-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, H8ayBsjZxMUelkCTS8zx7rXXBmvroRaP89aHvTCvdyLj8LcpmP4ej5kM3RVF8kQ3 OVoHX1Rtcew8Oz7q2dRMrg== 0000950134-00-002787.txt : 20000331 0000950134-00-002787.hdr.sgml : 20000331 ACCESSION NUMBER: 0000950134-00-002787 CONFORMED SUBMISSION TYPE: 10-K405 PUBLIC DOCUMENT COUNT: 7 CONFORMED PERIOD OF REPORT: 19991231 FILED AS OF DATE: 20000330 FILER: COMPANY DATA: COMPANY CONFORMED NAME: CULLEN FROST BANKERS INC CENTRAL INDEX KEY: 0000039263 STANDARD INDUSTRIAL CLASSIFICATION: NATIONAL COMMERCIAL BANKS [6021] IRS NUMBER: 741751768 STATE OF INCORPORATION: TX FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-K405 SEC ACT: SEC FILE NUMBER: 001-13221 FILM NUMBER: 586526 BUSINESS ADDRESS: STREET 1: 100 W HOUSTON ST STREET 2: P O BOX 1600 CITY: SAN ANTONIO STATE: TX ZIP: 78205 BUSINESS PHONE: 2102204841 FORMER COMPANY: FORMER CONFORMED NAME: FROST BANK CORP DATE OF NAME CHANGE: 19770823 10-K405 1 FORM 10-K FOR FISCAL YEAR END DECEMBER 31, 1999 1 SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-K [X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE FISCAL YEAR ENDED DECEMBER 31, 1999 [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE TRANSITION PERIOD FROM ______________ TO ______________ COMMISSION FILE NUMBER 0-7275 CULLEN/FROST BANKERS, INC. (Exact name of registrant as specified in its charter) TEXAS 74-1751768 --------------------------- ---------------- (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification No.) 100 W. HOUSTON STREET SAN ANTONIO, TEXAS 78205 ------------------------------------ ------------ (Address of principal executive offices) (Zip Code) REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE: (210) 220-4011 SECURITIES REGISTERED PURSUANT TO SECTION 12(B) OF THE ACT: COMMON STOCK, $.01 PAR VALUE (WITH ATTACHED RIGHTS) ------------------------------ (Title of Class) SECURITIES REGISTERED PURSUANT TO SECTION 12(G) OF THE ACT: NONE. Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes [X] No [ ] Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of the registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. [X] The aggregate market value of the voting stock held by non-affiliates of the registrant was $1,250,981,038 based on the closing price of such stock as of March 17, 2000. Indicate the number of shares outstanding of each of the registrant's classes of common stock, as of the latest practicable date. Outstanding at Class March 17, 2000 - ---------------------------- ---------------------------- COMMON STOCK, $.01 PAR VALUE 52,440,633 DOCUMENTS INCORPORATED BY REFERENCE (1) Proxy Statement for Annual Meeting of Shareholders to be held May 31, 2000 (Part III) 2 TABLE OF CONTENTS
PAGE ---- PART I - ------ ITEM 1. BUSINESS.................................................... 3 ITEM 2. PROPERTIES.................................................. 11 ITEM 3. LEGAL PROCEEDINGS........................................... 11 ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS......... * PART II - ------- ITEM 5. MARKET FOR REGISTRANT'S COMMON STOCK AND RELATED STOCKHOLDER MATTERS..................................................... 12 ITEM 6. SELECTED FINANCIAL DATA..................................... 13 ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS................................... 15 ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK........................................................ 35 ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA................. 36 ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE.................................... * PART III - -------- ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT.......... 68 ITEM 11. EXECUTIVE COMPENSATION...................................... 68 ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.................................................. 68 ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.............. 68 PART IV - ------- ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K......................................................... 69
* Not Applicable 2 3 PART I ITEM 1. BUSINESS - ---------------- GENERAL - ------- Cullen/Frost Bankers, Inc. ("Cullen/Frost" or the "Corporation"), a Texas business corporation incorporated in 1977 and headquartered in San Antonio, Texas, is a bank holding company within the meaning of the Bank Holding Company Act of 1956 ("the BHC Act") and as such is registered with the Board of Governors of the Federal Reserve System ("Federal Reserve Board"). The New Galveston Company, incorporated under the laws of Delaware, is a wholly owned second tier bank holding company subsidiary which owns all banking and non-banking subsidiaries with the exception of Cullen/Frost Capital Trust, a Delaware statutory business trust and wholly-owned subsidiary of the Corporation. At December 31, 1999, Cullen/Frost's principal assets consisted of all of the capital stock of two national banks which had 80 financial centers across Texas with 17 locations in the San Antonio area, 21 in the Houston/Galveston area, 20 in the Fort Worth/Dallas area, 5 in Austin, 9 in the Corpus Christi area, 3 in San Marcos, 2 in McAllen, 2 in the Boerne/Fair Oaks area, and 1 in New Braunfels. At December 31, 1999, Cullen/Frost had consolidated total assets of $7.0 billion and total deposits of $6.0 billion. Based on information from the Federal Reserve Board, at September 30, 1999, Cullen/Frost was the largest of the 109 unaffiliated bank holding companies headquartered in Texas. Cullen/Frost provides policy direction to the Cullen/Frost subsidiary banks in, among others, the following areas: (i) asset and liability management; (ii) accounting, budgeting, planning, insurance and investment banking; (iii) capitalization; and (iv) regulatory compliance. CULLEN/FROST SUBSIDIARY BANKS - ----------------------------- Each of the Cullen/Frost subsidiary banks is a separate entity which operates under the day-to-day management of its own board of directors and officers. The largest of these banks is The Frost National Bank ("Frost Bank"), the origin of which can be traced to a mercantile partnership organized in 1868. Frost Bank was chartered as a national banking association in 1899. At December 31, 1999, Frost Bank, which accounted for approximately 98 percent of consolidated assets, loans and deposits of Cullen/Frost, was the largest bank headquartered in San Antonio and South Texas. The Corporation's other subsidiary bank is United States National Bank of Galveston which had $134 million in assets at December 31, 1999. Cullen/Frost announced on February 17, 2000 that it plans to merge United States National Bank of Galveston into Frost Bank. The merger is expected to be effective in the second quarter of 2000. SERVICES OFFERED BY THE CULLEN/FROST SUBSIDIARY BANKS - ----------------------------------------------------- Commercial Banking The subsidiary banks provide commercial services for corporations and other business clients. Loans are made for a wide variety of general corporate purposes, including interim construction financing on industrial and commercial properties and financing on equipment, inventories, accounts receivable, and recapitalization for turnaround situations, as well as commercial leasing. Frost Bank provides financial services to business clients on both a national and international basis. Consumer Services The subsidiary banks provide a full range of consumer banking services, including checking accounts, savings programs, automated teller machines, installment and real estate loans, home equity loans, drive-in and night deposit services, safe deposit facilities, and discount brokerage services. 3 4 International Banking Frost Bank provides international banking services to customers residing in or dealing with businesses located in Mexico. Such services consist of accepting deposits (in United States dollars only), making loans (in United States dollars only), issuing letters of credit, handling foreign collections, transmitting funds and, to a limited extent, dealing in foreign exchange. Reference is made to pages 25 and 32 of this document. Correspondent Banking Frost Bank acts as correspondent for approximately 328 financial institutions, primarily banks in Texas. These banks maintain deposits with Frost Bank, which offers to the correspondents a full range of services including check clearing, transfer of funds, loan participations, fixed income security services, and securities custody and clearance. Insurance Frost Insurance Agency, Inc., is a wholly-owned subsidiary of Frost Bank and offers corporate and personal property and casualty insurance as well as group health and life insurance products to individuals and businesses. Trust Services The subsidiary banks provide a wide range of trust, investment, agency and custodial services for individual and corporate clients. These services include the administration of estates and personal trusts and the management of investment accounts for individuals, employee benefit plans and charitable foundations. At December 31, 1999, trust assets with a market value of approximately $12.8 billion were being administered by the subsidiary banks. These assets were comprised of discretionary assets of $5.6 billion and non- discretionary assets of $7.2 billion. Discount Brokerage Frost Brokerage Services was formed in March 1986 to provide discount brokerage services and perform other transactions or operations related to the sale and purchase of securities of all types. Frost Brokerage Services is a subsidiary of Frost Bank. SERVICES OFFERED BY THE CULLEN/FROST NON-BANKING SUBSIDIARIES - ------------------------------------------------------------- Frost Securities, Inc., a Section 20 investment banking subsidiary, began operations on August 2, 1999 in Dallas, Texas. The new subsidiary offers a full range of services including equity research, institutional sales, trading and investment banking services to institutional investors and corporate customers who need access to the capital markets. Main Plaza Corporation ("Main Plaza") is a wholly-owned non-banking subsidiary. Main Plaza occasionally makes loans to qualified borrowers. Loans are funded with borrowings against Cullen/Frost's current cash or borrowings against credit lines. Daltex General Agency, Inc. ("Daltex"), a wholly-owned non-banking subsidiary, is a managing general insurance agency. Daltex provides vendor's single interest insurance. COMPETITION - ----------- The subsidiary banks encounter intense competition in their commercial banking businesses, primarily from other banks located in their respective service areas. The subsidiary banks also compete with insurance, finance and mortgage companies, savings and loan institutions, credit unions, money market funds, investment banks and other financial institutions. In the case of some larger customers, competition exists with 4 5 institutions in other major metropolitan areas in Texas and in the remainder of the United States, some of which are larger than the Cullen/Frost subsidiary banks in terms of capital, resources and personnel. SUPERVISION AND REGULATION - -------------------------- Cullen/Frost Cullen/Frost is a legal entity separate and distinct from its bank subsidiaries and is a registered bank holding company under the BHC Act. The BHC Act generally prohibits Cullen/Frost from engaging in any business activity other than banking, managing and controlling banks, furnishing services to a bank which it owns and controls or engaging in non-banking activities closely related to banking. The recently enacted Gramm-Leach-Bliley Act, discussed below, broadens the range of permissible activities to activities that are deemed financial in nature. As a bank holding company, Cullen/Frost is primarily regulated by the Federal Reserve Board which has established guidelines with respect to the maintenance of appropriate levels of capital and payment of dividends by bank holding companies. Cullen/Frost is required to obtain prior approval of the Federal Reserve Board for the acquisition of more than five percent of the voting shares or certain assets of any company (including a bank) or to merge or consolidate with another bank holding company. On November 12, 1999, the Gramm-Leach-Bliley Act of 1999 ("Modernization Act") was signed into law. The Modernization Act: (i) allows bank holding companies meeting management, capital and CRA standards, and receiving the prior approval of the Federal Reserve, to engage in a substantially broader range of financial activities and activities incidental to financial activities than was previously permissible, including insurance underwriting and making merchant banking investments in commercial and financial companies; (ii) allows insurers and other financial services companies to acquire banks; (iii) removes various restrictions that previously applied to bank holding company ownership of securities firms and mutual fund advisory companies; and (iv) establishes the overall regulatory structure applicable to bank holding companies that also engage in insurance and securities operations. Bank holding companies approved for the broader range of activities are called "financial holding companies". This part of the Modernization Act became effective on March 11, 2000. Cullen/Frost was designated a financial holding company under the Modernization Act effective March 15, 2000. The Modernization Act also modified laws related to financial privacy and community reinvestment. The new financial privacy provisions generally prohibit financial institutions, including the Corporation, from disclosing nonpublic personal financial information to third parties unless customers have the opportunity to "opt out" of the disclosure. The Federal Reserve Act and the Federal Deposit Insurance Act ("FDIA") impose restrictions on loans by the subsidiary banks to Cullen/Frost and certain of its subsidiaries, on investments in securities thereof and on the taking of such securities as collateral for loans. Such restrictions generally prevent Cullen/Frost from borrowing from the subsidiary banks unless the loans are secured by marketable obligations. Further, such secured loans, other transactions, and investments by each of such bank subsidiaries are limited in amount as to Cullen/Frost or to certain other subsidiaries to ten percent of the lending bank subsidiary's capital and surplus and as to Cullen/Frost and all such subsidiaries to an aggregate of 20 percent of the lending bank subsidiary's capital and surplus. Under Federal Reserve Board policy, Cullen/Frost is expected to act as a source of financial strength to its banks and to commit resources to support such banks in circumstances where it might not do so absent such policy. In addition, any loans by Cullen/Frost to its banks would be subordinate in right of payment to deposits and to certain other indebtedness of its banks. In the event of a bank holding company's bankruptcy, any commitment by the bank holding company to a federal bank regulatory agency to maintain the capital of a subsidiary bank will be assumed by the bankruptcy trustee and be entitled to a priority of payment. 5 6 Subsidiary Banks The two subsidiary national banks are organized as national banking associations under the National Bank Act and are subject to regulation and examination by the Office of the Comptroller of the Currency (the "Comptroller of the Currency"). Federal and state laws and regulations of general application to banks have the effect, among others, of regulating the scope of the business of the subsidiary banks, their investments, cash reserves, the purpose and nature of loans, collateral for loans, the maximum interest rates chargeable on loans, the amount of dividends that may be declared and required capitalization ratios. Federal law imposes restrictions on extensions of credit to, and certain other transactions with, Cullen/Frost and other subsidiaries, on investments in stock or other securities thereof and on the taking of such securities as collateral for loans to other borrowers. The Comptroller of the Currency with respect to Cullen/Frost's bank subsidiaries has authority to prohibit a bank from engaging in what, in such agency's opinion, constitutes an unsafe or unsound practice in conducting its business. It is possible, depending upon the financial condition of the bank in question and other factors, that such agency could claim that the payment of dividends or other payments might, under some circumstances, be such an unsafe or unsound practice. The principal source of Cullen/Frost's cash revenues is dividends from its bank subsidiaries, and there are certain limitations on the payment of dividends to Cullen/Frost by such bank subsidiaries. The prior approval of the Comptroller of the Currency is required if the total of all dividends declared by a national bank in any calendar year would exceed the bank's net profits, as defined, for that year combined with its retained net profits for the preceding two calendar years less any required transfers to surplus. In addition, a national bank may not pay dividends in an amount in excess of its undivided profits less certain bad debts. Although not necessarily indicative of amounts available to be paid in future periods, Cullen/Frost's subsidiary banks had approximately $78.5 million available for the payment of dividends, without prior regulatory approval, at December 31, 1999. Capital Adequacy Bank regulators have adopted risk-based capital guidelines for bank holding companies and banks. The minimum ratio of qualifying total capital to risk-weighted assets (including certain off-balance sheet items) is eight percent. At least half of the total capital is to be comprised of common stock, retained earnings, perpetual preferred stocks, minority interests and for bank holding companies, a limited amount of qualifying cumulative perpetual preferred stock, less certain intangibles including goodwill ("Tier 1 capital"). The remainder ("Tier 2 capital") may consist of other preferred stock, certain other instruments, and limited amounts of subordinated debt and the allowance for loan and lease losses. In addition, bank regulators have established minimum leverage ratio (Tier 1 capital to average total assets) guidelines for bank holding companies and banks. These guidelines provide for a minimum leverage ratio of three percent for bank holding companies and banks that meet certain specified criteria, including that they have the highest regulatory rating. All other banking organizations will be required to maintain a leverage ratio of at least four percent plus an additional cushion where warranted. The guidelines also provide that banking organizations experiencing internal growth or making acquisitions will be expected to maintain strong capital positions substantially above the minimum supervisory levels, without significant reliance on intangible assets. Furthermore, the guidelines indicate that the Federal Reserve Board will continue to consider a "Tangible Tier 1 Leverage Ratio" in evaluating proposals for expansion or new activities. The Tangible Tier 1 Leverage Ratio is the ratio of Tier 1 capital, less intangibles not deducted from Tier 1 capital, to average total assets. The bank regulators have not advised Cullen/Frost or any bank subsidiary of any specific minimum leverage ratio applicable to it. For information concerning Cullen/Frost's capital ratios, see the discussion under the caption "Capital" on page 33 and Note L "Capital" on page 50. 6 7 FDICIA The Federal Deposit Insurance Corporation Improvements Act of 1991 ("FDICIA"), among other things, requires the Federal banking agencies to take "prompt corrective action" in respect to depository institutions that do not meet minimum capital requirements. FDICIA established five capital tiers: "well capitalized," "adequately capitalized," "undercapitalized," "significantly undercapitalized" and "critically undercapitalized". Under the final rules adopted by the Federal banking regulators relating to these capital tiers, an institution is deemed to be: well capitalized if the institution has a total risk-based capital ratio of ten percent or greater, a Tier 1 risk-based capital ratio of six percent or greater, and a leverage ratio of five percent or greater, and the institution is not subject to an order, written agreement, capital directive, or prompt corrective action directive to meet and maintain a specific capital level for any capital measure; adequately capitalized if the institution has a total risk-based capital ratio of eight percent or greater, a Tier 1 risk-based capital ratio of four percent or greater, and a leverage ratio of four percent or greater (or a leverage ratio of three percent for bank holding companies which meet certain specified criteria, including having the highest regulatory rating); undercapitalized if the institution has a total risk-based capital ratio that is less than eight percent, a Tier 1 risk-based capital ratio less than four percent or a leverage ratio less than four percent (or a leverage ratio less than three percent if the institution is rated composite one in its most recent report of examination, subject to appropriate Federal banking agency guidelines); significantly undercapitalized if the institution has a total risk-based capital ratio less than six percent, a Tier 1 risk-based capital ratio less than three percent, or a leverage ratio less than three percent; and critically undercapitalized if the institution has a ratio of tangible equity to total assets equal to or less than two percent. At December 31, 1999, the two subsidiaries of Cullen/Frost that are insured depository institutions -- Frost Bank and U.S. National Bank of Galveston -- were considered "well capitalized". FDICIA generally prohibits a depository institution from making any capital distributions (including payment of a dividend) or paying any management fee to its holding company if the depository institution would thereafter be undercapitalized. Undercapitalized institutions are subject to growth limitations and are required to submit a capital restoration plan. The agencies may not accept such a plan without determining, among other things, that the plan is based on realistic assumptions and is likely to succeed in restoring the depository institution's capital. In addition, for a capital restoration plan to be acceptable, the depository institution's parent holding company must guarantee that the institution will comply with such capital restoration plan. The aggregate liability of the parent holding company is limited to the lesser of (i) an amount equal to five percent of the depository institution's total assets at the time it became undercapitalized and (ii) the amount which is necessary (or would have been necessary) to bring the institution into compliance with all capital standards applicable with respect to such institution as of the time it fails to comply with the plan. If a depository institution fails to submit an acceptable plan, it is treated as if it is significantly undercapitalized. "Significantly undercapitalized" depository institutions may be subject to a number of requirements and restrictions, including orders to sell sufficient voting stock to become "adequately capitalized," requirements to reduce total assets, and cessation of receipt of deposits from correspondent banks. "Critically undercapitalized" institutions are subject to the appointment of a receiver or conservator. FDICIA also contains a variety of other provisions that affect the operations of Cullen/Frost, including reporting requirements, regulatory standards for real estate lending, "truth in savings" provisions, and the requirement that a depository institution give 90 days prior notice to customers and regulatory authorities before closing any branch. The Federal regulatory agencies have issued standards establishing loan-to-value limitations on real estate lending. These standards have not had a significant effect on Cullen/Frost and are not expected to have a significant effect in the future. 7 8 DEPOSIT INSURANCE - ----------------- Cullen/Frost's subsidiary banks are subject to Federal Deposit Insurance Corporation ("FDIC") deposit insurance assessments and to certain other statutory and regulatory provisions applicable to FDIC-insured depository institutions. The risk-based assessment system imposes insurance premiums based upon a matrix that takes into account a bank's capital level and supervisory rating. A depository institution insured by the FDIC can be held liable for any loss incurred by, or reasonably expected to be incurred by, the FDIC, in connection with (i) the default of a commonly controlled FDIC-insured depository institution or (ii) any assistance provided by the FDIC to a commonly controlled, FDIC-insured depository institution in danger of default. "Default" is defined generally as the appointment of a conservator or receiver, and "in danger of default" is defined generally as the existence of certain conditions indicating that a "default" is likely to occur in the absence of regulatory assistance. DEPOSITOR PREFERENCE - -------------------- Deposits and certain claims for administrative expenses and employee compensation against an insured depository institution are afforded priority over other general unsecured claims against such an institution, including federal funds and letters of credit, in the "liquidation or other resolution" of such an institution by any receiver. ACQUISITIONS - ------------ The BHC Act generally limits acquisitions by bank holding companies that are not financial holding companies to commercial banks and companies engaged in activities that the Federal Reserve Board has determined to be so closely related to banking as to be a proper incident thereto and requires the prior approval of the Federal Reserve Board to consummate such acquisitions. Financial holding companies may acquire non-banking entities under the Modernization Act by providing a notice to the Federal Reserve Board after consummation of such an acquisition. The BHC Act, the Federal Bank Merger Act, and the Texas Banking Code regulate the acquisition of commercial banks. The BHC Act requires the prior approval of the Federal Reserve Board for the direct or indirect acquisition of more than five percent of the voting shares of a commercial bank or bank holding company. With respect to Cullen/Frost's subsidiary banks, the approval of the Comptroller of the Currency is required for branching, purchasing the assets of other banks and bank mergers in which the continuing bank is a national bank. In reviewing bank acquisition and merger applications, the bank regulatory authorities will consider, among other things, the competitive effect and public benefits of the transactions, the capital position of the combined organization, and the applicant's record under the Community Reinvestment Act and fair housing laws. Cullen/Frost regularly evaluates acquisition opportunities and conducts due diligence activities in connection with possible acquisitions. As a result, acquisition discussions and, in some cases negotiations, regularly take place and future acquisitions could occur. INTERSTATE BANKING AND BRANCHING LEGISLATION - -------------------------------------------- The Riegle-Neal Interstate Branching Efficiency Act of 1994 ("IBBEA"), authorizes interstate acquisitions of banks and bank holding companies without geographic limitation beginning one year after enactment. In addition, as of June 1, 1997, IBBEA authorized a bank to merge with a bank in another state as long as neither of the states has opted out of interstate branching between the date of enactment of IBBEA and May 31, 1997. IBBEA further provided that states may enact laws permitting interstate bank merger transactions prior to June 1, 1997. A bank may establish a de novo branch in a state in which the bank does not maintain a branch if the state expressly permits de novo branching. Once a bank has established branches 8 9 in a state through an interstate merger transaction, the bank may establish and acquire additional branches at any location in the state where any bank involved in the merger transaction could have established or acquired branches under applicable federal or state law. A bank that has established a branch in a state through de novo branching may establish and acquire additional branches in such state in the same manner and to the same extent as a bank having a branch in such state as a result of an interstate merger. If a state opts out of interstate branching within the specified time period, no bank in any other state may establish a branch in the opting out state, whether through an acquisition or de novo. On August 28, 1995, Texas enacted legislation opting out of interstate branching; however, in the second quarter of 1998, the OCC approved a series of merger transactions requested by a non-Texas based institution that ultimately resulted in the merger of its Texas based bank into the non-Texas based institution. Although challenged in the courts, the final legal ruling allowed the merger to proceed. In addition, on May 13, 1998, the Texas Banking Commissioner began accepting applications filed by state banks to engage in interstate mergers and branching. REGULATORY ECONOMIC POLICIES - ---------------------------- The earnings of the subsidiary banks are affected not only by general economic conditions but also by the policies of various governmental regulatory authorities. The Federal Reserve Board regulates the supply of credit in order to influence general economic conditions, primarily through open market operations in United States government obligations, varying the discount rate on financial institution borrowings, varying reserve requirements against financial institution deposits and restricting certain borrowings by such financial institutions and their subsidiaries. The deregulation of interest rates has had and is expected to continue to have an impact on the competitive environment in which the subsidiary banks operate. Governmental policies have had a significant effect on the operating results of commercial banks in the past and are expected to continue to do so in the future. However, Cullen/Frost cannot accurately predict the nature or extent of any effect such policies may have on its future business and earnings. EMPLOYEES - --------- At December 31, 1999, Cullen/Frost employed 3,336 full-time equivalent employees. Employees of Cullen/Frost enjoy a variety of employee benefit programs, including a retirement plan, 401(k) stock purchase plans, various comprehensive medical, accident and group life insurance plans and paid vacations. Cullen/Frost considers its employee relations to be good. 9 10 EXECUTIVE OFFICERS OF THE REGISTRANT - ------------------------------------ The names, ages, recent business experience and positions or offices held by each of the executive officers during 1999 of Cullen/Frost are as follows:
AGE AS OF NAME AND POSITIONS OR OFFICES 12/31/99 RECENT BUSINESS EXPERIENCE - ------------------------------------------ --------- ------------------------------------------------ T.C. Frost 72 Officer and Director of Frost Bank since 1950. Senior Chairman of the Board Chairman of the Board of Cullen/Frost from 1973 and Director to October 1995. Member of the Executive Committee of Cullen/Frost 1973 to present. Chief Executive Officer of Cullen/Frost from July 1977 to October 1997. Senior Chairman of Cullen/Frost from October 1995 to present. Richard W. Evans, Jr. 53 Officer of Frost Bank since 1973. Executive Vice Chairman of the Board, President of Frost Bank from 1978 to April 1985. Chief Executive Officer and Director President of Frost Bank from April 1985 to August 1993. Chairman of the Board and Chief Executive Officer of Frost Bank from August 1993 to present. Director and Member of the Executive Committee of Cullen/Frost from August 1993 to present. Chairman of the Board and Chief Operating Officer of Cullen/Frost from October 1995 to October 1997. Chairman of the Board and Chief Executive Officer of Cullen/Frost from October 1997 to present. Patrick B. Frost 39 Officer of Frost Bank since 1985. President of President of Frost Bank Frost Bank from August 1993 to present. Director and Director of Cullen/ Frost from May 1997 to present. Member of the Executive Committee of Cullen/Frost from July 1997 to present. Phillip D. Green 45 Officer of Frost Bank since July 1980. Vice Senior Executive Vice President President and Controller of Frost Bank from and Chief Financial Officer January 1981 to January 1983. Senior Vice President and Controller of Frost Bank from January 1983 to July 1985. Senior Vice President and Treasurer of Cullen/Frost from July 1985 to April 1989. Executive Vice President and Treasurer of Cullen/Frost from May 1989 to October 1995. Executive Vice President and Chief Financial Officer of Cullen/Frost from October 1995 to July 1998. Senior Executive Vice President and Chief Financial Officer from July 1998 to present.
