machines (“ATMs”) throughout the State of Texas, approximately half of which are operated in connection with a branding arrangement to be the exclusive cash-machine provider for Corner Store in Texas. Frost Bank was originally chartered as a national banking association in 1899, but its origin can be traced to a mercantile partnership organized in 1868. At December 31, 2017, Frost Bank had consolidated total assets of $31.8 billion and total deposits of $26.9 billion and was one of the largest commercial banks headquartered in the State of Texas.
Significant services offered by Frost Bank include:
 Commercial Banking. Frost Bank provides commercial banking services to corporations and other business clients. Loans are made for a wide variety of general corporate purposes, including financing for industrial and commercial properties and to a lesser extent, financing for interim construction related to industrial and commercial properties, financing for equipment, inventories and accounts receivable, and acquisition financing. We also originate commercial leases and offer treasury management services.
Consumer Services. Frost Bank provides a full range of consumer banking services, including checking accounts, savings programs, ATMs, overdraft facilities, installment and real estate loans, home equity loans and lines of credit, drive-in and night deposit services, safe deposit facilities and brokerage services.
 International Banking. Frost Bank provides international banking services to customers residing in or dealing with businesses located in Mexico. These services consist of accepting deposits (generally only in U.S. dollars), making loans (generally only in U.S. dollars), issuing letters of credit, handling foreign collections, transmitting funds, and to a limited extent, dealing in foreign exchange.
Correspondent Banking. Frost Bank acts as correspondent for approximately 203 financial institutions, which are primarily banks in Texas. These banks maintain deposits with Frost Bank, which offers them a full range of services including check clearing, transfer of funds, fixed income security services, and securities custody and clearance services.
Trust Services. Frost Bank provides 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, as well as the management of investment accounts for individuals, employee benefit plans and charitable foundations. At December 31, 2017, the estimated fair value of trust assets was $32.8 billion, including managed assets of $14.1 billion and custody assets of $18.7 billion.
Capital Markets - Fixed-Income Services. Frost Bank’s Capital Markets Division supports the transaction needs of fixed-income institutional investors. Services include sales and trading, new issue underwriting, money market trading, advisory services and securities safekeeping and clearance.
Global Trade Services. Frost Bank's Global Trade Services Division supports international business activities including foreign exchange, international letters of credit and export-import financing, among other things.
Frost Insurance Agency, Inc.
Frost Insurance Agency, Inc. is a wholly-owned subsidiary of Frost Bank that provides insurance brokerage services to individuals and businesses covering corporate and personal property and casualty insurance products, as well as group health and life insurance products.
Frost Brokerage Services, Inc.
Frost Brokerage Services, Inc. (“FBS”) is a wholly-owned subsidiary of Frost Bank that provides brokerage services and performs other transactions or operations related to the sale and purchase of securities of all types. FBS is registered as a fully disclosed introducing broker-dealer under the Securities Exchange Act of 1934 and, as such, does not hold any customer accounts.

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Frost Investment Advisors, LLC
Frost Investment Advisors, LLC is a registered investment advisor and a wholly-owned subsidiary of Frost Bank that provides investment management services to Frost-managed mutual funds, institutions and individuals.
Frost Investment Services, LLC
Frost Investment Services, LLC is a registered investment advisor and a wholly-owned subsidiary of Frost Bank that provides investment management services to individuals.
Tri–Frost Corporation
Tri-Frost Corporation is a wholly-owned subsidiary of Frost Bank that primarily holds securities for investment purposes and the receipt of cash flows related to principal and interest on the securities until such time that the securities mature.
Main Plaza Corporation
Main Plaza Corporation is a wholly-owned subsidiary of Cullen/Frost that occasionally makes loans to qualified borrowers. Loans are funded with current cash or borrowings against internal credit lines. Main Plaza also holds severed mineral interests on certain oil producing properties. We receive royalties on these interests based upon production.
Cullen/Frost Capital Trust II and WNB Capital Trust I
Cullen/Frost Capital Trust II (“Trust II”) is a Delaware statutory business trust formed in 2004 for the purpose of issuing $120.0 million in trust preferred securities and lending the proceeds to Cullen/Frost. Cullen/Frost guarantees, on a limited basis, payments of distributions on the trust preferred securities and payments on redemption of the trust preferred securities.
WNB Capital Trust I (“WNB Trust”) is a Delaware statutory business trust formed in 2004 for the purpose of issuing $13.0 million in trust preferred securities and lending the proceeds to WNB Bancshares (“WNB”). Cullen/Frost, as WNB's successor, guarantees, on a limited basis, payments of distributions on the trust preferred securities and payments on redemption of the trust preferred securities.
Trust II and WNB Trust are variable interest entities for which we are not the primary beneficiary. As such, the accounts of Trust II and WNB Trust are not included in our consolidated financial statements. See our accounting policy related to consolidation in Note 1 - Summary of Significant Accounting Policies in the notes to consolidated financial statements included in Item 8. Financial Statements and Supplementary Data, which is located elsewhere in this report.
Although the accounts of Trust II and WNB Trust are not included in our consolidated financial statements, the $120.0 million in trust preferred securities issued by Trust II and the $13.0 million in trust preferred securities issued by WNB Trust were included in the regulatory capital of Cullen/Frost during the reported periods. See the section captioned “Supervision and Regulation - Capital Requirements” for a discussion of the regulatory capital treatment of our trust preferred securities.
Other Subsidiaries
Cullen/Frost has various other subsidiaries that are not significant to the consolidated entity.
Operating Segments
Our operations are managed along two reportable operating segments consisting of Banking and Frost Wealth Advisors. See the sections captioned “Results of Segment Operations” in Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations and Note 18 - Operating Segments in the notes to consolidated financial statements included in Item 8. Financial Statements and Supplementary Data, which are located elsewhere in this report.

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Competition
There is significant competition among commercial banks in our market areas. In addition, we also compete with other providers of financial services, such as savings and loan associations, credit unions, consumer finance companies, securities firms, insurance companies, insurance agencies, commercial finance and leasing companies, full service brokerage firms and discount brokerage firms. Some of our competitors have greater resources and, as such, may have higher lending limits and may offer other services that are not provided by us. We generally compete on the basis of customer service and responsiveness to customer needs, available loan and deposit products, the rates of interest charged on loans, the rates of interest paid for funds, and the availability and pricing of trust, brokerage and insurance services.
Supervision and Regulation
Cullen/Frost, Frost Bank and most of its non-banking subsidiaries are subject to extensive regulation under federal and state laws. The regulatory framework is intended primarily for the protection of depositors, federal deposit insurance funds and the banking system as a whole and not for the protection of shareholders and creditors.
Significant elements of the laws and regulations applicable to Cullen/Frost and its subsidiaries are described below. The description is qualified in its entirety by reference to the full text of the statutes, regulations and policies that are described. Also, such statutes, regulations and policies are continually under review by Congress and state legislatures and federal and state regulatory agencies. A change in statutes, regulations or regulatory policies applicable to Cullen/Frost and its subsidiaries could have a material effect on our business, financial condition or our results of operations. Recent political developments, including the change in administration in the United States, have added additional uncertainty to the implementation, scope and timing of regulatory reforms.
On February 3, 2017, the President of the United States issued an executive order identifying “core principles” for the administration’s financial services regulatory policy and directing the Secretary of the Treasury, in consultation with the heads of other financial regulatory agencies, to evaluate how the current regulatory framework promotes or inhibits the principles and what actions have been, and are being, taken to promote the principles. In response to the executive order, on June 12, 2017, October 6, 2017 and October 26, 2017, respectively, the U.S. Department of the Treasury issued the first three of four reports recommending a number of comprehensive changes in the current regulatory system for U.S. depository institutions, the U.S. capital markets and the U.S. asset management and insurance industries.
Regulatory Agencies
Cullen/Frost is a legal entity separate and distinct from Frost Bank and its other subsidiaries. As a financial holding company and a bank holding company, Cullen/Frost is regulated under the Bank Holding Company Act of 1956, as amended (“BHC Act”), and it and its subsidiaries are subject to inspection, examination and supervision by the Federal Reserve Board. The BHC Act provides generally for “umbrella” regulation of financial holding companies such as Cullen/Frost by the Federal Reserve Board, and for functional regulation of banking activities by bank regulators, securities activities by securities regulators, and insurance activities by insurance regulators. Cullen/Frost is also under the jurisdiction of the Securities and Exchange Commission (“SEC”) and is subject to the disclosure and regulatory requirements of the Securities Act of 1933, as amended, and the Securities Exchange Act of 1934, as amended, as administered by the SEC. Cullen/Frost’s common stock is listed on the New York Stock Exchange (“NYSE”) under the trading symbol “CFR” and our 5.375% Non-Cumulative Perpetual Preferred Stock, Series A, is listed on the NYSE under the trading symbol “CFRpA.”  Accordingly, Cullen/Frost is also subject to the rules of the NYSE for listed companies.
Frost Bank is a Texas state chartered bank and a member of the Federal Reserve System. Accordingly, the Texas Department of Banking and the Federal Reserve Board are the primary regulators of Frost Bank. Deposits at Frost Bank are insured by the Federal Deposit Insurance Corporation (“FDIC”) up to applicable limits.
All member banks of the Federal Reserve System, including Frost Bank, are required to hold stock in the Federal Reserve System's Reserve Banks in an amount equal to six percent of their capital stock and surplus (half paid to acquire the stock with the remainder held as a cash reserve). Member banks do not have any control over the Federal Reserve System as a result of owning the stock and the stock cannot be sold or traded. Prior to the enactment of the Fixing America's Surface Transportation Act (“FAST Act”) in December 2015, member banks received a fixed, six percent dividend annually on their stock. Under the FAST Act, the annual dividend rate for member banks with total assets in excess of $10 billion, including Frost Bank, changed from a fixed, six percent dividend rate to a floating dividend rate tied to 10-year U.S. Treasuries with the maximum dividend rate capped at six percent. The total amount of stock

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dividends that Frost Bank received from the Federal Reserve totaled $807 thousand in 2017, $735 thousand in 2016 and $2.1 million in 2015. The decrease in 2016 resulted from the implementation of the aforementioned FAST Act, as the 10-year U.S. Treasury yields used to determine the annual stock dividend rate for 2016 were significantly lower than the fixed, six percent dividend rate used to determine the annual stock dividend rate in 2015.
Most of our non-bank subsidiaries also are subject to regulation by the Federal Reserve Board and other federal and state agencies. Frost Brokerage Services, Inc. is regulated by the SEC, the Financial Industry Regulatory Authority (“FINRA”) and state securities regulators. Frost Investment Advisors, LLC and Frost Investment Services, LLC are subject to the disclosure and regulatory requirements of the Investment Advisors Act of 1940, as administered by the SEC. Our insurance subsidiary is subject to regulation by applicable state insurance regulatory agencies. Other non-bank subsidiaries are subject to both federal and state laws and regulations. Frost Bank and its affiliates are also subject to supervision, regulation, examination and enforcement by the Consumer Financial Protection Bureau (“CFPB”) with respect to consumer protection laws and regulations.
Bank Holding Company Activities
In general, the BHC Act limits the business of bank holding companies to banking, managing or controlling banks and other activities that the Federal Reserve Board has determined to be so closely related to banking as to be a proper incident thereto. In addition, bank holding companies that qualify and elect to be financial holding companies may engage in any activity, or acquire and retain the shares of a company engaged in any activity, that is either (i) financial in nature or incidental to such financial activity (as determined by the Federal Reserve Board in consultation with the Secretary of the Treasury) or (ii) complementary to a financial activity and does not pose a substantial risk to the safety and soundness of depository institutions or the financial system generally (as solely determined by the Federal Reserve Board), without prior approval of the Federal Reserve Board. Activities that are financial in nature include securities underwriting and dealing, insurance underwriting and making merchant banking investments.
To maintain financial holding company status, a financial holding company and all of its depository institution subsidiaries must be “well capitalized” and “well managed.” A depository institution subsidiary is considered to be “well capitalized” if it satisfies the requirements for this status discussed in the section captioned “Capital Adequacy and Prompt Corrective Action,” included elsewhere in this item. A depository institution subsidiary is considered “well managed” if it received a composite rating and management rating of at least “satisfactory” in its most recent examination. A financial holding company’s status will also depend upon it maintaining its status as “well capitalized” and “well managed’ under applicable Federal Reserve Board regulations. If a financial holding company ceases to meet these capital and management requirements, the Federal Reserve Board’s regulations provide that the financial holding company must enter into an agreement with the Federal Reserve Board to comply with all applicable capital and management requirements. Until the financial holding company returns to compliance, the Federal Reserve Board may impose limitations or conditions on the conduct of its activities, and the company may not commence any of the broader financial activities permissible for financial holding companies or acquire a company engaged in such financial activities without prior approval of the Federal Reserve Board. If the company does not return to compliance within 180 days, the Federal Reserve Board may require divestiture of the holding company’s depository institutions. Bank holding companies and banks must also be both well capitalized and well managed in order to acquire banks located outside their home state.
In order for a financial holding company to commence any new activity permitted by the BHC Act or to acquire a company engaged in any new activity permitted by the BHC Act, each insured depository institution subsidiary of the financial holding company must have received a rating of at least “satisfactory” in its most recent examination under the Community Reinvestment Act. See the section captioned “Community Reinvestment Act” included elsewhere in this item.
The Federal Reserve Board has the power to order any bank holding company or its subsidiaries to terminate any activity or to terminate its ownership or control of any subsidiary when the Federal Reserve Board has reasonable grounds to believe that continuation of such activity or such ownership or control constitutes a serious risk to the financial soundness, safety or stability of any bank subsidiary of the bank holding company.
The BHC Act, the Bank Merger Act, the Texas Banking Code and other federal and state statutes regulate acquisitions of commercial banks and their parent holding companies. The BHC Act requires the prior approval of the Federal Reserve Board for the direct or indirect acquisition by a bank holding company of more than 5.0% of the voting shares of a commercial bank or its parent holding company. Under the Bank Merger Act, the prior approval of the Federal Reserve Board or other appropriate bank regulatory authority is required for a member bank to merge with another

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bank or purchase substantially all of the assets or assume any deposits of another bank. In reviewing applications seeking approval of merger and acquisition transactions, the bank regulatory authorities will consider, among other things, the competitive effect and public benefits of the transactions, the applicant's managerial and financial resources, the capital position of the combined organization, the risks to the stability of the U.S. banking or financial system, the applicant’s performance record under the Community Reinvestment Act (see the section captioned “Community Reinvestment Act” included elsewhere in this item) and its compliance with fair housing and other consumer protection laws and the effectiveness of the subject organizations in combating money laundering activities.
Dividends and Stock Repurchases
The principal source of Cullen/Frost’s liquidity is dividends from Frost Bank. The prior approval of the Federal Reserve Board is required if the total of all dividends declared by a state-chartered member bank in any calendar year would exceed the sum of the bank’s net profits for that year and its retained net profits for the preceding two calendar years, less any required transfers to surplus or to fund the retirement of preferred stock. Federal law also prohibits a state-chartered, member bank from paying dividends that would be greater than the bank’s undivided profits. Frost Bank is also subject to limitations under Texas state law regarding the level of dividends that may be paid. Under the foregoing dividend restrictions, and while maintaining its “well capitalized” status, Frost Bank could pay aggregate dividends of approximately $544.8 million to Cullen/Frost, without obtaining affirmative governmental approvals, at December 31, 2017. This amount is not necessarily indicative of amounts that may be paid or available to be paid in future periods.
In addition, Cullen/Frost and Frost Bank are subject to other regulatory policies and requirements relating to the payment of dividends, including requirements to maintain adequate capital above regulatory minimums. The appropriate federal regulatory authority is authorized to determine under certain circumstances relating to the financial condition of a bank holding company or a bank that the payment of dividends would be an unsafe or unsound practice and to prohibit payment thereof. The appropriate federal regulatory authorities have stated that paying dividends that deplete a bank’s capital base to an inadequate level would be an unsafe and unsound banking practice and that banking organizations should generally pay dividends only out of current operating earnings. In addition, in the current financial and economic environment, the Federal Reserve Board has indicated that bank holding companies should carefully review their dividend policy and has discouraged payment ratios that are at maximum allowable levels unless both asset quality and capital are very strong.
Under the Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act” or “Dodd-Frank”), institutions, such as Cullen/Frost and Frost Bank, with average total consolidated assets greater than $10 billion are required to conduct an annual company-run stress test of capital, consolidated earnings and losses under one base and at least two stress scenarios provided by the federal bank regulators. The company-run stress tests are conducted using data as of December 31st of the preceding calendar year and scenarios released by the agencies. Stress test results must be reported to the agencies by July 31st with public disclosure of summary stress test results under the severely adverse scenario between October 15th and October 31st. Our capital ratios reflected in the stress test calculations are an important factor considered by the Federal Reserve Board in evaluating the capital adequacy of Cullen/Frost and Frost Bank and whether the appropriateness of any proposed payments of dividends or stock repurchases may be an unsafe or unsound practice.
Transactions with Affiliates
Transactions between Frost Bank and its subsidiaries, on the one hand, and Cullen/Frost or any other subsidiary, on the other hand, are regulated under federal banking law. The Federal Reserve Act imposes quantitative and qualitative requirements and collateral requirements on covered transactions by Frost Bank with, or for the benefit of, its affiliates, and generally requires those transactions to be on terms at least as favorable to Frost Bank as if the transaction were conducted with an unaffiliated third party. Covered transactions are defined by statute to include a loan or extension of credit, as well as a purchase of securities issued by an affiliate, a purchase of assets (unless otherwise exempted by the Federal Reserve Board) from the affiliate, certain derivative transactions that create a credit exposure to an affiliate, the acceptance of securities issued by the affiliate as collateral for a loan, and the issuance of a guarantee, acceptance or letter of credit on behalf of an affiliate. In general, any such transaction by Frost Bank or its subsidiaries must be limited to certain thresholds on an individual and aggregate basis and, for credit transactions with any affiliate, must be secured by designated amounts of specified collateral.