Stan McCormick, age 54, has been an officer of Frost Bank since 1994 and Secretary of Cullen/Frost from June 1999 to present. There are no arrangements or understandings between any executive officer of Cullen/Frost and any other person pursuant to which he was or is to be selected as an officer. 10 11 ITEM 2. PROPERTIES - ------------------- The executive offices of Cullen/Frost, as well as the principal banking quarters of Frost Bank, are housed in both a 21-story office tower and a nine-story office building located on approximately 3.5 acres of land in downtown San Antonio. Cullen/Frost and Frost Bank lease approximately 50 percent of the office tower. The nine-story office building was purchased in April 1994. Frost Bank also leases space in a seven-story parking garage adjacent to the banking quarters. In June 1987, Frost Bank consummated the sale of its office tower and leased back a portion of the premises under a 13-year primary lease term with options allowing for occupancy up to 50 years. The Bank also sold its related parking garage facility and leased back space in that structure under a 12-year primary lease term with options allowing for occupancy up to 50 years. Both leases allow for purchase of the related asset under specific terms. Frost Bank has agreed to repurchase the office tower and related parking garage facility. Closing of the transaction is expected to take place in the second quarter of 2002. The subsidiary bank located in Galveston is housed in facilities which, together with tracts of adjacent land used for parking and drive-in facilities, are either owned or leased by the subsidiary bank. ITEM 3. LEGAL PROCEEDINGS - ------------------------- Certain subsidiaries of Cullen/Frost are defendants in various matters of litigation which have arisen in the normal course of conducting a commercial banking business. In the opinion of management, the disposition of such pending litigation will not have a material effect on Cullen/Frost's consolidated financial position. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS - ------------------------------------------------------------ None. 11 12 PART II ITEM 5. MARKET FOR REGISTRANT'S COMMON STOCK AND RELATED STOCKHOLDER - ---------------------------------------------------------------------- MATTERS -------- Common Stock Market Prices and Dividends The tables below sets forth for each quarter the high and low sales prices for Cullen/Frost's common stock and the dividends per share paid for each quarter. The Company's common stock is traded on the New York Stock Exchange ("NYSE") under the symbol: CFR. High and low sales prices are as reported by the NYSE.
1999 1998 --------------- --------------- MARKET PRICE (PER SHARE) HIGH LOW HIGH LOW - ---------------------------------------------------------------------------------------------- First Quarter.............................................. $27.94 $22.69 $30.60 $25.38 Second Quarter............................................. 28.94 23.19 30.35 24.75 Third Quarter.............................................. 28.94 22.81 29.00 20.44 Fourth Quarter............................................. 30.38 23.88 28.47 21.82
The number of record holders of common stock at February 18, 2000 was 2,413.
CASH DIVIDENDS (PER SHARE) 1999 1998 - ---------------------------------------------------------------------------- First Quarter............................................... $.150 $.125 Second Quarter.............................................. .175 .150 Third Quarter............................................... .175 .150 Fourth Quarter.............................................. .175 .150 -------------- Total.................................................. $.675 $.575 ==============
The Corporation's management is committed to the continuation of the payment of regular cash dividends, however there is no assurance as to future dividends because they are dependent on future earnings, capital requirements and financial conditions. See "Capital" section on page 33 for further discussion and Note K "Dividends" on page 50. 12 13 ITEM 6. SELECTED FINANCIAL DATA - -------------------------------- CONSOLIDATED STATEMENTS OF OPERATIONS (dollars in thousands, except per share amounts)
Year Ended December 31 --------------------------------------------------------------- 1999 1998 1997 1996 1995 1994 - --------------------------------------------------------------------------------------------------------- INTEREST INCOME: Loans, including fees............... $329,610 $300,721 $261,607 $219,279 $180,696 $125,571 Securities.......................... 113,561 120,259 110,070 112,921 109,593 104,986 Time deposits....................... 164 Federal funds sold and securities purchased under resale agreements........................ 4,245 7,111 12,423 7,506 7,154 4,337 --------------------------------------------------------------- TOTAL INTEREST INCOME.......... 447,580 428,091 384,100 339,706 297,443 234,894 INTEREST EXPENSE: Deposits............................ 128,819 138,283 131,140 117,179 100,785 69,154 Federal funds purchased and securities sold under repurchase agreements........................ 12,500 11,606 8,739 9,773 15,347 8,336 Guaranteed preferred beneficial interests in the Corporation's junior subordinated deferrable interest debentures............... 8,475 8,475 7,652 Other borrowings.................... 808 1,754 1,434 1,037 739 8 --------------------------------------------------------------- TOTAL INTEREST EXPENSE......... 150,602 160,118 148,965 127,989 116,871 77,498 --------------------------------------------------------------- NET INTEREST INCOME............ 296,978 267,973 235,135 211,717 180,572 157,396 Provision for possible loan losses...... 12,427 10,393 9,174 8,494 7,605 473 --------------------------------------------------------------- NET INTEREST INCOME AFTER PROVISION FOR POSSIBLE LOAN LOSSES....................... 284,551 257,580 225,961 203,223 172,967 156,923 NON-INTEREST INCOME: Trust fees.......................... 46,411 46,863 43,275 36,898 34,342 31,767 Service charges on deposit accounts.......................... 58,787 53,601 47,627 41,570 33,364 30,848 Other service charges, collection and exchange charges, commissions and fees.......................... 23,503 15,482 11,349 9,199 11,456 9,668 Net (loss) gain on securities transactions...................... (86) 359 498 (892) (1,382) (4,767) Other............................... 28,470 22,361 18,953 17,403 18,241 15,628 --------------------------------------------------------------- TOTAL NON-INTEREST INCOME...... 157,085 138,666 121,702 104,178 96,021 83,144 NON-INTEREST EXPENSE: Salaries and wages.................. 126,471 111,423 98,874 85,646 70,104 62,412 Pension and other employee benefits.......................... 26,096 21,295 19,874 18,224 13,313 11,720 Net occupancy of banking premises... 27,149 25,486 22,812 21,486 20,238 17,779 Furniture and equipment............. 19,958 18,921 16,147 14,697 13,276 12,631 Intangible amortization............. 15,000 13,293 11,920 11,306 8,124 7,627 Other............................... 78,341 75,844 65,514 58,695 62,333 64,019 Merger related charges.............. 12,244 --------------------------------------------------------------- TOTAL NON-INTEREST EXPENSE..... 293,015 278,506 235,141 210,054 187,388 176,188 --------------------------------------------------------------- INCOME BEFORE INCOME TAXES..... 148,621 117,740 112,522 97,347 81,600 63,879 Income taxes............................ 50,979 42,095 39,555 34,409 28,213 22,100 --------------------------------------------------------------- NET INCOME..................... $ 97,642 $ 75,645 $ 72,967 $ 62,938 $ 53,387 $ 41,779 =============================================================== Net income per common share: Basic............................... $ 1.83 $ 1.42 $ 1.38 $ 1.18 $ 1.01 $ .79 Diluted............................. 1.78 1.38 1.33 1.16 .99 .78 Return on Average Assets................ 1.42% 1.18% 1.28% 1.23% 1.20% 1.02% Return on Average Equity................ 18.68 15.44 16.38 15.63 14.84 13.17
Historical amounts have been restated for stock splits and to reflect the merger with Overton Bancshares, Inc. 13 14 SELECTED FINANCIAL DATA (dollars in thousands, except per share amounts)
Year Ended December 31 --------------------------------------------------------------------------- 1999 1998 1997 1996 1995 1994 =========================================================================== BALANCE SHEET DATA Total assets......................... $6,996,680 $6,869,605 $6,045,573 $5,599,248 $4,774,750 $4,260,076 Guaranteed preferred beneficial interest in the Corporation's junior subordinated deferrable interest debentures, net........... 98,513 98,458 98,403 Shareholders' equity................. 509,311 512,919 462,929 424,786 382,003 326,569 Average shareholders' equity to average total assets............... 7.60% 7.63% 7.83% 7.87% 8.10% 7.76% Tier 1 risk based capital ratio...... 11.04 12.23 13.21 11.39 12.73 14.17 Total risk based capital ratio....... 12.28 13.48 14.46 12.64 13.98 15.42 PER COMMON SHARE DATA Net income-basic..................... $ 1.83 $ 1.42* $ 1.38 $ 1.18 $ 1.01 $ .79 Net income-diluted................... 1.78 1.38* 1.33 1.16 .99 .78 Cash dividends paid-CFR.............. .675 .575 .480 .403 .285 .17 Shareholders' equity................. 9.64 9.60 8.74 7.96 7.18 6.17 LOAN PERFORMANCE INDICATORS Non-performing assets................ $ 18,837 $ 17,104 $ 18,088 $ 14,069 $ 18,681 $ 22,114 Non-performing assets to: Total loans plus foreclosed assets.......................... .45% .47% .58% .53% .87% 1.27% Total assets....................... .27 .25 .30 .25 .39 .52 Allowance for possible loan losses... $ 58,345 $ 53,616 $ 48,073 $ 42,821 $ 36,525 $ 29,017 Allowance for possible loan losses to period-end loans................... 1.40% 1.47% 1.54% 1.60% 1.71% 1.67% Net loan charge-offs (recoveries).... $ 8,764 $ 6,100 $ 6,027 $ 2,825 $ 527 $ (1,894) Net loan charge-offs (recoveries) to average loans...................... .22% .18% .21% .12% .03% (.12)% COMMON STOCK DATA Common shares outstanding at period end......................... 52,823 53,425 52,940 53,365 53,224 52,918 Weighted average common shares....... 53,368 53,150 52,999 53,195 53,043 52,659 Dilutive effect of stock options..... 1,378 1,529 1,753 1,257 945 866 Dividends as a percentage of net income**........................... 36.88% 35.79% 30.50% 29.80% 24.47% 18.29% NON-FINANCIAL DATA Number of employees.................. 3,336 3,095 3,045 2,743 2,399 2,198 Shareholders of record............... 2,442 2,624 2,358 2,336 2,463 2,553
* 1998 basic and diluted earnings per share before the after-tax merger related charge were $1.60 and $1.56, respectively. ** Includes dividends paid by Overton and excludes the after-tax impact of the $12.2 million merger related charge in 1998. 14 15 ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND - ----------------------------------------------------------------------- RESULTS OF OPERATIONS --------------------- FINANCIAL REVIEW Discussed below are the operating results for Cullen/Frost Bankers, Inc. and Subsidiaries ("Cullen/ Frost" or the "Corporation") for the years 1997 through 1999. Cullen/Frost completed bank acquisitions during the first and second quarters of 1999 and one each in the first quarters of 1998 and 1997. The Corporation also acquired an independent insurance agency in the second quarter of 1999. These acquisitions, as described below, were all accounted for as purchase transactions, and as such, their related results of operations are included from the date of acquisition. During the second quarter of 1998, Cullen/Frost also completed the merger with Overton Bancshares, Inc., as described below. The merger was accounted for as a "pooling-of-interests" transaction, and as such, historical amounts were restated to reflect the merger. All balance sheet amounts presented in the following financial review are averages unless otherwise indicated. Certain reclassifications have been made to make prior periods comparable. Taxable-equivalent adjustments assume a 35 percent federal tax rate. Dollar amounts in tables are stated in thousands, except for per share amounts. The number of shares and related earnings per share amounts have been restated to retroactively give effect for the two-for-one stock split declared and paid by Cullen/Frost during the second quarter of 1999. MERGER AND ACQUISITIONS - ----------------------- On May 20, 1999, Cullen/Frost paid approximately $42.3 million to acquire Commerce Financial Corporation and its four-location subsidiary, Bank of Commerce, in Fort Worth, Texas. The Corporation acquired loans of approximately $76 million and deposits of approximately $164 million. The intangible assets associated with the acquisition amounted to approximately $30.5 million. This acquisition did not have a material impact on Cullen/Frost's 1999 net income. On May 1, 1999, Frost Insurance Agency, a subsidiary of The Frost National Bank, acquired Professional Insurance Agents, Inc. ("PIA"), a mid-sized independent insurance agency based in Victoria, Texas, with additional locations in San Antonio, New Braunfels and Refugio. PIA offers as agent, corporate and personal property and casualty insurance as well as group health and life insurance products to individuals and businesses. This acquisition did not have a material impact on Cullen/Frost's 1999 net income. On January 15, 1999, Cullen/Frost paid approximately $18.7 million to acquire Keller State Bank with three locations in Tarrant County, Texas. The Corporation acquired loans of approximately $38 million and deposits of approximately $62 million. This acquisition did not have a material impact on Cullen/Frost's 1999 net income. On May 29, 1998, Cullen/Frost completed the merger of Overton Bancshares, Inc., ("Overton") in Fort Worth, Texas, and its wholly-owned subsidiary, Overton Bank & Trust, N.A. The merger was the Corporation's first entry into the Fort Worth market. With the merger, the Corporation acquired twelve locations in Fort Worth/Arlington and two in Dallas. The Corporation issued approximately 4.38 million common shares as part of this transaction. As a result of the transaction, the Corporation recorded a merger related charge of $12.2 million primarily consisting of severance payments and other employee benefits, and investment banking fees. On January 2, 1998, the Corporation paid approximately $55.3 million to acquire Harrisburg Bancshares, Inc., including its subsidiary Harrisburg Bank in Houston, Texas. The Corporation acquired loans of approximately $125 million and deposits of approximately $222 million. This acquisition did not have a material impact on the Corporation's 1998 net income. On March 7, 1997, the Corporation paid approximately $32.2 million to acquire Corpus Christi Bancshares, Inc., including its subsidiary Citizens State Bank, based in Corpus Christi, Texas. The 15 16 Corporation acquired loans of approximately $108 million and deposits of approximately $184 million. This acquisition did not have a material impact on the Corporation's 1997 net income. Investment Banking Subsidiary On August 2, 1999 Cullen/Frost began operations of its Section 20 investment banking subsidiary in Dallas, Texas. The new subsidiary, Frost Securities, Inc., offers a full range of services including equity research, institutional sales, trading and investment banking services to institutional investors and corporate customers. RESULTS OF OPERATIONS - --------------------- For the year ended December 31, 1999, Cullen/Frost reported net income of $97.6 million or $1.78 per diluted common share, an all-time earnings high. Operating earnings for the year ended December 31, 1998 were $85.2 million or $1.56 per diluted common share. Operating earnings exclude the after-tax impact of the merger related charge of $12.2 million associated with the merger of Overton. Net income for 1997 was $73.0 million or $1.33 per diluted common share for 1997. Return on average assets for 1999 was 1.42 percent compared with 1.33 percent in 1998 (excluding the merger related charge), and 1.28 percent in 1997, while return on average equity was 18.68 percent in 1999 compared with 17.38 percent in 1998 (excluding the merger related charge), and 16.38 percent in 1997.
1999 Change 1998 Change EARNINGS SUMMARY 1999 FROM 1998 1998 FROM 1997 1997 - ------------------------------------------------------------------------------------------------- Taxable-equivalent net interest income............................. $301,480 $ 30,708 $270,772 $33,686 $237,086 Taxable-equivalent adjustment........ 4,502 1,703 2,799 848 1,951 ---------------------------------------------------------- Net interest income.................. 296,978 29,005 267,973 32,838 235,135 Provision for possible loan losses... 12,427 2,034 10,393 1,219 9,174 Non-interest income: Net (loss) gain on securities transactions.................. (86) (445) 359 (139) 498 Other........................... 157,171 18,864 138,307 17,103 121,204 ---------------------------------------------------------- Total non-interest income................... 157,085 18,419 138,666 16,964 121,702 Non-interest expense: Intangible amortization......... 15,000 1,707 13,293 1,373 11,920 Merger related charge........... (12,244) 12,244 12,244 Other operating expenses........ 278,015 25,046 252,969 29,748 223,221 ---------------------------------------------------------- Total non-interest expense.................. 293,015 14,509 278,506 43,365 235,141 ---------------------------------------------------------- Income before income taxes........... 148,621 30,881 117,740 5,218 112,522 Income taxes......................... 50,979 8,884 42,095 2,540 39,555 ---------------------------------------------------------- Net income........................... $ 97,642 $ 21,997 $ 75,645 $ 2,678 $ 72,967 ========================================================== Per common share: Net income-basic................ $ 1.83 $ .41 $ 1.42* $ .04 $ 1.38 Net income-diluted.............. 1.78 .40 1.38* .05 1.33 Return on Average Assets............. 1.42% .24% 1.18%* (.10)% 1.28% Return on Average Equity............. 18.68 3.24 15.44* (.94) 16.38
* Operating basic and diluted earnings per share for 1998 were $1.60 and $1.56, respectively. Operating ROA and ROE for 1998 were 1.33 percent and 17.38 percent, respectively. 16 17 RESULTS OF SEGMENT OPERATIONS - ----------------------------- The Corporation's operations are managed along two major Operating Segments: Banking and the Financial Management Group. A description of each business and the methodologies used to measure financial performance are described in Note V to the Consolidated Financial Statements on page 61. The following table summarizes operating earnings and net income by Operating Segment for each of the last three years:
YEAR ENDED DECEMBER 31 ---------------------------- (DOLLARS IN THOUSANDS) 1999 1998 1997 - ------------------------------------------------------------------------------------------ Banking..................................................... $ 93,427 $78,826 $68,312 Financial Management Group.................................. 15,262 14,497 12,878 Non-Banks................................................... (11,047) (8,167) (8,223) ---------------------------- Consolidated operating earnings............................. $ 97,642 $85,156* $72,967 Consolidated net income..................................... $ 97,642 $75,645 $72,967 ============================
* Excludes the after-tax impact of the $12.2 million Overton merger related charge. See discussion on page 15. Banking net income was $93.4 million for 1999 up from $78.8 million for 1998 and $68.3 million for 1997. The increase in net income in 1999 versus 1998 and 1997 was due primarily to loan growth. Acquisitions did occur in each of the three years, however, most of the loan growth was internally generated. Higher service charge income also contributed to the increases in 1999 and 1998 but were offset by increases in non-interest expenses, primarily from increased salaries and wages. The Financial Management Group net income for 1999 was $15.3 million compared to $14.5 million and $12.9 million for 1998 and 1997, respectively. Most of the growth between years was due to Frost Investment Services, which includes brokerage services as well as personal wealth management. Most of the increase in the operating loss for non-banks in 1999 was impacted by an increase in expenses relating to Frost Securities Inc., a section 20 investment banking subsidiary that began operations in August of 1999. NET INTEREST INCOME - ------------------- Net interest income on a tax equivalent basis for 1999 was $301.5 million, an increase from $270.8 million recorded in 1998 and the $237.1 million recorded in 1997. The primary reason for the increase has been the growth in loans, generated both internally and through acquisitions. See "Consolidated Average Balance Sheets" on pages 64 and 65 and "Rate Volume Analysis" on page 66. The net interest margin, was 5.15 percent for the year ended December 31, 1999, compared to 4.93 percent and 4.87 percent for the years 1998 and 1997, respectively. The increase in the net interest margin from a year ago is due to strong loan growth resulting in an improved earning asset mix. Net interest spread for 1999 increased 30 basis points to 4.34 percent. The increase in net interest spread for 1999 is primarily due to Cullen/Frost's ability to improve loan spreads through lower funding costs. Net interest spread was 4.04 percent and 3.99 percent for 1998 and 1997, respectively. The net interest spread as well as the net interest margin could be impacted by future changes in short-and long-term interest rate levels. 17 18 MARKET RISK DISCLOSURE -- INTEREST RATE SENSITIVITY - -------------------------------------------------- Market risk is the potential loss arising from adverse changes in the fair value of a financial instrument due to the changes in market rates and prices. In the ordinary course of business, Cullen/Frost's market risk is primarily that of interest rate risk. The Corporation's interest rate sensitivity and liquidity are monitored by its Asset/Liability Management Committee on an ongoing basis. The Committee seeks to avoid fluctuating net interest margins and to maintain consistent growth of net interest income through periods of changing interest rates. A variety of measures are used to provide for a comprehensive view of the magnitude of interest rate risk, the distribution of risk, level of risk over time and exposure to changes in certain interest rate relationships. Cullen/Frost utilizes an earnings simulation model as the primary quantitative tool in measuring the amount of interest rate risk associated with changing market rates. The model quantifies the effects of various interest rate scenarios on the projected net interest income and net income over the ensuing 12 month period. The model was used to measure the impact on net interest income relative to a base case scenario, of rates increasing or decreasing ratably 200 basis points over the next 12 months. These simulations incorporate assumptions regarding balance sheet growth and mix, pricing and the repricing and maturity characteristics of the existing and projected balance sheet. All off-balance sheet financial instruments such as derivatives are included in the model. Other interest rate-related risks such as prepayment, basis and option risk are also considered. The resulting model simulations show that a 200 basis point increase in rates will result in a positive variance in net interest income of 0.3 percent relative to the base case over the next 12 months; while a decrease of 200 basis points will result in a negative variance in net interest income of 0.8 percent. This compares to last year when a 200 basis points increase in rates resulted in a positive variance in net interest income of 0.7 percent relative to the base case over the next 12 months while a decrease of 200 basis points resulted in a negative variance in net interest income of 0.7 percent. The Corporation's trading portfolio is immaterial and as such separate quantitative disclosure is not presented. As the accompanying table indicates, the Corporation is liability-sensitive, on a cumulative basis, at time periods of one year or less (assuming non-maturity deposits are immediately rate sensitive). This gap analysis is based on a point in time and may not be meaningful because assets and liabilities must be categorized according to contractual maturities and repricing periods rather than estimating more realistic behaviors as is done in the sensitivity model discussed above. Also, the gap analysis does not consider subsequent changes in interest rate levels or spreads between asset and liability categories. Cullen/Frost continuously monitors and manages the balance between interest rate-sensitive assets and liabilities. The Corporation's objective is to manage the impact of fluctuating market rates on net interest income within acceptable levels. In order to meet this objective, the Corporation may lengthen or shorten the duration of assets or liabilities or enter into derivative contracts to mitigate potential market risk. 18 19
December 31, 1999 ------------------------------------------------------------------------------ Immediately Rate Non-Rate Sensitive Rate Sensitive Within Sensitive CUMULATIVE INTEREST RATE SENSITIVITY ----------- ------------------------------------- ----------- (PERIOD-END BALANCES) 0-30 Days 90 Days One Year Five Years >Five Years Total - -------------------------------------------------------------------------------------------------------------------- Earning Assets: Loans....................... $2,155,604 $ 2,316,977 $2,751,734 $3,648,046 $ 518,682 $4,166,728 Securities.................. 75,697 198,396 533,999 947,614 682,297 1,629,911 Federal funds sold & other short-term investments.... 41,496 41,496 41,496 41,496 41,496 ------------------------------------------------------------------------------ Total earning assets... $2,272,797 $ 2,556,869 $3,327,229 $4,637,156 $1,200,979 $5,838,135 ============================================================================== Interest -- Bearing Liabilities: Savings and Interest-on- Checking.................. $ 984,438 $ 984,438 $ 984,438 $ 984,438 $ 984,438 Money market deposit accounts... 1,635,524 1,635,524 1,635,524 1,635,524 1,635,524 Certificates of deposit and other time accounts....... 277,749 631,050 1,259,107 1,340,465 $ 130,145 1,470,610 Federal funds purchased and other borrowings.......... 356,979 356,979 356,979 356,979 98,513 455,492 ------------------------------------------------------------------------------ Total interest-bearing liabilities.......... $3,254,690 $ 3,607,991 $4,236,048 $4,317,406 $ 228,658 $4,546,064 ============================================================================== Interest sensitivity gap........ $ (981,893) $(1,051,122) $ (908,819) $ 319,750 $ 972,321 $1,292,071 ============================================================================== Ratio of earning assets to interest-bearing liabilities... .70 .71 .79 1.07 ===================================================
In developing the classifications used for this analysis, it was necessary to make certain assumptions and approximations in assigning assets and liabilities to different maturity categories. For example, savings and Interest-on-Checking are subject to immediate withdrawal and as such are presented as repricing within the earliest period presented even though their balances have historically not shown significant sensitivity to changes in interest rates. Loans are included net of unearned discount of $6.2 million. Consumer loans are distributed in the immediately rate-sensitive category for those tied to market rates or to other categories according to the repayment schedule. The above table does not reflect interest rate swaps further discussed on page 31. 19 20 LIQUIDITY - --------- Asset liquidity is provided by cash and assets which are readily marketable or pledgeable or which will mature in the near future. Liquid assets include cash, short-term time deposits in banks, securities available for sale, maturities and cash flow from securities held to maturity, and Federal funds sold and securities purchased under resale agreements. Liability liquidity is provided by access to funding sources which include core depositors and correspondent banks in Cullen/Frost's natural trade area which maintain accounts with and sell Federal funds to subsidiary banks of the Corporation, as well as Federal funds purchased and securities sold under repurchase agreements from upstream banks. The liquidity position of Cullen/Frost is continuously monitored and adjustments are made to the balance between sources and uses of funds as deemed appropriate. NON-INTEREST INCOME - ------------------- Non-interest income of $157.1 million was reported for 1999, compared with $138.7 million for 1998 and $121.7 million for 1997. Excluding securities transactions, total non-interest income increased 13.6 percent from 1998. In addition to core growth, non-interest income was favorably impacted in 1999 by the first quarter acquisition of Keller State Bank and the second quarter acquisitions of Commerce Financial Corporation and Professional Insurance Agency, Inc. ("PIA"). The non-interest income growth in 1998 and 1997 also included the impact of the acquisition of Harrisburg Bancshares, Inc. and Corpus Christi Bancshares, Inc., in the first quarter of 1998 and 1997, respectively.
Year Ended December 31 ------------------------------------------------------------ 1999 1998 1997 ------------------ ------------------ ------------------ PERCENT Percent Percent NON-INTEREST INCOME AMOUNT CHANGE AMOUNT CHANGE AMOUNT CHANGE ================================================================================================ Trust fees........................ $ 46,411 - 1.0% $ 46,863 + 8.3% $ 43,275 + 17.3% Service charges on deposit accounts........................ 58,787 + 9.7 53,601 + 12.5 47,627 + 14.6 Other service charges, collection and exchange charges, commissions and fees............ 23,503 + 51.8 15,482 + 36.4 11,349 + 23.4 Net (loss)gain on securities transactions.................... (86) -124.0 359 - 27.9 498 N/M Other............................. 28,470 + 27.3 22,361 + 18.0 18,953 + 8.9 -------- -------- -------- Total........................ $157,085 + 13.3 $138,666 + 13.9 $121,702 + 16.8 ======== ======== ========
20 21 Trust income was down $452 thousand or 1.0 percent during 1999, mainly due to decreases in management fees associated with some small cap value funds partially offset by increases in investment fees and custody fees. The market value of trust assets grew $1.1 billion to $12.8 billion in 1999 with 82 percent of the growth occurring in non-discretionary assets. In 1998 trust income was up $3.6 million or 8.3 percent from 1997 due mainly to the growth in market value of trust assets and the addition of new accounts through internal growth. Deposit service charges increased $5.2 million or 9.7 percent from 1998. The increase occurred as the result of deposit growth that generated increases in overdraft charges, cash management fees on commercial and individual deposits partially offset by lower NSF charges. In 1998, deposit service charges increased $6.0 million or 12.5 percent from 1997. The increase from 1997 to 1998 was attributed to some fee increases and deposit growth that generated increases in overdraft charges, cash management fees on commercial and individual deposits, as well as increases in ATM income. Other service charges and fees increased $8.0 million or 51.8 percent when compared to 1998. Insurance commission revenues from PIA acquired in the second quarter of 1999, and mutual fund fees were the main contributors to the increase in other service charges from last year. Other service charges and fees increased $4.1 million or 36.4 percent from 1997 to 1998 due to higher fees in accounts receivable factoring and mutual fund fees. During 1999 Cullen/Frost sold portions of its available for sale investment portfolio resulting in a net loss of $86 thousand. In 1998 and 1997 the Corporation sold portions of its available for sale investment portfolio resulting in net gains of $359 thousand and $498 thousand, respectively. Other non-interest income increased $6.1 million or 27.3 percent to $28.5 million in 1999 compared to $22.4 million in 1998. Growth in other non-interest income for 1999 can primarily be attributed to increases in the gain on sale of student loans, check card income, and a non-recurring $2 million gain on the sale of a piece of property in connection with a branch restructuring. The increase in 1998 from 1997 is primarily due to growth in VISA check card income, gains on the sale of student and mortgage loans and gains on the disposition of foreclosed assets. NON-INTEREST EXPENSE - -------------------- The acquisitions of Keller State Bank, Commerce Financial Corporation, and PIA, as well as the formation of Frost Securities, Inc. impacted the growth in expenses. Excluding the merger-related charge of $12.2 million during the second quarter of 1998 which was associated with the merger of Overton, non-interest expenses increased by 10.0 percent in 1999 to $293.0 million from $266.3 million in 1998.
Year Ended December 31 ------------------------------------------------------------ 1999 1998 1997 ------------------ ------------------ ------------------ PERCENT Percent Percent NON-INTEREST EXPENSE AMOUNT CHANGE AMOUNT CHANGE AMOUNT CHANGE - --------------------------------------------------------------------------------------------------- Salaries and wages................... $126,471 +13.5% $111,423 +12.7% $ 98,874 +15.4% Pension and other employee benefits........................... 26,096 +22.5 21,295 + 7.2 19,874 + 9.1 Net occupancy of banking premises.... 27,149 + 6.5 25,486 +11.7 22,812 + 6.2 Furniture and equipment.............. 19,958 + 5.5 18,921 +17.2 16,147 + 9.9 Intangible amortization.............. 15,000 +12.8 13,293 +11.5 11,920 + 5.4 Merger related charge................ 12,244 Other................................ 78,341 + 3.3 75,844 +15.8 65,514 +11.6 -------- -------- -------- Total........................... $293,015 + 5.2 $278,506 +18.4 $235,141 +11.9 ======== ======== ========
Salaries and wages increased by $15.0 million in 1999 and $12.5 million in 1998 or 13.5 percent and 12.7 percent, respectively. Salaries and wages in both years have experienced increases related to new business initiatives, acquisitions, and market increases. Pension and other employee benefits increased by $4.8 million or 22.5 percent during 1999 as a result of new business initiatives, retirement plan expense and the impact of the acquisitions on payroll taxes and medical insurance. For 1998 pension and other employee benefits increased 7.2 percent or $1.4 million as a result of retirement plan expense and the impact of the acquisitions on payroll taxes and medical insurance. 21 22 Net occupancy of banking premises increased $1.7 million or 6.5 percent during 1999 primarily attributable to costs associated with branch activity and building maintenance and higher property taxes impacted by the acquisitions. In 1998, net occupancy of banking premises increased $2.7 million or 11.7 percent due to higher property taxes, depreciation and lease expenses as impacted by the acquisition and de novo branches opened in 1998. Furniture and equipment costs increased $1.0 million or 5.5 percent in 1999 primarily due to upgrades and maintenance on software. In 1998, furniture and equipment costs increased $2.8 million or 17.2 percent primarily due to the continued expansion of the Corporation, as well as, technology initiatives and upgrades. Intangible amortization increased during 1999 and 1998 due to acquisitions accounted for under the purchase method. In 1998 non-interest expense included a $12.2 million merger related charge associated with the merger of Overton. The majority of the $12.2 million charge was related to severance payments and other employee benefits, and investment banking fees. Other non-interest expense increased $2.5 million or 3.3 percent during 1999 as a result of higher conversion costs related to the acquisitions, as well as increases in armored motor service expenses, appraisal, telephone, and data communication expenses. Other non-interest expense was up 15.8 percent in 1998 mostly due to outside computer services related to the Year 2000 compliance program as well as an increase in the volume of VISA checkcards issued after its initial introduction in late 1997. YEAR 2000 - --------- Cullen/Frost Bankers, Inc. conducted an extensive program to address the internal and external risks associated with the century date change to the Year 2000. The Corporation spent approximately $5.2 million on incremental costs over the three-year period beginning in 1997, funded out of its earnings and expensed as incurred. Additionally, the Corporation spent about 30 percent of its annual technology budget to facilitate progress on the Year 2000 program. All costs associated with the Year 2000 program were based upon management's best estimates and in line with forecasts. Cullen/Frost systematically inventoried and assessed the importance of application software and system hardware and software. The Corporation completed the renovation of mission critical systems and implemented 100 percent of the renovated mission critical systems. The Corporation completed the renovation, testing and installation of 100 percent of technology systems in its owned facilities, including vault doors, elevators, climate control systems, and security systems. During 1998 and 1999, Cullen/Frost reviewed the Year 2000 preparedness of its vendors and suppliers, and completed on-site due diligence visits with key service providers. The Corporation continued to monitor vendor and supplier progress and developed contingency plans where necessary and feasible. The Corporation tested for key dates in the new century with critical third party service providers, and relied on proxy testing in some cases. Cullen/Frost made available testing documentation, known as proxy tests, to clients utilizing certain products and services. Cullen/Frost also relied on entities such as the Federal Reserve System, Depository Trust Company, Participants Trust Company, Society for Worldwide Interbank Financial Telecommunications (SWIFT), and the Clearing House Interbank Payment Systems (CHIPS) in its securities processing and banking businesses, as did other financial service providers in similar businesses. Cullen/Frost developed contingency plans to provide alternatives in situations where a third party furnishing a critical product or service experienced significant Year 2000 issues. Cullen/Frost also updated existing business continuity plans for the date change. As part of its credit analysis process, the Corporation developed a project plan for assessing the Year 2000 readiness of its significant credit customers. 22 23 The Financial Management Group's (FMG) mission critical systems, such as the trust and brokerage accounting and trading systems were included in Cullen/Frost's evaluation and testing of systems. FMG also updated contingency plans to include possible Year 2000 circumstances. FMG obtained and relied upon for the purpose of evaluating a company's/issuer's Year 2000 readiness, public information provided by companies/issuers to regulatory bodies, such as the Securities and Exchange Commission, analysts' reports and/or official statements from companies/issuers. Cullen/Frost's Year 2000 program was regularly reviewed by examiners from various external agencies such as the Comptroller of the Currency and the Federal Reserve Bank. Cullen/Frost completed its Year 2000 effort as planned and had no significant disruptions resulting from the century date change. The Corporation is currently not aware of any ongoing implications related to the Year 2000. However, it is subject to unique risks and uncertainties due to the interdependencies in business and financial markets, and the numerous activities and events outside of its control. INCOME TAXES - ------------ The Corporation recognized income tax expense of $51.0 million in 1999, compared to $42.1 million in 1998, and $39.6 million in 1997. The effective tax rate in 1999 was 34.30 percent compared to 35.75 percent in 1998 and 35.15 percent in 1997. The effective tax rate is lower in 1999 due to an increase in tax-exempt interest. For a detailed analysis of the Corporation's income taxes see Note O "Income Taxes" on page 56. CASH EARNINGS - ------------- Historically, excluding the merger with Overton, the Corporation's acquisitions have been accounted for using the purchase method of accounting which results in the creation of intangible assets. These intangible assets are deducted from capital in the determination of regulatory capital. Thus, "cash" or "tangible" earnings represents the regulatory capital generated during the year and can be viewed as net income excluding intangible amortization, net of tax. While the definition of "cash" or "tangible" earnings may vary by company, we believe this definition is appropriate as it measures the per share growth of regulatory capital, which impacts the amount available for dividends and acquisitions. The following table reconciles reported earnings to net income excluding intangible amortization ("cash" earnings) for each of the three most recent year periods:
Year Ended December 31 ----------------------------------------------------------------------- 1999 1998 ---------------------------------- ---------------------------------- REPORTED INTANGIBLE "CASH" REPORTED INTANGIBLE "CASH" EARNINGS AMORTIZATION EARNINGS EARNINGS AMORTIZATION EARNINGS - -------------------------------------------------------------------------------------------------- Income before income taxes................... $148,621 $15,000 $163,621 $117,740 $13,293 $131,033 Income taxes............. 50,979 3,434 54,413 42,095 3,242 45,337 ----------------------------------------------------------------------- Net income............... $ 97,642 $11,566 $109,208 $ 75,645 $10,051 $ 85,696 ======================================================================= Net income per diluted common share(1)......... $ 1.78 $ .21 $ 1.99 $ 1.38 $ .19 $ 1.57 Return on assets(1)...... 1.42% 1.59%* 1.18% 1.34%* Return on equity(1)...... 18.68 20.89** 15.44 17.49** Year Ended December 31 -------------------------------- 1997 -------------------------------- REPORTED INTANGIBLE "CASH" EARNINGS AMORTIZATION EARNINGS - ------------------------------------------------------------ Income before income taxes................... $112,522 $11,920 $124,442 Income taxes............. 39,555 3,145 42,700 ---------------------------------- Net income............... $ 72,967 $ 8,775 $ 81,742 ================================== Net income per diluted common share(1)......... $ 1.33 $ .16 $ 1.49 Return on assets(1)...... 1.28% 1.44%* Return on equity(1)...... 16.38 18.35**
(1) 1998 diluted operating earnings per share and diluted operating cash earnings per share were $1.56 and $1.74, respectively. Operating cash ROA and cash ROE for 1998 were 1.48 percent and 19.43 percent, respectively. Operating earnings exclude the after-tax impact of the $12.2 million merger related charge associated with the merger with Overton. * CALCULATED AS A/B ** CALCULATED AS A/C - ---------------------
1999 1998 ---------- ---------- (A) Net income before intangible amortization (including goodwill and core deposit intangibles, net of tax).......... $ 109,208 $ 85,696 $ 81,742 (B) Total average assets........................................ 6,875,436 6,417,569 5,687,577 (C) Average shareholders' equity................................ 522,770 489,958 445,450
23 24 SOURCES AND USES OF FUNDS - ------------------------- Average assets for 1999 of $6.9 billion increased by 7.1 percent from 1998 levels and increased 12.8 percent between 1997 and 1998. Funding sources in 1999 reflected an increase in demand deposits and Federal funds purchased. The Corporation's uses of funds continued a trend which started in 1995 of replacing securities with loans as the largest component of earning assets. This reflects the increases in loan volumes from a year ago.
Percentage of Total Average Assets ------------------------------------ SOURCES AND USES OF FUNDS 1999 1998 1997 - -------------------------------------------------------------------------------------------------- Sources of Funds: Deposits: Demand............................................ 26.1% 25.4% 24.3% Time.............................................. 59.0 59.7 61.4 Federal funds purchased................................ 4.2 3.9 3.3 Equity capital......................................... 7.6 7.6 7.8 Borrowed funds......................................... 1.6 2.0 2.0 Other liabilities...................................... 1.5 1.4 1.2 ------------------------------------ Total............................................. 100.0% 100.0% 100.0% ==================================== Uses of Funds: Loans.................................................. 57.2% 53.5% 51.3% Securities............................................. 26.8 30.1 30.4 Federal funds sold..................................... 1.2 2.0 4.0 Non-earning assets..................................... 14.8 14.4 14.3 ------------------------------------ Total............................................. 100.0% 100.0% 100.0% ====================================
LOANS - ----- Average loans for 1999 were $3.9 billion, an increase of 14.5 percent from 1998. This increase was driven by continued improved economic conditions in the Texas markets the Corporation serves and the 1999 acquisitions.
December 31 ------------------------------------------------------------------------------ 1999 -------------------------- LOAN PORTFOLIO ANALYSIS PERCENTAGE OF (PERIOD-END BALANCES) AMOUNT TOTAL LOANS 1998 1997 1996 1995 - --------------------------------------------------------------------------------------------------------- Real estate: Construction........ $ 379,559 9.1% $ 292,789 $ 179,201 $ 125,054 $ 89,704 Land................ 128,765 3.1 75,397 60,339 53,742 40,005 Permanent Mortgages: Commercial........ 422,022 10.1 346,479 259,320 230,205 203,659 Residential....... 684,827 16.5 655,484 516,345 472,878 375,365 Other............... 364,875 8.8 349,255 355,475 355,712 282,467 ------------------------------------------------------------------------------ Total real estate... 1,980,048 47.6 1,719,404 1,370,680 1,237,591 991,200 Commercial and industrial: Energy.............. 129,394 3.1 67,187 41,293 45,305 37,918 Other............... 1,458,956 35.0 1,143,993 948,062 786,536 599,796 Consumer................. 541,026 13.0 625,018 645,988 526,778 431,223 Financial institutions... 7,416 3,767 12,749 10,409 Foreign.................. 20,298 .5 45,187 72,911 45,562 43,847 Other.................... 43,223 1.0 41,755 37,388 20,891 22,380 Unearned discount........ (6,217) (0.2) (3,357) (3,194) (2,098) (2,063) ------------------------------------------------------------------------------ Total............... $4,166,728 100.0% $3,646,603 $3,116,895 $2,673,314 $2,134,710 ============================================================================== Percent change from previous year.......... +14.3% +17.0% +16.6% +25.2% +22.9%
24 25 Loans increased to $4.2 billion at year-end 1999, up 14.3 percent from the previous year-end. Most of the increase in period-end loans is attributable to commercial and industrial loans up $377 million from 1998. Construction loans as well as commercial real estate loans also increased by $87 million and $76 million, respectively. Approximately 80 percent of the increase in loans from a year ago resulted from internally generated growth. The total for real estate loans at December 31, 1999 was $2.0 billion, up 15.2 percent from year-end 1998. Amortizing permanent mortgages represented 55.9 percent of the total real estate loan portfolio at year end. Residential mortgages increased $29 million or four percent. Real estate loans categorized as "other" are primarily amortizing commercial and industrial loans with maturities of less than five years. Approximately 55 percent of all commercial real estate loans are owner occupied or have a major tenant (National or Regional company), which historically has resulted in a lower risk, provides financial stability and is less susceptible to economic swings. See page 28 for further discussion of the loan portfolio and "Loan Maturity and Sensitivity" on page 66. MEXICAN LOANS - ------------- At December 31, 1999, Cullen/Frost's cross-border outstandings to Mexico, excluding $17.9 million in loans secured by liquid U.S. assets, totaled $2.4 million. The decrease from a year ago represents normal fluctuations in lines of credit used by Mexican banks to finance trade. At December 31, 1999, $342 thousand of the Mexican-related loans were on non-performing status compared to none for the years ended December 31, 1998 and 1997.
December 31 -------------------------------------------------------------------------------------------------------- 1999 1998 1997 -------------------------------------------------------------------------------------------------------- PERCENTAGE PERCENTAGE PERCENTAGE PERCENTAGE PERCENTAGE PERCENTAGE OF TOTAL OF TOTAL OF TOTAL OF TOTAL OF TOTAL OF TOTAL MEXICAN LOANS AMOUNT LOANS ASSETS AMOUNT LOANS ASSETS AMOUNT LOANS ASSETS - ------------------------------------------------------------------------------------------------------------------------------- Financial institutions....... $2,394 .1% N/M $21,346 .6% .3% $35,563 1.2% .6% Commercial and industrial......... 9 N/M 4,016 .1 .1 13,034 .4 .2 -------------------------------------------------------------------------------------------------------- Total............ $2,403 .1% N/M $25,362 .7% .4% $48,597 1.6% .8% ========================================================================================================
The above table excludes $17.9 million, $19.8 million and $24.3 million in loans secured by liquid assets held in the United States in 1999, 1998 and 1997, respectively. 25 26 NON-PERFORMING ASSETS - --------------------- Non-performing assets were $18.8 million at December 31, 1999, compared with $17.1 million at December 31, 1998 and $18.1 million at December 31, 1997. Non-performing assets as a percentage of total loans and foreclosed assets were .45 percent at December 31, 1999, flat when compared to .47 percent one year ago.
December 31 --------------------------------------------------- NON-PERFORMING ASSETS 1999 1998 1997 1996 1995 - ----------------------------------------------------------------------------------------------------------------- Non-accrual................................................. $14,854 $12,997 $13,077 $10,733 $15,372 Foreclosed assets........................................... 3,983 4,107 5,011 3,336 3,309 --------------------------------------------------- Total................................................... $18,837 $17,104 $18,088 $14,069 $18,681 =================================================== As a percentage of total assets............................. .27% .25% .30% .25% .39% As a percentage of total loans plus foreclosed assets....... .45 .47 .58 .53 .87 After-tax impact of lost interest per common share.......... $ .02 $ .02 $ .02 $ .02 $ .03 Accruing loans 90 days past due: Consumer.................................................. $ 733 $ 1,347 $ 3,410 $ 1,841 $ 1,294 All other................................................. 6,177 9,434 3,412 4,108 4,378 --------------------------------------------------- Total................................................... $ 6,910 $10,781 $ 6,822 $ 5,949 $ 5,672 ===================================================
Cullen/Frost did not have any restructured loans for the years ended December 31, 1999-1995. Interest income that would have been recorded in 1999 on non-performing assets, had such assets performed in accordance with their original contract terms, was $1.3 million on non-accrual loans and $263 thousand on foreclosed assets. During 1999, the amount of interest income actually recorded on non-accrual loans was $1.1 million. There were no foreign loans 90 days past due as of December 31, 1999. Loans to a customer whose financial condition has deteriorated are considered for non-accrual status whether or not the loan is 90 days or more past due. All non-consumer loans 90 days or more past due are classified as non-accrual unless the loan is well secured and in the process of collection. When a loan is placed on non-accrual status, interest income is not recognized until collected, and any previously accrued but uncollected interest is reversed. A loan is considered to be restructured if it has been modified as to original terms, resulting in a reduction or deferral of principal and/or interest as a concession to the debtor. Classification of an asset in the non-performing category does not preclude ultimate collection of loan principal or interest. At December 31, 1999, Cullen/Frost had $2.8 million in loans to borrowers experiencing financial difficulties which had not been included in either of the non-accrual or 90 days past due loan categories. Management monitors such loans closely and reviews their performance on a regular basis. 26 27 ALLOWANCE FOR POSSIBLE LOAN LOSSES - ---------------------------------- The allowance for possible loan losses was $58.3 million or 1.40 percent of period-end loans at December 31, 1999, compared to $53.6 million or 1.47 percent of period-end loans at year-end 1998. The allowance for possible loan losses as a percentage of non-accrual loans was 392.8 percent at December 31, 1999, compared with 412.5 percent at December 31, 1998. Cullen/Frost recorded a $12.4 million provision for possible loan losses during 1999, compared to $10.4 million and $9.2 million recorded during 1998 and 1997, respectively. The allowance for loan losses is maintained at a level considered appropriate by management, based on estimated probable losses in the loan portfolio. The allowance consists of three elements: (i) allowances established on specific loans, (ii) allowances based on historical loan loss experience and trends, and (iii) unallocated allowances based on general economic conditions and other internal and external risk factors in the Corporation's individual markets. The specific allowances are based on a regular analysis and evaluation of criticized loans. The quality of loans are determined based on an internal credit risk grading process that evaluates: the obligor's ability to repay, the underlying collateral, if any, and the economic environment and industry in which the obligor operates. This analysis is performed at the relationship manager level for all commercial loans. Obligors whose calculated grade is below a predetermined grade are viewed as criticized. Once criticized, a loan is analyzed (at least quarterly) by a special assets officer to determine if a specific allowance is needed. Specific allocations are based on an obligor's inability or unwillingness to repay, collateral deficiencies and/or the state of the borrower's industry. If a specific allowance is not assigned to a criticized loan, and it is not deemed impaired, it is included in the historical allowance portion of the process for loans with similar characteristics. Historical allowances are determined statistically using a loss analysis that examines loss experience of the portfolio in total, by specific loan types and the related internal gradings of loans charged off. This loss analysis is periodically updated based on actual experience. This analysis is performed on several groups of loans. As a result, several historical allowance pools result. Specifically, historical allowance pools exist for commercial real estate loans, commercial and industrial loans, consumer loans and one-to-four family residential mortgages. Unallocated allowances based on general economic conditions and other internal and external risk factors are determined by evaluating the experience, ability and effectiveness of the bank's lending management and staff, effectiveness of lending policies and procedures and internal controls, outlook for changes in asset quality, outlook for changes in loan portfolio volume, composition and concentrations of credit, impact of competition on loan structuring and pricing, effectiveness of the internal loan review, impact of environmental risks on portfolio risks, and impact of rising interest rate on portfolio risk. Quarterly, senior management evaluates the degree of risk that each one of these components has on the quality of the loan portfolio. Each component is determined to have either a high, moderate or low degree of risk. The results are then input into a "general allocation matrix" to determine the unallocated general allowance. While the loss analysis for the historical allowance is performed annually, the Corporation may revise the general allocation factors whenever necessary in order to address improving or deteriorating credit quality trends or events; or recognize specific risks associated with a given loan concentration or pool classification. Cullen/Frost recorded net charge-offs of $8.8 million for the year ended December 31, 1999, compared to net charge-offs of $6.1 million and $6.0 million in 1998 and 1997, respectively. The Corporation's gross charge-offs in 1999 consisted primarily of consumer loans which decreased $661 thousand to $7.4 million and commercial and industrial loans which increased $1.4 million to $5.3 million. The Corporation's gross charge-offs in 1998 consisted primarily of consumer loans which increased $872 thousand to $8.1 million and commercial and industrial loans which increased $2.0 million to $4.0 million. The Corporation's gross charge-offs in 1997 consisted primarily of consumer loans which increased to $7.2 million from $3.8 million in 1996 and commercial and industrial loans which decreased $4.5 million to $2.0 million. 27 28
Year Ended December 31 -------------------------------------------------------------- ALLOWANCE FOR POSSIBLE LOAN LOSSES 1999 1998 1997 1996 1995 - -------------------------------------------------------------------------------------------------- Average loans outstanding during year, net of unearned discount....................... $3,934,406 $3,437,510 $2,917,371 $2,445,777 $1,971,681 ============================================================== Balance of allowance for possible loan losses at beginning of year........................... $ 53,616 $ 48,073 $ 42,821 $ 36,525 $ 29,017 Provision for possible loan losses......................... 12,427 10,393 9,174 8,494 7,605 Loan loss reserve of acquired institutions................... 1,066 1,250 2,105 627 430 Charge-offs: Real estate.................... (357) (397) (650) (351) (288) Commercial and industrial...... (5,349) (3,980) (2,028) (6,485) (739) Consumer....................... (7,420) (8,081) (7,209) (3,776) (3,856) Other, including foreign....... (7) (90) (40) (9) (2) -------------------------------------------------------------- Total charge-offs........... (13,133) (12,548) (9,927) (10,621) (4,885) -------------------------------------------------------------- Recoveries: Real estate.................... 582 1,674 956 2,476 1,277 Commercial and industrial...... 1,799 2,176 965 3,747 1,796 Consumer....................... 1,919 2,528 1,853 1,445 1,231 Other, including foreign....... 69 70 126 128 54 -------------------------------------------------------------- Total recoveries............ 4,369 6,448 3,900 7,796 4,358 -------------------------------------------------------------- Net charge-offs.................. (8,764) (6,100) (6,027) (2,825) (527) -------------------------------------------------------------- Balance of allowance for possible loan losses at end of year..... $ 58,345 $ 53,616 $ 48,073 $ 42,821 $ 36,525 ============================================================== Net charge-offs as a percentage of average loans outstanding during year, net of unearned discount....................... (.22)% (.18)% (.21)% (.12)% (.03)% Allowance for possible loan losses as a percentage of year-end loans, net of unearned discount....................... 1.40 1.47 1.54 1.60 1.71
There were no foreign charge-offs in 1999-1995. Cullen/Frost has certain lending policies and procedures in place which are designed to maximize loan income within an acceptable level of risk. These policies and procedures, some of which are described below, are reviewed regularly by senior management. A reporting system supplements this review process by providing management and the board of directors with frequent reports related to loan production, loan quality, concentrations of credit, loan delinquencies and non-performing and potential problem loans. Commercial and industrial loans are a diverse group of loans to small, medium and large businesses. The purpose of these loans vary from supporting seasonal working capital needs to term financing of equipment. These loans are underwritten focusing on evaluating and understanding that management's ability to operate profitably and prudently expand their business. Once it is determined management possesses sound ethics and solid business acumen, current and projected cash flows are examined to determine the ability to repay their obligations as agreed upon. In addition, collateral must be of good quality and single purpose projects are avoided. Underwriting standards are designed to promote relationship banking rather than transactional banking. While some short-term loans may be made on an unsecured basis, most are secured by the assets being financed with appropriate collateral margins. Diversification in the loan portfolio is a means of managing risk associated with fluctuations in economic conditions. At December 31, 1999, Cullen/Frost had no concentration of commercial and industrial loans in any single industry that exceeded 10 percent of total loans. 28 29 The diversity of the commercial real estate portfolio allows Cullen/Frost to reduce the impact of a decline in a single market or industry. In addition to monitoring and evaluating commercial real estate loans based on collateral, geography and risk grade criteria, management closely tracks its level of owner-occupied commercial real estate loans versus non-owner occupied loans. Additionally, the Corporation utilizes the knowledge of third party experts to provide insight and guidance about the economic conditions and dynamics of the markets served by the Corporation. Within the commercial real estate loan category, the Corporation's primary focus has been the growth of loans secured by owner-occupied properties. At December 31, 1999, a majority of the Corporation's commercial real estate loans were secured by owner-occupied properties. These loans are viewed primarily as cash flow loans and secondarily as loans secured by real estate. Consequently, these loans must withstand the analysis of a commercial loan and the underwriting process of a commercial real estate loan. Loans secured by non-owner occupied commercial real estate are made to developers and builders who have a relationship with Cullen/Frost and who have a proven record of success. These loans are underwritten through the use of feasibility studies, independent appraisal reviews, sensitivity analysis of absorption and lease rates and financial analysis of the developers and property owners. Sources of repayment for these types of loans may be pre-committed permanent loans from approved long-term lenders, sales of developed property or an interim loan commitment from the Corporation. These loans are closely monitored by on-site inspections and are considered to have higher risks than the other real estate loans due to their ultimate repayment being sensitive to interest rate changes, general economic conditions and the availability of long-term financing. The consumer loan portfolio has three distinct segments -- indirect consumer loans, which represent 27 percent of the consumer loan portfolio, direct non-real estate consumer loans, which represent 33 percent of the portfolio and direct real estate consumer loans, which represent 40 percent. The indirect segment is composed almost exclusively of new and used automobile financing. Non-real estate direct loans include automobile loans, unsecured revolving credit products, personal loans secured by cash and cash equivalents, and other similar types of credit facilities. The direct real estate loans are primarily home equity, home improvement and residential lot loans. Effective January 1, 1998, in accordance with a constitutional amendment allowing for the existence of home equity loans in the state of Texas, Cullen/Frost began offering home equity loans up to 80 percent of the estimated value of the personal residence of the borrower less the balances on existing mortgage and home improvement loans. As of December 31, 1999, home equity loans aggregated approximately $118 million, and were originated for a general variety of purposes including: education, business start-ups, debt consolidation and automobile financing. It is anticipated this product will continue to grow and eventually represent the largest distinct segment of the consumer portfolio. To date the primary growth of this product has been from existing customers. Underwriting standards for this product are heavily influenced by the statute requirements, which include but are not limited to, maximum loan-to-value percentage, collection remedies, the number of such loans a borrower can have at one time and documentation requirements. A computer based credit scoring analysis is used to supplement the consumer loan underwriting process. To monitor and manage consumer loan risk, policies and procedures are developed and modified, as needed, jointly by line and staff personnel. This activity, coupled with relatively small loan amounts that are spread across many individual borrowers, minimizes the risk. Additionally, trend and outlook reports are provided to senior management on a frequent basis to aid in planning. Cullen/Frost has an independent Loan Review Division that reviews and validates the credit risk program on a periodic basis. Results of these reviews are presented to senior management and the board of directors. Loan Review's function complements and reinforces the risk identification and assessment decisions made by lenders and credit personnel as well as the Corporation's policies and procedures. Loans identified as losses by management, internal loan review and/or bank examiners are charged-off. Furthermore, consumer loan accounts are charged-off automatically based on regulatory requirements. 29 30 An allowance for possible loan losses in maintained in an amount which, in management's judgment, provides an adequate reserve to absorb probable credit losses related to specifically identified loans as well as loan losses inherent in the remainder of the loan portfolio that have been incurred as of the balance sheet date. An audit committee of non-management directors reviews the adequacy of the allowance for possible loan losses quarterly.