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Federal law also limits a bank’s authority to extend credit to its directors, executive officers and 10% stockholders, as well as to entities controlled by such persons. Among other things, extensions of credit to insiders are required to be made on terms that are substantially the same as, and follow credit underwriting procedures that are not less stringent than, those prevailing for comparable transactions with unaffiliated persons. Also, the terms of such extensions of credit may not involve more than the normal risk of non-repayment or present other unfavorable features and may not exceed certain limitations on the amount of credit extended to such persons individually and in the aggregate.
Source of Strength Doctrine
Federal Reserve Board policy and federal law require bank holding companies to act as a source of financial and managerial strength to their subsidiary banks. Under this requirement, Cullen/Frost is expected to commit resources to support Frost Bank, including at times when Cullen/Frost may not be in a financial position to provide such resources. Any capital loans by a bank holding company to any of its subsidiary banks are subordinate in right of payment to depositors 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 entitled to priority of payment.
Capital Requirements
Cullen/Frost and Frost Bank are each required to comply with applicable capital adequacy standards established by the Federal Reserve Board. The current risk-based capital standards applicable to Cullen/Frost and Frost Bank, parts of which are currently in the process of being phased-in, are based on the December 2010 final capital framework for strengthening international capital standards, known as Basel III, of the Basel Committee on Banking Supervision (the “Basel Committee”). In July 2013, the federal bank regulators approved final rules (the “Basel III Capital Rules”) implementing the Basel III framework as well as certain provisions of the Dodd-Frank Act. The Basel III Capital Rules became effective for Cullen/Frost and Frost Bank on January 1, 2015 (subject to a phase-in period for certain provisions).
The Basel III Capital Rules, among other things, (i) include a new capital measure called “Common Equity Tier 1” (“CET1”), (ii) specify that Tier 1 capital consists of CET1 and “Additional Tier 1 capital” instruments meeting certain revised requirements, (iii) define CET1 narrowly by requiring that most deductions/adjustments to regulatory capital measures be made to CET1 and not to the other components of capital, and (iv) expand the scope of the deductions/adjustments to capital as compared to existing regulations.
Under the Basel III Capital Rules, the minimum capital ratios effective as of January 1, 2015 are:
4.5% CET1 to risk-weighted assets;
6.0% Tier 1 capital (that is, CET1 plus Additional Tier 1 capital) to risk-weighted assets;
8.0% Total capital (that is, Tier 1 capital plus Tier 2 capital) to risk-weighted assets; and
4.0% Tier 1 capital to average consolidated assets as reported on consolidated financial statements (known as the “leverage ratio”).
The Basel III Capital Rules also require a “capital conservation buffer”, composed entirely of CET1, on top of these minimum risk-weighted asset ratios. The implementation of the capital conservation buffer began on January 1, 2016 at the 0.625% level and will increase by 0.625% on each subsequent January 1, until it reaches 2.5% on January 1, 2019. The Basel III Capital Rules also provide for a “countercyclical capital buffer” that is only applicable to certain covered institutions and does not have any current applicability to Cullen/Frost or Frost Bank. The capital conservation buffer is designed to absorb losses during periods of economic stress and effectively increases the minimum required risk-weighted capital ratios. Banking institutions with a ratio of CET1 to risk-weighted assets below the effective minimum (4.5% plus the capital conservation buffer and, if applicable, the countercyclical capital buffer) will face constraints on dividends, equity repurchases and compensation based on the amount of the shortfall.
When fully phased in on January 1, 2019, the Basel III Capital Rules will require Cullen/Frost and Frost Bank to maintain an additional capital conservation buffer of 2.5% of CET1, effectively resulting in minimum ratios of (i) CET1 to risk-weighted assets of at least 7%, (ii) Tier 1 capital to risk-weighted assets of at least 8.5%, (iii) a minimum ratio of Total capital to risk-weighted assets of at least 10.5%; and (iv) a minimum leverage ratio of 4%.

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The Basel III Capital Rules also provide for a number of deductions from and adjustments to CET1. These include, for example, the requirement that certain deferred tax assets and significant investments in non-consolidated financial entities be deducted from CET1 to the extent that any one such category exceeds 10% of CET1 or all such items, in the aggregate, exceed 15% of CET1. Implementation of the deductions and other adjustments to CET1 began on January 1, 2015 and will be phased-in over a 4-year period (beginning at 40% on January 1, 2015 and an additional 20% per year thereafter).
In addition, under the general risk-based capital rules, the effects of accumulated other comprehensive income items included in capital were excluded for the purposes of determining regulatory capital ratios. Under the Basel III Capital Rules, the effects of certain accumulated other comprehensive income items are not excluded; however, non-advanced approaches banking organizations, including Cullen/Frost and Frost Bank, were able to make a one-time permanent election to continue to exclude these items. Both Cullen/Frost and Frost Bank made this election in order to avoid significant variations in the level of capital depending upon the impact of interest rate fluctuations on the fair value of their available-for-sale securities portfolio. Under the Basel III Capital Rules, trust preferred securities no longer included in our Tier 1 capital may nonetheless be included as a component of Tier 2 capital on a permanent basis without phase-out.
The Basel III Capital Rules prescribe a standardized approach for risk weightings that expanded the risk-weighting categories from the general risk-based capital rules to a much larger and more risk-sensitive number of categories, depending on the nature of the assets, generally ranging from 0% for U.S. government and agency securities, to 600% for certain equity exposures, and resulting in higher risk weights for a variety of asset categories.
With respect to Frost Bank, the Basel III Capital Rules also revise the “prompt corrective action” regulations pursuant to Section 38 of the Federal Deposit Insurance Act, as discussed below under “Prompt Corrective Action.”
Management believes that, as of December 31, 2017, Cullen/Frost and Frost Bank would meet all capital adequacy requirements under the Basel III Capital Rules on a fully phased-in basis as if such requirements had been in effect.
In September 2017, the federal bank regulators proposed to revise and simplify the capital treatment for certain deferred tax assets, mortgage servicing assets, investments in non-consolidated financial entities and minority interests for banking organizations, such as Cullen/Frost and Frost Bank, that are not subject to the advanced approaches requirements. In November 2017, the federal banking regulators revised the Basel III Capital Rules to extend the current transitional treatment of these items for non-advanced approaches banking organizations until the September 2017 proposal is finalized. The September 2017 proposal would also change the capital treatment of certain commercial real estate loans under the standardized approach, which we use to calculate our capital ratios.
In December 2017, the Basel Committee published standards that it described as the finalization of the Basel III post-crisis regulatory reforms (the standards are commonly referred to as “Basel IV”). Among other things, these standards revise the Basel Committee's standardized approach for credit risk (including by recalibrating risk weights and introducing new capital requirements for certain “unconditionally cancellable commitments,” such as unused credit card lines of credit) and provides a new standardized approach for operational risk capital. Under the Basel framework, these standards will generally be effective on January 1, 2022, with an aggregate output floor phasing in through January 1, 2027. Under the current U.S. capital rules, operational risk capital requirements and a capital floor apply only to advanced approaches institutions, and not to Cullen/Frost or Frost Bank. The impact of Basel IV on us will depend on the manner in which it is implemented by the federal bank regulators.
Liquidity Requirements
Historically, the regulation and monitoring of bank and bank holding company liquidity has been addressed as a supervisory matter, without required formulaic measures. Liquidity risk management has become increasingly important since the financial crisis. The Basel III liquidity framework requires banks and bank holding companies to measure their liquidity against specific liquidity tests that, although similar in some respects to liquidity measures historically applied by banks and regulators for management and supervisory purposes, going forward would be required by regulation. One test, referred to as the liquidity coverage ratio (“LCR”), is designed to ensure that the banking entity maintains an adequate level of unencumbered high-quality liquid assets equal to the entity’s expected net cash outflow for a 30-day time horizon (or, if greater, 25% of its expected total cash outflow) under an acute liquidity stress scenario. The other test, referred to as the net stable funding ratio (“NSFR”), is designed to promote more medium- and long-term funding of the assets and activities of banking entities over a one-year time horizon.

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In September 2014, the federal bank regulators approved final rules implementing the LCR for advanced approaches banking organizations (i.e., banking organizations with $250 billion or more in total consolidated assets or $10 billion or more in total on-balance sheet foreign exposure) and a modified version of the LCR for bank holding companies with at least $50 billion in total consolidated assets that are not advanced approach banking organizations, neither of which would apply to Cullen/Frost or Frost Bank. In the second quarter of 2016, the federal banking regulators issued a proposed rule that would implement the NSFR for certain U.S. banking organizations to ensure they have access to stable funding over a one-year time horizon. The proposed rule would not apply to U.S. banking organizations with less than $50 billion in total consolidated assets such as Cullen/Frost and Frost Bank.
Prompt Corrective Action
The Federal Deposit Insurance Act, as amended (“FDIA”), requires among other things, the federal banking agencies to take “prompt corrective action” in respect of depository institutions that do not meet minimum capital requirements. The FDIA includes the following five capital tiers: “well capitalized,” “adequately capitalized,” “undercapitalized,” “significantly undercapitalized” and “critically undercapitalized.” A depository institution’s capital tier will depend upon how its capital levels compare with various relevant capital measures and certain other factors, as established by regulation. The relevant capital measures, which reflect changes under the Basel III Capital Rules that became effective on January 1, 2015, are the total capital ratio, the CET1 capital ratio, the Tier 1 capital ratio and the leverage ratio.
A bank will be (i) “well capitalized” if the institution has a total risk-based capital ratio of 10.0% or greater, a CET1 capital ratio of 6.5% or greater, a Tier 1 risk-based capital ratio of 8.0% or greater, and a leverage ratio of 5.0% or greater, and is not subject to any order or written directive by any such regulatory authority to meet and maintain a specific capital level for any capital measure; (ii) “adequately capitalized” if the institution has a total risk-based capital ratio of 8.0% or greater, a CET1 capital ratio of 4.5% or greater, a Tier 1 risk-based capital ratio of 6.0% or greater, and a leverage ratio of 4.0% or greater and is not “well capitalized”; (iii) “undercapitalized” if the institution has a total risk-based capital ratio that is less than 8.0%, a CET1 capital ratio less than 4.5%, a Tier 1 risk-based capital ratio of less than 6.0% or a leverage ratio of less than 4.0%; (iv) “significantly undercapitalized” if the institution has a total risk-based capital ratio of less than 6.0%, a CET1 capital ratio less than 3.0%, a Tier 1 risk-based capital ratio of less than 4.0% or a leverage ratio of less than 3.0%; and (v) “critically undercapitalized” if the institution’s tangible equity is equal to or less than 2.0% of average quarterly tangible assets. An institution may be downgraded to, or deemed to be in, a capital category that is lower than indicated by its capital ratios if it is determined to be in an unsafe or unsound condition or if it receives an unsatisfactory examination rating with respect to certain matters. A bank’s capital category is determined solely for the purpose of applying prompt corrective action regulations, and the capital category may not constitute an accurate representation of the bank’s overall financial condition or prospects for other purposes.
In addition, the FDIA prohibits an insured depository institution from accepting brokered deposits or offering interest rates on any deposits significantly higher than the prevailing rate in the bank’s normal market area or nationally (depending upon where the deposits are solicited), unless it is well capitalized or is adequately capitalized and receives a waiver from the FDIC. A depository institution that is adequately capitalized and accepts brokered deposits under a waiver from the FDIC may not pay an interest rate on any deposit in excess of 75 basis points over certain prevailing market rates.
The FDIA generally prohibits a depository institution from making any capital distributions (including payment of a dividend) or paying any management fee to its parent 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 bank holding company must also provide appropriate assurances of performance. The aggregate liability of the parent holding company is limited to the lesser of (i) an amount equal to 5.0% 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.”

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“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,” 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.
The appropriate federal banking agency may, under certain circumstances, reclassify a well capitalized insured depository institution as adequately capitalized. The FDIA provides that an institution may be reclassified if the appropriate federal banking agency determines (after notice and opportunity for hearing) that the institution is in an unsafe or unsound condition or deems the institution to be engaging in an unsafe or unsound practice.
The appropriate agency is also permitted to require an adequately capitalized or undercapitalized institution to comply with the supervisory provisions as if the institution were in the next lower category (but not treat a significantly undercapitalized institution as critically undercapitalized) based on supervisory information other than the capital levels of the institution.
Cullen/Frost believes that, as of December 31, 2017, its bank subsidiary, Frost Bank, was “well capitalized” based on the aforementioned ratios. For further information regarding the capital ratios and leverage ratio of Cullen/Frost and Frost Bank see the discussion under the section captioned “Capital and Liquidity” included in Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations and Note 9 - Capital and Regulatory Matters in the notes to consolidated financial statements included in Item 8. Financial Statements and Supplementary Data, elsewhere in this report.
Safety and Soundness Standards
The FDIA requires the federal bank regulatory agencies to prescribe standards, by regulations or guidelines, relating to internal controls, information systems and internal audit systems, loan documentation, credit underwriting, interest rate risk exposure, asset growth, asset quality, earnings, stock valuation and compensation, fees and benefits, and such other operational and managerial standards as the agencies deem appropriate. Guidelines adopted by the federal bank regulatory agencies establish general standards relating to internal controls and information systems, internal audit systems, loan documentation, credit underwriting, interest rate exposure, asset growth and compensation, fees and benefits. In general, the guidelines require, among other things, appropriate systems and practices to identify and manage the risk and exposures specified in the guidelines. The guidelines prohibit excessive compensation as an unsafe and unsound practice and describe compensation as excessive when the amounts paid are unreasonable or disproportionate to the services performed by an executive officer, employee, director or principal stockholder. In addition, the agencies adopted regulations that authorize, but do not require, an agency to order an institution that has been given notice by an agency that it is not satisfying any of such safety and soundness standards to submit a compliance plan. If, after being so notified, an institution fails to submit an acceptable compliance plan or fails in any material respect to implement an acceptable compliance plan, the agency must issue an order directing action to correct the deficiency and may issue an order directing other actions of the types to which an undercapitalized institution is subject under the “prompt corrective action” provisions of the FDIA. See “Prompt Corrective Action” above. If an institution fails to comply with such an order, the agency may seek to enforce such order in judicial proceedings and to impose civil money penalties.
Deposit Insurance
Substantially all of the deposits of Frost Bank are insured up to applicable limits by the Deposit Insurance Fund (“DIF”) of the FDIC and Frost Bank is subject to deposit insurance assessments to maintain the DIF. Deposit insurance assessments are based on average total assets minus average tangible equity. For larger institutions, such as Frost Bank, the FDIC uses a performance score and a loss-severity score that are used to calculate an initial assessment rate. In calculating these scores, the FDIC uses a bank’s capital level and supervisory ratings (its “CAMELS ratings”) and certain financial measures to assess an institution’s ability to withstand asset-related stress and funding-related stress. The FDIC has the ability to make discretionary adjustments to the total score based upon significant risk factors that are not adequately captured in the calculations.
In October 2010, the FDIC adopted a new DIF restoration plan to ensure that the fund reserve ratio reaches 1.35% by September 30, 2020, as required by the Dodd-Frank Act. In August 2016, the FDIC announced that the DIF reserve ratio had surpassed 1.15% as of June 30, 2016. As a result, beginning in the third quarter of 2016, the range of initial assessment ranges for all institutions were adjusted downward such that the initial base deposit insurance assessment rate ranges from 3 to 30 basis points on an annualized basis. After the effect of potential base-rate adjustments, the total base assessment rate could range from 1.5 to 40 basis points on an annualized basis. In March 2016, the FDIC adopted

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a final rule increasing the reserve ratio for the DIF to 1.35% of total insured deposits. The rule imposes a surcharge on the assessments of depository institutions with $10 billion or more in assets, including Frost Bank, beginning in the third quarter of 2016 and continuing through the earlier of the quarter that the reserve ratio first reaches or exceeds 1.35% and December 31, 2018. This surcharge resulted in increased costs for Frost Bank in 2016 and 2017. Under the rule, if the reserve ratio does not reach 1.35% by December 31, 2018, the FDIC will impose a shortfall assessment on larger depository institutions, including Frost Bank.
FDIC deposit insurance expense totaled $20.1 million, $17.4 million and $14.5 million in 2017, 2016 and 2015, respectively. FDIC deposit insurance expense includes deposit insurance assessments and Financing Corporation (“FICO”) assessments related to outstanding FICO bonds. The FICO is a mixed-ownership government corporation established by the Competitive Equality Banking Act of 1987 whose sole purpose was to function as a financing vehicle for the now defunct Federal Savings & Loan Insurance Corporation.
Under the FDIA, the FDIC may terminate deposit insurance upon a finding that the institution has engaged in unsafe and unsound practices, is in an unsafe or unsound condition to continue operations, or has violated any applicable law, regulation, rule, order or condition imposed by the FDIC.
Enhanced Prudential Standards
The Dodd-Frank Act directed the Federal Reserve Board to monitor emerging risks to financial stability and enact enhanced supervision and prudential standards applicable to bank holding companies with total consolidated assets of $50 billion or more and non-bank covered companies designated as systemically important by the Financial Stability Oversight Council (often referred to as systemically important financial institutions). The Dodd-Frank Act mandates that certain regulatory requirements applicable to systemically important financial institutions be more stringent than those applicable to other financial institutions.
In February 2014, the Federal Reserve adopted rules to implement certain of these enhanced prudential standards. Beginning in 2015, the rules require publicly traded bank holding companies with $10 billion or more in total consolidated assets to establish risk committees and require bank holding companies with $50 billion or more in total consolidated assets to comply with enhanced liquidity and overall risk management standards. Cullen/Frost has established a risk committee and is in compliance with this requirement.
We are monitoring developments with respect to the enhanced prudential standards because of their application to us if our total consolidated assets reach $50 billion or more.
The Volcker Rule
The so-called Volcker Rule under the Dodd-Frank Act prohibits banks and their affiliates from engaging in proprietary trading and investing in and sponsoring hedge funds and private equity funds. The Volcker Rule, which became effective in July 2015, does not significantly impact the operations of Cullen/Frost and its subsidiaries, as we do not have any significant engagement in the businesses prohibited by the Volcker Rule.
Depositor Preference
The FDIA provides that, in the event of the “liquidation or other resolution” of an insured depository institution, the claims of depositors of the institution, including the claims of the FDIC as subrogee of insured depositors, and certain claims for administrative expenses of the FDIC as a receiver, will have priority over other general unsecured claims against the institution. If an insured depository institution fails, insured and uninsured depositors, along with the FDIC, will have priority in payment ahead of unsecured, non-deposit creditors, including depositors whose deposits are payable only outside of the United States and the parent bank holding company, with respect to any extensions of credit they have made to such insured depository institution.
Interchange Fees
Under the Durbin Amendment to the Dodd-Frank Act, the Federal Reserve adopted rules establishing standards for assessing whether the interchange fees that may be charged with respect to certain electronic debit transactions are “reasonable and proportional” to the costs incurred by issuers for processing such transactions.
Interchange fees, or “swipe” fees, are charges that merchants pay to us and other card-issuing banks for processing electronic payment transactions. Federal Reserve Board rules applicable to financial institutions that have assets of