December 31 ------------------------------------------------------------------------------------------------- 1999 1998 1997 1996 ---------------------- ---------------------- ---------------------- ---------------------- ALLOWANCE Allowance Allowance Allowance FOR AS A FOR AS A FOR AS A FOR AS A POSSIBLE PERCENTAGE POSSIBLE PERCENTAGE POSSIBLE PERCENTAGE POSSIBLE PERCENTAGE ALLOCATION OF ALLOWANCE LOAN OF TOTAL LOAN OF TOTAL LOAN OF TOTAL LOAN OF TOTAL FOR POSSIBLE LOSS LOSSES LOSSES LOANS LOSSES LOANS LOSSES LOANS LOSSES LOANS - ------------------------------------------------------------------------------------------------------------------------------ Commercial and industrial................ $22,404 .54% $15,085 .41% $14,346 .46% $ 9,648 .36% Real estate................ 9,485 .23 10,021 .28 9,460 .31 9,853 .37 Consumer................... 12,621 .30 17,130 .47 17,486 .56 13,903 .52 Purchasing or carrying securities................ 1 85 88 6 Financial institutions..... 98 36 60 44 Other, including foreign... 215 .01 246 .01 371 .01 213 .01 Unallocated................ 13,521 .32 11,013 .30 6,262 .20 9,154 .34 ------------------------------------------------------------------------------------------------- Total................... $58,345 1.40% $53,616 1.47% $48,073 1.54% $42,821 1.60% ================================================================================================= December 31 ---------------------- 1995 ---------------------- Allowance FOR AS A POSSIBLE PERCENTAGE ALLOCATION OF ALLOWANCE LOAN OF TOTAL FOR POSSIBLE LOSS LOSSES LOSSES LOANS - --------------------------- ---------------------- Commercial and industrial................ $10,411 .49% Real estate................ 11,479 .54 Consumer................... 12,201 .57 Purchasing or carrying securities................ 6 Financial institutions..... 32 Other, including foreign... 167 .01 Unallocated................ 2,229 .10 ---------------------- Total................... $36,525 1.71% ======================
Allocation of a portion of the allowance does not preclude its availability to absorb losses in other categories. SECURITIES - ------------ Total securities, including securities available for sale, were $1.6 billion at year-end 1999 compared to $2.1 billion a year ago. The securities portfolio has been impacted by strong loan growth in 1999. Securities available for sale totaled $1.5 billion at December 31, 1999, compared to $2.0 billion at year-end 1998. These securities consist primarily of U.S. Treasury securities and obligations of U.S. Government agencies. Securities held to maturity totaled $85 million at December 31, 1999 compared to $111 million at December 31, 1998. Securities classified as held to maturity are carried at amortized cost and consist primarily of U. S. Government agency obligations. The remaining securities, consisting primarily of municipal bonds, are classified as trading and are carried at fair value. Trading securities were $1 thousand at December 31, 1999 compared to $709 thousand at December 31, 1998. Debt securities are classified as held to maturity when the Corporation has the positive intent and ability to hold the securities to maturity. Available for sale securities are stated at fair value, with unrealized gains and losses, net of tax, reported as a separate component of shareholders' equity. Trading securities held primarily for sale in the near term are valued at their fair values, with unrealized gains and losses included immediately in other income. The average yield of the securities portfolio for the year ended December 31, 1999 was 6.38 percent compared with 6.32 percent for 1998. See page 67 "Maturity Distribution and Securities Portfolio Yields." 30 31 Total securities including trading, available for sale and held to maturity are summarized below:
December 31 --------------------------------------------------------------------------- 1999 1998 1997 ----------------------- ----------------------- ----------------------- PERIOD-END PERCENTAGE PERIOD-END PERCENTAGE PERIOD-END PERCENTAGE SECURITIES BALANCE OF TOTAL BALANCE OF TOTAL BALANCE OF TOTAL - ------------------------------------------------------------------------------------------------------ U.S. Treasury............ $ 118,130 7.2% $ 189,574 9.1% $ 341,681 19.3% U.S. Government agencies and corporations....... 1,324,440 81.3 1,719,580 82.2 1,367,500 77.2 States and political subdivisions........... 153,319 9.4 125,939 6.0 46,171 2.6 Other.................... 34,022 2.1 56,610 2.7 16,066 .9 --------------------------------------------------------------------------- Total............... $1,629,911 100.0% $2,091,703 100.0% $1,771,418 100.0% =========================================================================== Average yield earned during the year (taxable-equivalent basis)................. 6.38% 6.32% 6.43%
INTEREST RATE SWAPS/FLOORS - -------------------------- Cullen/Frost uses off-balance sheet interest rate swaps to hedge its interest rate risk. These swap transactions allow management to structure the interest rate sensitivity of the asset side of the Corporation's balance sheet to more closely match its view of the interest rate sensitivity of the Corporation's funding sources. Cullen/Frost had 30 interest rate swaps at December 31, 1999 compared to 22 interest rate swaps at December 31, 1998. In 1999, each swap was a hedge against a specific commercial fixed-rate loan or against a specific pool of commercial floating-rate loans, with a notional amount of $259 million. In 1998 each swap was a hedge against a specific commercial fixed-rate loan or against a specific pool of consumer fixed-rate loans with a notional amount of $75 million. For 1999 and 1998, in each case, the amortization of the interest rate swap effectively matched the expected amortization of the underlying loan or pool of loans with lives ranging from approximately one and one-half to ten years. These interest rate contracts involve the risk of dealing with counterparties and their ability to meet contractual terms. Each counterparty to a swap transaction has a credit rating that is investment grade. The net amount payable or receivable under interest rate swaps/floors is accrued as an adjustment to interest income and was not material in 1999 or 1998. In the third quarter of 1998, Cullen/Frost terminated interest rate swaps hedging fixed rate consumer loans. Cullen/Frost is amortizing the loss on the transaction of $1.9 million over the remaining term of the interest swaps ending in the second quarter of 2002. During 1998, Cullen/Frost terminated all three of its interest rate floor agreements with a notional amount totaling $500 million and an original term of three years. These interest rate floors were purchased in 1997 for the purpose of hedging floating interest rate exposure in commercial loan accounts in an environment of falling interest rates. Cullen/Frost is amortizing the gain on the transaction of $2.8 million over the remaining term of the interest rate floors. 31 32 DEPOSITS - -------- Total average demand deposits increased 10.2 percent from 1998. Most of the increase came in commercial and individual accounts which increased $145.3 million. The increase in commercial and individual levels is mostly related to the 1999 acquisitions. Cullen/Frost has made a strategic effort in growing its correspondent bank relationships in the markets it serves. In response to this effort correspondent bank deposits have increased $26.0 million or 13.3 percent. As of June 30, 1999, the Corporation ranked 27th in the United States for Correspondent bank balances.
1999 1998 1997 -------------------- -------------------- -------------------- AVERAGE PERCENT AVERAGE PERCENT AVERAGE PERCENT DEMAND DEPOSITS BALANCE CHANGE BALANCE CHANGE BALANCE CHANGE - -------------------------------------------------------------------------------------------------- Commercial and individual... $1,533,160 +10.5% $1,387,824 +21.3% $1,143,828 +16.7% Correspondent banks......... 221,530 +13.3 195,555 + 1.7 192,231 - 3.9 Public funds................ 37,567 -13.7 43,507 - 1.5 44,183 - 2.3 ---------- ---------- ---------- Total.................. $1,792,257 +10.2 $1,626,886 +17.9 $1,380,242 +12.7 ========== ========== ==========
Total average time deposits increased 6.0 percent from 1998 with the largest increase of 17.9 percent coming from money market deposit accounts offset slightly by decreases in Jumbo and Consumer time accounts of 1.2 percent and 4.4 percent, respectively.
1999 1998 1997 --------------------------- --------------------------- --------------------------- AVERAGE PERCENT AVERAGE PERCENT AVERAGE PERCENT TIME DEPOSITS BALANCE CHANGE COST BALANCE CHANGE COST BALANCE CHANGE COST - ----------------------------------------------------------------------------------------------------------------------------- Savings and Interest-on-Checking.... $ 948,487 + 5.2% .69% $ 901,960 +10.2% 1.21% $ 818,216 +10.4% 1.32% Money market deposit accounts....... 1,636,915 +17.9 3.69 1,387,994 +16.1 3.91 1,195,773 +13.5 4.08 Time accounts of $100,000 or more... 648,820 - 1.2 4.44 656,776 +15.9 5.23 566,588 +13.2 5.14 Time accounts under $100,000........ 601,520 - 4.4 4.15 629,260 - 1.5 4.65 638,673 - 1.0 4.81 Public funds........................ 220,845 -12.2 3.61 251,570 - 6.5 3.73 269,027 + 9.7 4.35 ---------- ---------- ---------- Total........................... $4,056,587 + 6.0 3.18 $3,827,560 + 9.7 3.61 $3,488,277 + 9.5 3.76 ========== ========== ==========
The following table summarizes the certificates of deposit in amounts of $100,000 or more as of December 31, 1999 by time remaining until maturity.
December 31 --------------------- 1999 REMAINING MATURITY OF PRIVATE --------------------- CERTIFICATES OF DEPOSIT PERCENTAGE OF $100,000 OR MORE AMOUNT OF TOTAL - ----------------------------------------------------------------------------------- Three months or less........................................ $337,754 52.0% After three, within six months.............................. 165,270 25.4 After six, within twelve months............................. 132,466 20.4 After twelve months......................................... 14,073 2.2 --------------------- Total.................................................. $649,563 100.0% ===================== Percentage of total private time deposits................... 16.9%
Other time deposits of $100,000 or more were $100.8 million at December 31, 1999. Of this amount 67.9 percent matures within three months, 15.2 percent matures between three and six months and the remainder matures between six months and one year. Mexico is a part of the natural trade territory of the banking offices of Cullen/Frost. Thus, dollar-denominated foreign deposits from Mexican sources have traditionally been a significant source of funding. The Corporation's average foreign deposits increased 7.6 percent from 1998.
FOREIGN DEPOSITS 1999 1998 1997 - -------------------------------------------------------------------------------------------- Average balance............................................. $691,356 $642,822 $607,642 Percentage of total average deposits........................ 11.8% 11.8% 12.5%
32 33 SHORT-TERM BORROWINGS - --------------------- The Corporation's primary source of short-term borrowings is Federal funds purchased from correspondent banks and securities sold under repurchase agreements in the natural trade territories of the Cullen/Frost subsidiary banks, as well as from upstream banks. The net purchase position experienced in both 1999 and 1998 is primarily the result of continued growth in earning assets over core deposit growth. The weighted-average interest rate on Federal funds purchased at December 31, 1999 and 1998 was 3.66 percent and 4.69 percent, respectively. Generally, the interest rates on securities sold under repurchase agreements are 80 percent of the Federal funds rate.
1999 1998 1997 ------------------- ------------------- ------------------- AVERAGE AVERAGE AVERAGE AVERAGE AVERAGE AVERAGE FEDERAL FUNDS BALANCE RATE BALANCE RATE BALANCE RATE - -------------------------------------------------------------------------------------------------- Federal funds sold............... $ 81,363 5.22% $ 127,273 5.59% $ 228,245 5.44% Federal funds purchased and securities sold under repurchase agreements.......... (285,470) 4.38 (252,977) 4.59 (189,468) 4.61 --------- --------- --------- Net funds position............... $(204,107) $(125,704) $ 38,777 --------- --------- ---------
Year Ended December 31 FEDERAL FUNDS PURCHASED AND SECURITIES ------------------------------ SOLD UNDER REPURCHASE AGREEMENTS 1999 1998 1997 - -------------------------------------------------------------------------------------------- Balance at year end......................................... $333,459 $305,564 $200,774 Maximum month-end balance................................... 474,013 523,178 231,418
Other funding sources include a $7.5 million short-term line of credit to the parent Corporation used for short-term liquidity needs. There were no borrowings outstanding from this source at December 31, 1999 and 1998. GUARANTEED PREFERRED BENEFICIAL INTEREST IN THE CORPORATION'S JUNIOR - -------------------------------------------------------------------- SUBORDINATED DEFERRABLE INTEREST DEBENTURES - ------------------------------------------- During February 1997, the Corporation issued $100 million of its 8.42 percent Capital Securities, Series A which represent a beneficial interest in Cullen/Frost Capital Trust I, a Delaware statutory business trust and wholly-owned subsidiary of the Corporation. The Issuer Trust used the proceeds of the sale of the Capital Securities to purchase Junior Subordinated Debentures of Cullen/Frost. The $100 million Trust Preferred Capital Securities are included in the Tier 1 capital of Cullen/Frost for regulatory capital purposes and are reported as debt on the balance sheet. See Note I "Borrowed Funds" on page 48. CAPITAL - ------- At December 31, 1999, shareholders' equity was $509.3 million, a decrease of .7 percent from $512.9 million at December 31, 1998. Activity in 1999 included $36.0 million of dividends paid and $24.3 million paid for the repurchase of shares of the Corporation, offset by strong earnings growth. In addition, Cullen/Frost had an unrealized loss on securities available for sale, net of deferred taxes, of $39.1 million as of December 31, 1999 compared to an unrealized gain of $7.7 million as of December 31, 1998 which had the effect of reducing capital by $46.8 million. Currently, under regulatory requirements, the unrealized gain or loss on securities available for sale is not included in the calculation of risk-based capital and leverage ratios. Cullen/Frost paid a quarterly dividend of $.15 per common share during the first quarter of 1999. During the second quarter of 1999 the Corporation declared and distributed a two-for-one stock split and raised its cash dividend 17 percent to .175 for the second, third, and fourth quarters of 1999. The Corporation paid a quarterly dividend of $.125 per common share during the first quarter of 1998 increasing to $.15 per common share during the second, third and fourth quarters of 1998. The dividend payout ratio was 36.9 percent for 33 34 1999 compared to 35.8 percent, excluding the merger related charge, for 1998. In addition, the Corporation announced that its Board of Directors had authorized it to repurchase up to $100 million of its common stock from time to time. As of December 31, 1999, $23.4 million worth of shares had been repurchased under this program. The Federal Reserve Board utilizes capital guidelines designed to measure Tier 1 and Total Capital and take into consideration the risk inherent in both on-balance sheet and off-balance sheet items. For the Corporation's capital ratios at December 31, 1999 and 1998, see Note L "Capital" on page 50. FORWARD-LOOKING STATEMENTS - -------------------------- Cullen/Frost may from time to time make forward-looking statements (within the meaning of the Private Securities Litigation Reform Act of 1995) with respect to earnings per share, credit quality, corporate objectives and other financial and business matters. The Corporation cautions the reader that these forward-looking statements are subject to numerous assumptions, risks and uncertainties, including economic conditions, actions taken by the Federal Reserve Board, legislative and regulatory actions and reforms, competition, as well as other reasons, all of which change over time. Actual results may differ materially from forward-looking statements. PARENT CORPORATION - ------------------ Historically, a large portion of the parent Corporation's income, which provides funds for the payment of dividends to shareholders and for other corporate purposes, has been derived from Cullen/Frost's investments in subsidiaries. Dividends received from the subsidiaries are based upon each bank's earnings and capital position. See Note K "Dividends" on page 50. Management fees are not assessed. NON-BANKING SUBSIDIARIES - ------------------------ The New Galveston Company is a wholly-owned second tier bank holding company subsidiary which holds all shares of each banking and non-banking subsidiary. Cullen/Frost has four principal non-banking subsidiaries. Main Plaza Corporation occasionally makes loans to qualified borrowers. Such loans are typically funded with borrowings against Cullen/Frost's current cash or borrowing against credit lines. Daltex General Agency, Inc., a managing general insurance agency, provides vendor's single interest insurance for Cullen/ Frost subsidiary banks. Cullen/Frost Capital Trust I, a wholly-owned non-banking subsidiary, is a Delaware statutory trust. The sole purpose of the trust was to sell Capital Securities and to purchase Junior Debentures of the Corporation. In 1999 Cullen/Frost formed Frost Securities, Inc., a Section 20 investment banking subsidiary based in Dallas, Texas. Frost Securities, Inc. offers a full range of services including equity research, institutional sales, trading and investment banking services to institutional investors and corporate customers. SUBSEQUENT EVENTS - ----------------- On January 27, 2000 Frost Insurance Agency, a subsidiary of The Frost National Bank signed a letter of intent to acquire Wayland Hancock Insurance Agency, Inc. ("Wayland Hancock"), a Houston-based independent insurance agency. Wayland Hancock offers a full range of life and health insurance, as well as retirement and financial planning, to individuals and businesses. The transaction is subject to regulatory approval and is expected to close in April, 2000. Wayland Hancock is Frost Insurance Agency's second acquisition, following the 1999 acquisition of Victoria-based Professional Insurance Agents, Inc. The purchase method of accounting will be used to record the transaction. On February 17, 2000 Cullen/Frost announced that United States National Bank of Galveston will merge its charter into Frost National Bank. The Galveston-based bank has been a member bank of Cullen/ Frost since 1982. The merger will be effective in the second quarter of 2000. 34 35 MANAGEMENT'S RESPONSIBILITY FOR FINANCIAL REPORTING - --------------------------------------------------- The management of Cullen/Frost Bankers, Inc. is responsible for the preparation of the financial statements, related financial data and other information in this annual report. The consolidated financial statements have been prepared in accordance with generally accepted accounting principles and include amounts based on management's estimates and judgment where appropriate. Financial information appearing throughout this annual report is consistent with the financial statements. In meeting its responsibility both for the integrity and fairness of these financial statements and information, management depends on the accounting systems and related internal accounting controls that are designed to provide reasonable assurances that transactions are authorized and recorded in accordance with established procedures and that assets are safeguarded and that proper and reliable records are maintained. The concept of reasonable assurance is based on the recognition that the cost of a system of internal controls should not exceed the related benefits. As an integral part of the system of internal controls, Cullen/ Frost maintains an internal audit staff which monitors compliance with and evaluates the effectiveness of the system of internal controls and coordinates audit coverage with the independent auditors. The Audit Committee of Cullen/Frost's Board of Directors, which is composed entirely of directors independent of management, meets regularly with management, regulatory examiners, internal auditors, the asset review staff and independent auditors to discuss financial reporting matters, internal controls, regulatory reports, internal auditing and the nature, scope and results of the audit efforts. Internal Audit and Asset Review report directly to the Audit Committee. The banking regulators, internal auditors and independent auditors have direct access to the Audit Committee. The consolidated financial statements have been audited by Ernst & Young LLP, independent auditors, who render an independent opinion on management's financial statements. Their appointment was recommended by the Audit Committee and approved by the Board of Directors and by the shareholders. The audit by the independent auditors provides an additional assessment of the degree to which Cullen/Frost's management meets its responsibility for financial reporting. Their opinion on the financial statements is based on auditing procedures, which include their consideration of internal controls and performance of selected tests of transactions and records, as they deem appropriate. These auditing procedures are designed to provide an additional reasonable level of assurance that the financial statements are fairly presented in conformity with generally accepted accounting principles in all material respects. /S/ DICK EVANS /s/ PHILLIP D. GREEN Dick Evans Phillip D. Green Chairman and Chief Senior Executive Vice President Executive Officer and Chief Financial Officer ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK - --------------------------------------------------------------------- The information required by this Item is set forth in the section entitled "Market Risk -- Interest Rate Sensitivity" included under Item 7 of this document on page 18, and is incorporated herein by reference. 35 36 ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA - ---------------------------------------------------- CONSOLIDATED STATEMENTS OF OPERATIONS (dollars in thousands, except per share amounts)
Year Ended December 31 ============================== 1999 1998 1997 ============================================================================================ INTEREST INCOME: Loans, including fees.................................. $329,610 $300,721 $261,607 Securities: Taxable........................................... 106,893 117,261 108,249 Tax-exempt........................................ 6,668 2,998 1,821 ------------------------------ TOTAL SECURITIES............................. 113,561 120,259 110,070 Time deposits.......................................... 164 Federal funds sold and securities purchased under resale agreements.................................... 4,245 7,111 12,423 ------------------------------ TOTAL INTEREST INCOME........................ 447,580 428,091 384,100 INTEREST EXPENSE: Deposits............................................... 128,819 138,283 131,140 Federal funds purchased and securities sold under repurchase agreements................................ 12,500 11,606 8,739 Guaranteed preferred beneficial interests in the Corporation's subordinated debentures................ 8,475 8,475 7,652 Long-term notes payable and other borrowings........... 808 1,754 1,434 ------------------------------ TOTAL INTEREST EXPENSE....................... 150,602 160,118 148,965 ------------------------------ NET INTEREST INCOME.......................... 296,978 267,973 235,135 Provision for possible loan losses.......................... 12,427 10,393 9,174 ------------------------------ NET INTEREST INCOME AFTER PROVISION FOR POSSIBLE LOAN LOSSES....................... 284,551 257,580 225,961 NON-INTEREST INCOME: Trust fees............................................. 46,411 46,863 43,275 Service charges on deposit accounts.................... 58,787 53,601 47,627 Other service charges, collection and exchange charges, commissions and fees................................. 23,503 15,482 11,349 Net (loss) gain on securities transactions............. (86) 359 498 Other.................................................. 28,470 22,361 18,953 ------------------------------ TOTAL NON-INTEREST INCOME.................... 157,085 138,666 121,702 NON-INTEREST EXPENSE: Salaries and wages..................................... 126,471 111,423 98,874 Pension and other employee benefits.................... 26,096 21,295 19,874 Net occupancy of banking premises...................... 27,149 25,486 22,812 Furniture and equipment................................ 19,958 18,921 16,147 Intangible amortization................................ 15,000 13,293 11,920 Merger related charge.................................. 12,244 Other.................................................. 78,341 75,844 65,514 ------------------------------ TOTAL NON-INTEREST EXPENSE................... 293,015 278,506 235,141 ------------------------------ INCOME BEFORE INCOME TAXES................... 148,621 117,740 112,522 Income taxes................................................ 50,979 42,095 39,555 ------------------------------ NET INCOME................................... $ 97,642 $ 75,645 $ 72,967 ============================== Net income per share: Basic.................................................. $ 1.83 $ 1.42 $ 1.38 Diluted................................................ 1.78 1.38 1.33 Dividends per share......................................... .675 .575 .480
See notes to consolidated financial statements. 36 37 CONSOLIDATED BALANCE SHEETS (dollars in thousands, except per share amounts)
December 31 ======================= 1999 1998 ===================================================================================== ASSETS Cash and due from banks..................................... $ 760,612 $ 684,941 Time deposits............................................... 6,546 Securities held to maturity (market value: 1999 -- $85,627; 1998 -- $113,682)......................................... 85,045 111,439 Securities available for sale............................... 1,544,865 1,979,555 Trading account securities.................................. 1 709 Federal funds sold and securities purchased under resale agreements................................................ 34,950 102,900 Loans, net of unearned discount of $6,217 in 1999 and $3,357 in 1998................................................... 4,166,728 3,646,603 Less: Allowance for possible loan losses.................. (58,345) (53,616) ----------------------- Net loans.............................................. 4,108,383 3,592,987 Banking premises and equipment.............................. 142,984 137,290 Accrued interest and other assets........................... 313,294 259,784 ----------------------- TOTAL ASSETS......................................... $6,996,680 $6,869,605 ======================= LIABILITIES Demand deposits: Commercial and individual................................. $1,601,977 $1,585,891 Correspondent banks....................................... 212,942 201,355 Public funds.............................................. 48,341 56,253 ----------------------- Total demand deposits................................ 1,863,260 1,843,499 Time deposits: Savings and Interest-on-Checking.......................... 984,438 961,597 Money market deposit accounts............................. 1,635,524 1,493,778 Time accounts............................................. 1,234,894 1,264,121 Public funds.............................................. 235,716 282,492 ----------------------- Total time deposits.................................. 4,090,572 4,001,988 ----------------------- Total deposits....................................... 5,953,832 5,845,487 Federal funds purchased and securities sold under repurchase agreements................................................ 333,459 305,564 Accrued interest and other liabilities...................... 101,565 107,177 Guaranteed preferred beneficial interest in the Corporation's junior subordinated deferrable interest debentures, net........................................... 98,513 98,458 ----------------------- TOTAL LIABILITIES.................................... 6,487,369 6,356,686 SHAREHOLDERS' EQUITY Common stock, par value $.01 per share...................... 536 267 Shares authorized: 1999 -- 90,000,000; 1998 -- 90,000,000 Shares issued: 1999 -- 53,561,616; 1998 -- 53,425,296 Surplus..................................................... 185,437 183,151 Retained earnings........................................... 382,168 321,754 Accumulated other comprehensive (loss) income, net of tax... (39,110) 7,747 Treasury stock at cost (738,463 shares)..................... (19,720) ----------------------- TOTAL SHAREHOLDERS' EQUITY........................... 509,311 512,919 ----------------------- TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY........... $6,996,680 $6,869,605 =======================
See notes to consolidated financial statements. 37 38 CONSOLIDATED STATEMENTS OF CASH FLOWS (dollars in thousands)
Year Ended December 31 ======================================= 1999 1998 1997 =============================================================================================== OPERATING ACTIVITIES Net income............................................ $ 97,642 $ 75,645 $ 72,967 Adjustments to reconcile net income to net cash provided by operating activities: Provision for possible loan losses............... 12,427 10,393 9,174 Credit for deferred taxes........................ (6,083) (5,574) (6,703) Accretion of discounts on loans.................. (547) (2,841) (1,212) Accretion of securities' discounts............... (2,306) (3,911) (11,960) Amortization of securities' premiums............. 4,738 5,824 3,847 Decrease (increase) in trading account securities..................................... 708 1,231 (1,153) Net realized loss (gain) on securities transactions................................... 86 (359) (498) Net gain on sale of assets....................... (4,052) (773) (654) Depreciation and amortization.................... 32,657 30,024 26,459 (Increase) decrease in accrued interest receivable..................................... (1,951) 660 (6,374) Increase (decrease) in accrued interest payable........................................ 3,566 (4,072) 4,453 Originations of mortgages held-for-sale.......... (69,587) (181,219) (104,271) Proceeds from sales of mortgages held-for-sale... 75,054 177,160 102,728 Net change in other assets and liabilities....... (5,716) 13,161 (38,571) --------------------------------------- NET CASH PROVIDED BY OPERATING ACTIVITIES........ 136,636 115,349 48,232 INVESTING ACTIVITIES Proceeds from maturities of securities held to maturity............................................ 26,471 36,906 40,606 Purchases of securities held to maturity.............. (123) (9,650) (32,040) Proceeds from sales of securities available for sale................................................ 1,696,657 900,398 434,488 Proceeds from maturities of securities available for sale................................................ 929,644 1,145,806 908,197 Purchases of securities available for sale............ (2,172,113) (2,314,252) (1,354,280) Net increase in loan portfolio........................ (421,478) (407,212) (342,559) Proceeds from sales of premises and equipment......... 4,694 30 49 Purchases of premises and equipment................... (20,334) (18,798) (18,104) Proceeds from sales of repossessed properties......... 2,653 2,982 2,038 Net cash and cash equivalents (paid) received from acquisitions........................................ (23,788) (8,899) 14,277 --------------------------------------- NET CASH PROVIDED (USED) BY INVESTING ACTIVITIES..................................... 22,283 (672,689) (347,328) FINANCING ACTIVITIES Net increase in demand deposits, IOC accounts, and savings accounts.................................... 77,501 566,136 159,070 Net decrease in certificates of deposit............... (195,031) (111,941) (16,532) Net increase (decrease) in Federal funds purchased and securities sold under repurchase agreements......... 27,895 89,361 (31,916) Net proceeds from issuance of guaranteed preferred beneficial interest in the Corporation's subordinated debentures............................. 98,353 Net proceeds from issuance of common stock............ 5,314 7,983 3,735 Purchase of treasury stock............................ (24,318) (3,495) (17,834) Dividends paid........................................ (36,013) (30,476) (22,256) --------------------------------------- NET CASH (USED) PROVIDED BY FINANCING ACTIVITIES..................................... (144,652) 517,568 172,620 --------------------------------------- INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS.................................... 14,267 (39,772) (126,476) Cash and cash equivalents at beginning of year........ 787,841 827,613 954,089 --------------------------------------- CASH AND CASH EQUIVALENTS AT END OF YEAR......... $ 802,108 $ 787,841 $ 827,613 =======================================
See notes to consolidated financial statements. 38 39 CONSOLIDATED STATEMENT OF CHANGES IN SHAREHOLDERS' EQUITY (dollars in thousands)
Accumulated Other Comprehensive Common Retained Income (Loss) Treasury Stock Surplus Earnings Net of Tax Stock Total ===================================================================================================================== BALANCE AT JANUARY 1, 1997.................... $ 133,475 $ 51,132 $232,201 $ 8,114 $ (136) $424,786 Net Income for 1997......................... 72,967 72,967 Unrealized gain on securities available for sale of $1,127, net of tax and reclassification adjustment for after-tax gains included in net income of $324...... 803 803 -------- Total comprehensive income............ 73,770 -------- Proceeds from employee stock purchase plan and option................................ 300 437 (1,949) 3,201 1,989 Tax benefit related to exercise of stock options................................... 1,492 1,492 Purchase of treasury stock.................. (17,814) (17,814) Issuance of restricted stock................ 522 2,297 2,819 Restricted stock plan deferred compensation, net....................................... (2,112) (2,112) Cash dividend............................... (21,463) (21,463) Pre-merger transaction of pooled company: Release of unearned ESOP shares........... 64 143 207 Cash dividend............................. (793) (793) Purchase of treasury stock................ (20) (20) Sale of treasury stock.................... 68 68 --------------------------------------------------------------------- BALANCE AT DECEMBER 31, 1997.................. 133,775 53,647 278,994 8,917 (12,404) 462,929 Net Income for 1998......................... 75,645 75,645 Unrealized loss on securities available for sale of $937, net of tax and reclassification adjustment for after-tax gains included in net income of $233...... (1,170) (1,170) -------- Total comprehensive income............ 74,475 -------- Proceeds from employee stock purchase plan and options............................... 390 (2,014) 2,802 1,178 Tax benefit related to exercise of stock options................................... 1,771 1,771 Purchase of treasury stock.................. (3,495) (3,495) Issuance of restricted stock................ 1 1,889 126 2,016 Restricted stock plan deferred compensation, net....................................... (514) (514) Cash dividend............................... (29,567) (29,567) ESOP shares released........................ 2,820 658 3,478 Constructive retirement of treasury stock issued in connection with a business combination............................... (1,382) (11,023) 12,883 478 Change in par value......................... (132,974) 132,974 Pre-merger transactions of pooled company: Proceeds from employee stock purchase plan and options............................. 847 683 (539) 88 1,079 Cash dividend............................. (909) (909) --------------------------------------------------------------------- BALANCE AT DECEMBER 31, 1998.................. 267 183,151 321,754 7,747 -- 512,919 Net Income for 1999......................... 97,642 97,642 Unrealized loss on securities available for sale of $46,913 net of tax and reclassification adjustment for after-tax losses included in net income of $56...... (46,857) (46,857) -------- Total comprehensive income............ 50,785 -------- Proceeds from employee stock purchase plan and options............................... 1 856 (1,839) 4,598 3,616 Tax benefit related to exercise of stock options................................... 1,698 1,698 Purchase of treasury stock.................. (24,318) (24,318) Restricted stock plan deferred compensation, net....................................... 624 624 Cash dividend............................... (36,013) (36,013) Two-for-one stock split..................... 268 (268) --------------------------------------------------------------------- BALANCE AT DECEMBER 31, 1999.................. $ 536 $185,437 $382,168 $(39,110) $(19,720) $509,311 =====================================================================
See notes to consolidated financial statements. 39 40 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS NOTE A -- SUMMARY OF ACCOUNTING POLICIES - ---------------------------------------- Cullen/Frost Bankers, Inc., ("Cullen/Frost" or "the Corporation") through its wholly-owned subsidiary banks provides a broad array of products and services throughout 11 Texas markets. In addition to general commercial banking, other products and services offered include trust and investment management, mortgage banking, insurance, investment banking, leasing, asset-based lending, treasury management and item processing. The accounting and reporting policies followed by Cullen/Frost are in accordance with generally accepted accounting principles and conform to general practices within the banking industry. The more significant accounting and reporting policies are summarized below. BASIS OF PRESENTATION -- The consolidated financial statements include the accounts of Cullen/Frost and its wholly-owned subsidiaries. Condensed parent company financial statements reflect investments in subsidiaries using the equity method of accounting. All significant intercompany balances and transactions have been eliminated in consolidation. Certain reclassifications have been made to make prior years comparable. USE OF ESTIMATES -- The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the amounts reported in the consolidated financial statements and accompanying notes. Actual results could differ from those estimates. SECURITIES -- Securities are classified as held to maturity and carried at amortized cost when Cullen/Frost has the intent and ability to hold the securities until maturity. Securities held for resale in anticipation of short-term market movements are classified as trading and are carried at market value with both net realized and unrealized gains and losses included in other income during the period. Securities to be held for indefinite periods of time are classified as available for sale and stated at fair value, with the unrealized gains and losses, net of tax, reported as a separate component of shareholders' equity. The adjusted carrying value of the specific security sold is used to compute gain or loss on the sale of securities. Declines in value other than temporary declines are adjusted against the security with a charge to operations. LOANS -- Interest on loans is accrued and accreted to operations based on the principal amount outstanding. Interest on certain consumer loans is recognized over their respective terms using a method which approximates the interest method. Generally, loans are placed on non-accrual status if principal or interest payments become 90 days past due and/or management deems the collectability of the principal and/or interest to be in question as well as when required by regulatory provisions. Once interest accruals are discontinued, uncollected but accrued interest is charged to current year operations. Subsequent receipts on nonaccrual loans are recorded as a reduction of principal, and interest income is recorded once principal recovery is reasonably assured. Loans which are determined to be uncollectible are charged to the allowance for possible loan losses. The collectability of loans is continually reviewed by management. ALLOWANCE FOR POSSIBLE LOAN LOSSES -- The allowance for possible loan losses is established through a provision for possible loan losses charged to current operations. The allowance for loan losses is maintained at a level considered appropriate by management, based on estimated probable losses in the loan portfolio. The allowance consists of three elements: (i) allowances established on specific loans, (ii) allowances based on historical loan loss experience and trends, and (iii) unallocated allowances based on general economic conditions and other internal and external risk factors in the Corporation's individual markets. An allowance for possible loan losses is maintained in an amount which, in management's judgment, provides an adequate reserve to absorb probable credit losses related to specifically identified loans as well as loan losses inherent in the remainder of the loan portfolio that have been incurred as of the balance sheet date. Certain non-homogeneous loans are accounted for under the provisions of SFAS No. 114, "Accounting by Creditors for Impairment of a Loan," as amended by SFAS No. 118, "Accounting by Creditors for Impairment of a Loan -- Income Recognition and Disclosure." These standards require an allowance to be established as a 40 41 component of the allowance for loan losses for certain loans when it is probable that all amounts due pursuant to the contractual terms of the loan will not be collected and the recorded investment in the loan exceeds the fair value. The allowance for possible loan losses related to loans that are impaired as defined by SFAS No. 114 and SFAS No. 118 is based on discounted cash flows using the loan's initial effective interest rate or the fair value of the collateral for certain collateral dependent loans. Income on impaired loans is recognized in accordance with SFAS No. 118 which is based on the collectability of the principal amount. FORECLOSED ASSETS -- Foreclosed assets consist of property which has been formally repossessed. Collateral obtained through foreclosure is recorded at the lower of fair value less estimated selling costs or the underlying loan amounts. Write-downs are provided for subsequent declines in value. BANKING PREMISES AND EQUIPMENT -- Banking premises and equipment are stated at cost, less accumulated depreciation and amortization. Depreciation and amortization are generally computed on a straight-line basis over the estimated useful lives of the assets. Leasehold improvements are generally amortized over the lesser of the term of the respective leases or the estimated useful lives of the improvements. Long-lived assets and certain identifiable intangibles are accounted for under SFAS No. 121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed Of." This statement requires that those assets and intangibles be reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable on an undiscounted basis. If impairment is indicated the present value of expected future cash flows from the use of the asset and its eventual disposition are less than the carrying amount of the asset, an impairment loss is recognized. INTANGIBLE ASSETS -- The excess of cost over fair value of net assets of businesses acquired (goodwill) is amortized on a straight-line and accelerated basis (as appropriate) over periods generally not exceeding twenty-five years. Core deposit and other intangibles are amortized on an accelerated basis over their estimated lives ranging from five to ten years. Intangible assets are included in other assets. All such intangible assets are periodically evaluated as to the recoverability of their carrying value. FEDERAL INCOME TAXES -- Cullen/Frost files a consolidated federal income tax return which includes the taxable income of all of its principal subsidiaries. Deferred tax assets and liabilities are recognized for the expected future tax consequences of temporary differences between the financial reporting bases and the tax bases of assets and liabilities. If it is more likely than not that some portion or all of a deferred tax asset will not be realized, a valuation allowance is recognized. STOCK OPTION PLANS -- Cullen/Frost accounts for its stock option plans under SFAS No. 123, "Accounting for Stock Based Compensation." The Statement allows the continued use of Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees," (APB No. 25) and related Interpretations. Cullen/Frost continues to account for its stock option plans in accordance with APB No. 25. Under APB No. 25, because the exercise price of Cullen/Frost's employee stock options equals the market price of the underlying stock on the date of grant, no compensation expense is recognized. SFAS No. 123 also allows for the fair value method of accounting for employees stock options. The continued use of APB No. 25 requires pro forma disclosures of net income and earnings per share as if the fair value method of accounting had been applied. STOCK SPLIT -- The number of shares outstanding and related earnings per share amounts have been restated to retroactively give effect for the two-for-one stock split declared and distributed by Cullen/Frost during the second quarter of 1999. FINANCIAL DERIVATIVES -- Derivatives are used to hedge interest rate exposure by modifying the interest rate characteristics of related balance sheet instruments. The specific criteria required for derivatives used for these purposes are described below. Derivatives that do not meet these criteria are carried at market value with changes in value recognized currently in earnings. Derivatives used as hedges must be effective at reducing the risk associated with the exposure being hedged and must be designated as a hedge at the inception of the derivative contract. Derivatives currently 41 42 used for hedging purposes include interest rate swaps. These swap transactions allow management to structure the interest rate sensitivity of the asset side of the balance sheet to more closely match its view of the interest rate sensitivity of Cullen/Frost's funding sources. The fair value of derivative contracts are carried off-balance sheet and the unrealized gains and losses on derivative contracts are generally deferred. The interest component associated with derivatives used as hedges or to modify the interest rate characteristics of assets and liabilities is recognized over the life of the contract in net interest income. Upon contract settlement or early termination, the cumulative change in the market value of such derivatives is recorded as an adjustment to the carrying value of the underlying asset or liability and recognized in net interest income over the expected remaining life of the derivative contract. In instances where the underlying instrument is repaid, the cumulative change in the value of the associated derivative is recognized immediately in earnings. ACCOUNTING CHANGES -- The following is a brief discussion of the SFAS pronouncements issued by the FASB that are pending adoption by Cullen/Frost. During 1999, the FASB issued SFAS No. 137, "Accounting for Derivative Instruments and Hedging Activities-Deferral of the Effective Date of FASB Statement No. 133" which deferred the required adoption date of SFAS No. 133 to fiscal years beginning after June 15, 2000. SFAS No. 133 "Accounting for Derivative Instruments and Hedging Activities" will require the recognition of all derivatives on the balance sheet at fair value. Derivatives that are not hedges must be adjusted to fair value through income. If the derivative is a hedge, depending on the nature of the hedge, changes in the fair value of derivatives will either be offset against the change in fair value of the hedged assets, liabilities, or firm commitments through earnings or recognized in other comprehensive income until the hedged item is recognized in earnings. The ineffective portion of a derivative's change in fair value will be immediately recognized in earnings. Even though early adoption is allowed, Cullen/Frost has no plans to adopt this statement prior to the effective date for the Corporation of January 1, 2001. The impact on future results will depend on the financial position of the Corporation and the nature and purpose of the derivatives in use by Cullen/Frost at that time. NOTE B -- ACQUISITIONS - --------------------- The transactions listed below, with the exception of the merger with Overton Bancshares, Inc. ("Overton"), have been accounted for as purchase transactions with the total cash consideration funded through internal sources. The purchase price has been allocated to the underlying assets and liabilities based on estimated fair values at the date of acquisition. Results of operations are included from the date of acquisition. The Overton acquisition was accounted for under the pooling-of-interests method of accounting which requires the assets, liabilities and shareholders' equity of the merged entity to be retroactively combined with the Corporation's respective accounts at recorded value. 1999 ACQUISITIONS COMMERCE FINANCIAL CORP. -- FORT WORTH On May 20, 1999, Cullen/Frost paid approximately $42.3 million to acquire Commerce Financial Corporation and its four-location subsidiary, Bank of Commerce, in Fort Worth, Texas. The total cash consideration was funded through internal sources. The purchase method of accounting has been used to record the transaction and as such, the purchase price has been allocated to the underlying assets and liabilities based on estimated fair values at the date of acquisition. Such estimates may be subsequently revised. The Corporation acquired loans of approximately $76 million and deposits of approximately $164 million. The intangible assets associated with the acquisition amounted to approximately $30.5 million. This acquisition did not have a material impact on Cullen/Frost's 1999 net income. PROFESSIONAL INSURANCE AGENTS, INC. -- VICTORIA On May 1, 1999, Frost Insurance Agency, a subsidiary of The Frost National Bank, acquired Professional Insurance Agents, Inc. (PIA), a mid-sized independent insurance agency based in Victoria, Texas, with additional locations in San Antonio, New Braunfels and Refugio. PIA offers corporate and personal property and casualty insurance as well as group health and life insurance products to individuals and businesses. The 42 43 purchase method of accounting was used to record the transaction. This acquisition did not have a material impact on Cullen/Frost's 1999 net income. KELLER STATE BANK -- TARRANT COUNTY On January 15, 1999, Cullen/Frost paid approximately $18.7 million to acquire Keller State Bank with three locations in Tarrant County, Texas. The total cash consideration was funded through internal sources. The purchase method of accounting has been used to record the transaction and as such the purchase price has been allocated to the underlying assets and liabilities based on estimated fair values at the date of acquisition. The Corporation acquired loans of approximately $38 million and deposits of approximately $62 million. The intangible assets associated with the acquisition amounted to approximately $11.8 million. This acquisition did not have a material impact on Cullen/Frost's 1999 net income. 1998 MERGERS AND ACQUISITIONS OVERTON BANCSHARES, INC. -- FORT WORTH On May 29, 1998, the Corporation completed the merger of Overton Bancshares, Inc., in Fort Worth, Texas, and its wholly-owned subsidiary Overton Bank & Trust, N.A. The merger, which was accounted for as a "pooling-of-interests" transaction, was Cullen/Frost's first entry into the Fort Worth market. With the merger, Cullen/Frost acquired twelve locations in Fort Worth/Arlington and two in Dallas. Cullen/Frost issued approximately 4.38 million common shares as part of this transaction. As a result of the transaction, Cullen/Frost recorded a merger related charge of $12.2 million primarily consisting of severance payments, other employee benefits and investment banking fees. In addition, shortly after the merger was consummated Cullen/Frost reclassified approximately $116 million of held to maturity securities of Overton to available for sale securities. HARRISBURG BANCSHARES, INC. -- HOUSTON On January 2, 1998, the Corporation paid approximately $55.3 million to acquire Harrisburg Bancshares, Inc., including its subsidiary Harrisburg Bank in Houston, Texas. Goodwill associated with the transaction amounted to approximately $24.5 million and approximately $10.6 million of other intangibles associated with the acquisition were recorded. Cullen/Frost acquired loans of approximately $125 million and deposits of approximately $222 million. This acquisition did not have a material impact on the Corporation's 1998 net income. 1997 ACQUISITION CORPUS CHRISTI BANCSHARES, INC. -- CORPUS CHRISTI On March 7, 1997, Cullen/Frost paid approximately $32.2 million to acquire Corpus Christi Bancshares, Inc., including its subsidiary Citizens State Bank, in Corpus Christi, Texas. Goodwill associated with the transaction amounted to approximately $13.8 million and approximately $7.1 million of other intangibles associated with the acquisition were recorded. Cullen/Frost acquired loans of approximately $108 million and deposits of approximately $184 million. This acquisition did not have a material impact on the Corporation's 1997 net income. INVESTMENT BANKING SUBSIDIARY On August 2, 1999 Cullen/Frost began operations of its Section 20 investment banking subsidiary in Dallas, Texas. The new subsidiary, Frost Securities, Inc., offers a full range of services including equity research, institutional sales, trading and investment banking services to institutional investors and corporate customers who need access to the capital markets. 43 44 NOTE C -- CASH AND DUE FROM BANKS - --------------------------------- Cullen/Frost subsidiary banks are required to maintain cash or non-interest bearing reserves with the Federal Reserve Bank which are equal to specified percentages of deposits. The average amounts of reserve and contractual balances were $76.9 million for 1999 and $75.1 million for 1998. NOTE D -- SECURITIES - -------------------- A summary of the amortized cost and estimated fair value of securities is presented below.
DECEMBER 31, 1999 December 31, 1998 ================================================= ================================================= AMORTIZED UNREALIZED UNREALIZED ESTIMATED AMORTIZED UNREALIZED UNREALIZED ESTIMATED (IN THOUSANDS) COST GAINS LOSSES FAIR VALUE COST GAINS LOSSES FAIR VALUE ================================================================================================================================= Securities Held to Maturity: U.S. Government agencies and corporations...... $ 82,413 $ 664 $ 220 $ 82,857 $ 107,182 $ 1,939 $ 12 $ 109,109 States and political subdivisions.......... 2,582 142 4 2,720 4,232 316 4,548 Other................... 50 50 25 25 ----------------------------------------------------------------------------------------------------- Total................. $ 85,045 $ 806 $ 224 $ 85,627 $ 111,439 $ 2,255 $ 12 $ 113,682 ===================================================================================================== Securities Available for Sale: U.S. Treasury........... $ 118,269 $ 55 $ 194 $ 118,130 $ 189,240 $ 357 $ 23 $ 189,574 U.S. Government agencies and corporations...... 1,293,803 2,668 54,444 1,242,027 1,601,930 13,448 2,980 1,612,398 State and political subdivisions.......... 158,990 262 8,516 150,736 119,962 1,943 907 120,998 Other................... 33,972 33,972 56,504 97 16 56,585 ----------------------------------------------------------------------------------------------------- Total................. $1,605,034 $2,985 $63,154 $1,544,865 $1,967,636 $15,845 $3,926 $1,979,555 =====================================================================================================
The amortized cost and estimated fair value of securities at December 31, 1999 are presented below by contractual maturity. Actual maturities will differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without prepayment penalties.