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$10 billion or more provide that the maximum permissible interchange fee for an electronic debit transaction is the sum of 21 cents per transaction and 5 basis points multiplied by the value of the transaction. An upward adjustment of no more than 1 cent to an issuer's debit card interchange fee is allowed if the card issuer develops and implements policies and procedures reasonably designed to achieve certain fraud-prevention standards. The Federal Reserve Board also has rules governing routing and exclusivity that require issuers to offer two unaffiliated networks for routing transactions on each debit or prepaid product.
Consumer Financial Protection
We are subject to a number of federal and state consumer protection laws that extensively govern our relationship with our customers. These laws include the Equal Credit Opportunity Act, the Fair Credit Reporting Act, the Truth in Lending Act, the Truth in Savings Act, the Electronic Fund Transfer Act, the Expedited Funds Availability Act, the Home Mortgage Disclosure Act, the Fair Housing Act, the Real Estate Settlement Procedures Act, the Fair Debt Collection Practices Act, the Service Members Civil Relief Act and these laws’ respective state-law counterparts, as well as state usury laws and laws regarding unfair and deceptive acts and practices. These and other federal laws, among other things, require disclosures of the cost of credit and terms of deposit accounts, provide substantive consumer rights, prohibit discrimination in credit transactions, regulate the use of credit report information, provide financial privacy protections, prohibit unfair, deceptive and abusive practices, restrict our ability to raise interest rates and subject us to substantial regulatory oversight. Violations of applicable consumer protection laws can result in significant potential liability from litigation brought by customers, including actual damages, restitution and attorneys’ fees. Federal bank regulators, state attorneys general and state and local consumer protection agencies may also seek to enforce consumer protection requirements and obtain these and other remedies, including regulatory sanctions, customer rescission rights, action by the state and local attorneys general in each jurisdiction in which we operate and civil money penalties. Failure to comply with consumer protection requirements may also result in our failure to obtain any required bank regulatory approval for merger or acquisition transactions we may wish to pursue or our prohibition from engaging in such transactions even if approval is not required.
The Consumer Financial Protection Bureau (“CFPB”) is a federal agency responsible for implementing, examining and enforcing compliance with federal consumer protection laws. The CFPB has broad rulemaking authority for a wide range of consumer financial laws that apply to all banks, including, among other things, the authority to prohibit “unfair, deceptive or abusive” acts and practices. Abusive acts or practices are defined as those that materially interfere with a consumer’s ability to understand a term or condition of a consumer financial product or service or take unreasonable advantage of a consumer’s (i) lack of financial savvy, (ii) inability to protect himself in the selection or use of consumer financial products or services, or (iii) reasonable reliance on a covered entity to act in the consumer’s interests. The CFPB can issue cease-and-desist orders against banks and other entities that violate consumer financial laws. The CFPB may also institute a civil action against an entity in violation of federal consumer financial law in order to impose a civil penalty or injunction. The CFPB has examination and enforcement authority over all banks with more than $10 billion in assets, as well as their affiliates.
Banking regulators take into account compliance with consumer protection laws when considering approval of a proposed transaction.
Community Reinvestment Act
The Community Reinvestment Act of 1977 (“CRA”) requires depository institutions to assist in meeting the credit needs of their market areas consistent with safe and sound banking practice. Under the CRA, each depository institution is required to help meet the credit needs of its market areas by, among other things, providing credit to low- and moderate-income individuals and communities. Depository institutions are periodically examined for compliance with the CRA and are assigned ratings. In order for a financial holding company to commence any new activity permitted by the BHC Act, or to acquire any company engaged in any new activity permitted by the BHC Act, each insured depository institution subsidiary of the financial holding company must have received a rating of at least “satisfactory” in its most recent examination under the CRA. Furthermore, banking regulators take into account CRA ratings when considering a request for an approval of a proposed transaction. Frost Bank received a rating of “satisfactory” in its most recent CRA examination in 2015.

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Financial Privacy
The federal banking regulators adopted rules that limit the ability of banks and other financial institutions to disclose non-public information about consumers to nonaffiliated third parties. These limitations require disclosure of privacy policies to consumers and, in some circumstances, allow consumers to prevent disclosure of certain personal information to a nonaffiliated third party. These regulations affect how consumer information is transmitted through diversified financial companies and conveyed to outside vendors.
Anti-Money Laundering and the USA Patriot Act
A major focus of governmental policy on financial institutions in recent years has been aimed at combating money laundering and terrorist financing. The USA PATRIOT Act of 2001, or the USA Patriot Act, substantially broadened the scope of United States anti-money laundering laws and regulations by imposing significant new compliance and due diligence obligations, creating new crimes and penalties and expanding the extra-territorial jurisdiction of the United States. Financial institutions are also prohibited from entering into specified financial transactions and account relationships and must use enhanced due diligence procedures in their dealings with certain types of high-risk customers and implement a written customer identification program. Financial institutions must take certain steps to assist government agencies in detecting and preventing money laundering and report certain types of suspicious transactions. Regulatory authorities routinely examine financial institutions for compliance with these obligations, and failure of a financial institution to maintain and implement adequate programs to combat money laundering and terrorist financing, or to comply with all of the relevant laws or regulations, could have serious legal and reputational consequences for the institution, including causing applicable bank regulatory authorities not to approve merger or acquisition transactions when regulatory approval is required or to prohibit such transactions even if approval is not required. Regulatory authorities have imposed cease and desist orders and civil money penalties against institutions found to be violating these obligations.
Office of Foreign Assets Control Regulation
The U.S. Treasury Department’s Office of Foreign Assets Control, or OFAC, administers and enforces economic and trade sanctions against targeted foreign countries and regimes, under authority of various laws, including designated foreign countries, nationals and others. OFAC publishes lists of specially designated targets and countries. We are responsible for, among other things, blocking accounts of, and transactions with, such targets and countries, prohibiting unlicensed trade and financial transactions with them and reporting blocked transactions after their occurrence. Failure to comply with these sanctions could have serious legal and reputational consequences, including causing applicable bank regulatory authorities not to approve merger or acquisition transactions when regulatory approval is required or to prohibit such transactions even if approval is not required. Regulatory authorities have imposed cease and desist orders and civil money penalties against institutions found to be violating these obligations.
Incentive Compensation
The Federal Reserve Board reviews, as part of its regular, risk-focused examination process, the incentive compensation arrangements of banking organizations, such as Cullen/Frost, that are not “large, complex banking organizations.” These reviews are tailored to each organization based on the scope and complexity of the organization’s activities and the prevalence of incentive compensation arrangements. The findings of this supervisory initiative will be included in reports of examination. Deficiencies will be incorporated into the organization’s supervisory ratings, which can affect the organization’s ability to make acquisitions and take other actions. Enforcement actions may be taken against a banking organization if its incentive compensation arrangements, or related risk-management control or governance processes, pose a risk to the organization’s safety and soundness and the organization is not taking prompt and effective measures to correct the deficiencies.
In June 2010, the Federal Reserve Board, OCC and FDIC issued comprehensive final guidance on incentive compensation policies intended to ensure that the incentive compensation policies of banking organizations do not undermine the safety and soundness of such organizations by encouraging excessive risk-taking. The guidance, which covers all employees that have the ability to materially affect the risk profile of an organization, either individually or as part of a group, is based upon the key principles that a banking organization’s incentive compensation arrangements should (i) provide incentives that do not encourage risk-taking beyond the organization’s ability to effectively identify and manage risks, (ii) be compatible with effective internal controls and risk management, and (iii) be supported by strong corporate governance, including active and effective oversight by the organization’s board of directors.

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During the second quarter of 2016, the U.S. financial regulators, including the Federal Reserve Board and the SEC, proposed revised rules on incentive-based payment arrangements at specified regulated entities having at least $1 billion in total assets (including Cullen/Frost and Frost Bank). The proposed revised rules would establish general qualitative requirements applicable to all covered entities, which would include (i) prohibiting incentive arrangements that encourage inappropriate risks by providing excessive compensation; (ii) prohibiting incentive arrangements that encourage inappropriate risks that could lead to a material financial loss; (iii) establishing requirements for performance measures to appropriately balance risk and reward; (iv) requiring board of director oversight of incentive arrangements; and (v) mandating appropriate record-keeping. Under the proposed rule, larger financial institutions with total consolidated assets of at least $50 billion would also be subject to additional requirements applicable to such institutions’ “senior executive officers” and “significant risk-takers.” These additional requirements would not be applicable to Cullen/Frost or Frost Bank, each of which currently have less than $50 billion in total consolidated assets.
Cybersecurity
In March 2015, federal regulators issued two related statements regarding cybersecurity. One statement indicates that financial institutions should design multiple layers of security controls to establish lines of defense and to ensure that their risk management processes also address the risk posed by compromised customer credentials, including security measures to reliably authenticate customers accessing internet-based services of the financial institution. The other statement indicates that a financial institution’s management is expected to maintain sufficient business continuity planning processes to ensure the rapid recovery, resumption and maintenance of the institution’s operations after a cyber-attack involving destructive malware. A financial institution is also expected to develop appropriate processes to enable recovery of data and business operations and address rebuilding network capabilities and restoring data if the institution or its critical service providers fall victim to this type of cyber-attack. If we fail to observe the regulatory guidance, we could be subject to various regulatory sanctions, including financial penalties.
In the ordinary course of business, we rely on electronic communications and information systems to conduct our operations and to store sensitive data. We employ an in-depth, layered, defensive approach that leverages people, processes and technology to manage and maintain cybersecurity controls. We employ a variety of preventative and detective tools to monitor, block, and provide alerts regarding suspicious activity, as well as to report on any suspected advanced persistent threats. Notwithstanding the strength of our defensive measures, the threat from cyber attacks is severe, attacks are sophisticated and increasing in volume, and attackers respond rapidly to changes in defensive measures. While to date, we have not detected a significant compromise, significant data loss or any material financial losses related to cybersecurity attacks, our systems and those of our customers and third-party service providers are under constant threat and it is possible that we could experience a significant event in the future. Risks and exposures related to cybersecurity attacks are expected to remain high for the foreseeable future due to the rapidly evolving nature and sophistication of these threats, as well as due to the expanding use of Internet banking, mobile banking and other technology-based products and services by us and our customers. See Item 1A. Risk Factors for a further discussion of risks related to cybersecurity.
Future Legislation and Regulation
Congress may enact legislation from time to time that affects the regulation of the financial services industry, and state legislatures may enact legislation from time to time affecting the regulation of financial institutions chartered by or operating in those states. Federal and state regulatory agencies also periodically propose and adopt changes to their regulations or change the manner in which existing regulations are applied. The substance or impact of pending or future legislation or regulation, or the application thereof, cannot be predicted, although any change could impact the regulatory structure under which we or our competitors operate and may significantly increase costs, impede the efficiency of internal business processes, require an increase in regulatory capital, require modifications to our business strategy, and limit our ability to pursue business opportunities in an efficient manner. It could also affect our competitors differently than us, including in a manner that would make them more competitive. A change in statutes, regulations or regulatory policies applicable to Cullen/Frost or any of its subsidiaries could have a material, adverse effect on our business, financial condition and results of operations.
Employees
At December 31, 2017, we employed 4,270 full-time equivalent employees. None of our employees are represented by collective bargaining agreements. We believe our employee relations to be good.

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Executive Officers of the Registrant
The names, ages as of December 31, 2017, recent business experience and positions or offices held by each of the executive officers of Cullen/Frost are as follows:
Name and Position Held
Age
Recent Business Experience
 
 
 
Phillip D. Green
  Chairman of the Board, Chief Executive
  Officer and Director of Cullen/Frost
63
Officer of Frost Bank since July 1980. Group Executive Vice President, Chief Financial Officer of Cullen/Frost from October 1995 to January 2015. President of Cullen/Frost from January 2015 to March 2016. Chairman of the Board and Chief Executive Officer of Cullen/Frost from April 2016 to present.
Patrick B. Frost
  Director of Cullen/Frost, President of
  Frost Bank, Group Executive Vice
  President, Frost Wealth Advisors of Frost
  Bank and President of Frost Insurance
57
Officer of Frost Bank since 1985. President of Frost Bank from August 1993 to present. Director of Cullen/Frost from May 1997 to present. Group Executive Vice President, Frost Wealth Advisors of Frost Bank from April 2016 to present. President of Frost Insurance from October 2014 to present.
Jerry Salinas
  Group Executive Vice President, Chief
  Financial Officer of Cullen/Frost
59
Officer of Frost Bank since March 1986. Senior Executive Vice President, Treasurer of Cullen/Frost from 1997 to January 2015. Group Executive Vice President, Chief Financial Officer of Cullen/Frost from January 2015 to present.
Annette Alonzo
Group Executive Vice President, Chief
Human Resources Officer of Frost Bank
49
Officer of Frost Bank since 1993. Executive Vice President, Human Resources of Frost Bank from July 2006 to January 2015. Senior Executive Vice President, Human Resources of Frost Bank from January 2015 to July 2015. Group Executive Vice President, Human Resources of Frost Bank from July 2015 to March 2016. Group Executive Vice President, Chief Human Resources Officer of Frost Bank from April 2016 to present.
Robert A. Berman
  Group Executive Vice President,
  Research and Strategy of Frost Bank
55
Officer of Frost Bank since January 1989. Group Executive Vice President, Research and Strategy of Frost Bank from May 2001 to present.
Paul H. Bracher
  President of Cullen/Frost and Group
  Executive Vice President, Chief
  Banking Officer of Frost Bank
61
Officer of Frost Bank since January 1982. President, State Regions of Frost Bank from February 2001 to January 2015. Group Executive Vice President, Chief Banking Officer of Frost Bank from January 2015 to present. President of Cullen/Frost from April 2016 to present.
Gary McKnight
  Group Executive Vice President,
  Technology and Operations of Frost Bank
64
Officer of Frost Bank since 1981. Senior Executive Vice President, Technology and Operations of Frost Bank from January 2005 to July 2015. Group Executive Vice President, Technology and Operations of Frost Bank from July 2015 to present.
William L. Perotti
  Group Executive Vice President, Chief
  Risk Officer of Frost Bank
60
Officer of Frost Bank since December 1982. Group Executive Vice President, Chief Credit Officer of Frost Bank from May 2001 to January 2015. Group Executive Vice President, Chief Risk Officer of Frost Bank from April 2005 to present.
Mike Russell
  Group Executive Vice President, Chief
  Operations Officer
61
Officer of Frost Bank since December 2017. Group Executive Vice President, Chief Operations Officer since January 2018. Prior to joining Frost, Mr. Russell was a management consultant and former corporate technology executive.
Jimmy Stead
  Group Executive Vice President,
  Executive Officer - Consumer Banking
  of Frost Bank
42
Officer of Frost Bank since July 2001. Senior Vice President Electronic Commerce Operations of Frost Bank from October 2007 to December 2015, Executive Vice President, Electronic Commerce Operations of Frost Bank from January 2016 to January 2017. Group Executive Vice President, Chief Consumer Banking Officer of Frost Bank from January 2017 to present.
Candace Wolfshohl
  Group Executive Vice President, Culture
  and People Development of Frost Bank
57
Officer of Frost Bank since 1989. Executive Vice President, Staff Development of Frost Bank from January 2008 to January 2015. Senior Executive Vice President, Staff Development of Frost Bank from January 2015 to July 2015. Group Executive Vice President, Culture and People Development of Frost Bank from July 2015 to present.
There are no arrangements or understandings between any executive officer of Cullen/Frost and any other person pursuant to which such executive officer was or is to be selected as an officer.

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Available Information
Under the Securities Exchange Act of 1934, we are required to file annual, quarterly and current reports, proxy statements and other information with the Securities and Exchange Commission (“SEC”). You may read and copy any document we file with the SEC at the SEC’s Public Reference Room at 100 F Street, N.E., Washington, D.C. 20549. Please call the SEC at 1-800-SEC-0330 for further information about the public reference room. The SEC maintains a website at http://www.sec.gov that contains reports, proxy and information statements, and other information regarding issuers that file electronically with the SEC. We file electronically with the SEC.
We make available, free of charge through our website, our reports on Forms 10-K, 10-Q and 8-K, and amendments to those reports, as soon as reasonably practicable after such reports are filed with or furnished to the SEC. Additionally, we have adopted and posted on our website a code of ethics that applies to our principal executive officer, principal financial officer and principal accounting officer. Our website also includes our corporate governance guidelines and the charters for our audit committee, our compensation and benefits committee, our risk committee, and our corporate governance and nominating committee. The address for our website is http://www.frostbank.com. We will provide a printed copy of any of the aforementioned documents to any requesting shareholder.
ITEM 1A. RISK FACTORS
An investment in our common stock is subject to risks inherent to our business. The material risks and uncertainties that management believes affect us are described below. Before making an investment decision, you should carefully consider the risks and uncertainties described below together with all of the other information included or incorporated by reference in this report. The risks and uncertainties described below are not the only ones facing us. Additional risks and uncertainties that management is not aware of or focused on or that management currently deems immaterial may also impair our business operations. This report is qualified in its entirety by these risk factors.
If any of the following risks actually occur, our business, financial condition and results of operations could be materially and adversely affected. If this were to happen, the market price of our common stock could decline significantly, and you could lose all or part of your investment.
Risks Related To Our Business
Our Business May Be Adversely Affected By Conditions In The Financial Markets and Economic and Political Conditions Generally
Our success depends, to a certain extent, upon local, national and global economic and political conditions, as well as governmental monetary policies. Our financial performance generally, and in particular the ability of borrowers to pay interest on and repay principal of outstanding loans and the value of collateral securing those loans, as well as demand for loans and other products and services we offer, is highly dependent upon the business environment in the markets where we operate, in the State of Texas and in the United States as a whole. A favorable business environment is generally characterized by, among other factors, economic growth, efficient capital markets, low inflation, low unemployment, high business and investor confidence, and strong business earnings. Unfavorable or uncertain economic and market conditions can be caused by declines in economic growth, business activity or investor or business confidence; limitations on the availability or increases in the cost of credit and capital; increases in inflation or interest rates; high unemployment, natural disasters; or a combination of these or other factors. In recent years, economic growth and business activity across a wide range of industries and regions in the U.S. has been slow and uneven. In addition, oil price volatility, the level of U.S. debt and global economic conditions have had a destabilizing effect on financial markets. While economic conditions in the State of Texas, the United States and worldwide have improved, there can be no assurance that this improvement will continue. Economic pressure on consumers and uncertainty regarding continuing economic improvement may result in changes in consumer and business spending, borrowing and savings habits. Such conditions, as well as further oil price volatility, could have a material adverse effect on the credit quality of our loans and our business, financial condition and results of operations.

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We Are Subject To Lending Risk and Lending Concentration Risk
There are inherent risks associated with our lending activities. These risks include, among other things, the impact of changes in interest rates and changes in the economic conditions in the markets where we operate as well as those across the State of Texas and the United States. Increases in interest rates and/or weakening economic conditions could adversely impact the ability of borrowers to repay outstanding loans or the value of the collateral securing these loans. We are also subject to various laws and regulations that affect our lending activities. Failure to comply with applicable laws and regulations could subject us to regulatory enforcement action that could result in the assessment of significant civil money penalties against us.
As of December 31, 2017, approximately 88.1% of our loan portfolio consisted of commercial and industrial, energy, construction and commercial real estate mortgage loans. These types of loans are generally viewed as having more risk of default and are typically larger than residential real estate loans or consumer loans. Because our loan portfolio contains a significant number of commercial and industrial, energy, construction and commercial real estate loans with relatively large balances, the deterioration of one or a few of these loans could cause a significant increase in non-performing loans. An increase in non-performing loans could result in a net loss of earnings from these loans, an increase in the provision for loan losses and an increase in loan charge-offs, all of which could have a material adverse effect on our business, financial condition and results of operations.
See the section captioned “Loans” in Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations located elsewhere in this report for further discussion related to commercial and industrial, energy, construction and commercial real estate loans.
We Are Subject To Interest Rate Risk
Our earnings and cash flows are largely dependent upon our net interest income. Net interest income is the difference between interest income earned on interest-earning assets such as loans and securities and interest expense paid on interest-bearing liabilities such as deposits and borrowed funds. Interest rates are highly sensitive to many factors that are beyond our control, including general economic conditions and policies of various governmental and regulatory agencies and, in particular, the Federal Open Market Committee. Changes in monetary policy, including changes in interest rates, could influence not only the interest we receive on loans and securities and the amount of interest we pay on deposits and borrowings, but such changes could also affect (i) our ability to originate loans and obtain deposits, (ii) the fair value of our financial assets and liabilities, and (iii) the average duration of our mortgage-backed securities portfolio. If the interest rates paid on deposits and other borrowings increase at a faster rate than the interest rates received on loans and other investments, our net interest income, and therefore earnings, could be adversely affected. Earnings could also be adversely affected if the interest rates received on loans and other investments fall more quickly than the interest rates paid on deposits and other borrowings. Any substantial, unexpected, prolonged change in market interest rates could have a material adverse effect on our business, financial condition and results of operations.
See Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations under the section captioned “Net Interest Income” and Item 7A. Quantitative and Qualitative Disclosures About Market Risk located elsewhere in this report for further discussion related to interest rate sensitivity and our management of interest rate risk.
Our Allowance For Loan Losses May Be Insufficient
We maintain an allowance for loan losses, which is a reserve established through a provision for loan losses charged to expense, which represents management’s best estimate of inherent losses that have been incurred within the existing portfolio of loans. The allowance, in the judgment of management, is necessary to reserve for estimated loan losses and risks inherent in the loan portfolio. The level of the allowance reflects management’s continuing evaluation 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 determination of the appropriate level of the allowance for loan losses inherently involves a high degree of subjectivity and requires us to make significant estimates of current credit risks and future trends, all of which may undergo material changes. Continuing deterioration in economic conditions affecting borrowers, new information regarding existing loans, identification of additional problem loans and other factors, both within and outside of our control, may require an increase in the allowance for loan losses. In addition, bank regulatory agencies periodically review our allowance for loan losses and may require an increase in the provision for loan losses or the recognition of further loan charge-offs, based on judgments different than those of management. Furthermore, if charge-offs in future periods exceed the

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allowance for loan losses, we will need additional provisions to increase the allowance for loan losses. Any increases in the allowance for loan losses will result in a decrease in net income and, possibly, capital, and may have a material adverse effect on our business, financial condition and results of operations.
See the section captioned “Allowance for Loan Losses” in Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations located elsewhere in this report for further discussion related to our process for determining the appropriate level of the allowance for loan losses.
Our Profitability Depends Significantly On Economic Conditions In The State Of Texas
Our success depends primarily on the general economic conditions of the State of Texas and the specific local markets in which we operate. Unlike larger national or other regional banks that are more geographically diversified, we provide banking and financial services to customers across Texas through financial centers in the Austin, Corpus Christi, Dallas, Fort Worth, Houston, Permian Basin, Rio Grande Valley and San Antonio regions. The local economic conditions in these areas have a significant impact on the demand for our products and services as well as the ability of our customers to repay loans, the value of the collateral securing loans and the stability of our deposit funding sources. Moreover, approximately 98.2% of the securities in our municipal bond portfolio were issued by political subdivisions or agencies within the State of Texas. A significant decline in general economic conditions in Texas, whether caused by recession, inflation, unemployment, changes in oil prices, changes in securities markets, acts of terrorism, outbreak of hostilities or other international or domestic occurrences or other factors could impact these local economic conditions and, in turn, have a material adverse effect on our business, financial condition and results of operations.
We May Be Adversely Affected By Volatility in Crude Oil Prices
As of December 31, 2017, energy loans comprised approximately 11.4% of our loan portfolio. Furthermore, energy production and related industries represent a large part of the economies in some of our primary markets. In recent years, actions by certain members of the Organization of Petroleum Exporting Countries (“OPEC”) impacting crude oil production levels have led to increased global oil supplies which has resulted in significant declines in market oil prices. Decreased market oil prices compressed margins for many U.S. and Texas-based oil producers, particularly those that utilize higher-cost production technologies such as hydraulic fracking and horizontal drilling, as well as oilfield service providers, energy equipment manufacturers and transportation suppliers, among others. The price per barrel of crude oil was approximately $60 at December 31, 2017 up from $54 at December 31, 2016. We have experienced increased losses within our energy portfolio in recent years as a result of oil price volatility, relative to our historical experience. Though oil prices have recovered from recent low-levels, future oil price volatility could have a negative impact on the U.S. economy and, in particular, the economies of energy-dominant states such as Texas and, accordingly, could have a material adverse effect on our business, financial condition and results of operations.
We May Be Adversely Affected By The Soundness Of Other Financial Institutions
Financial services institutions are interrelated as a result of trading, clearing, counterparty, or other relationships. We have exposure to many different industries and counterparties, and routinely execute transactions with counterparties in the financial services industry, including commercial banks, brokers and dealers, investment banks, and other institutional clients. Many of these transactions expose us to credit risk in the event of a default by a counterparty or client. In addition, our credit risk may be exacerbated when the collateral held by us cannot be realized upon or is liquidated at prices not sufficient to recover the full amount of the credit or derivative exposure due to us. Any such losses could have a material adverse effect on our business, financial condition and results of operations.
We Operate In A Highly Competitive Industry and Market Area
We face substantial competition in all areas of our operations from a variety of different competitors, many of which are larger and may have more financial resources. Such competitors primarily include national, regional, and community banks within the various markets where we operate. We also face competition from many other types of financial institutions, including, without limitation, savings and loans, credit unions, finance companies, brokerage firms, insurance companies and other financial intermediaries. The financial services industry could become even more competitive as a result of legislative, regulatory and technological changes and continued consolidation. Also, technology and other changes have lowered barriers to entry and made it possible for non-banks to offer products and services traditionally provided by banks. For example, consumers can maintain funds that would have historically been held as bank deposits in brokerage accounts or mutual funds. Consumers can also complete transactions such as paying bills and/or transferring funds directly without the assistance of banks. The process of eliminating banks as

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intermediaries, known as “disintermediation,” could result in the loss of fee income, as well as the loss of customer deposits and the related income generated from those deposits. Further, many of our competitors have fewer regulatory constraints and may have lower cost structures. Additionally, due to their size, many competitors may be able to achieve economies of scale and, as a result, may offer a broader range of products and services as well as better pricing for those products and services than we can.
Our ability to compete successfully depends on a number of factors, including, among other things:
The ability to develop, maintain and build long-term customer relationships based on top quality service, high ethical standards and safe, sound assets.
The ability to expand our market position.
The scope, relevance and pricing of products and services offered to meet customer needs and demands.
The rate at which we introduce new products and services relative to our competitors.
Customer satisfaction with our level of service.
Industry and general economic trends.
Failure to perform in any of these areas could significantly weaken our competitive position, which could adversely affect our growth and profitability, which, in turn, could have a material adverse effect on our business, financial condition and results of operations.
We Are Subject To Extensive Government Regulation and Supervision and Possible Enforcement and Other Legal Actions
We, primarily through Cullen/Frost, Frost Bank and certain non-bank subsidiaries, are subject to extensive federal and state regulation and supervision, which vests a significant amount of discretion in the various regulatory authorities. Banking regulations are primarily intended to protect depositors’ funds, federal deposit insurance funds and the banking system as a whole, not security holders. These regulations and supervisory guidance affect our lending practices, capital structure, investment practices, dividend policy and growth, among other things. Congress and federal regulatory agencies continually review banking laws, regulations and policies for possible changes. The Dodd-Frank Act, enacted in July 2010, instituted major changes to the banking and financial institutions regulatory regimes. Other changes to statutes, regulations or regulatory policies or supervisory guidance, including changes in interpretation or implementation of statutes, regulations, policies or supervisory guidance, could affect us in substantial and unpredictable ways. Such changes could subject us to additional costs, limit the types of financial services and products we may offer and/or increase the ability of non-banks to offer competing financial services and products, among other things. Failure to comply with laws, regulations, policies or supervisory guidance could result in enforcement and other legal actions by Federal or state authorities, including criminal and civil penalties, the loss of FDIC insurance, the revocation of a banking charter, other sanctions by regulatory agencies, civil money penalties and/or reputational damage. In this regard, government authorities, including the bank regulatory agencies, are pursuing aggressive enforcement actions with respect to compliance and other legal matters involving financial activities, which heightens the risks associated with actual and perceived compliance failures. Any of the foregoing could have a material adverse effect on our business, financial condition and results of operations.
See the sections captioned “Supervision and Regulation” included in Item 1. Business and Note 9 - Capital and Regulatory Matters in the notes to consolidated financial statements included in Item 8. Financial Statements and Supplementary Data, which are located elsewhere in this report.
Our Accounting Estimates and Risk Management Processes Rely On Analytical and Forecasting Models
The processes we use to estimate our inherent loan losses and to measure the fair value of financial instruments, as well as the processes used to estimate the effects of changing interest rates and other market measures on our financial condition and results of operations, depends upon the use of analytical and forecasting models. These models reflect assumptions that may not be accurate, particularly in times of market stress or other unforeseen circumstances. Even if these assumptions are adequate, the models may prove to be inadequate or inaccurate because of other flaws in their design or their implementation. If the models we use for interest rate risk and asset-liability management are inadequate, we may incur increased or unexpected losses upon changes in market interest rates or other market measures. If the models we use for determining our probable loan losses are inadequate, the allowance for loan losses may not be sufficient to support future charge-offs. If the models we use to measure the fair value of financial instruments are inadequate, the fair value of such financial instruments may fluctuate unexpectedly or may not accurately reflect what

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we could realize upon sale or settlement of such financial instruments. Any such failure in our analytical or forecasting models could have a material adverse effect on our business, financial condition and results of operations.
Changes In Accounting Standards Could Materially Impact Our Financial Statements
From time to time accounting standards setters change the financial accounting and reporting standards that govern the preparation of our financial statements. These changes can be difficult to predict and can materially impact how we record and report our financial condition and results of operations. In some cases, we could be required to apply a new or revised standard retroactively, resulting in changes to previously reported financial results or a cumulative charge to retained earnings.
The Repeal Of Federal Prohibitions On Payment Of Interest On Demand Deposits Could Increase Our Interest Expense
All federal prohibitions on the ability of financial institutions to pay interest on demand deposit accounts were repealed as part of the Dodd-Frank Act beginning on July 21, 2011. As a result, some financial institutions have commenced offering interest on demand deposits to compete for customers. We do not yet know what interest rates other institutions may offer as market interest rates increase. Our interest expense will increase and our net interest margin will decrease if we begin offering interest on demand deposits to attract additional customers or maintain current customers, which could have a material adverse effect on our business, financial condition and results of operations.
We May Need To Raise Additional Capital In The Future, and Such Capital May Not Be Available When Needed Or At All
We may need to raise additional capital in the future to provide us with sufficient capital resources and liquidity to meet our commitments and business needs, particularly if our asset quality or earnings were to deteriorate significantly. Our ability to raise additional capital, if needed, will depend on, among other things, conditions in the capital markets at that time, which are outside of our control, and our financial condition. Economic conditions and the loss of confidence in financial institutions may increase our cost of funding and limit access to certain customary sources of capital, including inter-bank borrowings, repurchase agreements and borrowings from the discount window of the Federal Reserve.
We cannot assure that such capital will be available on acceptable terms or at all. Any occurrence that may limit our access to the capital markets, such as a decline in the confidence of debt purchasers, depositors of Frost Bank or counterparties participating in the capital markets, or a downgrade of Cullen/Frost’s or Frost Bank’s debt ratings, may adversely affect our capital costs and our ability to raise capital and, in turn, our liquidity. Moreover, if we need to raise capital in the future, we may have to do so when many other financial institutions are also seeking to raise capital and would have to compete with those institutions for investors. An inability to raise additional capital on acceptable terms when needed could have a materially adverse effect on our business, financial condition and results of operations.
The Value Of Our Goodwill and Other Intangible Assets May Decline In The Future
As of December 31, 2017, we had $660.0 million of goodwill and other intangible assets. A significant decline in our expected future cash flows, a significant adverse change in the business climate, slower growth rates or a significant and sustained decline in the price of Cullen/Frost’s common stock may necessitate taking charges in the future related to the impairment of our goodwill and other intangible assets. If we were to conclude that a future write-down of goodwill and other intangible assets is necessary, we would record the appropriate charge, which could have a material adverse effect on our business, financial condition and results of operations.
Our Controls and Procedures May Fail or Be Circumvented
Our internal controls, disclosure controls and procedures, and corporate governance policies and procedures are based in part on certain assumptions and can provide only reasonable, not absolute, assurances that the objectives of the system are met. Any failure or circumvention of our controls and procedures or failure to comply with regulations related to controls and procedures could have a material adverse effect on our business, financial condition and results of operations.

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New Lines Of Business Or New Products and Services May Subject Us To Additional Risks
From time to time, we may implement new lines of business or offer new products and services within existing lines of business. There are substantial risks and uncertainties associated with these efforts, particularly in instances where the markets are not fully developed. In developing and marketing new lines of business and/or new products and services we may invest significant time and resources. Initial timetables for the introduction and development of new lines of business and/or new products or services may not be achieved and price and profitability targets may not prove feasible. External factors, such as compliance with regulations, competitive alternatives, and shifting market preferences, may also impact the successful implementation of a new line of business or a new product or service. Furthermore, any new line of business and/or new product or service could have a significant impact on the effectiveness of our system of internal controls. Failure to successfully manage these risks in the development and implementation of new lines of business or new products or services could have a material adverse effect on our business, financial condition and results of operations.
Negative Publicity Could Damage Our Reputation And Our Business
Reputation risk, or the risk to our earnings and capital from negative public opinion, is inherent in our business. Negative public opinion could adversely affect our ability to keep and attract customers and expose us to adverse legal and regulatory consequences. Negative public opinion could result from our actual or alleged conduct in any number of activities, including lending practices, corporate governance, regulatory compliance, mergers and acquisitions, and disclosure, sharing or inadequate protection of customer information, and from actions taken by government regulators and community organizations in response to that conduct. Negative public opinion could also result from adverse news or publicity that impairs the reputation of the financial services industry generally. Because we conduct most of our business under the “Frost” brand, negative public opinion about one business could affect our other businesses.
Cullen/Frost Relies On Dividends From Its Subsidiaries For Most Of Its Revenue
Cullen/Frost is a separate and distinct legal entity from its subsidiaries. It receives substantially all of its revenue from dividends from its subsidiaries. These dividends are the principal source of funds to pay dividends on Cullen/Frost’s common stock and preferred stock and interest and principal on Cullen/Frost’s debt. Various federal and state laws and regulations limit the amount of dividends that Frost Bank and certain non-bank subsidiaries may pay to Cullen/Frost. Also, Cullen/Frost’s right to participate in a distribution of assets upon a subsidiary’s liquidation or reorganization is subject to the prior claims of the subsidiary’s creditors. In the event Frost Bank is unable to pay dividends to Cullen/Frost, Cullen/Frost may not be able to service debt, pay obligations or pay dividends on our common stock or our preferred stock. The inability to receive dividends from Frost Bank could have a material adverse effect on our business, financial condition and results of operations.
See the section captioned “Supervision and Regulation” in Item 1. Business and Note 9 - Capital and Regulatory Matters in the notes to consolidated financial statements included in Item 8. Financial Statements and Supplementary Data, which are located elsewhere in this report.
Potential Acquisitions May Disrupt Our Business and Dilute Stockholder Value
We generally seek merger or acquisition partners that are culturally similar and have experienced management and possess either significant market presence or have potential for improved profitability through financial management, economies of scale or expanded services. Acquiring other banks, businesses, or branches involves various risks commonly associated with acquisitions, including, among other things:
Potential exposure to unknown or contingent liabilities of the target company.
Exposure to potential asset quality issues of the target company.
Potential disruption to our business.
Potential diversion of our management’s time and attention.
The possible loss of key employees and customers of the target company.
Difficulty in estimating the value of the target company.
Potential changes in banking or tax laws or regulations that may affect the target company.
Acquisitions typically involve the payment of a premium over book and market values, and, therefore, some dilution of our tangible book value and net income per common share may occur in connection with any future transaction.