DECEMBER 31, 1999 ============================================================== SECURITIES HELD TO MATURITY SECURITIES AVAILABLE FOR SALE ---------------------------- ------------------------------ AMORTIZED ESTIMATED AMORTIZED ESTIMATED (IN THOUSANDS) COST FAIR VALUE COST FAIR VALUE ============================================================================================================ Due in one year or less..................... $ 25 $ 25 $ 117,460 $ 117,485 Due after one year through five years....... 945 941 35,347 34,627 Due after five years through ten years...... 1,662 1,804 45,546 43,461 Due after ten years......................... 112,878 107,265 -------------------------------------------------------------- 2,632 2,770 311,231 302,838 Mortgage-backed securities and collateralized mortgage obligations....... 82,413 82,857 1,293,803 1,242,027 -------------------------------------------------------------- Total.................................. $85,045 $85,627 $1,605,034 $1,544,865 ==============================================================
Proceeds from sales of securities available for sale during 1999 were $1.7 billion. During 1999, gross gains of $625 thousand and gross losses of $711 thousand were realized on those sales. Proceeds from sales of securities available for sale during 1998 were $900.4 million. During 1998, gross gains of $1.1 million and gross losses of $705 thousand were realized on those sales. Proceeds from sales of securities available for sale during 1997 were $434.5 million. During 1997, gross gains of $556 thousand and gross losses of $58 thousand were realized on those sales. 44 45 The carrying value of securities pledged to secure public funds, trust deposits, securities sold under repurchase agreements and for other purposes as required or permitted by law amounted to $1.5 billion at December 31, 1999 and $1.2 billion at December 31, 1998. NOTE E -- LOANS AND ALLOWANCE FOR POSSIBLE LOAN LOSSES - ------------------------------------------------------ A summary of loans outstanding follows:
December 31 ======================= (in thousands) 1999 1998 ===================================================================================== Real estate: Construction........................................... $ 379,559 $ 292,789 Land................................................... 128,765 75,397 Permanent mortgages: Commercial........................................ 422,022 346,479 Residential....................................... 684,827 655,484 Other.................................................. 364,875 349,255 Commercial and industrial: Energy................................................. 129,394 67,187 Other.................................................. 1,458,956 1,143,993 Consumer.................................................... 541,026 625,018 Financial institutions...................................... 7,416 Foreign..................................................... 20,298 45,187 Other....................................................... 43,223 41,755 Unearned discount........................................... (6,217) (3,357) ----------------------- Total loans............................................ $4,166,728 $3,646,603 =======================
In the normal course of business, in order to meet the financial needs of its customers, Cullen/Frost is a party to financial instruments with off-balance sheet risk. These include commitments to extend credit and standby letters of credit which commit the Corporation to make payments on behalf of customers when certain specified future events occur. Both arrangements have credit risk essentially the same as that involved in extending loans to customers and are subject to the Corporation's normal credit policies. Collateral is obtained based on management's credit assessment of the customer. No material losses are anticipated as a result of these commitments. Commitments to extend credit and standby letters of credit amounted to $1.8 billion and $80.2 million, respectively, at December 31, 1999. Commitments to extend credit and standby letters of credit amounted to $1.2 billion and $53 million respectively, at December 31, 1998. Commercial and industrial loan commitments represent approximately 71 percent of the total loan commitments outstanding at December 31, 1999 and 1998. The majority of Cullen/Frost's real estate loans are secured by real estate in San Antonio, Houston and Fort Worth. Mortgage loans of approximately $8.6 million and $14.0 million were held for sale by the Corporation and are included in residential permanent mortgages at December 31, 1999 and 1998, respectively. These loans are valued at the lower of cost or market, on an aggregate basis. In the normal course of business, Cullen/Frost subsidiary banks make loans to directors and officers of both Cullen/Frost and its subsidiaries. These loans are made on substantially the same terms, including interest rates and collateral, as those prevailing at the time for comparable transactions with other persons. Loans made to directors and executive officers of Cullen/Frost and its significant subsidiaries, including loans made to their associates, amounted to $16.5 million and $45.3 million at December 31, 1999 and 1998, respectively. During 1999, additions to these loans amounted to $5.8 million, repayments totaled $16.3 million and other changes totaled $18.3 million. These other changes consist primarily of changes in related-party status. Standby letters of credit extended to directors and executive officers of Cullen/Frost and its significant 45 46 subsidiaries and their associates amounted to $608 thousand and $614 thousand at December 31, 1999 and 1998, respectively. A summary of the changes in the allowance for possible loan losses follows:
Year Ended December 31 =========================== (in thousands) 1999 1998 1997 ========================================================================================= Balance at the beginning of the year........................ $53,616 $48,073 $42,821 Provision for possible loan losses.......................... 12,427 10,393 9,174 Loan loss reserve of acquired institutions.................. 1,066 1,250 2,105 Net charge-offs: Losses charged to the allowance........................ (13,133) (12,548) (9,927) Recoveries............................................. 4,369 6,448 3,900 --------------------------- Net charge-offs................................... (8,764) (6,100) (6,027) --------------------------- Balance at the end of the year.............................. $58,345 $53,616 $48,073 ===========================
A loan within the scope of SFAS No. 114 is considered impaired when, based on current information and events, it is probable that Cullen/Frost will be unable to collect all amounts due according to the contractual terms of the loan agreement, including scheduled principal and interest payments. All impaired loans are included in non-performing assets. At December 31, 1999, the majority of the impaired loans were real estate loans and collectability was measured based on the fair value of the collateral. Interest payments on impaired loans are typically applied to principal unless collectability of the principal amount is fully assured, in which case interest is recognized on the cash basis. There was no interest revenue recognized on impaired loans in 1999 compared to $70,000 recognized in 1998. The total allowance for possible loan losses includes activity related to allowances calculated in accordance with SFAS No. 114 and activity related to other loan loss allowances determined in accordance with SFAS No. 5. The following is a summary of loans considered to be impaired:
December 31 =============== (in thousands) 1999 1998 ============================================================================= Impaired loans with no valuation reserve.................... $1,783 $1,924 Impaired loans with a valuation reserve..................... 6,637 2,779 --------------- Total recorded investment in impaired loans................. $8,420 $4,703 =============== Valuation reserve........................................... $3,387 $1,834
The average recorded investment in impaired loans was $6.2 million, $5.7 million, and $5.5 million for the years ended December 31, 1999, 1998, and 1997 respectively. NOTE F -- NON-PERFORMING ASSETS - ------------------------------- A summary of non-performing assets follows:
December 31 ================= (in thousands) 1999 1998 =============================================================================== Non-accrual................................................. $14,854 $12,997 Foreclosed assets........................................... 3,983 4,107 ----------------- $18,837 $17,104 =================
Cullen/Frost did not have any restructured loans for the years ended December 31, 1999 and 1998, respectively. Cullen/Frost recognized interest income on non-accrual loans of approximately $1.1 million, $742 thousand and $594 thousand in 1999, 1998 and 1997, respectively. Had these reduced earning and non-earning loans performed according to their original contract terms, Cullen/Frost would have recognized additional interest income of approximately $1.3 million in 1999 and 1998 and $1.2 million in 1997. 46 47 NOTE G -- BANKING PREMISES AND EQUIPMENT - ---------------------------------------- A summary of banking premises and equipment follows:
December 31 ======================================================================= 1999 1998 ---------------------------------- ---------------------------------- ACCUMULATED ACCUMULATED DEPRECIATION NET DEPRECIATION NET AND CARRYING AND CARRYING (IN THOUSANDS) COST AMORTIZATION VALUE COST AMORTIZATION VALUE ==================================================================================================== Land....................... $ 47,125 $ 47,125 $ 44,528 $ 44,528 Buildings.................. 78,403 $ 31,074 47,329 64,103 $ 22,012 42,091 Furniture and equipment.... 115,180 88,485 26,695 104,200 79,730 24,470 Leasehold improvements..... 39,980 22,475 17,505 37,881 19,519 18,362 Construction in progress... 4,330 4,330 7,839 7,839 ----------------------------------------------------------------------- Total banking premises and equipment....... $285,018 $142,034 $142,984 $258,551 $121,261 $137,290 =======================================================================
NOTE H -- DEPOSITS - ------------------ A summary of deposits outstanding by category follows:
December 31 ======================= (IN THOUSANDS) 1999 1998 ===================================================================================== Demand deposits............................................. $1,863,260 $1,843,499 Savings and Interest-on-Checking............................ 984,438 961,597 Money market deposit accounts............................... 1,635,524 1,493,778 Time accounts of $100,000 or more........................... 649,563 662,923 Time accounts under $100,000................................ 585,331 601,198 Other....................................................... 235,716 282,492 ----------------------- Total deposits......................................... $5,953,832 $5,845,487 =======================
Foreign deposits totaled $716 million and $673 million at December 31, 1999 and 1998, respectively. At December 31, 1999, Cullen/Frost's aggregate amount of maturities of public and private time accounts are as follows:
(in thousands) Maturities ========================================================================= 2000........................................................ $1,251,844 2001........................................................ 78,260 2002........................................................ 6,410 2003........................................................ 3,206 2004........................................................ 745 Subsequent to 2004.......................................... 225 ---------- Total.................................................. $1,340,690 ==========
47 48 NOTE I -- BORROWED FUNDS - ------------------------ Cullen/Frost has a $7.5 million revolving credit facility with another financial institution. The line of credit bears interest at prime. There were no borrowings outstanding on this line at December 31, 1999 and 1998. Cullen/Frost has received advances totaling $23.5 million, and $13.3 million as of December 31, 1999 and 1998, respectively, from the Federal Home Loan Bank (FHLB) included in other liabilities. These advances fall under provisions of a credit facility designed to enable the Corporation to fund long-term loans. The advances mature on October 30, 2000 through July 2, 2018, bear interest at the FHLB's floating rate (average 6.22 percent at December 31, 1999), and are collateralized by a blanket floating lien on all first mortgage loans, the FHLB capital stock owned by the Corporation, and any Bank funds on deposit with the FHLB. Scheduled payments and principal amounts due under terms of the above notes and advances are as follows:
FHLB Repayment (in thousands) Obligations ========================================================================== 2000........................................................ $ 9,818 2001........................................................ 5,353 2002........................................................ 749 2003........................................................ 6,021 2004........................................................ 314 Subsequent to 2004.......................................... 1,265 ---------- Total.................................................. $23,520 ----------
The following table represents balances as they relate to securities sold under repurchase agreements:
Year Ended December 31 ======================= (IN THOUSANDS) 1999 1998 ===================================================================================== Balance at year end......................................... $210,909 $209,526 Maximum month-end balance................................... 229,455 209,526 For the year: Average daily balance..................................... 194,823 175,699
Cullen/Frost Capital Trust I, a Delaware statutory business trust (the "Issuer Trust") and wholly-owned subsidiary of the Corporation, issued on February 6, 1997, $100 million of its 8.42 percent Capital Securities, Series A (the "Capital Securities"), which represent beneficial interests in the Issuer Trust, in an offering exempt from registration under the Securities Act of 1933 pursuant to Rule 144A. The Capital Securities will mature on February 1, 2027 and are redeemable in whole or in part at the option of the Corporation at any time after February 1, 2007 with the approval of the Federal Reserve and in whole at any time upon the occurrence of certain events affecting their tax or regulatory capital treatment. The Issuer Trust used the proceeds of the offering of the Capital Securities to purchase Junior Subordinated Debentures of the Corporation which constitute its only assets and which have terms substantially similar to the Capital Securities. Payments of distributions on the Capital Securities and payments on liquidation or redemption of the Capital Securities are guaranteed by the Corporation on a limited basis pursuant to a Guarantee. The Corporation has also entered into an Agreement as to Expenses and Liabilities with the Issuer Trust pursuant to which it has agreed on a subordinated basis to pay any costs, expenses or liabilities of the Issuer Trust other than those arising under the Capital Securities. The obligations of the Corporation under the Junior Subordinated Debentures, the related Indenture, the trust agreement establishing the Issuer Trust, the Guarantee and the Agreement as to Expenses and Liabilities, in the aggregate, constitute a full and unconditional guarantee by the Corporation of the Issuer Trust's obligations under the Capital Securities. 48 49 The Corporation used the majority of the proceeds of the sale of the Junior Subordinated Debentures for acquisitions and the repurchase of the Corporation's common stock. The Capital Securities are included in the Tier 1 capital of the Corporation for regulatory capital purposes and are reported as debt on the balance sheet, net of deferred issuance costs. The Corporation records distributions payable on the Capital Securities as interest expense. The Corporation has the right to defer payments of interest on the Junior Subordinated Debentures at any time or from time to time for a period of up to ten consecutive semi-annual periods with respect to each deferral period. Under the terms of the Junior Subordinated Debentures, in the event that under certain circumstances there is an event of default under the Junior Subordinated Debentures or the Corporation has elected to defer interest on the Junior Subordinated Debentures, the Corporation may not, with certain exceptions, declare or pay any dividends or distributions on its capital stock or purchase or acquire any of its capital stock. On March 13, 1997, the Corporation and the Issuer Trust, filed a Registration Statement on Form S-4 with the Securities and Exchange Commission to register under the Securities Act of 1933 the exchange of up to $100 million aggregate Liquidation Amount of "new" 8.42 percent Capital Securities, Series A for the then outstanding Capital Securities. On April 25, 1997, the Corporation exchanged all of the outstanding Capital Securities for registered Capital Securities. The "new" Capital Securities have the same terms as the "old" Capital Securities. This exchange enhanced the transferability of the Capital Securities and had no impact on redemption of the Capital Securities, the Junior Subordinated Debentures issued by the Company, the Company's guarantee of the Capital Securities, or other matters described above. NOTE J -- COMMON STOCK AND EARNINGS PER COMMON SHARE - ---------------------------------------------------- A reconciliation of earnings per share for 1999, 1998 and 1997 follows:
December 31 =========================== (IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) 1999 1998 1997 ========================================================================================= Numerators for both basic and diluted earnings per share, net income................................................ $97,642 $75,645 $72,967 =========================== Denominators: Denominators for basic earnings per share, average outstanding common shares................................. 53,368 53,150 52,999 Dilutive effect of stock options............................ 1,378 1,529 1,753 --------------------------- Denominator for diluted earnings per share.................. 54,746 54,679 54,752 =========================== Earnings per share: Basic....................................................... $ 1.83 $ 1.42 $ 1.38 Diluted..................................................... 1.78 1.38 1.33
49 50 NOTE K -- DIVIDENDS - ------------------- In the ordinary course of business Cullen/Frost is dependent upon dividends from its subsidiary banks to provide funds for the payment of dividends to shareholders and to provide for other cash requirements. The amount of dividends that subsidiary banks may declare is subject to regulations. Without prior regulatory approval, the subsidiary banks had approximately $78.5 million available for the payment of dividends to Cullen/Frost at December 31, 1999. NOTE L -- CAPITAL - ----------------- The table below reflects various measures of regulatory capital at year end 1999 and 1998 for Cullen/Frost. As a result of the acquisitions during the first half of 1999, all regulatory capital ratios are down when compared to a year ago.
DECEMBER 31, 1999 December 31, 1998 =================== =================== (IN THOUSANDS) AMOUNT RATIO AMOUNT RATIO ============================================================================================= Risk-Based Tier 1 Capital.............................. $ 519,151 11.04% $ 512,125 12.23% Tier 1 Capital Minimum requirement.......... 188,131 4.00 167,470 4.00 Total Capital............................... $ 577,496 12.28% $ 564,477 13.48% Total Capital Minimum requirement........... 376,263 8.00 334,940 8.00 Risk-adjusted assets, net of goodwill....... $4,703,284 $4,186,744 Leverage ratio................................... 7.56% 7.71% Average equity as a percentage of average assets......................................... 7.60 7.63
At December 31, 1999 and 1998, Cullen/Frost's subsidiary banks were considered "well capitalized" as defined by the FDIC Improvement Act of 1991, the highest rating, and Cullen/Frost's capital ratios were in excess of "well capitalized" levels. A financial institution is deemed to be well capitalized if the institution has a total risk-based capital ratio of 10.0 percent or greater, a Tier 1 risk-based capital ratio of 6.0 percent or greater, and a Tier 1 leverage ratio of 5.0 percent or greater and the institution is not subject to an order, written agreement, capital directive or prompt corrective action directive to meet and maintain a specific capital level for any capital measure. Cullen/Frost and its subsidiary banks currently exceed all minimum capital requirements. Management is not aware of any conditions or events that would have changed the Corporation's capital rating since December 31, 1999. Cullen/Frost is subject to the regulatory capital requirements administered by the Federal Reserve Bank. Regulators can initiate certain mandatory actions, if the Corporation fails to meet the minimum requirements, that could have a direct material effect on the Corporation's financial statements. 50 51 NOTE M -- LEASES AND RENTAL AGREEMENTS - -------------------------------------- Rental expense for all leases amounted to $14.3 million, $13.9 million and $12.8 million for the years ended December 31, 1999, 1998 and 1997, respectively. In June 1987, Frost Bank consummated the sale of its office tower and leased back a portion of the premises under a 13-year primary lease term with options allowing for occupancy up to 50 years. The Bank also sold its related parking garage facility and leased back space in that structure under a 12-year primary lease term with options allowing for occupancy up to 50 years. Both leases allow for purchase of the related asset under specific terms. Frost Bank has agreed to repurchase the office tower and related parking garage facility. Closing of the transaction is expected to take place in the second quarter of 2002. A summary of the total future minimum rental commitments due under non-cancelable equipment leases and long-term agreements on banking premises, not including the aforementioned commitment after the second quarter of 2002, at December 31, 1999 follows:
Total (in thousands) Commitments ========================================================================= 2000........................................................ $14,911 2001........................................................ 15,261 2002........................................................ 12,317 2003........................................................ 8,365 2004........................................................ 6,580 Subsequent to 2004.......................................... 24,863 ---------- Total future minimum rental commitments................ $82,297 ==========
It is expected that certain leases will be renewed, or equipment replaced with new leased equipment, as these leases expire. NOTE N -- EMPLOYEE BENEFIT PLANS - -------------------------------- RETIREMENT PLANS -- Cullen/Frost has a non-contributory defined benefit plan which covers substantially all employees who have completed at least one year of service and have attained the age of 21. Defined benefits are provided based on an employee's final average compensation, age at retirement and years of service. Cullen/Frost's funding policy is to contribute quarterly an amount necessary to satisfy the Employee Retirement Income Security Act (ERISA) funding standards. An eligible employee's right to receive benefits under the plan becomes fully vested upon the earlier of the date on which such employee has completed five years of service or the date on which such employee attains 65 years of age. Retirement benefits under the plan are paid to vested employees upon their (i) normal retirement at age 65 or later or (ii) early retirement at or after age 55, but before age 65. In addition, Cullen/Frost has a Restoration of Retirement Income Plan (providing benefits in excess of the limits under Section 415 of the Internal Revenue Code of 1986, as amended) for eligible employees which is designed to comply with the requirements of ERISA and the entire cost of which is provided by Cullen/Frost contributions. Both plans, as amended, provide for the payment of monthly retirement income pursuant to a formula based on an eligible employee's highest three consecutive years of final average compensation during the last ten consecutive years of employment. 51 52 The following table summarizes benefit obligation and plan asset activity for the plans.
(IN THOUSANDS) 1999 1998 =============================================================================== CHANGE IN BENEFIT OBLIGATION: Benefit obligation at beginning of year................... $65,666 $51,776 Service cost.............................................. 3,987 2,915 Interest cost............................................. 4,387 3,711 Plan Amendments........................................... 6,071 Actuarial (gain) loss..................................... (7,997) 2,545 Benefits paid............................................. (1,450) (1,352) ----------------- Benefit obligation at end of year......................... $64,593 $65,666 CHANGE IN PLAN ASSETS: Fair value of plan assets at beginning of year............ $47,760 $42,357 Actual return on plan assets.............................. 4,747 6,601 Employer contributions.................................... 237 154 Benefits paid............................................. (1,450) (1,352) ----------------- Fair value of plan assets at end of year.................. $51,294 $47,760 Funded status of the plan................................. $13,299 $17,906 Unrecognized net actuarial gain (loss).................... 1,292 (7,329) Unrecognized prior service cost........................... (8,731) (9,805) Unrecognized net transition asset......................... 390 490 ----------------- Accrued benefit cost...................................... $ 6,250 $ 1,262 ================= WEIGHTED-AVERAGE ASSUMPTIONS AS OF DECEMBER 31 Discount rate............................................. 7.50% 6.75% Expected return on plan assets............................ 9.00 9.00 Rate of compensation increase............................. 5.00 5.00
Net pension cost included the following components:
(IN THOUSANDS) 1999 1998 1997 ========================================================================================= Service cost for benefits earned during the year............ $ 3,987 $ 2,915 $ 2,741 Expected return on plan assets, net of expenses............. (4,245) (3,765) (3,000) Interest cost on projected benefit obligation............... 4,387 3,711 3,319 Net amortization and deferral............................... 1,096 714 742 --------------------------- Net pension cost....................................... $ 5,225 $ 3,575 $ 3,802 ===========================
Cullen/Frost has a supplemental executive retirement plan ("SERP") for certain key executives. The plan provides for target retirement benefits, as a percentage of pay, beginning at age 55. The target percentage is 45 percent of pay at age 55, increasing to 60 percent at age 60 and later. Benefits under the SERP are reduced, dollar-for-dollar, by benefits received under the Retirement and Restoration Plans, described above, and any social security benefits. 52 53 SAVINGS PLANS -- Cullen/Frost maintains a 401(k) stock purchase plan (the "401(k) Plan"). The 401(k) Plan permits each participant to make before-tax or after-tax contributions up to 16 percent of eligible compensation. Cullen/Frost makes matching contributions to the 401(k) Plan based on the amount of each participant's contributions up to a maximum of six percent of eligible compensation. Eligible employees must complete 90 days of service to be eligible for enrollment and beginning on January 1, 1999, vest in the Corporation's matching contributions immediately. Cullen/Frost's gross expenses related to the 401(k) Plan were $4.8 million, $2.8 million and $2.3 million for 1999, 1998 and 1997, respectively. During 1999, 1998 and 1997, the Corporation utilized forfeitures with a value of $38 thousand, $199 thousand and $308 thousand, respectively, to offset this expense. The 1991 Thrift Incentive Stock Purchase Plan ("1991 Stock Purchase Plan") was adopted to offer those employees whose participation in the 401(k) Plan is limited an alternative means of receiving comparable benefits. Cullen/Frost's expenses related to the 1991 Stock Purchase Plan were $123 thousand, $861 thousand and $743 thousand for 1999, 1998 and 1997, respectively. EXECUTIVE STOCK PLANS -- Cullen/Frost has four executive stock plans and one outside director stock plan; the 1983 Nonqualified Stock Option Plan ("1983 Plan"), the 1988 Nonqualified Stock Option Plan ("1988 Plan"), the Restricted Stock Plan, the 1992 Stock Plan and the 1997 Outside Directors Stock Plan ("1997 Plan"). The 1992 Stock Plan is an all-inclusive plan, with an aggregate of 8,707,410 shares of common stock authorized for award. The 1992 Stock Plan has replaced all other previously approved executive stock plans. The 1992 Stock Plan allows Cullen/Frost to grant restricted stock, incentive stock options, nonqualified stock options, stock appreciation rights, or any combination thereof to certain key executives of the Corporation. The 1997 Outside Directors Plan allows Cullen/Frost to grant nonqualified stock options to outside directors. The options may be awarded to outside directors in such number, and upon such terms, and at any time and from time to time as determined by the Compensation and Benefits Committee ("Committee"). Each award is evidenced by an award agreement that specifies the option price, the duration of the option, the number of shares to which the option pertains, and such other provisions as the Committee determines. The option price for each grant is at least equal to the fair market value of a share on the date of grant. Options granted expire at such time as the Committee determines at the date of grant and in no event does the exercise period exceed a maximum of ten years. 53 54 The following is a summary of option transactions in each of the last three years:
1983 Plan 1988 Plan 1992 Plan ====================== ====================== =================================== Weighted Weighted Shares Weighted Options Average Options Average Available Options Average Outstanding Price Outstanding Price For Grant Outstanding Price ============================================================================================================ Balance, Dec. 31, 1996................ 73,260 $2.42 356,096 $2.60 717,380 2,341,852 $11.28 Authorized........... 2,000,000 Granted.............. (352,000) 352,000 24.10 Exercised............ (20,496) 2.73 (71,430) 2.53 (191,676) 9.15 Canceled............. 18,760 (18,760) 11.33 ------------------------------------------------------------------------------------- Balance, Dec. 31, 1997................ 52,764 2.29 284,666 2.62 2,384,140 2,483,416 13.26 Granted.............. (841,800) 841,800 24.70 Exercised............ (32,492) 2.02 (26,164) 2.21 (126,070) 10.25 Canceled............. 15,080 (15,080) 26.26 ------------------------------------------------------------------------------------- Balance Dec. 31, 1998................ 20,272 2.73 258,502 2.66 1,557,420 3,184,066 16.35 Granted.............. (1,519,000) 1,519,000 24.80 Authorized........... 3,000,000 Exercised............ (77,578) 2.50 (187,262) 11.27 Canceled............. 54,000 (54,000) 21.57 ------------------------------------------------------------------------------------- Balance Dec. 31, 1999................ 20,272 $2.73 180,924 $2.73 3,092,420 4,461,804 $19.37 ===================================================================================== At Dec. 31, 1999 Per Share Price $6.37-$*9.07 Range............... $2.73 $2.73 $11.44-$15.13** $24.09-$30.31*** Weighted-Average Remaining * 4.2 Years Contractual Life.... 1.8 Years 1.8 Years ** 6.5 Years ***9.2 Years 1997 Plan ===================================== Shares Weighted Available Options Average For Grant Outstanding Price =============================================================== Balance, Dec. 31, 1996................ Authorized........... 300,000 Granted.............. (36,000) 36,000 $22.56 Exercised............ Canceled............. ---------------------------------------- Balance, Dec. 31, 1997................ 264,000 36,000 22.56 Granted.............. (72,000) 72,000 26.88 Exercised............ Canceled............. ---------------------------------------- Balance Dec. 31, 1998................ 192,000 108,000 25.44 Granted.............. (76,000) 76,000 26.63 Authorized........... Exercised............ Canceled............. ---------------------------------------- Balance Dec. 31, 1999................ 116,000 184,000 $25.93 ======================================== At Dec. 31, 1999 Per Share Price Range............... $22.56-$26.88 Weighted-Average Remaining Contractual Life.... 8.8 Years