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Furthermore, failure to realize the expected revenue increases, cost savings, increases in geographic or product presence, and/or other projected benefits from an acquisition could have a material adverse effect on our business, financial condition and results of operations.
Acquisitions May Be Delayed, Impeded, Or Prohibited Due To Regulatory Issues
Acquisitions by financial institutions, including us, are subject to approval by a variety of federal and state regulatory agencies (collectively, “regulatory approvals”). The process for obtaining these required regulatory approvals has become substantially more difficult in recent years. Regulatory approvals could be delayed, impeded, restrictively conditioned or denied due to existing or new regulatory issues we have, or may have, with regulatory agencies, including, without limitation, issues related to Bank Secrecy Act compliance, Community Reinvestment Act issues, fair lending laws, fair housing laws, consumer protection laws, unfair, deceptive, or abusive acts or practices regulations and other similar laws and regulations. We may fail to pursue, evaluate or complete strategic and competitively significant acquisition opportunities as a result of our inability, or perceived or anticipated inability, to obtain regulatory approvals in a timely manner, under reasonable conditions or at all. Difficulties associated with potential acquisitions that may result from these factors could have a material adverse effect on our business, financial condition and results of operations.
We Are Subject To Liquidity Risk
We require liquidity to meet our deposit and debt obligations as they come due. Our access to funding sources in amounts adequate to finance our activities or on terms that are acceptable to us could be impaired by factors that affect us specifically or the financial services industry or economy generally. Factors that could reduce our access to liquidity sources include a downturn in the Texas economy, difficult credit markets or adverse regulatory actions against us. Our access to deposits may also be affected by the liquidity needs of our depositors. In particular, a substantial majority of our liabilities are demand, savings, interest checking and money market deposits, which are payable on demand or upon several days’ notice, while by comparison, a substantial portion of our assets are loans, which cannot be called or sold in the same time frame. We may not be able to replace maturing deposits and advances as necessary in the future, especially if a large number of our depositors sought to withdraw their accounts, regardless of the reason. A failure to maintain adequate liquidity could have a material adverse effect on our business, financial condition and results of operations.
We May Not Be Able To Attract and Retain Skilled People
Our success depends, in large part, on our ability to attract and retain key people. Competition for the best people in most activities engaged in by us can be intense and we may not be able to hire people or to retain them. We do not currently have employment agreements or non-competition agreements with any of our senior officers. The unexpected loss of services of key personnel could have a material adverse impact on our business, financial condition and results of operations because of their skills, knowledge of our market, years of industry experience and the difficulty of promptly finding qualified replacement personnel. In addition, the scope and content of U.S. banking regulators' policies on incentive compensation, as well as changes to these policies, could adversely affect our ability to hire, retain and motivate our key employees.
Our Information Systems May Experience Failure, Interruption Or Breach In Security
In the ordinary course of business, we rely on electronic communications and information systems to conduct our operations and to store sensitive data. Any failure, interruption or breach in security of these systems could result in significant disruption to our operations. Information security breaches and cybersecurity-related incidents may include, but are not limited to, attempts to access information, including customer and company information, malicious code, computer viruses and denial of service attacks that could result in unauthorized access, misuse, loss or destruction of data (including confidential customer information), account takeovers, unavailability of service or other events. These types of threats may derive from human error, fraud or malice on the part of external or internal parties, or may result from accidental technological failure. Further, to access our products and services our customers may use computers and mobile devices that are beyond our security control systems. Our technologies, systems, networks and software, and those of other financial institutions have been, and are likely to continue to be, the target of cybersecurity threats and attacks, which may range from uncoordinated individual attempts to sophisticated and targeted measures directed at us. The risk of a security breach or disruption, particularly through cyber attack or cyber intrusion, has increased as the number, intensity and sophistication of attempted attacks and intrusions from around the world have increased.

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Our business requires the collection and retention of large volumes of customer data, including personally identifiable information in various information systems that we maintain and in those maintained by third parties with whom we contract to provide data services. We also maintain important internal company data such as personally identifiable information about our employees and information relating to our operations. The integrity and protection of that customer and company data is important to us. Our collection of such customer and company data is subject to extensive regulation and oversight.
Our customers and employees have been, and will continue to be, targeted by parties using fraudulent e-mails and other communications in attempts to misappropriate passwords, bank account information or other personal information or to introduce viruses or other malware through “Trojan horse” programs to our information systems and/or our customers' computers. Though we endeavor to mitigate these threats through product improvements, use of encryption and authentication technology and customer and employee education, such cyber attacks against us or our merchants and our third party service providers remain a serious issue. The pervasiveness of cybersecurity incidents in general and the risks of cyber crime are complex and continue to evolve. More generally, publicized information concerning security and cyber-related problems could inhibit the use or growth of electronic or web-based applications or solutions as a means of conducting commercial transactions.
Although we make significant efforts to maintain the security and integrity of our information systems and have implemented various measures to manage the risk of a security breach or disruption, there can be no assurance that our security efforts and measures will be effective or that attempted security breaches or disruptions would not be successful or damaging. Even the most well protected information, networks, systems and facilities remain potentially vulnerable because attempted security breaches, particularly cyber attacks and intrusions, or disruptions will occur in the future, and because the techniques used in such attempts are constantly evolving and generally are not recognized until launched against a target, and in some cases are designed not to be detected and, in fact, may not be detected. Accordingly, we may be unable to anticipate these techniques or to implement adequate security barriers or other preventative measures, and thus it is virtually impossible for us to entirely mitigate this risk. While we maintain specific “cyber” insurance coverage, which would apply in the event of various breach scenarios, the amount of coverage may not be adequate in any particular case. Furthermore, because cyber threat scenarios are inherently difficult to predict and can take many forms, some breaches may not be covered under our cyber insurance coverage. A security breach or other significant disruption of our information systems or those related to our customers, merchants and our third party vendors, including as a result of cyber attacks, could (i) disrupt the proper functioning of our networks and systems and therefore our operations and/or those of certain of our customers; (ii) result in the unauthorized access to, and destruction, loss, theft, misappropriation or release of confidential, sensitive or otherwise valuable information of ours or our customers; (iii) result in a violation of applicable privacy, data breach and other laws, subjecting us to additional regulatory scrutiny and expose the us to civil litigation, governmental fines and possible financial liability; (iv) require significant management attention and resources to remedy the damages that result; or (v) harm our reputation or cause a decrease in the number of customers that choose to do business with us. The occurrence of any of the foregoing could have a material adverse effect on our business, financial condition and results of operations.
We Continually Encounter Technological Change
The financial services industry is continually undergoing rapid technological change with frequent introductions of new technology-driven products and services. The effective use of technology increases efficiency and enables financial institutions to better serve customers and to reduce costs. Our future success depends, in part, upon our ability to address the needs of our customers by using technology to provide products and services that will satisfy customer demands, as well as to create additional efficiencies in our operations. Many of our competitors have substantially greater resources to invest in technological improvements. We may not be able to effectively implement new technology-driven products and services or be successful in marketing these products and services to our customers. Failure to successfully keep pace with technological change affecting the financial services industry could have a material adverse effect on our business, financial condition and results of operations.

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We Are Subject To Claims and Litigation Pertaining To Fiduciary Responsibility
From time to time, customers make claims and take legal action pertaining to our performance of our fiduciary responsibilities. Whether customer claims and legal action related to our performance of our fiduciary responsibilities are founded or unfounded, if such claims and legal actions are not resolved in a manner favorable to us they may result in significant financial liability and/or adversely affect the market perception of us and our products and services as well as impact customer demand for those products and services. Any financial liability or reputational damage could have a material adverse effect on our business, financial condition and results of operations.
Our Operations Rely On Certain External Vendors
We rely on certain external vendors to provide products and services necessary to maintain our day-to-day operations. These third party vendors are sources of operational and informational security risk to us, including risks associated with operational errors, information system interruptions or breaches and unauthorized disclosures of sensitive or confidential client or customer information. If these vendors encounter any of these issues, or if we have difficulty communicating with them, we could be exposed to disruption of operations, loss of service or connectivity to customers, reputational damage, and litigation risk that could have a material adverse effect on our business and, in turn, our financial condition and results of operations.
In addition, our operations are exposed to risk that these vendors will not perform in accordance with the contracted arrangements under service level agreements. While we have selected these external vendors carefully, we do not control their actions. The failure of an external vendor to perform in accordance with the contracted arrangements under service level agreements, because of changes in the vendor’s organizational structure, financial condition, support for existing products and services or strategic focus or for any other reason, could be disruptive to our operations, which could have a material adverse effect on our business and, in turn, our financial condition and results of operations. Replacing these external vendors could also entail significant delay and expense.
We Are Subject to Claims and Litigation Pertaining to Intellectual Property
Banking and other financial services companies, including us, rely on technology companies to provide information technology products and services necessary to support day-to-day operations. Technology companies frequently enter into litigation based on allegations of patent infringement or other violations of intellectual property rights. In addition, patent holding companies seek to monetize patents they have purchased or otherwise obtained. Competitors of our vendors, or other individuals or companies, have from time to time claimed to hold intellectual property sold to us by our vendors. Such claims may increase in the future as the financial services sector becomes more reliant on information technology vendors. The plaintiffs in these actions frequently seek injunctions and substantial damages.
Regardless of the scope or validity of such patents or other intellectual property rights, or the merits of any claims by potential or actual litigants, we may have to engage in protracted litigation. Such litigation is often expensive, time-consuming, disruptive to our operations and distracting to management. If we are found to infringe upon one or more patents or other intellectual property rights, we may be required to pay substantial damages or royalties to a third-party. In certain cases, we may consider entering into licensing agreements for disputed intellectual property, although no assurance can be given that such licenses can be obtained on acceptable terms or that litigation will not occur. These licenses may also significantly increase our operating expenses. If legal matters related to intellectual property claims were resolved against us or settled, we could be required to make payments in amounts that could have a material adverse effect on our business, financial condition and results of operations.
We Are Subject To Environmental Liability Risk Associated With Lending Activities
A significant portion of our loan portfolio is secured by real property. During the ordinary course of business, we may foreclose on and take title to properties securing certain loans. In doing so, there is a risk that hazardous or toxic substances could be found on these properties. If hazardous or toxic substances are found, we may be liable for remediation costs, as well as for personal injury and property damage. Environmental laws may require us to incur substantial expenses and may materially reduce the affected property’s value or limit our ability to use or sell the affected property. In addition, future laws or more stringent interpretations or enforcement policies with respect to existing laws may increase our exposure to environmental liability. Environmental reviews of real property before initiating foreclosure actions may not be sufficient to detect all potential environmental hazards. The remediation costs and any other financial liabilities associated with an environmental hazard could have a material adverse effect on our business, financial condition and results of operations.

27


Severe Weather, Natural Disasters, Acts Of War Or Terrorism and Other External Events Could Significantly Impact Our Business
Severe weather, natural disasters, acts of war or terrorism and other adverse external events could have a significant impact on our ability to conduct business. In addition, such events could affect the stability of our deposit base, impair the ability of borrowers to repay outstanding loans, impair the value of collateral securing loans, cause significant property damage, result in loss of revenue and/or cause us to incur additional expenses. The occurrence of any such event in the future could have a material adverse effect on our business, which, in turn, could have a material adverse effect on our business, financial condition and results of operations.
Financial Services Companies Depend On The Accuracy and Completeness Of Information About Customers and Counterparties
In deciding whether to extend credit or enter into other transactions, we may rely on information furnished by or on behalf of customers and counterparties, including financial statements, credit reports and other financial information. We may also rely on representations of those customers, counterparties or other third parties, such as independent auditors, as to the accuracy and completeness of that information. Reliance on inaccurate or misleading financial statements, credit reports or other financial information could have a material adverse impact on our business, financial condition and results of operations.
Risks Associated With Our Common Stock
Our Stock Price Can Be Volatile
Stock price volatility may make it more difficult for you to resell your common stock when you want and at prices you find attractive. Our stock price can fluctuate significantly in response to a variety of factors including, among other things:
Actual or anticipated variations in quarterly results of operations.
Recommendations by securities analysts.
Operating and stock price performance of other companies that investors deem comparable to us.
News reports relating to trends, concerns and other issues in the financial services industry.
Perceptions in the marketplace regarding us and/or our competitors.
New technology used, or services offered, by competitors.
Significant acquisitions or business combinations, strategic partnerships, joint ventures or capital commitments by or involving us or our competitors.
Failure to integrate acquisitions or realize anticipated benefits from acquisitions.
Changes in government regulations.
Geopolitical conditions such as acts or threats of terrorism or military conflicts.
General market fluctuations, including real or anticipated changes in the strength of the Texas economy; industry factors and general economic and political conditions and events, such as economic slowdowns or recessions; interest rate changes, oil price volatility or credit loss trends could also cause our stock price to decrease regardless of operating results.
The Trading Volume In Our Common Stock Is Less Than That Of Other Larger Financial Services Companies
Although our common stock is listed for trading on the New York Stock Exchange (NYSE), the trading volume in our common stock is less than that of other, larger financial services companies. A public trading market having the desired characteristics of depth, liquidity and orderliness depends on the presence in the marketplace of willing buyers and sellers of our common stock at any given time. This presence depends on the individual decisions of investors and general economic and market conditions over which we have no control. Given the lower trading volume of our common stock, significant sales of our common stock, or the expectation of these sales, could cause our stock price to fall.

28


Cullen/Frost May Not Continue To Pay Dividends On Its Common Stock In The Future
Holders of Cullen/Frost common stock are only entitled to receive such dividends as its board of directors may declare out of funds legally available for such payments. Although Cullen/Frost has historically declared cash dividends on its common stock, it is not required to do so and may reduce or eliminate its common stock dividend in the future. This could adversely affect the market price of Cullen/Frost’s common stock. Also, Cullen/Frost is a bank holding company, and its ability to declare and pay dividends is dependent on certain federal regulatory considerations, including the guidelines of the Federal Reserve Board regarding capital adequacy and dividends.
As more fully discussed in Note 9 - Capital and Regulatory Matters in the notes to consolidated financial statements included in Item 8. Financial Statements and Supplementary Data, which are located elsewhere in this report, our ability to declare or pay dividends on our common stock may also be subject to certain restrictions in the event that we elect to defer the payment of interest on our junior subordinated deferrable interest debentures or do not declare and pay dividends on our Series A Preferred Stock.
An Investment In Our Common Stock Is Not An Insured Deposit
Our common stock is not a bank deposit and, therefore, is not insured against loss by the Federal Deposit Insurance Corporation (FDIC), any other deposit insurance fund or by any other public or private entity. Investment in our common stock is inherently risky for the reasons described in this “Risk Factors” section and elsewhere in this report and is subject to the same market forces that affect the price of common stock in any company. As a result, if you acquire our common stock, you could lose some or all of your investment.
Certain Banking Laws May Have An Anti-Takeover Effect
Provisions of federal banking laws, including regulatory approval requirements, could make it more difficult for a third party to acquire us, even if doing so would be perceived to be beneficial to our shareholders. These provisions effectively inhibit a non-negotiated merger or other business combination, which, in turn, could adversely affect the market price of our common stock.
ITEM 1B. UNRESOLVED STAFF COMMENTS
None
ITEM 2. PROPERTIES
Our headquarters is located in downtown San Antonio, Texas. These facilities, which we lease, house our executive and primary administrative offices, as well as the principal banking headquarters of Frost Bank. We also own or lease other facilities within our primary market areas in the regions of Austin, Corpus Christi, Dallas, Fort Worth, Houston, Permian Basin, Rio Grande Valley and San Antonio. We consider our properties to be suitable and adequate for our present needs.
ITEM 3. LEGAL PROCEEDINGS
We are subject to various claims and legal actions that have arisen in the course of conducting business. Management does not expect the ultimate disposition of these matters to have a material adverse effect on our business, financial condition and results of operations.
ITEM 4. MINE SAFETY DISCLOSURES
None


29


PART II
ITEM 5. MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES
Common Stock Market Prices and Dividends
Our common stock is traded on the New York Stock Exchange, Inc. (“NYSE”) under the symbol “CFR”. The tables below set forth for each quarter of 2017 and 2016 the high and low intra-day sales prices per share of Cullen/Frost’s common stock and the cash dividends declared per share.
 
2017
 
2016
Sales Price Per Share
High
 
Low
 
High
 
Low
First quarter
$
96.62


$
82.08

 
$
59.59

 
$
42.41

Second quarter
99.20


85.53

 
67.72

 
51.43

Third quarter
98.70


81.09

 
73.80

 
59.00

Fourth quarter
103.37


92.03

 
88.98

 
69.86

Cash Dividends Per Share
2017
 
2016
First quarter
$
0.54

 
$
0.53

Second quarter
0.57

 
0.54

Third quarter
0.57

 
0.54

Fourth quarter
0.57

 
0.54

Total
$
2.25

 
$
2.15

As of December 31, 2017, there were 63,475,586 shares of our common stock outstanding held by 1,220 holders of record. The closing price per share of common stock on December 29, 2017, the last trading day of our fiscal year, was $94.65.
Our management is currently committed to continuing to pay regular cash dividends; however, there can be no assurance as to future dividends because they are dependent on our future earnings, capital requirements and financial condition. See the section captioned “Supervision and Regulation” included in Item 1. Business, the section captioned “Capital and Liquidity” included in Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations and Note 9 - Capital and Regulatory Matters in the notes to consolidated financial statements included in Item 8. Financial Statements and Supplementary Data, all of which are included elsewhere in this report.
Stock-Based Compensation Plans
Information regarding stock-based compensation awards outstanding and available for future grants as of December 31, 2017, segregated between stock-based compensation plans approved by shareholders and stock-based compensation plans not approved by shareholders, is presented in the table below. Additional information regarding stock-based compensation plans is presented in Note 11 - Employee Benefit Plans in the notes to consolidated financial statements included in Item 8. Financial Statements and Supplementary Data located elsewhere in this report.
Plan Category
Number of Shares
to be Issued Upon
Exercise of
Outstanding Awards
 
Weighted-Average
Exercise
Price of
Outstanding
Awards
 
Number of Shares
Available for
Future Grants
Plans approved by shareholders
3,339,499

(1) 
$
63.34

(2) 
1,367,750

Plans not approved by shareholders

 

 

Total
3,339,499

 
63.34

 
1,367,750


(1)
Includes 2,917,142 shares related to stock options, 289,246 shares related to non-vested stock units, 53,008 shares related to director deferred stock units and 80,103 shares related to performance stock units (assuming attainment of the maximum payout rate as set forth by the performance criteria).
(2)
Excludes outstanding stock units which are exercised for no consideration.

30


Stock Repurchase Plans
From time to time, our board of directors has authorized stock repurchase plans. In general, stock repurchase plans allow us to proactively manage our capital position and return excess capital to shareholders. Shares purchased under such plans also provide us with shares of common stock necessary to satisfy obligations related to stock compensation awards. On October 24, 2017, our board of directors authorized a $150.0 million stock repurchase program, allowing us to repurchase shares of our common stock over a two-year period from time to time at various prices in the open market or through private transactions. No shares were repurchased under this plan during 2017. Under prior plans, we repurchased 1,134,966 shares at a total cost of $100.0 million during 2017 and 1,485,493 shares at a total cost of $100.0 million during 2015.
The following table provides information with respect to purchases made by or on behalf of us or any “affiliated purchaser” (as defined in Rule 10b-18(a)(3) under the Securities Exchange Act of 1934), of our common stock during the fourth quarter of 2017.
Period
 
Total Number of
Shares Purchased
 
Average Price
Paid Per Share
 
Total Number of
Shares Purchased
as Part of Publicly
Announced Plans
 
Maximum Number (or Approximate Dollar Value) of Shares That May Yet Be Purchased Under the Plans at 
the End of the Period
October 1, 2017 to October 31, 2017
 
14,120

(1) 
$
101.40

 

 
$
150,000

November 1, 2017 to November 30, 2017
 

 

 

 
150,000

December 1, 2017 to December 31, 2017
 

 

 

 
150,000

Total
 
14,120

 
$

 

 
 
(1)
All of these repurchases were made in connection with the vesting of certain share awards.