* Includes 807,484 options of which 807,484 are exercisable, both with a weighted-average exercise price of $8.63. ** Includes 1,000,920 options of which 602,696 are exercisable, both with a weighted-average exercise price of $13.98. *** Includes 2,653,400 options of which 257,440 are exercisable, both with a weighted-average exercise price of $24.68. There were 2,052,816, 1,702,272 and 1,299,956 options exercisable for 1999, 1998, and 1997 with a weighted-average exercise price of $13.07, $10.69 and $8.33, respectively. The 1999 and 1998 options were awarded having a ten-year life with a three-year cliff vesting period. In general, options awarded prior to 1998 had a ten-year life with a five-year vesting period. These plans which were approved by shareholders were established to enable Cullen/Frost to retain and motivate key employees. A committee of non-participating directors has sole authority to select the employees, establish the awards to be issued, and approve the terms and conditions of each award contract. Cullen/Frost has common stock reserved for future issuance upon the grant and exercise of options of 8,055,420 shares. In accounting for the impact of issuing stock options, Cullen/Frost has elected to continue to follow the requirements of Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees" (APB 25) and Related Interpretation as allowed by SFAS No. 123, rather than to follow the recognition requirements of SFAS No. 123, which requires fair value accounting. SFAS No. 123 requires disclosure of proforma net income and earnings per share information assuming that stock options granted in 1997, 1998 and 1999 have been accounted for in accordance with the fair value requirements of SFAS No. 123. The fair value for these options was estimated at the date of grant using a Black-Scholes option pricing model. The Black-Scholes option valuation model was developed for use in estimating the fair value of traded options which have characteristics which are different from Cullen/Frost's employee stock options. In addition, option valuation models require the input of highly subjective assumptions which can significantly 54 55 impact the estimated fair value. As such, in management's opinion, the existing models do not necessarily provide a reliable single measure of the fair value of employee/outside director stock options. The following weighted-average assumptions were used for 1999, 1998 and 1997, respectively: risk-free interest rates of 5.87 percent, 4.87 percent and 5.37 percent; dividend yield of 3.00 percent, 2.25 percent and 2.00 percent; volatility factors of the expected market price of Cullen/Frost's common stock of 24 percent, 23 percent and 19 percent; and weighted-average expected lives of the options of 8 years. The weighted-average grant-date fair value of options granted during 1999, 1998 and 1997 was $6.65, $8.36, and $6.59, respectively. For purposes of proforma disclosures, the estimated fair value of the options is amortized to expense over the options' vesting period. Cullen/Frost's proforma information as if compensation expense had been recognized in accordance with SFAS 123 is summarized below:
(IN THOUSANDS EXCEPT FOR EARNINGS PER SHARE AMOUNTS) 1999 1998 1997 =========================================================================================== Proforma net income*........................................ $95,091 $74,345 $72,265 Proforma earnings per common share Basic.................................................. $ 1.78 $ 1.40 $ 1.37 Diluted................................................ 1.77 1.40 1.36
* Because SFAS No. 123 is applicable only to options granted subsequent to December 31, 1994, its proforma effect is not necessarily indicative of its impact on future years. In 1999, restricted stock grants of 50,171 were awarded under the 1992 Stock Plan. Restricted stock grants awarded under the 1992 Stock Plan totaled 83,000 and 117,000 shares for 1998 and 1997, respectively. The weighted-average price for these awards equaled the market price at the date of grant and was $25.12, $24.65, and $24.10 for 1999, 1998 and 1997, respectively. Deferred compensation expense related to the restricted stock was $1.6 million in 1999, $1.5 million in 1998, and $707 thousand in 1997. Restricted shares are generally awarded under a three-year to four-year cliff vesting period. The market value of restricted shares at the date of grant is expensed over the restriction period. Cullen/Frost has change-in-control agreements with 18 of its executives. Under seven of these agreements, as revised, each covered person could receive, in the event of a change in control, one-half of his base compensation upon the effectiveness of the change in control, and from one and one-half times up to 2.49 times (depending on the executive) of his average annual W-2 compensation during the previous five years if such person is constructively terminated or discharged for reasons other than cause within two years following the change in control. Under the remaining 11 agreements, each covered person could receive from two times up to 2.99 times (depending on the executive) of his average W-2 compensation during the previous five years if such person is constructively terminated or discharged for reasons other than cause within two years following the change in control. These agreements, other than certain instances of stock appreciation and SERPS, limit payments to avoid being considered "parachute payments" as defined by the Internal Revenue Code. The maximum contingent liability under these agreements approximated $13.6 million at December 31, 1999. The Corporation has no material liability for post-retirement or post-employment benefits other than pensions. 55 56 NOTE O -- INCOME TAXES - ---------------------- The following is an analysis of the Corporation's income taxes included in the consolidated statements of operations for the years ended December 31, 1999, 1998, and 1997:
(IN THOUSANDS) 1999 1998 1997 ========================================================================================= Current income tax expense.................................. $57,062 $47,669 $46,236 Deferred income tax benefit................................. (6,083) (5,574) (6,681) --------------------------- Income tax expense as reported.............................. $50,979 $42,095 $39,555 ===========================
The following is a reconciliation of the difference between income tax expense as reported and the amount computed by applying the statutory income tax rate to income before income taxes:
Year Ended December 31 ============================== (IN THOUSANDS) 1999 1998 1997 ============================================================================================ Income before income taxes.................................. $148,621 $117,740 $112,522 Statutory rate.............................................. 35% 35% 35% ------------------------------ Income tax expense at the statutory rate.................... 52,017 41,209 39,383 Effect of tax-exempt interest............................... (2,927) (1,820) (1,298) Amortization of goodwill.................................... 1,910 1,410 1,027 Acquisition costs........................................... 931 Other....................................................... (21) 365 443 ------------------------------ Income tax expense as reported.............................. $ 50,979 $ 42,095 $ 39,555 ============================== Tax (expense) benefits related to securities transactions... $ 30 $ (126) $ (174) ==============================
The tax effects of temporary differences that give rise to significant portions of deferred tax assets and liabilities at December 31, 1999, and 1998 are presented below:
(IN THOUSANDS) 1999 1998 =============================================================================== Deferred tax assets: Allowance for possible loan losses..................... $20,421 $18,766 Building modification reserve.......................... 1,592 1,592 Gain on sale of assets................................. 1,064 1,079 Unrealized loss on securities available for sale....... 21,059 Retirement plan........................................ 2,450 903 Other.................................................. 1,421 698 ----------------- Total gross deferred tax assets................... $48,007 $23,038 Deferred tax liabilities: Prepaid expenses....................................... $ (508) $ (569) Unrealized gain on securities available for sale....... (4,172) Intangible assets...................................... (6,239) (3,896) Bank premises and equipment............................ (323) (351) Other.................................................. (1,144) (500) ----------------- Total gross deferred tax liabilities.............. (8,214) (9,488) ----------------- Net deferred tax asset............................ $39,793 $13,550 =================
At December 31, 1999 and 1998, no valuation allowance for deferred tax assets was necessary because they were supported by recoverable taxes paid in prior years. 56 57 NOTE P -- NON-INTEREST EXPENSE - ------------------------------ Significant components of other non-interest expense for the years ended December 31, 1999, 1998, and 1997 are presented below:
Year Ended December 31 ============================= (IN THOUSANDS) 1999 1998 1997 =========================================================================================== Outside computer service.................................... $ 9,537 $ 9,380 $ 7,936 Other professional expenses................................. 5,867 6,327 5,793 Stationery, printing and supplies........................... 6,676 6,024 5,850 Armored motor service....................................... 4,441 3,946 3,497 Postage and express......................................... 4,154 3,830 3,558 Other....................................................... 47,666 46,337 38,880 ----------------------------- Total.................................................. $78,341 $75,844 $65,514 =============================
NOTE Q -- CASH FLOW DATA - ------------------------ For purposes of reporting cash flow, cash and cash equivalents include the following:
December 31 ================================ (IN THOUSANDS) 1999 1998 1997 ============================================================================================= Cash and due from banks.................................... $760,612 $684,941 $637,613 Time deposits.............................................. 6,546 Federal funds sold and securities purchased under resale agreements............................................... 34,950 102,900 190,000 -------------------------------- Total................................................. $802,108 $787,841 $827,613 ================================
Generally, Federal funds are sold for one-day periods and securities purchased under resale agreements are held for less than thirty-five days. Supplemental cash flow information is as follows:
Year Ended December 31 ================================ (IN THOUSANDS) 1999 1998 1997 ============================================================================================= Cash paid: Interest.............................................. $147,036 $164,150 $144,512 Income Taxes.......................................... 57,549 45,968 39,391 Non-cash items: Loans originated to facilitate the sale of foreclosed assets.............................................. 278 269 1,690 Loan foreclosures..................................... 2,766 1,995 4,240
57 58 NOTE R -- FAIR VALUES OF FINANCIAL INSTRUMENTS - ---------------------------------------------- Fair Values of Financial Instruments -- SFAS No. 107, "Disclosures about Fair Value of Financial Instruments" requires disclosure of fair value information about financial instruments, whether or not recognized in the balance sheet, for which it is practicable to estimate that value. In cases where quoted market prices are not available, fair values are based on estimates using present value or other valuation techniques. Those techniques are significantly affected by the assumptions used, including the discount rate and estimates of future cash flows. SFAS No. 107 excludes certain financial instruments and all non-financial instruments from its disclosure requirements. This disclosure does not and is not intended to represent the fair value of Cullen/Frost. The following methods and assumptions were used by Cullen/Frost in estimating its fair value disclosures for financial instruments: Cash and cash equivalents: The carrying amounts reported in the consolidated balance sheet, for cash and due from banks, including time deposits, and Federal funds sold and securities purchased under resale agreements, approximates their fair value. Securities: Estimated fair values are based on quoted market prices, if available. If a quoted market price is not available, fair value is estimated using quoted market prices for similar instruments. Loans: For variable-rate loans that reprice frequently and with no significant change in credit risk, fair values are based on carrying values. The fair values for certain mortgage loans are based on quoted market prices of similar loans sold, adjusted for differences in loan characteristics. The fair value for other loans is estimated using discounted cash flow analyses, using interest rates currently being offered for loans with similar terms to borrowers of similar credit quality. The carrying amount of accrued interest approximated its fair value. Deposits: SFAS No. 107 defines the fair value of demand deposits as the amount payable on demand, and prohibits adjusting fair value for any deposit base intangible. The deposit base intangible is not considered in the fair value amounts. The carrying amounts for variable-rate money market accounts approximate their fair value. The fair value of fixed-term certificates of deposit are estimated using a discounted cash flow calculation that applies interest rates currently being offered on certificates to a schedule of aggregated expected monthly maturities. Short-term borrowings: The carrying amount reported in the consolidated balance sheet approximates the estimated fair value. Loan commitments, standby and commercial letters of credit: Cullen/Frost's lending commitments have variable interest rates and "escape" clauses if the customer's credit quality deteriorates. Therefore the amounts committed approximate fair value. Guaranteed preferred beneficial interest in the Corporation's junior subordinated deferrable interest debentures: The fair value of the Trust Preferred Capital Securities is estimated based on the quoted market prices of the instruments. Interest rate swaps: The estimated fair value of the existing agreements are based on quoted market prices. 58 59 The estimated fair values of Cullen/Frost's financial instruments are as follows:
December 31 ================================================= 1999 1998 ----------------------- ----------------------- ESTIMATED Estimated CARRYING FAIR CARRYING FAIR (IN THOUSANDS) AMOUNT VALUE AMOUNT VALUE ================================================================================================ Financial assets: Cash and cash equivalents............... $ 802,108 $ 802,108 $ 787,841 $ 787,841 Securities.............................. 1,629,911 1,630,493 2,091,703 2,093,946 Loans................................... 4,166,728 4,153,626 3,646,603 3,678,077 Allowance for loan losses............... (58,345) (53,616) ------------------------------------------------- Net loans.......................... 4,108,383 4,153,626 3,592,987 3,678,077 Financial liabilities: Deposits................................ 5,953,832 5,792,352 5,845,487 5,845,859 Short-term borrowings................... 356,979 356,979 305,564 305,564 Guaranteed preferred beneficial interest in the Corporation's junior subordinated deferrable interest debentures, net....................... 98,513 94,230 98,458 108,340 Off-balance sheet instruments: Interest rate swaps..................... 211 (2,505)
NOTE S -- DERIVATIVE FINANCIAL INSTRUMENTS - ------------------------------------------ Cullen/Frost uses off-balance sheet interest rate swaps to hedge its interest rate risk. These swap transactions allow management to structure the interest rate sensitivity of the asset side of the Corporation's balance sheet to more closely match its view of the interest rate sensitivity of the Corporation's funding sources. Cullen/Frost had 30 interest rate swaps at December 31, 1999 compared to 22 interest rate swaps at December 31, 1998. In 1999, each swap was a hedge against a specific commercial fixed-rate loan or against a specific pool of commercial floating-rate loans, with a notional amount of $259 million. In 1998 each swap was a hedge against a specific commercial fixed-rate loan or against a specific pool of consumer fixed-rate loans with a notional amount of $75 million. For 1999 and 1998, in each case, the amortization of the interest rate swap effectively matched the expected amortization of the underlying loan or pool of loans with lives ranging from approximately one and one-half to ten years. These interest rate contracts involve the risk of dealing with counterparties and their ability to meet contractual terms. Each counterparty to a swap transaction has a credit rating that is investment grade. The net amount payable or receivable under interest rate swaps/floors is accrued as an adjustment to interest income and was not material in 1999 or 1998. In the third quarter of 1998, Cullen/Frost terminated interest rate swaps hedging fixed rate consumer loans. Cullen/Frost is amortizing the loss on the transaction of $1.9 million over the remaining term of the interest swaps ending in the second quarter of 2002. During 1998, Cullen/Frost terminated all three of its interest rate floor agreements with a notional amount totaling $500 million and an original term of three years. These interest rate floors were purchased in 1997 for the purpose of hedging floating interest rate exposure in commercial loan accounts in an environment of falling interest rates. Cullen/Frost is amortizing the gain on the transaction of $2.8 million over the remaining term of the interest rate floors. Cullen/Frost's credit exposure on interest rate swaps/floors is limited to Cullen/Frost's net favorable value and interest payments of all swaps/floors to each counterparty. In such cases collateral is required from the counterparties involved if the net value of the swaps/floors exceeds a nominal amount considered to be immaterial. At December 31, 1999, the Corporation's credit exposure relating to interest rate swaps/floors was immaterial. The fair value and related carrying amounts of the interest rate swaps can be found in Note R on page 58. 59 60 Activity in the notional amounts of end-user derivatives for each of the three years ended December 31, 1999, 1998 and 1997, is summarized as follows:
Amortizing Interest Rate Interest Rate Total (in millions) Swaps Floors Derivatives ========================================================================================================= Balance, January 1, 1997.................................. $ 251 $ 251 Additions............................................ 125 $ 500 625 Amortization and maturities.......................... (89) (89) Terminations......................................... (20) (20) ---------------------------------------- Balance, December 31, 1997................................ 267 500 767 Additions............................................ 19 19 Amortization and maturities.......................... (55) (55) Terminations......................................... (156) (500) (656) ---------------------------------------- Balance, December 31, 1998................................ 75 -- 75 Additions............................................ 239 239 Amortization and maturities.......................... (54) (54) Terminations......................................... (1) (1) ---------------------------------------- Balance, December 31, 1999................................ $ 259 $ -- $ 259 ========================================
NOTE T -- CONTINGENCIES - ----------------------- Certain subsidiaries of Cullen/Frost are defendants in various matters of litigation which have arisen in the normal course of conducting a commercial banking business. In the opinion of management, the disposition of such pending litigation will not have a material effect on Cullen/Frost's consolidated financial position. NOTE U -- SUBSEQUENT EVENTS (UNAUDITED) - --------------------------------------- PENDING ACQUISITION On January 27, 2000 Frost Insurance Agency, a subsidiary of The Frost National Bank signed a letter of intent to acquire Wayland Hancock Insurance Agency, Inc. ("Wayland Hancock"), a Houston-based independent insurance agency. Wayland Hancock offers a full range of life and health insurance, as well as retirement and financial planning, to individuals and businesses. The transaction is subject to regulatory approval and is expected to close in the second quarter of 2000. The purchase method of accounting will be used to record the transaction. PENDING MERGER On February 17, 2000, Cullen/Frost announced that United States National Bank of Galveston, member bank of Cullen/Frost since 1982, will merge its charter into Frost National Bank. United States National Bank's two branches in Galveston will be converted to Frost Bank branches. It is expected that the merger will be effective in the second quarter of 2000. 60 61 NOTE V -- OPERATING SEGMENTS - ---------------------------- The Corporation has two reportable operating segments: Banking and the Financial Management Group. Banking includes both commercial and consumer banking services. Commercial services are provided to corporations and other business clients and include a wide array of lending and cash management products. Consumer banking services include direct and indirect lending, mortgage lending and depository services. The Financial Management Group includes fee based services within private trust, retirement services, and financial management services including personal wealth management, insurance, and brokerage services. These business units were identified through the products and services that are offered within each unit. The accounting policies of each reportable segment are the same as those of the Corporation described in Note A, except for the following items. The Corporation uses a match-funded transfer pricing process to assess operating segment performance. Expenses for consolidated back-office operations are allocated to operating segments based on estimated uses of those services. General overhead type expenses such as executive administration, accounting, internal audit, and personnel are allocated based on the direct expense level of the operating segment. Income tax expense for the individual segments is calculated basically at the statutory rate. Parent Company records the tax expense or benefit necessary to reconcile to the consolidated total.
Financial Management Consolidated (in thousands) Banking Group Non-Banks Total ================================================================================================== 1999 NET INTEREST INCOME (EXPENSE)................... $297,636 $ 8,077 $ (8,735) $296,978 PROVISION FOR LOAN LOSSES....................... 12,426 1 12,427 NON-INTEREST INCOME............................. 102,071 53,808 1,206 157,085 NON-INTEREST EXPENSE............................ 243,547 38,404 11,064 293,015 ------------------------------------------------ INCOME (LOSS) BEFORE INCOME TAXES............... 143,734 23,480 (18,593) 148,621 INCOME TAX EXPENSE (CREDIT)..................... 50,307 8,218 (7,546) 50,979 ------------------------------------------------ NET INCOME (LOSS)............................... $ 93,427 $15,262 $(11,047) $ 97,642 ================================================ AVERAGE ASSETS (IN MILLIONS).................... $ 6,841 $ 34 $ N/M $ 6,875 ================================================================================================== 1998 Net interest income (expense)................... $270,261 $ 6,456 $ (8,744) $267,973 Provision for loan losses....................... 10,337 56 10,393 Non-interest income............................. 84,820 53,162 684 138,666 Non-interest expense............................ 223,473 37,282 5,507 266,262 ------------------------------------------------ Earnings (loss) before income taxes............. 121,271 22,280 (13,567) 129,984* Income tax expense (credit)..................... 42,445 7,783 (5,400) 44,828 ------------------------------------------------ Operating earnings (loss)....................... $ 78,826 $14,497 $ (8,167) $ 85,156* ================================================ Average assets (in millions).................... $ 6,413 $ 31 $ N/M $ 6,418 ================================================================================================== 1997 Net interest income (expense)................... $236,998 $ 6,100 $ (7,963) $235,135 Provision for loan losses....................... 9,169 5 9,174 Non-interest income............................. 73,136 48,220 346 121,702 Non-interest expense............................ 195,870 34,507 4,764 235,141 ------------------------------------------------ Income (loss) before income taxes............... 105,095 19,808 (12,381) 112,522 Income tax expense (credit)..................... 36,783 6,930 (4,158) 39,555 ------------------------------------------------ Net income (loss)............................... $ 68,312 $12,878 $ (8,223) $ 72,967 ================================================ Average assets (in millions).................... $ 5,654 $ 24 $ N/M $ 5,688 ==================================================================================================
* Excludes the after-tax impact of the $12.2 million Overton merger related charge. See discussion on page 15. 61 62 NOTE W -- CONDENSED PARENT CORPORATION FINANCIAL STATEMENTS - ----------------------------------------------------------- Condensed financial information of the Parent Corporation as of December 31, 1999 and 1998 and for each of the three years in the period ended December 31, 1999 follows:
Year Ended December 31 =========================== STATEMENT OF OPERATIONS (IN THOUSANDS) 1999 1998 1997 ========================================================================================= INCOME: Dividends from second tier bank holding company subsidiary............................................. $81,444 $91,673 $23,514 Interest and other...................................... 3,851 2,943 5,075 --------------------------- TOTAL INCOME........................................ 85,295 94,616 28,589 EXPENSES: Salaries and employee benefits.......................... 4,645 6,698 3,350 Interest expense........................................ 8,735 8,761 7,962 Other................................................... 1,534 6,635 1,414 --------------------------- TOTAL EXPENSES...................................... 14,914 22,094 12,726 --------------------------- INCOME BEFORE INCOME TAX CREDITS AND EQUITY IN UNDISTRIBUTED NET INCOME OF SUBSIDIARIES............ 70,381 72,522 15,863 Income tax credits.......................................... 4,394 4,812 2,326 Equity in undistributed net income of subsidiaries.......... 22,867 (1,689) 54,778 --------------------------- NET INCOME.......................................... $97,642 $75,645 $72,967 ===========================
December 31 =================== BALANCE SHEETS (IN THOUSANDS) 1999 1998 ================================================================================= ASSETS Cash........................................................ $ 421 $ 304 Securities purchased under resale agreements................ 71,330 100,830 Loans to non-bank subsidiaries.............................. 52 Investment in second tier bank holding company subsidiary... 553,655 527,124 Other....................................................... 3,275 2,370 ------------------- TOTAL ASSETS........................................ $628,681 $630,680 =================== LIABILITIES Other....................................................... $ 17,764 $ 16,210 Guaranteed preferred beneficial interest in the Corporation's junior subordinated deferrable interest debentures................................................ 101,606 101,551 ------------------- TOTAL LIABILITIES................................... 119,370 117,761 SHAREHOLDERS' EQUITY........................................ 509,311 512,919 ------------------- TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY.......... $628,681 $630,680 ===================
Year Ended December 31 =============================== STATEMENTS OF CASH FLOWS (IN THOUSANDS) 1999 1998 1997 ============================================================================================= OPERATING ACTIVITIES Net income.................................................. $ 97,642 $ 75,645 $ 72,967 Adjustments to reconcile net income to net cash provided by operating activities: Net income of subsidiaries.............................. (104,311) (89,984) (78,292) Dividends from subsidiaries............................. 81,444 91,673 23,514 Net change in other liabilities and assets.............. 1,328 5,557 1,523 ------------------------------- NET CASH PROVIDED BY OPERATING ACTIVITIES........... 76,103 82,891 19,712 INVESTING ACTIVITIES Capital contributions to subsidiaries....................... (50,521) (88,211) Decrease in loans........................................... 52 160 ------------------------------- NET CASH USED BY INVESTING ACTIVITIES............... (50,469) (88,051) FINANCING ACTIVITIES Proceeds from issuance of guaranteed preferred beneficial interest in the Corporation's junior subordinated deferrable interest debentures............................ 101,446 Purchase of treasury stock.................................. (24,318) (3,495) (17,834) Net proceeds from issuance of common stock.................. 5,314 7,983 3,735 Cash dividends.............................................. (36,013) (30,476) (22,256) ------------------------------- NET CASH (USED) PROVIDED BY FINANCING ACTIVITIES.... (55,017) (25,988) 65,091 ------------------------------- (DECREASE) INCREASE IN CASH AND CASH EQUIVALENTS.... (29,383) 56,903 (3,248) Cash and cash equivalents at beginning of year.............. 101,134 44,231 47,479 ------------------------------- CASH AND CASH EQUIVALENTS AT END OF YEAR............ $ 71,751 $101,134 $ 44,231 ===============================
62 63 Report of Ernst & Young LLP Independent Auditors SHAREHOLDERS AND BOARD OF DIRECTORS CULLEN/FROST BANKERS, INC. We have audited the accompanying consolidated balance sheets of Cullen/Frost Bankers, Inc. and Subsidiaries (Cullen/Frost or Corporation) as of December 31, 1999 and 1998, and the related consolidated statements of operations, changes in shareholders' equity, and cash flows for each of the three years in the period ended December 31, 1999. These financial statements are the responsibility of the Corporation's management. Our responsibility is to express an opinion on these financial statements based on our audits. The consolidated financial statements give retroactive effect to the merger of Cullen/Frost and Overton Bancshares, Inc. and Subsidiaries (Overton) on May 29, 1998, which has been accounted for using the pooling of interests method as described in Note B to the consolidated financial statements. We did not audit the consolidated financial statements of Overton for the year ended December 31, 1997, which statements reflect net interest income of 16 percent in 1997 of the related Cullen/Frost's consolidated totals. Those Overton statements were audited by other auditors whose report has been furnished to us, and our opinion, insofar as it relates to data included for Overton, is based solely on the report of other auditors. We conducted our audits in accordance with auditing standards generally accepted in the United States. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits and the report of other auditors provide a reasonable basis for our opinion. In our opinion, based on our audits and the report of other auditors, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of Cullen/Frost Bankers, Inc. and Subsidiaries at December 31, 1999 and 1998, and the consolidated results of their operations and their cash flows for each of the three years in the period ended December 31, 1999 in conformity with accounting principles generally accepted in the United States. /s/ ERNST & YOUNG LLP San Antonio, Texas February 4, 2000 63 64 CONSOLIDATED AVERAGE BALANCE SHEETS (dollars in thousands -- taxable-equivalent basis) The following unaudited schedule is presented for additional information and analysis.
Year Ended December 31 1999 1998 ------------------------------ ------------------------------ INTEREST Interest AVERAGE INCOME/ YIELD/ AVERAGE INCOME/ YIELD/ BALANCE EXPENSE COST BALANCE EXPENSE COST ====================================================================================================================== ASSETS: Time deposits........................................ $ 3,103 $ 164 5.27% Securities: U.S. Treasury.................................... 176,718 8,976 5.08 $ 262,098 $ 14,339 5.47% U.S. Government agencies and corporations........ 1,478,519 95,491 6.46 1,557,489 99,971 6.42 States and political subdivisions: Tax-exempt................................... 141,224 10,377 7.35 66,278 4,963 7.49 Taxable...................................... 3,585 229 6.38 2,229 138 6.19 Other............................................ 38,803 2,203 5.68 42,025 2,579 6.14 ---------- -------- ---------- -------- Total securities......................... 1,838,849 117,276 6.38 1,930,119 121,990 6.32 Federal funds sold and securities purchased under resale agreements.................................. 81,363 4,245 5.22 127,273 7,111 5.59 Loans, net of unearned discount...................... 3,934,406 330,397 8.40 3,437,510 301,789 8.78 ---------- -------- ---------- -------- TOTAL EARNING ASSETS AND AVERAGE RATE EARNED..... 5,857,721 452,082 7.72 5,494,902 430,890 7.84 Cash and due from banks.............................. 619,917 577,489 Allowance for possible loan losses................... (57,481) (51,230) Banking premises and equipment....................... 141,453 135,577 Accrued interest and other assets.................... 313,826 260,831 ---------- ---------- TOTAL ASSETS..................................... $6,875,436 $6,417,569 ========== ========== LIABILITIES: Demand deposits: Commercial and individual........................ $1,533,160 $1,387,824 Correspondent banks.............................. 221,530 195,555 Public funds..................................... 37,567 43,507 ---------- ---------- Total demand deposits........................ 1,792,257 1,626,886 Time deposits: Savings and Interest-on-Checking................. 948,487 6,557 0.69 901,960 10,958 1.21 Money market deposit accounts.................... 1,636,915 60,478 3.69 1,387,994 54,326 3.91 Time accounts.................................... 1,250,340 53,815 4.30 1,286,036 63,621 4.95 Public funds..................................... 220,845 7,969 3.61 251,570 9,378 3.73 ---------- -------- ---------- -------- Total time deposits...................... 4,056,587 128,819 3.18 3,827,560 138,283 3.61 ---------- ---------- Total deposits........................... 5,848,844 5,454,446 Federal funds purchased and securities sold under repurchase agreements.............................. 285,470 12,500 4.38 252,977 11,606 4.59 Guaranteed preferred beneficial interests in the Corporation's junior subordinated deferrable interest debentures, net........................... 98,485 8,475 8.61 98,429 8,475 8.61 Long-term notes payable.............................. 1,793 103 5.74 Other borrowings..................................... 12,186 705 5.79 30,666 1,754 5.72 ---------- -------- ---------- -------- TOTAL INTEREST-BEARING FUNDS AND AVERAGE RATE PAID........................................... 4,454,521 150,602 3.38 4,209,632 160,118 3.80 -------- ---- -------- ---- Accrued interest and other liabilities............... 105,888 91,093 ---------- ---------- TOTAL LIABILITIES................................ 6,352,666 5,927,611 SHAREHOLDERS' EQUITY................................. 522,770 489,958 ---------- ---------- TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY....... $6,875,436 $6,417,569 ========== ========== Net interest income.................................. $301,480 $270,772 ======== ======== Net interest spread.................................. 4.34% 4.04% ==== ==== Net interest income to total average earning assets............................................. 5.15% 4.93% ==== ====