31


Performance Graph
The performance graph below compares the cumulative total shareholder return on Cullen/Frost Common Stock with the cumulative total return on the equity securities of companies included in the Standard & Poor’s 500 Stock Index and the Standard and Poor’s 500 Bank Index, measured at the last trading day of each year shown. The graph assumes an investment of $100 on December 31, 2012 and reinvestment of dividends on the date of payment without commissions. The performance graph represents past performance and should not be considered to be an indication of future performance.

chart-48339693efbb58579eca04.jpg


 
 
2012
 
2013
 
2014
 
2015
 
2016
 
2017
Cullen/Frost
$
100.00

 
$
141.26

 
$
137.67

 
$
120.55

 
$
183.24

 
$
201.43

S&P 500
100.00

 
132.39

 
150.51

 
152.59

 
170.84

 
208.14

S&P 500 Banks
100.00

 
135.72

 
156.78

 
158.10

 
196.54

 
240.87


32


ITEM 6. SELECTED FINANCIAL DATA
The following consolidated selected financial data is derived from our audited financial statements as of and for the five years ended December 31, 2017. The following consolidated financial data should be read in conjunction with Management’s Discussion and Analysis of Financial Condition and Results of Operations and the Consolidated Financial Statements and related notes included elsewhere in this report. The operating results of companies acquired during the periods presented are included with our results of operations since their respective dates of acquisition. Dollar amounts, except per share data, and common shares outstanding are in thousands.
 
Year Ended December 31,
 
2017
 
2016
 
2015
 
2014
 
2013
Consolidated Statements of Income
 
 
 
 
 
 
 
 
 
Interest income:
 
 
 
 
 
 
 
 
 
Loans, including fees
$
534,804

 
$
458,094

 
$
433,872

 
$
440,958

 
$
415,230

Securities
315,599

 
313,943

 
307,394

 
249,705

 
219,904

Interest-bearing deposits
41,608

 
16,103

 
8,123

 
10,725

 
7,284

Federal funds sold and resell agreements
936

 
272

 
107

 
83

 
82

Total interest income
892,947

 
788,412

 
749,496

 
701,471

 
642,500

Interest expense:
 
 
 
 
 
 
 
 
 
Deposits
17,188

 
7,248

 
9,024

 
11,022

 
14,459

Federal funds purchased and repurchase agreements
1,522

 
204

 
167

 
134

 
121

Junior subordinated deferrable interest debentures
3,955

 
3,281

 
2,725

 
2,488

 
6,426

Subordinated notes payable and other borrowings
3,860

 
1,343

 
948

 
893

 
939

Total interest expense
26,525

 
12,076

 
12,864

 
14,537

 
21,945

Net interest income
866,422

 
776,336

 
736,632

 
686,934

 
620,555

Provision for loan losses
35,460

 
51,673

 
51,845

 
16,314

 
20,582

Net interest income after provision for loan losses
830,962

 
724,663

 
684,787

 
670,620

 
599,973

Non-interest income:
 
 
 
 
 
 
 
 
 
Trust and investment management fees
110,675

 
104,240

 
105,512

 
106,237

 
91,375

Service charges on deposit accounts
84,182

 
81,203

 
81,350

 
81,946

 
81,432

Insurance commissions and fees
46,169

 
47,154

 
48,926

 
45,115

 
43,140

Interchange and debit card transaction fees
23,232

 
21,369

 
19,666

 
18,372

 
16,979

Other charges, commissions and fees
39,931

 
39,623

 
37,551

 
36,180

 
34,185

Net gain (loss) on securities transactions
(4,941
)
 
14,975

 
69

 
38

 
1,176

Other
37,222

 
41,144

 
35,656

 
32,256

 
34,531

Total non-interest income
336,470

 
349,708

 
328,730

 
320,144

 
302,818

Non-interest expense:
 
 
 
 
 
 
 
 
 
Salaries and wages
337,068

 
318,665

 
310,504

 
292,349

 
273,692

Employee benefits
74,575

 
72,615

 
69,746

 
60,151

 
62,407

Net occupancy
75,971

 
71,627

 
65,690

 
55,745

 
50,468

Technology, furniture and equipment
74,335

 
71,208

 
64,373

 
62,087

 
58,443

Deposit insurance
20,128

 
17,428

 
14,519

 
13,232

 
11,682

Intangible amortization
1,703

 
2,429

 
3,325

 
3,520

 
3,141

Other
175,289

 
178,988

 
165,561

 
167,656

 
152,077

Total non-interest expense
759,069

 
732,960

 
693,718

 
654,740

 
611,910

Income before income taxes
408,363

 
341,411

 
319,799

 
336,024

 
290,881

Income taxes
44,214

 
37,150

 
40,471

 
58,047

 
53,015

Net income
364,149

 
304,261

 
279,328

 
277,977

 
237,866

Preferred stock dividends
8,063

 
8,063

 
8,063

 
8,063

 
6,719

Net income available to common shareholders
$
356,086

 
$
296,198

 
$
271,265

 
$
269,914

 
$
231,147


33


 
As of or for the Year Ended December 31,
 
2017
 
2016
 
2015
 
2014
 
2013
Per Common Share Data
 
 
 
 
 
 
 
 
 
Net income - basic
$
5.56

 
$
4.73

 
$
4.31

 
$
4.32

 
$
3.82

Net income - diluted
5.51

 
4.70

 
4.28

 
4.29

 
3.80

Cash dividends declared and paid
2.25

 
2.15

 
2.10

 
2.03

 
1.98

Book value
49.68

 
45.03

 
44.30

 
42.87

 
39.13

Common Shares Outstanding
 
 
 
 
 
 
 
 
 
Period-end
63,476

 
63,474

 
61,982

 
63,149

 
60,566

Weighted-average shares - basic
63,694

 
62,376

 
62,758

 
62,072

 
60,350

Dilutive effect of stock compensation
968

 
593

 
715

 
902

 
766

Weighted - average shares - diluted
64,662

 
62,969

 
63,473

 
62,974

 
61,116

Performance Ratios
 
 
 
 
 
 
 
 
 
Return on average assets
1.17
%
 
1.03
%
 
0.97
%
 
1.05
%
 
1.02
%
Return on average common equity
11.76

 
10.16

 
9.86

 
10.51

 
9.93

Net interest income to average earning assets
3.69

 
3.56

 
3.45

 
3.41

 
3.41

Dividend pay-out ratio
40.49

 
45.54

 
48.72

 
47.12

 
51.75

Balance Sheet Data
 
 
 
 
 
 
 
 
 
Period-end:
 
 
 
 
 
 
 
 
 
Loans
$
13,145,665

 
$
11,975,392

 
$
11,486,531

 
$
10,987,535

 
$
9,515,700

Earning assets
29,595,375

 
28,025,439

 
26,431,176

 
26,052,339

 
22,238,286

Total assets
31,747,880

 
30,196,319

 
28,565,942

 
28,276,421

 
24,311,408

Non-interest-bearing demand deposits
11,197,093

 
10,513,369

 
10,270,233

 
10,149,061

 
8,311,149

Interest-bearing deposits
15,675,296

 
15,298,206

 
14,073,362

 
13,986,869

 
12,377,637

Total deposits
26,872,389

 
25,811,575

 
24,343,595

 
24,135,930

 
20,688,786

Long-term debt and other borrowings
234,736

 
236,117

 
235,939

 
235,761

 
222,181

Shareholders’ equity
3,297,863

 
3,002,528

 
2,890,343

 
2,851,403

 
2,514,161

Average:
 
 
 
 
 
 
 
 
 
Loans
$
12,460,148

 
$
11,554,823

 
$
11,267,402

 
$
10,299,025

 
$
9,229,574

Earning assets
28,359,131

 
26,717,013

 
25,954,510

 
23,877,476

 
20,991,221

Total assets
30,450,207

 
28,832,093

 
28,060,626

 
25,766,301

 
22,750,422

Non-interest-bearing demand deposits
10,819,426

 
10,034,319

 
10,179,810

 
9,125,030

 
7,657,774

Interest-bearing deposits
15,085,492

 
14,477,525

 
13,860,948

 
12,927,729

 
11,610,320

Total deposits
25,904,918

 
24,511,844

 
24,040,758

 
22,052,759

 
19,268,094

Long-term debt and other borrowings
226,194

 
236,033

 
235,856

 
230,170

 
222,098

Shareholders’ equity
3,173,264

 
3,058,896

 
2,895,192

 
2,712,226

 
2,455,041

Asset Quality
 
 
 
 
 
 
 
 
 
Allowance for loan losses
$
155,364

 
$
153,045

 
$
135,859

 
$
99,542

 
$
92,438

Allowance for losses to year-end loans
1.18
%
 
1.28
%
 
1.18
%
 
0.91
%
 
0.97
%
Net loan charge-offs
$
33,141

 
$
34,487

 
$
15,528

 
$
9,210

 
$
32,597

Net loan charge-offs to average loans
0.27
%
 
0.30
%
 
0.14
%
 
0.09
%
 
0.35
%
Non-performing assets
$
157,292

 
$
102,591

 
$
85,722

 
$
65,176

 
$
69,773

Non-performing assets to:
 
 
 
 
 
 
 
 
 
Total loans plus foreclosed assets
1.20
%
 
0.86
%
 
0.75
%
 
0.59
%
 
0.73
%
Total assets
0.50

 
0.34

 
0.30

 
0.23

 
0.29

Consolidated Capital Ratios









Common equity tier 1 risk-based ratio
12.42
%
 
12.52
%
 
11.37
%
 
N/A
 
N/A
Tier 1 risk-based ratio
13.16


13.33


12.38

 
13.68
%
 
14.39
%
Total risk-based ratio
15.15


14.93


13.85

 
14.55

 
15.52

Leverage ratio
8.46


8.14


7.79

 
8.16

 
8.49

Average shareholders’ equity to average total assets
10.42

 
10.61

 
10.32

 
10.53

 
10.79


34


The following tables set forth unaudited consolidated selected quarterly statement of operations data for the years ended December 31, 2017 and 2016. Dollar amounts are in thousands, except per share data.
 
Year Ended December 31, 2017
 
4th
Quarter
 
3rd
Quarter
 
2nd
Quarter
 
1st
Quarter
Interest income
$
234,295

 
$
227,586

 
$
219,274

 
$
211,792

Interest expense
10,381

 
8,375

 
4,486

 
3,283

Net interest income
223,914

 
219,211

 
214,788

 
208,509

Provision for loan losses
8,102

 
10,980

 
8,426

 
7,952

Non-interest income(1)
90,075

 
81,615

 
81,080

 
83,700

Non-interest expense
196,280

 
186,823

 
188,051

 
187,915

Income before income taxes
109,607

 
103,023

 
99,391

 
96,342

Income taxes
9,083

 
9,892

 
13,838

 
11,401

Net income
100,524

 
93,131

 
85,553

 
84,941

Preferred stock dividends
2,016

 
2,016

 
2,015

 
2,016

Net income available to common shareholders
$
98,508

 
$
91,115

 
$
83,538

 
$
82,925

Net income per common share:
 
 
 
 
 
 
 
Basic
$
1.54

 
$
1.43

 
$
1.30

 
$
1.29

Diluted
1.53

 
1.41

 
1.29

 
1.28

 
Year Ended December 31, 2016
 
4th
Quarter
 
3rd
Quarter
 
2nd
Quarter
 
1st
Quarter
Interest income
$
204,868

 
$
197,489

 
$
193,451

 
$
192,604

Interest expense
3,265

 
2,982

 
2,949

 
2,880

Net interest income
201,603

 
194,507

 
190,502

 
189,724

Provision for loan losses
8,939

 
5,045

 
9,189

 
28,500

Non-interest income(2)
93,434

 
82,114

 
78,017

 
96,143

Non-interest expense
193,851

 
180,505

 
179,445

 
179,159

Income before income taxes
92,247

 
91,071

 
79,885

 
78,208

Income taxes
8,528

 
10,852

 
8,378

 
9,392

Net income
83,719

 
80,219

 
71,507

 
68,816

Preferred stock dividends
2,016

 
2,016

 
2,015

 
2,016

Net income available to common shareholders
$
81,703

 
$
78,203

 
$
69,492

 
$
66,800

Net income per common share:
 
 
 
 
 
 
 
Basic
$
1.29

 
$
1.24

 
$
1.12

 
$
1.07

Diluted
1.28

 
1.24

 
1.11

 
1.07

(1)
Includes net losses on securities transactions of $50 thousand, $4.9 million and $24 thousand during the second, third and fourth quarters of 2017, respectively.
(2)
Includes net gains on securities transactions of $14.9 million and $109 thousand during the first and fourth quarters of 2016, respectively, and a net loss on securities transactions of $37 thousand during the third quarter of 2016.


35


ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Forward-Looking Statements and Factors that Could Affect Future Results
Certain statements contained in this Annual Report on Form 10-K that are not statements of historical fact constitute forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995 (the “Act”), notwithstanding that such statements are not specifically identified as such. In addition, certain statements may be contained in our future filings with the SEC, in press releases, and in oral and written statements made by us or with our approval that are not statements of historical fact and constitute forward-looking statements within the meaning of the Act. Examples of forward-looking statements include, but are not limited to: (i) projections of revenues, expenses, income or loss, earnings or loss per share, the payment or nonpayment of dividends, capital structure and other financial items; (ii) statements of plans, objectives and expectations of Cullen/Frost or its management or Board of Directors, including those relating to products or services; (iii) statements of future economic performance; and (iv) statements of assumptions underlying such statements. Words such as “believes”, “anticipates”, “expects”, “intends”, “targeted”, “continue”, “remain”, “will”, “should”, “may” and other similar expressions are intended to identify forward-looking statements but are not the exclusive means of identifying such statements.
Forward-looking statements involve risks and uncertainties that may cause actual results to differ materially from those in such statements. Factors that could cause actual results to differ from those discussed in the forward-looking statements include, but are not limited to:
Local, regional, national and international economic conditions and the impact they may have on us and our customers and our assessment of that impact.
Volatility and disruption in national and international financial and commodity markets.
Government intervention in the U.S. financial system.
Changes in the mix of loan geographies, sectors and types or the level of non-performing assets and charge-offs.
Changes in estimates of future reserve requirements based upon the periodic review thereof under relevant regulatory and accounting requirements.
The effects of and changes in trade and monetary and fiscal policies and laws, including the interest rate policies of the Federal Reserve Board.
Inflation, interest rate, securities market and monetary fluctuations.
The effect of changes in laws and regulations (including laws and regulations concerning taxes, banking, securities and insurance) with which we and our subsidiaries must comply.
The soundness of other financial institutions.
Political instability.
Impairment of our goodwill or other intangible assets.
Acts of God or of war or terrorism.
The timely development and acceptance of new products and services and perceived overall value of these products and services by users.
Changes in consumer spending, borrowings and savings habits.
Changes in the financial performance and/or condition of our borrowers.
Technological changes.
Acquisitions and integration of acquired businesses.
Our ability to increase market share and control expenses.
Our ability to attract and retain qualified employees.
Changes in the competitive environment in our markets and among banking organizations and other financial service providers.
The effect of changes in accounting policies and practices, as may be adopted by the regulatory agencies, as well as the Public Company Accounting Oversight Board, the Financial Accounting Standards Board and other accounting standard setters.
Changes in the reliability of our vendors, internal control systems or information systems.
Changes in our liquidity position.
Changes in our organization, compensation and benefit plans.
The costs and effects of legal and regulatory developments, the resolution of legal proceedings or regulatory or other governmental inquiries, the results of regulatory examinations or reviews and the ability to obtain required regulatory approvals.

36


Greater than expected costs or difficulties related to the integration of new products and lines of business.
Our success at managing the risks involved in the foregoing items.
Forward-looking statements speak only as of the date on which such statements are made. We do not undertake any obligation to update any forward-looking statement to reflect events or circumstances after the date on which such statement is made, or to reflect the occurrence of unanticipated events.
Application of Critical Accounting Policies and Accounting Estimates
We follow accounting and reporting policies that conform, in all material respects, to accounting principles generally accepted in the United States and to general practices within the financial services industry. The preparation of financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. While we base estimates on historical experience, current information and other factors deemed to be relevant, actual results could differ from those estimates.
We consider accounting estimates to be critical to reported financial results if (i) the accounting estimate requires management to make assumptions about matters that are highly uncertain and (ii) different estimates that management reasonably could have used for the accounting estimate in the current period, or changes in the accounting estimate that are reasonably likely to occur from period to period, could have a material impact on our financial statements.
Accounting policies related to the allowance for loan losses are considered to be critical, as these policies involve considerable subjective judgment and estimation by management. The allowance for loan losses is a reserve established through a provision for loan losses charged to expense, which represents management’s best estimate of probable losses that have been incurred within the existing portfolio of loans. The allowance, in the judgment of management, is necessary to reserve for estimated loan losses and risks inherent in the loan portfolio. Our allowance for loan loss methodology includes allowance allocations calculated in accordance with Accounting Standards Codification (ASC) Topic 310, “Receivables” and allowance allocations calculated in accordance with ASC Topic 450, “Contingencies.” The level of the allowance reflects management’s continuing evaluation 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, as well as trends in the foregoing. Portions of the allowance may be allocated for specific credits; however, the entire allowance is available for any credit that, in management’s judgment, should be charged off. While management utilizes its best judgment and information available, the ultimate adequacy of the allowance is dependent upon a variety of factors beyond our control, including the performance of our loan portfolio, the economy, changes in interest rates and the view of the regulatory authorities toward loan classifications. See the section captioned “Allowance for Loan Losses” elsewhere in this discussion and Note 3 - Loans in the notes to consolidated financial statements included in Item 8. Financial Statements and Supplementary Data elsewhere in this report for further details of the risk factors considered by management in estimating the necessary level of the allowance for loan losses.
Overview
The following discussion and analysis presents the more significant factors that affected our financial condition as of December 31, 2017 and 2016 and results of operations for each of the years in the three-year period ended December 31, 2017. This discussion and analysis should be read in conjunction with our consolidated financial statements, notes thereto and other financial information appearing elsewhere in this report. During 2014, we acquired WNB Bancshares, Inc., a privately-held bank holding company headquartered in Odessa, Texas (“WNB”). From time to time, we have also acquired various small businesses through our insurance subsidiary. All of our acquisitions during the reported periods were accounted for using the acquisition method, and as such, their related results of operations are included from the date of acquisition, though none of these acquisitions had a significant impact on our financial statements during their respective reporting periods.
Taxable-equivalent adjustments are the result of increasing income from tax-free loans and investments by an amount equal to the taxes that would be paid if the income were fully taxable based on a 35% federal tax rate, thus making tax-exempt yields comparable to taxable asset yields. The Tax Cuts and Jobs Act was enacted on December 22, 2017. Among other things, the new law establishes a new, flat corporate federal statutory income tax rate of 21% beginning in 2018.
Dollar amounts in tables are stated in thousands, except for per share amounts.