The above information is shown on a taxable-equivalent basis assuming a 35 percent tax rate. Non-accrual loans are included in the average loan amounts outstanding for these computations. 64 65
Year Ended December 31 ================================================================================================================================= 1997 1996 1995 1994 - ------------------------------ ------------------------------ ------------------------------ ------------------------------ Interest Interest Interest Interest Average Income/ Yield/ Average Income/ Yield/ Average Income/ Yield/ Average Income/ Yield/ Balance Expense Cost Balance Expense Cost Balance Expense Cost Balance Expense Cost ================================================================================================================================= $ 301,133 $ 16,596 5.51% $ 282,692 $ 15,049 5.32% $ 238,968 $ 14,142 5.92% $ 362,881 $ 16,616 4.58% 1,374,202 90,688 6.60 1,439,744 95,838 6.66 1,447,288 93,373 6.45 1,438,632 85,507 5.94 36,888 2,850 7.73 29,863 2,340 7.84 27,128 2,211 8.15 20,555 1,729 8.41 3,185 239 7.50 1,783 118 6.62 605 39 6.45 320 20 6.25 11,317 686 6.06 6,723 389 5.79 9,314 593 6.37 30,908 1,711 5.54 - ---------- -------- ---------- -------- ---------- -------- ---------- -------- 1,726,725 111,059 6.43 1,760,805 113,734 6.46 1,723,303 110,358 6.40 1,853,296 105,583 5.70 228,245 12,423 5.44 143,401 7,476 5.21 121,122 6,957 5.74 109,563 4,217 3.85 2,917,371 262,569 9.00 2,445,777 220,417 9.01 1,971,681 181,597 9.21 1,552,249 126,039 8.12 - ---------- -------- ---------- -------- ---------- -------- ---------- -------- 4,872,341 386,051 7.92 4,349,983 341,627 7.85 3,816,106 298,912 7.83 3,515,108 235,839 6.71 527,924 508,934 400,270 358,927 (44,837) (39,814) (31,969) (29,214) 124,629 117,352 102,920 99,518 207,520 177,040 156,229 144,359 - ---------- ---------- ---------- ---------- $5,687,577 $5,113,495 $4,443,556 $4,088,698 ========== ========== ========== ========== $1,143,828 $ 979,757 $ 814,169 $ 773,912 192,231 199,983 131,295 124,416 44,183 45,200 42,033 40,293 - ---------- ---------- ---------- ---------- 1,380,242 1,224,940 987,497 938,621 818,216 10,764 1.32 741,102 10,176 1.37 741,003 13,195 1.78 880,969 15,923 1.81 1,195,773 48,816 4.08 1,053,819 40,208 3.82 801,081 29,631 3.70 638,277 18,294 2.87 1,205,261 59,867 4.97 1,145,194 56,110 4.90 1,057,100 52,509 4.97 939,493 32,273 3.44 269,027 11,693 4.35 245,266 10,685 4.36 125,971 5,450 4.33 92,092 2,705 2.94 - ---------- -------- ---------- -------- ---------- -------- ---------- -------- 3,488,277 131,140 3.76 3,185,381 117,179 3.68 2,725,155 100,785 3.70 2,550,831 69,195 2.71 - ---------- ---------- ---------- ---------- 4,868,519 4,410,321 3,712,652 3,489,452 189,468 8,739 4.61 204,515 9,761 4.77 290,636 15,150 5.21 220,367 8,177 3.71 88,745 7,652 8.62 25,794 1,434 5.56 19,389 1,019 5.26 12,514 733 5.86 - ---------- -------- ---------- -------- ---------- -------- ---------- -------- 3,792,284 148,965 3.93 3,409,285 127,959 3.75 3,028,305 116,668 3.85 2,771,198 77,372 2.79 -------- ---- -------- ---- -------- ---- -------- ---- 69,601 76,583 67,940 61,579 - ---------- ---------- ---------- ---------- 5,242,127 4,710,808 4,083,742 3,771,398 445,450 402,687 359,814 317,300 - ---------- ---------- ---------- ---------- $5,687,577 $5,113,495 $4,443,556 $4,088,698 ========== ========== ========== ========== $237,086 $213,668 $182,244 $158,467 ======== ======== ======== ======== 3.99% 4.10% 3.98% 3.92% ==== ==== ==== ==== 4.87% 4.91% 4.78% 4.51% ==== ==== ==== ====
65 66 FINANCIAL STATISTICS (dollars in thousands) The following unaudited schedules and statistics are presented for additional information and analysis. RATE/VOLUME ANALYSIS - --------------------
1999/1998 1998/1997 ================================= ================================= INCREASE (DECREASE) Increase (Decrease) DUE TO CHANGE IN TOTAL Due to Change in Total -------------------- OR NET -------------------- or Net AVERAGE AVERAGE INCREASE AVERAGE AVERAGE INCREASE RATE BALANCE (DECREASE) RATE BALANCE (DECREASE) ============================================================================================================ Changes in interest earned on: Time deposits...................... $ 164 $ 164 Securities: U.S. Treasury................... $ (966) (4,397) (5,363) $ (121) $ (2,136) $ (2,257) U.S. Government agencies and corporations.................. 617 (5,097) (4,480) (2,538) 11,821 9,283 States and political subdivisions Tax-exempt.................... (95) 5,509 5,414 (90) 2,203 2,113 Taxable....................... 4 87 91 (64) (37) (101) Other........................... (186) (190) (376) 9 1,884 1,893 Federal funds sold................. (444) (2,422) (2,866) 321 (5,633) (5,312) Loans.............................. (13,558) 42,166 28,608 (6,584) 45,804 39,220 --------------------------------------------------------------------- Total...................... (14,628) 35,820 21,192 (9,067) 53,906 44,839 Changes in interest paid on: Savings, Interest-on-Checking...... 4,940 (539) 4,401 859 (1,053) (194) Money market deposits accounts..... 3,175 (9,327) (6,152) 2,080 (7,590) (5,510) Time accounts and public funds..... 8,374 2,841 11,215 1,833 (3,272) (1,439) Federal funds purchased and securities sold under repurchase agreements...................... 546 (1,440) (894) 47 (2,914) (2,867) Long-term notes payable and other borrowings...................... (16) 962 946 (31) (1,112) (1,143) --------------------------------------------------------------------- Total...................... 17,019 (7,503) 9,516 4,788 (15,941) (11,153) --------------------------------------------------------------------- Changes in net interest income....... $ 2,391 $28,317 $30,708 $(4,279) $ 37,965 $ 33,686 =====================================================================
The allocation of the rate/volume variance has been made on a pro-rata basis assuming absolute values. The above information is shown on a taxable-equivalent basis assuming a 35 percent tax rate. LOAN MATURITY AND SENSITIVITY - -----------------------------
DECEMBER 31, 1999 ================================================ DUE IN AFTER ONE, AFTER ONE YEAR BUT WITHIN FIVE OR LESS FIVE YEARS YEARS TOTAL ================================================================================================ Real estate construction and land loans....... $ 287,315 $ 142,973 $ 78,037 $ 508,325 Other real estate loans....................... 90,202 285,550 446,153 821,905 All other loans............................... 887,501 572,652 191,718 1,651,871 ------------------------------------------------ Total.................................... $1,265,018 $1,001,175 $715,908 $2,982,101 ================================================ Loans with fixed interest rates............... $ 386,489 $ 346,406 $397,458 $1,130,353 Loans with floating interest rates............ 878,529 654,769 318,450 1,851,748 ------------------------------------------------ Total.................................... $1,265,018 $1,001,175 $715,908 $2,982,101 ================================================
Loans for 1-4 family housing totaling $650 million and consumer loans totaling $541 million and unearned income of $6 million are not included in the amounts in the table. 66 67 MATURITY DISTRIBUTION AND SECURITIES PORTFOLIO YIELDS - -----------------------------------------------------
December 31, 1999 ====================================================================================== Maturity -------------------------------------------------------------------------------------- Within 1 Year 1-5 Years 5-10 Years After 10 Years ------------------- ------------------- ------------------ --------------------- Weighted Weighted Weighted Weighted Average Average Average Average (in thousands) Amount Yield Amount Yield Amount Yield Amount Yield ================================================================================================================== Held to maturity: U.S. Government agencies and corporations........ $10,011 8.31% $ 72,402 9.91% States and political subdivisions............ $ 920 7.42% 1,662 10.00 Other..................... $ 25 7.64% 25 7.00 -------------------------------------------------------------------------------------- Total securities held to maturity......... $ 25 7.64% $ 945 4.88% $11,673 8.05% $ 72,402 9.91% ====================================================================================== Available for sale: U.S. Treasury............. $113,331 5.31% $ 4,799 5.51% U.S. Government agencies and corporations........ 48,944 6.83 117,710 6.53 $16,091 6.33% $1,059,282 6.52% States and political subdivisions............ 4,154 7.88 29,828 7.62 43,461 6.98 73,293 6.83 Other..................... 33,972 5.83 -------------------------------------------------------------------------------------- Total securities available for sale................ $166,429 5.75% $152,337 6.19% $59,552 5.02% $1,166,547 6.37% ====================================================================================== December 31, 1999 ===================== Maturity --------------------- Total Carrying Amount --------------------- Weighted Average (in thousands) Amount Yield ================================================= Held to maturity: U.S. Government agencies and corporations........ $ 82,413 9.72% States and political subdivisions............ 2,582 9.08 Other..................... 50 7.32 --------------------- Total securities held to maturity......... $ 85,045* 9.60% ===================== Available for sale: U.S. Treasury............. $ 118,130 5.31% U.S. Government agencies and corporations........ 1,242,027 6.53 States and political subdivisions............ 150,736 7.06 Other..................... 33,972 5.83 --------------------- Total securities available for sale................ $1,544,865* 6.23% =====================
Weighted average yields have been computed on a fully taxable-equivalent basis assuming a tax rate of 35%. * Included in the totals are mortgage-backed securities and collateralized mortgage obligations of $1.3 billion which are included in maturity categories based on their stated maturity date. QUARTERLY RESULTS OF OPERATIONS - -------------------------------
THREE MONTHS ENDED 1999 Three Months Ended 1998 ========================================= ========================================= (IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) MAR 31 JUNE 30 SEPT 30 DEC 31 MAR 31* JUNE 30 SEPT 30 DEC 31 =============================================================================================================================== Interest income.................... $109,167 $109,063 $112,466 $116,884 $104,072 $106,240 $107,920 $109,859 Interest expense................... 37,727 36,156 37,297 39,422 40,014 40,018 40,250 39,836 Net interest income................ 71,440 72,907 75,169 77,462 64,058 66,222 67,670 70,023 Provision for possible loan losses... 3,000 2,975 2,976 3,476 2,579 2,600 2,555 2,659 (Loss)gain on securities transactions... (68) (18) 73 71 67 148 Non-interest income**.............. 38,361 38,195 39,663 40,866 33,462 35,004 36,009 34,191 Non-interest expense***............ 70,076 71,480 74,555 76,904 64,853 79,028 67,398 67,227 Income before income taxes......... 36,725 36,647 37,301 37,948 30,088 19,598 33,726 34,328 Income taxes....................... 12,430 12,559 12,928 13,062 10,675 8,142 11,728 11,550 Net income......................... 24,295 24,088 24,373 24,886 19,413 11,456 21,998 22,778 Net income per diluted common share... .44 .44 .45 .46 .35 .21 .40 .42
* All financial information has been restated for the merger with Overton Bancshares, Inc. accounted for as a pooling-of-interests. ** Includes (loss) gain on securities transactions. *** Includes a merger related charge of $12.2 million associated with the second quarter 1998 merger with Overton Bancshares, Inc. Without the merger related charge after-tax operating earnings per diluted common share for the second quarter of 1998 were $.38. 67 68 CULLEN/FROST BANKERS, INC. AND SUBSIDIARIES BANK SUBSIDIARIES (in thousands)
=================================================================================================== DECEMBER 31, 1999 ------------------------------------ TOTAL TOTAL TOTAL ASSETS LOANS DEPOSITS ==================================== Frost National Bank......................................... $6,868,318 $4,103,284 $5,832,133 San Antonio, Austin, Boerne/Fair Oaks, Corpus Christi, Dallas, Fort Worth, Houston, McAllen, New Braunfels, San Marcos Main Office: P. O. Box 1600, 100 West Houston Street San Antonio, Texas 78296 (210)220-4011 United States National Bank................................. 133,534 63,200 122,882 P. O. Box 179, 2201 Market Street Galveston, Texas 77553 (409)763-1151
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING - ------------------------------------------------------------------- AND FINANCIAL DISCLOSURE ------------------------ None. PART III ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT - ------------------------------------------------------------ The information regarding directors and executive officers called for by Item 10 is incorporated herein by reference to Cullen/Frost's Proxy Statement for its Annual Meeting of Shareholders to be held May 31, 2000. The additional information regarding executive officers called for by Item 10 is included in Part I, Item 1 of this document under the heading "Executive Officers of the Registrant". ITEM 11. EXECUTIVE COMPENSATION - -------------------------------- The information called for by Item 11 is incorporated herein by reference to Cullen/Frost's Proxy Statement for its Annual Meeting of Shareholders to be held May 31, 2000. ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT - ------------------------------------------------------------------------ The information called for by Item 12 is incorporated herein by reference to Cullen/Frost's Proxy Statement for its Annual Meeting of Shareholders to be held May 31, 2000. ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS - -------------------------------------------------------- The information called for by Item 13 is incorporated herein by reference to Cullen/Frost's Proxy Statement for its Annual Meeting of Shareholders to be held May 31, 2000. 68 69 PART IV ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K - -------------------------------------------------------------------------- (a) The following documents are filed as part of this Annual Report on Form 10-K: 1. Financial Statements -- Reference is made to Part II, Item 8, of this Annual Report on Form 10-K. 2. The Financial Statement Schedules are omitted, as the required information is included as a part of this Annual Report. 3. Exhibits -- The following exhibits are filed as a part of this Annual Report on Form 10-K:
EXHIBIT NUMBER ------- 3.1 -- Articles of Incorporation, of Cullen/Frost Bankers, Inc. as amended (10) 3.2 -- Amended By-Laws of Cullen/Frost Bankers, Inc. (8) 4.1 -- Shareholder Protection Rights Agreement dated as of February 1, 1999 between Cullen/Frost Bankers, Inc. and The Frost National Bank, as Rights Agent (12) 10.1 -- Restoration of Retirement Income Plan for Participants in the Retirement Plan for Employees of Cullen/Frost Bankers, Inc. and its Affiliates (as amended and restated) (11)* 10.2 -- 1983 Non-qualified Stock Option Plan, as amended (1) 10.3 -- Form of Revised Change-In-Control Agreements with four Executive Officers (3)* 10.4 -- 1988 Non-qualified Stock Option Plan (2)* 10.5 -- The 401(k) Stock Purchase Plan for employees of Cullen/Frost Bankers, Inc. and its Affiliates (4)* 10.6 -- 1991 Thrift Incentive Stock Purchase Plan for Employees of Cullen/Frost Bankers, Inc. and its Affiliates (5)* 10.7 -- Cullen/Frost Bankers, Inc. Restricted Stock Plan (6)* 10.8 -- Cullen/Frost Bankers, Inc. Supplemental Executive Retirement Plan (7)* 10.9 -- Form of Revised Change-In-Control Agreements with one Executive Officer (7)* 10.10 -- Cullen/Frost Bankers, Inc. 1997 Directors Stock Plan (9) 10.11 -- Cullen/Frost Bankers, Inc. 1992 Stock Plan, as amended (9) 19.1 -- Annual Report on Form 11-K for the Year Ended December 31, 1999, for the 1991 Thrift Incentive Stock Purchase Plan (filed pursuant to Rule 15d-21 of the Securities and Exchange Act of 1934)(13) 19.2 -- Annual Report on Form 11-K for the Year Ended December 31, 1999, for the 401(k) Stock Purchase Plan (filed pursuant to Rule 15d-21 of the Securities and Exchange Act of 1934)(13) 21 -- Subsidiaries of Cullen/Frost Bankers, Inc. 23.1 -- Consent of Independent Auditors 23.2 -- Consent of PricewaterhouseCoopers LLP Independent Auditors for Overton Bancshares, Inc. 24 -- Power of Attorney 27 -- Financial Date Schedule (EDGAR Version) 99 -- Report of PricewaterhouseCoopers LLP on Overton Bancshares, Inc. financial statements as of December 31, 1997 and for each of the years in the two year period ended December 31, 1997.
* Management contract or compensatory plan or arrangement required to be filed as an exhibit pursuant to Item 601 of Regulation S-K. (b) Reports on Form 8-K -- No such reports were filed during the quarter ended December 31, 1999. 69 70 - --------------- (1) Incorporated herein by reference to the designated Exhibits to Cullen/Frost's Report on Form S-8 filed September 5, 1989 (File No. 33-30776) (2) Incorporated herein by reference to the designated Exhibits to Cullen/Frost's Report on Form S-8 filed September 5, 1989 (File No. 33-30777) (3) Incorporated herein by reference to the designated Exhibits to the Cullen/Frost Annual Report on Form 10-K for the Year Ended December 31, 1989 (File No. 0-7275) (4) Incorporated herein by reference to the designated Exhibits to Cullen/Frost's Report on Form S-8 filed October 31, 1990 (File No. 33-37500) (5) Incorporated herein by reference to the designated Exhibits to Cullen/Frost's Report on Form S-8 filed March 18, 1991 (File No. 33-39478) (6) Incorporated herein by reference to the designated Exhibits to Cullen/Frost's Report on Form S-8 filed October 20, 1992 (File No. 33-53492) (7) Incorporated herein by reference to the designated Exhibits to Cullen/Frost's Annual Report on Form 10-K for the Year Ended December 31, 1994 (File No. 0-7275) (8) Incorporated herein by reference to the designated Exhibits to Cullen/Frost's Annual Report on Form 10-K/A for the Year Ended December 31, 1995 (File No. 0-7275) (9) Incorporated herein by reference to the designated Exhibits to Cullen/Frost's Annual Report on Form 10-K for the Year Ended December 31, 1997 (File No. 0-7275) (10) Incorporated herein by reference to the designated Exhibits to Cullen/Frost's Report on Form 8-A12B/A filed on August 31, 1998 (File No. 0-7275) (11) Incorporated herein by reference to the designated Exhibits to Cullen/Frost's Annual report on Form 10-K for the Year Ended December 31, 1998 (File No. 0-7275) (12) Incorporated herein by reference to the designated Exhibits to Cullen/Frost's Current Report on Form 8-A12G/A dated February 1, 1999 (File No. 0-7275) (13) To be filed as an amendment. 70 71 SIGNATURES PURSUANT TO THE REQUIREMENTS OF SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934, THE REGISTRANT HAS DULY CAUSED THIS REPORT TO BE SIGNED ON ITS BEHALF BY THE UNDERSIGNED, THEREUNTO DULY AUTHORIZED. Date: March 30, 2000 CULLEN/FROST BANKERS, INC. (Registrant) By: /s/ PHILLIP D. GREEN ---------------------------------- PHILLIP D. GREEN SENIOR EXECUTIVE VICE PRESIDENT AND CHIEF FINANCIAL OFFICER PURSUANT TO THE REQUIREMENTS OF THE SECURITIES EXCHANGE ACT OF 1934, THIS REPORT HAS BEEN SIGNED BELOW BY THE FOLLOWING PERSONS ON BEHALF OF THE REGISTRANT AND IN THE CAPACITIES INDICATED ON MARCH 30, 2000.
SIGNATURES TITLE DATE ---------- ----- ---- T.C. FROST* Senior Chairman of the Board - ----------------------------------------------------- and Director T.C. FROST RICHARD W. EVANS, JR.* Chairman of the Board and - ----------------------------------------------------- Director (Principal Executive RICHARD W. EVANS, JR. Officer) R. DENNY ALEXANDER* Director - ----------------------------------------------------- R. DENNY ALEXANDER ISAAC ARNOLD, JR.* Director - ----------------------------------------------------- ISAAC ARNOLD, JR. ROYCE S. CALDWELL* Director - ----------------------------------------------------- ROYCE S. CALDWELL RUBEN R. CARDENAS* Director - ----------------------------------------------------- RUBEN R. CARDENAS HENRY E. CATTO* Director - ----------------------------------------------------- HENRY E. CATTO BOB W. COLEMAN* Director - ----------------------------------------------------- BOB W. COLEMAN HARRY H. CULLEN* Director - ----------------------------------------------------- HARRY H. CULLEN ROY H. CULLEN* Director - ----------------------------------------------------- ROY H. CULLEN
71 72 SIGNATURES -- (CONTINUED)
SIGNATURES TITLE DATE ---------- ----- ---- EUGENE H. DAWSON, SR.* Director - ----------------------------------------------------- EUGENE H. DAWSON, SR. CASS EDWARDS* Director - ----------------------------------------------------- CASS EDWARDS RUBEN M. ESCOBEDO* Director - ----------------------------------------------------- RUBEN M. ESCOBEDO PATRICK B. FROST* Director - ----------------------------------------------------- PATRICK B. FROST JOE R. FULTON* Director - ----------------------------------------------------- JOE R. FULTON JAMES W. GORMAN, JR.* Director - ----------------------------------------------------- JAMES W. GORMAN, JR. JAMES L. HAYNE* Director - ----------------------------------------------------- JAMES L. HAYNE RICHARD M. KLEBERG, III* Director - ----------------------------------------------------- RICHARD M. KLEBERG, III ROBERT S. MCCLANE* Director - ----------------------------------------------------- ROBERT S. MCCLANE IDA CLEMENT STEEN* Director - ----------------------------------------------------- IDA CLEMENT STEEN HORACE WILKINS, JR.* Director - ----------------------------------------------------- HORACE WILKINS, JR. MARY BETH WILLIAMSON* Director - ----------------------------------------------------- MARY BETH WILLIAMSON *By: /s/ PHILLIP D. GREEN Senior Executive Vice March 30, 2000 President and Chief Financial - ----------------------------------------------------- Officer PHILLIP D. GREEN (AS ATTORNEY-IN-FACT FOR THE PERSONS INDICATED)
72 73 EXHIBIT INDEX
Exhibit Number Description of Exhibits - -------------------------------------------------------------------------------- 21 Subsidiaries of Cullen/Frost 23.1 Consent of Independent Auditors 23.2 Consent of PricewaterhouseCoopers LLP, Independent Auditors for Overton Bancshares, Inc. 24 Power of Attorney 27 1999 Financial Data Schedule* 99 Report of PricewaterhouseCoopers LLP on Overton Bancshares, Inc. financial statements as of December 31, 1997 and for each of the years in the two year period ended December 31, 1997.
* EDGAR Version Only. EX-21 2 SUBSIDIARIES OF THE REGISTRANT 1 EXHIBIT 21 Subsidiaries of the Registrant As of March 30, 2000 Cullen/Frost owned directly, or indirectly through wholly owned subsidiaries, the following subsidiaries.
Percentage of Organized Voting Securities Under Owned By Laws of Cullen/Frost ===================================================================================================== The Frost National Bank United States 100% United States National Bank of Galveston United States 100% Main Plaza Corporation Texas 100% Daltex General Agency, Inc. Texas 100% The New Galveston Company, Inc. Delaware 100% Cullen/Frost Capital Trust I Delaware 100% Frost Insurance Agency Texas 100% Frost Securities, Inc. Delaware 100%
EX-23.1 3 CONSENT OF INDEPENDENT AUDITORS 1 EXHIBIT 23.1 Consent of Independent Auditors We consent to the incorporation by reference in the Registration Statement (Form S-8 No. 33-30776) pertaining to the Cullen/Frost Bankers, Inc. 1983 Nonqualified Stock Option Plan, the Registration Statement (Form S-8 No. 33-30777) pertaining to the Cullen/Frost Bankers, Inc. 1988 Nonqualified Stock Option Plan, the Registration Statement (Form S-8 No. 33-37500) pertaining to the 401(k) Stock Purchase Plan for Employees of Cullen/Frost Bankers, Inc. and Its Affiliates, the Registration Statement (Form S-8 No. 33-39478) pertaining to the 1991 Thrift Incentive Stock Purchase Plan for Employees of Cullen/Frost Bankers, Inc. and Its Affiliates, the Registration Statement (Form S-8 No. 33-53492) pertaining to the Cullen/Frost Bankers, Inc. Restricted Stock Plan, the Registration Statement (Form S-8 No. 33-53622) pertaining to the Cullen/Frost Bankers, Inc. 1992 Stock Plan, and the Registration Statement (Form S-8 No. 333-81461) pertaining to 1997 Directors Stock Plan of Cullen/Frost Bankers, Inc.) of our report dated February 4, 2000, with respect to the consolidated financial statements of Cullen/Frost Bankers, Inc. included in this Annual Report (Form 10-K) for the year ended December 31, 1999. /s/ ERNST & YOUNG LLP San Antonio, Texas March 24, 2000 EX-23.2 4 CONSENT OF PRICEWATERHOUSECOOPERS LLP 1 EXHIBIT 23.2 CONSENT OF INDEPENDENT ACCOUNTANTS ---------------------------------- We hereby consent to the incorporation by reference in the Registration Statement (Form S-8 No. 33-30776) pertaining to the Cullen/Frost Bankers, Inc. 1983 Nonqualified Stock Option Plan, the Registration Statement (Form S-8 No. 33-30777) pertaining to the Cullen/Frost Bankers, Inc. 1988 Nonqualified Stock Option Plan, the Registration Statement (Form S-8 No. 33-37500) pertaining to the 401 (k) Stock Purchase Plan for Employees of Cullen/Frost Bankers, Inc. and Its Affiliates, the Registration Statement (Form S-8 No. 33-39478) pertaining to the 1991 Thrift Incentive Stock Purchase Plan for Employees of Cullen/Frost Bankers, Inc. and Its Affiliates, the Registration Statement (Form S-8 No. 33-53492) pertaining to the Cullen/Frost Bankers, Inc. Restricted Stock Plan, the Registration Statement (Form S-8 No 33-53622) pertaining to the Cullen/Frost Bankers, Inc. 1992 Stock Plan, and the Registration Statement (Form S-8 No. 333-81461) pertaining to the 1997 Directors Stock Plan of Cullen/Frost Bankers, Inc., of our report dated February 17, 1998, on our audit of the consolidated statements of income, shareholders' equity and cash flows of Overton Bancshares, Inc. and Subsidiaries for the year ended December 31, 1997 (not presented separately in the Cullen/Frost Bankers, Inc., 1999 Annual Report on Form 10-K), which report is included as Exhibit 99 to the Cullen/Frost Bankers, Inc. 1999 Annual Report on Form 10-K. /s/ PricewaterhouseCoopers LLP Fort Worth, Texas March 24, 2000 EX-24 5 POWER OF ATTORNEY 1 EXHIBIT 24 POWER OF ATTORNEY KNOW ALL MEN BY THESE PRESENTS, that each person whose signature appears below constitutes and appoints Patrick B. Frost, Richard W. Evans, Jr. and Phillip D. Green, and each of them, his true and lawful attorneys-in-fact and agents, and with power of substitution and resubstitution, for him and in his name, place and stead, and in any and all capacities, to sign the Annual Report on Form 10-K of Cullen/Frost Bankers, Inc. for the fiscal year ended December 31, 1999, to sign any and all amendments thereto, and to file such Annual Report and amendments, with all exhibits thereto, and other documents in connection therewith, with the Securities and Exchange Commission, granting unto said attorneys-in-fact and agents, and each of them, full power and authority to do and perform each and every act and thing requisite or necessary to be done in and about the premises, as fully to all intents and purposes as he might or could do in person, hereby ratifying and confirming all that said attorneys-in-fact and agents or either of them, or their or his substitute or substitutes, may lawfully do or cause to be done by virtue hereof. 2
Signatures Title Date - ------------------------------------------- ------------------------------- ---------------- /s/ T.C. FROST - ------------------------------------------- Senior Chairman of the Board January 26, 2000 (T.C. Frost) and Director /s/ RICHARD W. EVANS, JR. - ------------------------------------------- Chairman of the Board and January 26, 2000 (Richard W. Evans, Jr.) Director /s/ R. DENNY ALEXANDER - ------------------------------------------- Director January 26, 2000 (R. Denny Alexander) /s/ ISAAC ARNOLD, JR. - ------------------------------------------- Director January 26, 2000 (Isaac Arnold, Jr.) /s/ ROYCE S. CALDWELL - ------------------------------------------- Director January 26, 2000 (Royce S. Caldwell) /s/ RUBEN R. CARDENAS - ------------------------------------------- Director January 26, 2000 (Ruben R. Cardenas) /s/ HENRY E. CATTO - ------------------------------------------- Director January 26, 2000 (Henry E. Catto) /s/ BOB W. COLEMAN - ------------------------------------------- Director January 26, 2000 (Bob W. Coleman) /s/ HARRY H. CULLEN - ------------------------------------------- Director January 26, 2000 (Harry H. Cullen) /s/ ROY H. CULLEN - ------------------------------------------- Director January 26, 2000 (Roy H. Cullen) /s/ EUGENE H. DAWSON, SR. - ------------------------------------------- Director January 26, 2000 (Eugene H. Dawson, Sr.)
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Signatures Title Date - ------------------------------------------- ------------------------------- ---------------- /s/ CASS EDWARDS - ------------------------------------------ Director January 26, 2000 (Cass Edwards) /s/ RUBEN M. ESCOBEDO - ------------------------------------------- Director January 26, 2000 (Ruben M. Escobedo) /s/ PATRICK B. FROST - ------------------------------------------- Director January 26, 2000 (Patrick B. Frost) /s/ JOE R. FULTON - ------------------------------------------- Director January 26, 2000 (Joe R. Fulton) /s/ JAMES W. GORMAN, JR. - ------------------------------------------- Director January 26, 2000 (James W. Gorman, Jr.) /s/ JAMES L. HAYNE - ------------------------------------------- Director January 26, 2000 (James L. Hayne) /s/ RICHARD M. KLEBERG, III - ------------------------------------------- Director January 26, 2000 (Richard M. Kleberg, III) /s/ ROBERT S. McCLANE - ------------------------------------------- Director January 26, 2000 (Robert S. McClane) /s/ IDA CLEMENT STEEN - ------------------------------------------- Director January 26, 2000 (Ida Clement Steen) /s/ HORACE WILKINS, JR. - ------------------------------------------- Director January 26, 2000 (Horace Wilkins, Jr.)
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Signatures Title Date - ------------------------------------------- ------------------------------- ----------------- /s/ MARY BETH WILLIAMSON - ------------------------------------------- Director January 26, 2000 (Mary Beth Williamson) /s/ PHILLIP D. GREEN - ------------------------------------------- Senior Executive Vice President January 26, 2000 (Phillip D. Green) and Chief Financial Officer
EX-27 6 FINANCIAL DATA SCHEDULE
9 THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE CURRENT REPORT ON FORM 10-K FOR THE YEAR ENDED DECEMBER 31, 1999 AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS AND ACCOMPANYING DISCLOSURES. 0000039263 CULLEN/FROST BANKERS INC 1,000 YEAR DEC-31-1999 DEC-31-1999 751,612 6,546 34,950 1 1,544,865 85,045 85,627 4,166,728 58,345 6,987,680 5,953,832 92,565 333,459 98,513 536 0 0 508,775 6,987,680 329,610 113,561 4,409 447,580 128,819 150,602 296,978 12,427 (86) 293,015 148,621 148,621 0 0 97,642 1.83 1.78 7.72 14,854 6,910 0 2,812 53,616 (13,132) 4,369 58,345 55,367 64 2,914
EX-99 7 REPORT OF PRICEWATERHOUSECOOPERS LLP 1 EXHIBIT 99 Report of Independent Accountants Board of Directors and Shareholders Overton Bancshares, Inc. Fort Worth, Texas In our opinion, the consolidated statements of income, shareholders' equity and cash flows for the year ended December 31, 1997 (not presented separately in the Cullen/Frost Bankers, Inc., 1999 Annual Report on Form 10-K) present fairly, in all material respects, the results of operations and cash flows of Overton Bancshares, Inc. and Subsidiaries for the year ended December 31, 1997, in conformity with accounting principles generally accepted in the United States. These financial statements are the responsibility of the Company's management; our responsibility is to express an opinion on these financial statements based on our audit. We conducted our audit of these statements in accordance with auditing standards generally accepted in the United States, which require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audit provides a reasonable basis for the opinion expressed above. We have not audited the consolidated financial statements of Overton Bancshares, Inc. for any period subsequent to December 31, 1997. /s/ PricewaterhouseCoopers LLP Fort Worth, Texas February 17, 1998 -----END PRIVACY-ENHANCED MESSAGE-----