37


Results of Operations
Net income available to common shareholders totaled $356.1 million, or $5.51 diluted per common share, in 2017 compared to $296.2 million, or $4.70 diluted per common share, in 2016 and $271.3 million, or $4.28 diluted per common share, in 2015. The operating results of acquired entities are included with our results of operations since their dates of acquisition.
Selected income statement data, returns on average assets and average equity and dividends per share for the comparable periods were as follows:
 
2017
 
2016
 
2015
Taxable-equivalent net interest income
$
1,043,431

 
$
939,958

 
$
888,035

Taxable-equivalent adjustment
177,009

 
163,622

 
151,403

Net interest income
866,422

 
776,336

 
736,632

Provision for loan losses
35,460

 
51,673

 
51,845

Non-interest income
336,470

 
349,708

 
328,730

Non-interest expense
759,069

 
732,960

 
693,718

Income before income taxes
408,363

 
341,411

 
319,799

Income taxes
44,214

 
37,150

 
40,471

Net income
364,149

 
304,261

 
279,328

Preferred stock dividends
8,063

 
8,063

 
8,063

Net income available to common shareholders
$
356,086

 
$
296,198

 
$
271,265

Earnings per common share - basic
$
5.56

 
$
4.73

 
$
4.31

Earnings per common share - diluted
5.51

 
4.70

 
4.28

Dividends per common share
2.25

 
2.15

 
2.10

Return on average assets
1.17
%
 
1.03
%
 
0.97
%
Return on average common equity
11.76

 
10.16

 
9.86

Average shareholders' equity to average assets
10.42

 
10.61

 
10.32

Net income available to common shareholders increased $59.9 million for 2017 compared to 2016. The increase was primarily the result of a $90.1 million increase in net interest income and a $16.2 million decrease in the provision for loan losses partly offset by a $26.1 million increase in non-interest expense, a $13.2 million decrease in non-interest income and a $7.1 million increase in income tax expense. Income tax expense for 2017 was impacted by the enactment of the Tax Cuts and Jobs Act on December 22, 2017, as further discussed below. Net income available to common shareholders increased $24.9 million for 2016 compared to 2015. The increase was primarily the result of a $39.7 million increase in net interest income, a $21.0 million increase in non-interest income and a $3.3 million decrease in income tax expense partly offset by a $39.2 million increase in non-interest expense.
Details of the changes in the various components of net income are further discussed below.
Net Interest Income
Net interest income is the difference between interest income on earning assets, such as loans and securities, and interest expense on liabilities, such as deposits and borrowings, which are used to fund those assets. Net interest income is our largest source of revenue, representing 72.0% of total revenue during 2017. Net interest margin is the ratio of taxable-equivalent net interest income to average earning assets for the period. The level of interest rates and the volume and mix of earning assets and interest-bearing liabilities impact net interest income and net interest margin.
The Federal Reserve influences the general market rates of interest, including the deposit and loan rates offered by many financial institutions. Our loan portfolio is significantly affected by changes in the prime interest rate. The prime interest rate, which is the rate offered on loans to borrowers with strong credit, remained at 3.25% during most of 2015. In December 2015, the prime rate increased 25 basis points to 3.50% and remained at that level through most of 2016. In December 2016, the prime rate increased 25 basis points to end the year at 3.75%. During 2017, the prime rate increased 75 basis points (25 basis points in each of March, June and December) to end the year at to 4.50%. Our loan portfolio is also significantly impacted, by changes in the London Interbank Offered Rate (LIBOR). At December 31, 2017, the one-month and three-month U.S. dollar LIBOR rates were 1.56% and 1.69%, respectively, while at December 31, 2016, the one-month and three-month U.S. dollar LIBOR rates were 0.77% and 1.00%, respectively.

38


The effective federal funds rate, which is the cost of immediately available overnight funds, remained at zero to 0.25% during most of 2015. In December 2015, the effective federal funds rate increased 25 basis points to 0.50% and remained at that level through most of 2016. In December 2016, the effective federal funds rate increased 25 basis points to end the year at 0.75%. During 2017, the effective federal funds rate increased 75 basis points (25 basis points in each of March, June and December) to end the year at 1.50%.
We are primarily funded by core deposits, with non-interest-bearing demand deposits historically being a significant source of funds. This lower-cost funding base is expected to have a positive impact on our net interest income and net interest margin in a rising interest rate environment. Federal prohibitions on the payment of interest on demand deposits were repealed in 2011. Nonetheless, we have not experienced any significant additional costs as a result. See Item 7A. Quantitative and Qualitative Disclosures About Market Risk elsewhere in this report for information about our sensitivity to interest rates. Further analysis of the components of our net interest margin is presented below.
The following table presents the changes in taxable-equivalent net interest income and identifies the changes due to differences in the average volume of earning assets and interest-bearing liabilities and the changes due to changes in the average interest rate on those assets and liabilities. The changes in net interest income due to changes in both average volume and average interest rate have been allocated to the average volume change or the average interest rate change in proportion to the absolute amounts of the change in each. The comparison between the periods includes an additional change factor that shows the effect of the difference in the number of days in each period for assets and liabilities that accrue interest based upon the actual number of days in the period, as further discussed below. Our consolidated average balance sheets along with an analysis of taxable-equivalent net interest income are presented in Item 8. Financial Statements and Supplementary Data of this report.
 
2017 vs. 2016
 
2016 vs. 2015
 
Increase (Decrease) Due
to Change in
 
 
 
Increase (Decrease) Due
to Change in
 
 
 
Rate
 
Volume
 
Number of Days
 
Total
 
Rate
 
Volume
 
Number of Days
 
Total
Interest-bearing deposits
$
22,369

 
$
3,180

 
$
(44
)
 
$
25,505

 
$
7,896

 
$
40

 
$
44

 
$
7,980

Federal funds sold and resell agreements
385

 
280

 
(1
)
 
664

 
67

 
97

 
1

 
165

Securities:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Taxable
(4,482
)
 
(5,358
)
 
(206
)
 
(10,046
)
 
(5,340
)
 
(4,442
)
 
206

 
(9,576
)
Tax-exempt
(8,741
)
 
31,136

 

 
22,395

 
(1,231
)
 
30,149

 

 
28,918

Loans, net of unearned discounts
42,509

 
38,161

 
(1,266
)
 
79,404

 
11,753

 
10,629

 
1,266

 
23,648

Total earning assets
52,040

 
67,399

 
(1,517
)
 
117,922

 
13,145

 
36,473

 
1,517

 
51,135

Savings and interest checking

 
252

 
(3
)
 
249

 

 
55

 
3

 
58

Money market deposit accounts
8,040

 
21

 
(13
)
 
8,048

 
(1,557
)
 
(201
)
 
13

 
(1,745
)
Time accounts
475

 
(38
)
 
(4
)
 
433

 
(65
)
 
(81
)
 
4

 
(142
)
Public funds
1,216

 
(5
)
 
(1
)
 
1,210

 
47

 
5

 
1

 
53

Federal funds purchased and repurchase agreements
1,241

 
78

 
(1
)
 
1,318

 

 
36

 
1

 
37

Junior subordinated deferrable interest debentures
673

 
1

 

 
674

 
555

 
1

 

 
556

Subordinated notes payable and other notes
2,599

 
(82
)
 

 
2,517

 
394

 
1

 

 
395

Total interest-bearing liabilities
14,244

 
227

 
(22
)
 
14,449

 
(626
)
 
(184
)
 
22

 
(788
)
Net change
$
37,796

 
$
67,172

 
$
(1,495
)
 
$
103,473

 
$
13,771

 
$
36,657

 
$
1,495

 
$
51,923

Taxable-equivalent net interest income for 2017 increased $103.5 million, or 11.0%, compared to 2016. Taxable-equivalent net interest income for 2017 included 365 days compared to 366 days for the same period in 2016 as a result of the leap year. The additional day added approximately $1.5 million to taxable-equivalent net interest income during 2016. Excluding the impact of the additional day results in an effective increase in taxable-equivalent net interest income of approximately $105.0 million during 2017. The increase in taxable-equivalent net interest income during 2017, excluding the effect of the aforementioned additional day, was primarily related to the impact of increases in the average volume of loans, tax-exempt securities and interest-bearing deposits as well as increases in the average yields on loans and interest-bearing deposits partly offset by the impact of decreases in the average yields on tax-exempt and taxable securities, a decrease in the average volume of taxable securities and the impact of an increase in the average rate paid on interest-bearing liabilities. The average volume of interest-earning assets for 2017 increased $1.6 billion, or 6.1%,

39


compared to 2016. The increase in earning assets included a $905.3 million increase in average loans, a $548.3 million increase in average federal funds sold, resell agreements and interest-bearing deposits and a $546.8 million increase in average tax-exempt securities, partly offset by a $358.4 million decrease in average taxable securities.
Taxable-equivalent net interest income for 2016 increased $51.9 million, or 5.8%, compared to 2015. Taxable-equivalent net interest income for 2016 included 366 days compared to 365 days for the same period in 2015 as a result of the leap year. The additional day added approximately $1.5 million to taxable-equivalent net interest income during 2016. Excluding the impact of the additional day results in an effective increase in taxable-equivalent net interest income of approximately $50.4 million during 2016. The increase in taxable-equivalent net interest income during 2016, excluding the effect of the aforementioned additional day, was primarily related to the impact of increases in the average volume of tax-exempt securities and loans as well as increases in the average yield on loans and interest-bearing deposits partly offset by the impact of decreases in the average yield and volume of taxable securities. Taxable-equivalent net interest income during 2016 was also positively impacted by a decrease in the average rate paid on money market deposit accounts. The average volume of interest-earning assets for 2016 increased $762.5 million or 2.9% compared to 2015. The increase in earning assets included a $442.7 million increase in average securities, a $287.4 million increase in average loans and a $32.3 million increase in average federal funds sold, resell agreements and interest-bearing deposits.
The net interest margin increased 13 basis points from 3.56% during 2016 to 3.69% during 2017. The increase was primarily due to an increase in the average yield on interest earning assets partly offset by an increase in the average rate paid on interest-bearing liabilities. The average yield on interest-earning assets increased 19 basis points to 3.79% during 2017 from 3.60% during 2016 while the average rate paid on interest-bearing liabilities increased 8 basis points from 0.08% during 2016 to 0.16% during 2017. The increase in the average yield on interest earning assets during 2017 was mostly due to increases in the average yields on loans and interest-bearing deposits while the increase in the average rate paid on interest-bearing liabilities was primarily due to increases in the rates paid on various deposit products and long-term debt. The average yield on interest-earning assets and the average rate paid on interest-bearing liabilities are primarily impacted by changes in market interest rates as well as changes in the volume and relative mix of the underlying assets and liabilities. Taxable-equivalent yields and the net interest margin during the comparable periods are presented based upon a tax rate of 35%. Beginning January 1, 2018, taxable-equivalent-yields and the net interest margin will be based upon a tax rate of 21%. See the section captioned “Income Taxes” elsewhere in this discussion for information regarding the Tax Cuts and Jobs Act enacted on December 22, 2017. Assuming a tax rate of 21%, the net interest margin and the average yield on interest-earning assets on a taxable-equivalent basis for 2017 would have been 3.37% and 3.47%, respectively.
The net interest margin increased 11 basis points from 3.45% during 2015 to 3.56% during 2016. The increase was primarily due to increases in the average yield on interest earning assets. The average yield on interest-earning assets increased 10 basis points to 3.60% during 2016 from 3.50% during 2015 while the average rate paid on interest-bearing liabilities decreased 1 basis point from 0.09% during 2015 to 0.08% during 2016. The increase in the average yield on interest earning assets during 2016 was due to increases in the average yields on interest-bearing deposits, federal funds sold and resell agreements, loans and total securities.
The average yield on loans was 4.36% during 2017 compared to 4.01% during 2016 and 3.90% during 2015, increasing 35 basis points during 2017 compared to 2016 and 11 basis points during 2016 compared to 2015. These increases were positively impacted by increases in market interest rates during the comparable periods, as discussed above. The average volume of loans increased $905.3 million, or 7.8%, in 2017 compared to 2016 and increased $287.4 million, or 2.6%, in 2016 compared to 2015. Loans made up approximately 43.9% of average interest-earning assets during 2017 compared to 43.2% during 2016 and 43.4% in 2015.
The average yield on securities was 3.99% in 2017 compared to 4.02% in 2016 and 3.97% in 2015. The average yield on taxable securities was 1.92% in 2017 compared to 2.01% in 2016 and 2.11% in 2015 while the average yield on tax exempt securities was 5.37% in 2017 compared to 5.57% in 2016 and 5.59% in 2015. Despite the fact that the average yield on taxable and tax-exempt securities decreased 9 and 20 basis points, respectively, during 2017 compared to 2016, the overall average yield on securities in 2017 only decreased 3 basis points compared to 2016 because a larger proportion of average securities was invested in higher yielding tax-exempt securities during 2017 compared to 2016. Similarly, the overall average yield on securities during 2016 increased 5 basis points compared to 2015 despite 10 and 2 basis point decreases in the average yield on taxable and tax-exempt securities, respectively, as a result of a higher average proportion of tax-exempt securities. Tax exempt securities made up approximately 60.0% of total average securities during 2017, compared to 56.4% during 2016 and 53.2% during 2015. The average volume of securities

40


increased $188.5 million, or 1.6%, during 2017 compared to 2016 and increased $442.7 million, or 3.8%, during 2016 compared to 2015. These increases were primarily related to the investment of excess liquidity from deposit growth. Securities made up approximately 43.2% of average interest-earning assets in 2017 compared to 45.1% in 2016 and 44.8% in 2015.
Average federal funds sold, resell agreements and interest-bearing deposits during 2017 increased $548.3 million, or 17.7%, compared to 2016 and increased $32.3 million, or 1.1%, in 2016 compared to 2015. The increases in average federal funds sold, resell agreements and interest-bearing deposits during the comparable periods were primarily related to growth in average deposits. Federal funds sold, resell agreements and interest-bearing deposits made up approximately 12.9% of average interest-earning assets during 2017 compared to approximately 11.6% in 2016 and 11.8% in 2015. The combined average yield on federal funds sold, resell agreements and interest-bearing deposits was 1.16% during 2017, 0.53% during 2016, and 0.27% during 2015. As discussed above, since December 2015, there have been five separate 25 basis point increases in the expected federal funds rate.
Average deposits increased $1.4 billion, or 5.7%, in 2017 compared to 2016 and $471.1 million, or 2.0%, in 2016 compared to 2015. Average interest-bearing deposits increased $608.0 million in 2017 compared to 2016 and increased $616.6 million in 2016 compared to 2015, while average non-interest-bearing deposits increased $785.1 million in 2017 compared to 2016 and decreased $145.5 million in 2016 compared to 2015. The ratio of average interest-bearing deposits to total average deposits was 58.2% in 2017 compared to 59.1% in 2016 and 57.7% in 2015. The average cost of deposits is primarily impacted by changes in market interest rates as well as changes in the volume and relative mix of interest-bearing deposits. The average rate paid on interest-bearing deposits and total deposits was 0.11% and 0.07% in 2017 compared to 0.05% and 0.03% in 2016 and 0.07% and 0.04% in 2015. The increase in the average cost of deposits during 2017 was related to the aforementioned increases in interest rates paid on most of our interest-bearing deposit products during the third quarter. The decrease in the average raid paid on interest-bearing deposits during 2016 compared to 2015 was primarily the result of decreases in interest rates offered on certain deposit products due to decreases in average market interest rates and decreases in renewal interest rates on maturing certificates of deposit given the prevailing low interest rate environment. The relative proportion of higher-cost certificates of deposit to total average interest-bearing deposits decreased to 5.1% in 2017 from 5.6% in 2016 and 6.3% in 2015.
Our net interest spread, which represents the difference between the average rate earned on earning assets and the average rate paid on interest-bearing liabilities, was 3.63% in 2017 compared to 3.52% in 2016 and 3.41% in 2015. The net interest spread, as well as the net interest margin, will be impacted by future changes in short-term and long-term interest rate levels, as well as the impact from the competitive environment. A discussion of the effects of changing interest rates on net interest income is set forth in Item 7A. Quantitative and Qualitative Disclosures About Market Risk included elsewhere in this report.
Our hedging policies permit the use of various derivative financial instruments, including interest rate swaps, swaptions, caps and floors, to manage exposure to changes in interest rates. Details of our derivatives and hedging activities are set forth in Note 15 - Derivative Financial Instruments in the accompanying notes to consolidated financial statements included elsewhere in this report. Information regarding the impact of fluctuations in interest rates on our derivative financial instruments is set forth in Item 7A. Quantitative and Qualitative Disclosures About Market Risk included elsewhere in this report.
Provision for Loan Losses
The provision for loan losses is determined by management as the amount to be added to the allowance for loan losses after net charge-offs have been deducted to bring the allowance to a level which, in management’s best estimate, is necessary to absorb inherent losses within the existing loan portfolio. The provision for loan losses totaled $35.5 million in 2017 compared to $51.7 million in 2016 and $51.8 million in 2015. See the section captioned “Allowance for Loan Losses” elsewhere in this discussion for further analysis of the provision for loan losses.

41


Non-Interest Income
The components of non-interest income were as follows:
 
2017
 
2016
 
2015
Trust and investment management fees
$
110,675

 
$
104,240

 
$
105,512

Service charges on deposit accounts
84,182

 
81,203

 
81,350

Insurance commissions and fees
46,169

 
47,154

 
48,926

Interchange and debit card transaction fees
23,232

 
21,369

 
19,666

Other charges, commissions and fees
39,931

 
39,623

 
37,551

Net gain (loss) on securities transactions
(4,941
)
 
14,975

 
69

Other
37,222

 
41,144

 
35,656

Total
$
336,470

 
$
349,708

 
$
328,730

Total non-interest income for 2017 decreased $13.2 million, or 3.8%, compared to 2016 while total non-interest income for 2016 increased $21.0 million, or 6.4%, compared to 2015. Changes in the various components of non-interest income are discussed in more detail below.
Trust and Investment Management Fees. Trust and investment management fee income for 2017 increased $6.4 million, or 6.2%, compared to 2016 while trust and investment management fee income for 2016 decreased $1.3 million, or 1.2%, compared to 2015. Investment fees are the most significant component of trust and investment management fees, making up approximately 84%, 82% and 79% of total trust and investment management fees in 2017, 2016 and 2015, respectively. Investment and other custodial account fees are generally based on the market value of assets within a trust account. Volatility in the equity and bond markets impacts the market value of trust assets and the related investment fees.
The increase in trust and investment management fees during 2017 compared to the same period in 2016 was primarily the result of an increase in trust investment fees (up $6.8 million). The increase in trust investment fees during 2017 was due to higher average equity valuations on managed accounts. Trust and investment management fees during 2017 also included an increase in real estate fees (up $225 thousand) and a decrease in estate fees (down $618 thousand) compared to 2016. The decrease in estate fees during 2017 was related to a decrease in the aggregate value of estates settled compared to 2016.
The decrease in trust and investment management fees during 2016 compared to 2015 was primarily the result of decreases in oil and gas fees (down $1.2 million), estate fees (down $970 thousand), securities lending income (down $741 thousand) and custody fees (down $168 thousand). These decreases were partly offset by an increase in trust investment fees (up $1.8 million). The decrease in oil and gas fees during 2016 was partly due to lower energy prices and decreased production. The decrease in estate fees during 2016 was related to a decrease in the aggregate value of estates settled compared to 2015. The decrease in securities lending income during 2016 was due to the termination of our securities lending operations during the first quarter of 2015 in part due to the negative impact securities lending transactions would have had on our regulatory capital ratios under Basel III capital rules. See Note 9 - Capital and Regulatory Matters in the accompanying notes to consolidated financial statements included elsewhere in this report. The increase in trust investment fees during 2016 was due to higher average equity valuations on managed accounts and an increase in the number of accounts.
At December 31, 2017, trust assets, including both managed assets and custody assets, were primarily composed of equity securities (50.3% of trust assets), fixed income securities (37.3% of trust assets) and cash equivalents (7.9% of trust assets). The estimated fair value of trust assets was $32.8 billion (including managed assets of $14.1 billion and custody assets of $18.7 billion) at December 31, 2017 compared to $29.3 billion (including managed assets of $13.4 billion and custody assets of $15.9 billion) at December 31, 2016.
Service Charges on Deposit Accounts. Service charges on deposit accounts for 2017 increased $3.0 million, or 3.7%, compared to 2016. The increase was primarily due to an increase in overdraft/insufficient funds charges on consumer and commercial accounts (up $1.9 million and $511 thousand, respectively) and consumer service charges (up $1.0 million) partly offset by a decrease in commercial service charges (down $428 thousand). Service charges on deposit accounts for 2016 decreased $147 thousand, or 0.2%, compared to 2015 The decrease was primarily due to a decrease in service charges on consumer accounts (down $945 thousand) partly offset by increases in service charges on commercial accounts (up $384 thousand), overdraft/insufficient funds charges on consumer accounts (up

42


$260 thousand) and overdraft/insufficient funds charges on commercial accounts (up $192 thousand). Overdraft/insufficient funds charges totaled $34.9 million during 2017 compared to $32.5 million during 2016 and $32.0 million in 2015. Overdraft/insufficient funds charges included $27.0 million, $25.0 million and $24.8 million related to consumer accounts during 2017, 2016 and 2015, respectively, and $8.0 million, $7.5 million and $7.3 million related to commercial accounts during 2017, 2016 and 2015, respectively.
Insurance Commissions and Fees. Insurance commissions and fees for 2017 decreased $985 thousand, or 2.1%, compared to 2016. The decrease was related to a decrease in contingent income (down $2.9 million) partly offset by an increase in commission income (up $1.9 million), which was primarily related to an increase in benefit plan commissions due to increased business volumes partly offset by a decrease in commissions on property and casualty policies. Insurance commissions and fees for 2016 decreased $1.8 million, or 3.6%, compared to 2015. The decrease was related to a decrease in commission income (down $2.8 million) partly offset by an increase in contingent commissions (up $1.1 million). The decrease in commission income during 2016 was primarily related to declines in employee benefit plan commissions and consulting fees due to lower business volumes and decreases in commercial lines property and casualty commissions.
Insurance commissions and fees include contingent commissions which totaled $3.6 million in 2017, $6.5 million in 2016 and $5.5 million 2015. Contingent commissions primarily consist of amounts received from various property and casualty insurance carriers related to the loss performance of insurance policies previously placed. Such commissions are seasonal in nature and are mostly received during the first quarter of each year. These commissions totaled $2.1 million in 2017, $4.9 million in 2016 and $3.8 million in 2015. The decrease in performance related contingent income during 2017 was related to a lack of growth within the portfolio and a deterioration in the loss performance of insurance policies during 2016. Contingent commissions also include amounts received from various benefit plan insurance companies related to the volume of business generated and/or the subsequent retention of such business. These commissions totaled $1.5 million in 2017, $1.7 million in 2016 and $1.7 million in 2015.
Interchange and Debit Card Transaction Fees. Interchange fees, or “swipe” fees, are charges that merchants pay to us and other card-issuing banks for processing electronic payment transactions. Interchange and debit card transaction fees consist of income from check card usage, point of sale income from PIN-based debit card transactions and ATM service fees. Interchange and debit card transaction fees for 2017 increased $1.9 million, or 8.7% compared to 2016 and increased $1.7 million, or 8.7%, in 2016 compared to 2015. Income from debit card transactions totaled approximately $19.4 million in 2017 compared to $17.9 million in 2016 and $17.0 million in 2015. ATM service fees totaled approximately $3.8 million in 2017 compared to $3.5 million in 2016 and $2.7 million in 2015. The increases in income from debit card transactions during the comparable periods were primarily related to increased transaction volume. The increases in ATM service fees during the comparable period were related to increased transaction volume and a change in the fee schedule during the first quarter of 2016.
Federal Reserve Board rules applicable to financial institutions that have assets of $10 billion or more provide that the maximum permissible interchange fee for an electronic debit transaction is the sum of 21 cents per transaction and 5 basis points multiplied by the value of the transaction. An upward adjustment of no more than 1 cent to an issuer's debit card interchange fee is allowed if the card issuer develops and implements policies and procedures reasonably designed to achieve certain fraud-prevention standards. The Federal Reserve Board also has rules governing routing and exclusivity that require issuers to offer two unaffiliated networks for routing transactions on each debit or prepaid product.
Other Charges, Commissions and Fees. Other charges, commissions and fees for 2017 increased $308 thousand, or 0.8%, compared to 2016. The increase included increases in income related to the sale of mutual funds (up $1.2 million) and wire transfer fees (up $317 thousand), among other things. These items were partly offset by decreases in human resources consulting fee income (down $650 thousand) and income from corporate finance and capital market advisory services (down $605 thousand), among other things. Human resources consulting fee income decreased as we no longer provide these services. Changes in the other aforementioned categories of other charges, commissions and fees were due to fluctuations in business volumes.
Other charges, commissions and fees for 2016 increased $2.1 million or 5.5%, compared to 2015. The increase included increases in income related to the sale of money market accounts (up $815 thousand), loan processing fees (up $627 thousand), origination fees collected on loans that did not fund (up $464 thousand), agent income from the sale of federal funds (up $397 thousand), wire transfer fees (up $309 thousand), lease processing fees (up $227 thousand) and income from corporate finance and capital market advisory services (up $213 thousand), among other things. These

43


increases were partly offset by decreases in income related to the sale of annuities (down $802 thousand), unused balance fees on loan commitments (down $405 thousand) and income related to the sale of mutual funds (down $264 thousand). Fluctuations in the aforementioned items were due to fluctuations in business volumes.
Net Gain/Loss on Securities Transactions. During 2017, we sold certain available-for-sale U.S Treasury securities with an amortized cost totaling $11.2 billion and realized a net loss of $74 thousand on those sales. The sales were primarily related to securities purchased during 2017 and subsequently sold in connection with our tax planning strategies related to the Texas franchise tax. The gross proceeds from the sales of these securities outside of Texas are included in total revenues/receipts from all sources reported for Texas franchise tax purposes, which results in a reduction in the overall percentage of revenues/receipts apportioned to Texas and subjected to taxation under the Texas franchise tax. We also sold certain other available-for-sale U.S. Treasury securities with an amortized cost totaling $751.4 million and realized a net loss of $4.9 million on those sales. These securities were sold with the intent to reinvest the sales proceeds in higher yielding debt securities and other investments.
During 2016, we sold available-for-sale securities with an amortized cost totaling $14.8 billion and realized a net gain of $11.2 million on those sales. We also sold held-to-maturity securities with an amortized cost totaling $132.9 million and realized a net gain of $3.7 million on those sales. As more fully discussed in Note 2 - Securities in the accompanying notes to consolidated financial statements included elsewhere in this report, a portion of the available-for-sale securities and all of the held-to maturity securities that were sold during 2016 were sold as a result of a significant deterioration in the creditworthiness of the issuers. In aggregate, the securities sold as a result of credit deterioration had an amortized cost totaling $528.6 million and we realized a net gain of $11.9 million on those sales. We sold U.S Treasury securities with an amortized cost totaling $13.7 billion and realized a net loss of $57 thousand on those sales. The sales were primarily related to securities purchased during 2016 and subsequently sold in connection with our aforementioned tax planning strategies related to the Texas franchise tax. Other securities sold during 2016 included available-for-sale U.S. Treasury securities with an amortized cost totaling $764.5 million and we realized a net gain of $3.3 million on those sales. Most of these securities were due to mature during 2016 and most of the proceeds from the sale of these securities were reinvested into U.S. Treasury securities having comparable yields, but longer-terms.
During 2015, we sold available-for-sale securities with an amortized cost totaling $12.7 billion and realized a net gain of $69 thousand on those sales. We sold an available-for-sale U.S. Treasury security with an amortized cost totaling $223.8 million and realized a gain of $228 thousand on the sale. The security sold had a short term and low yield. The proceeds from the sale of this security were reinvested into longer-term, higher-yielding securities. The remaining sales were primarily related to securities purchased during 2015 and subsequently sold in connection with our aforementioned tax planning strategies related to the Texas franchise tax.
Other Non-Interest Income. Other non-interest income for 2017 decreased $3.9 million, or 9.5%, compared to 2016. The decrease was primarily related to decreases in gains on the sale of foreclosed and other assets (down $6.3 million), lease rental income (down $482 thousand) and earnings on the cash surrender value of life insurance policies (down $409 thousand), among other things, partly offset by increases in sundry and other miscellaneous income (up $1.4 million), income from customer derivative and trading activities (up $815 thousand) and income from customer foreign currency transactions (up $760 thousand), among other things. During 2016, gains on the sale of foreclosed and other assets included a $10.3 million net gain on the sale of our headquarters building and other adjacent properties in connection with a comprehensive development agreement with the City of San Antonio and a third party controlled by one of our directors, among other things. See Note 4 -Premises and Equipment in the accompanying notes to consolidated financial statements included elsewhere in this report. During 2017, gains on the sale of foreclosed and other assets included $2.9 million related to amortization of the deferred portion of the gain on our headquarters building sold in 2016 and $2.0 million related to the sale of a motor-bank location. Sundry income during 2017 included $1.9 million in VISA check card incentives related to business volumes, $1.2 million related to the collection of amounts charged-off by Western National Bank prior to our acquisition, $864 thousand related to the settlement of a non-solicitation agreement and $541 thousand related to recoveries of prior write-offs, among other things, while sundry and other miscellaneous income during 2016 included $1.8 million in VISA check card incentives related to business volumes and $1.4 million related to recoveries of prior write-offs, among other things. The fluctuations in income from customer derivative and trading activities and income from customer foreign currency transactions were primarily related to changes in business volumes.
Other non-interest income for 2016 increased $5.5 million, or 15.4%, compared to 2015. The increase was primarily related to increases in gains on the sale of foreclosed and other assets (up $7.3 million), income from customer foreign currency transactions (up $592 thousand) and income from customer derivative and trading activities (up $491 thousand)

44


partly offset by decreases in mineral interest income (down $1.9 million) and sundry and other miscellaneous income (down $1.2 million). The increase in gains on the sale of foreclosed and other assets was primarily related to the realization of a $10.3 million net gain on the sale of our headquarters building and other adjacent properties in connection with a comprehensive development agreement with the City of San Antonio and a third party controlled by one of our directors. During 2016, sundry and other miscellaneous income included, among other things, $1.8 million in VISA check card incentives related to business volumes and $1.4 million related to recoveries of prior write-offs, while sundry and other miscellaneous income during 2015 included, among other things, $1.2 million related to distributions received on a small business investment company ("SBIC") investment, $1.7 million related to recoveries of prior write-offs, $1.7 million in VISA check card incentives related to business volumes and $324 thousand related to an insurance settlement. Mineral interest income is primarily related to oil and gas royalties received from severed mineral interests owned by our wholly-owned non-banking subsidiary Main Plaza Corporation. The decrease in mineral interest income was partly related to lower energy prices and a decrease in production. The fluctuations in public finance underwriting fees, income from customer foreign currency transactions and income from customer derivative and trading activities were primarily related to changes in business volumes.
Non-Interest Expense
The components of non-interest expense were as follows:
 
2017
 
2016
 
2015
Salaries and wages
$
337,068

 
$
318,665

 
$
310,504

Employee benefits
74,575

 
72,615

 
69,746

Net occupancy
75,971

 
71,627

 
65,690

Technology, furniture and equipment
74,335

 
71,208

 
64,373

Deposit insurance
20,128

 
17,428

 
14,519

Intangible amortization
1,703

 
2,429

 
3,325

Other
175,289

 
178,988

 
165,561

Total
$
759,069

 
$
732,960

 
$
693,718

Total non-interest expense for 2017 increased $26.1 million, or 3.6%, compared to 2016 while total non-interest expense for 2016 increased $39.2 million, or 5.7%, compared to 2015. Changes in the various components of non-interest expense are discussed below.
Salaries and Wages. Salaries and wages increased $18.4 million, or 5.8%, in 2017 compared to 2016 and increased $8.2 million, or 2.6%, in 2016 compared to 2015. The increase during 2017 compared to 2016 was primarily related to an increase in salaries due to normal annual merit and market increases, an increase in the number of employees, an increase in incentive compensation, due to improved operating performance, and an increase in stock-based compensation. Salaries and wages during 2017 also included approximately $2.5 million in severance expense primarily related to the closure of certain branch locations and the elimination of certain job positions. The increase during 2016 compared to 2015 was primarily related to an increase in salaries due to normal annual merit and market increases, an increase in the number of employees and an increase in incentive compensation partly offset by a decrease in stock-based compensation.
Employee Benefits. Employee benefits expense for 2017 increased $2.0 million, or 2.7%, compared to 2016. The increase was primarily due to increases in expenses related to our 401(k) and profit sharing plans (up $1.7 million), payroll taxes (up $1.3 million), other employee benefits (up $826 thousand) and medical insurance expense (up $487 thousand) partly offset by a decrease in expenses related to our defined benefit retirement plans (down $2.2 million).
Employee benefits expense for 2016 increased $2.9 million, or 4.1%, compared to 2015. The increase was primarily due to increases in medical insurance expense (up $1.8 million), payroll taxes (up $898 thousand) and profit sharing plan expense (up $620 thousand), among other things, partly offset by a decrease in expenses related to our defined benefit retirement plans (down $599 thousand).
Our defined benefit retirement and restoration plans were frozen in 2001 and were replaced by the profit sharing plan. Management believes these actions help reduce the volatility in retirement plan expense. However, we still have funding obligations related to the defined benefit and restoration plans and could recognize retirement expense related to these plans in future years, which would be dependent on the return earned on plan assets, the level of interest rates

45


and employee turnover. We recognized a combined net periodic pension expense of $501 thousand related to our defined benefit retirement and restoration plans in 2017 compared to a combined net periodic pension expense of $2.7 million in 2016 and $3.3 million in 2015. Net periodic pension expense during 2016 included $1.0 million in supplemental executive retirement plan (“SERP”) settlement costs related to the retirement of a former executive officer. Despite the impact of these settlement costs, net periodic pension expense decreased during the comparable years in part due to a change in 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. Future expense/benefits related to these plans is dependent upon a variety of factors, including the actual return on plan assets. For additional information related to our employee benefit plans, see Note 11 - Employee Benefit Plans in the accompanying notes to consolidated financial statements included elsewhere in this report.
Net Occupancy. Net occupancy expense for 2017 increased $4.3 million, or 6.1%, compared to 2016. The increase during 2017 was primarily related to increases in lease expense (up $3.2 million), repairs and maintenance/service contracts expense (up $1.3 million), depreciation on leasehold improvements (up $658 thousand) and utilities expense (up $375 thousand) partly offset by a decrease in building depreciation (down $1.3 million). The increases in lease expense and the decreases in building depreciation during the reported periods were primarily related to the sale and lease back of our headquarters building in December 2016. See Note 4 - Premises and Equipment in the accompanying notes to consolidated financial statements included elsewhere in this report.
Net occupancy expense for 2016 increased $5.9 million, or 9.0%, compared to 2015. The increase was primarily related to increases in building depreciation (up $2.7 million), property taxes (up $1.4 million), repairs and maintenance/service contracts expense (up $1.3 million) and depreciation on leasehold improvements (up $764 thousand). The net increase in occupancy expense was partly related to a new operations and support center, a portion of which was placed into service during 2015 with the remainder placed into service in 2016, and new financial center locations.
Technology, Furniture and Equipment. Technology, furniture and equipment expense for 2017 increased $3.1 million, or 4.4%, compared to 2016. The increase was primarily related to increases in software maintenance (up $3.9 million) and depreciation on furniture and equipment (up $988 thousand) partly offset by a decrease in equipment rental expense (down $1.6 million), and a decrease in service contracts (down $436 thousand), among other things. The increase in software maintenance was primarily due to new and renewed software applications and an increase in volume-based service payments.
Technology, furniture and equipment expense for 2016