Annual Statements Open main menu

CULLEN/FROST BANKERS, INC. - Quarter Report: 2012 March (Form 10-Q)

Form 10-Q
Table of Contents

 

 

United States

Securities and Exchange Commission

Washington, D.C. 20549

Form 10-Q

 

x Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

For the quarterly period ended: March 31, 2012

Or

 

¨ Transition Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

For the transition period from                      to

Commission file number: 001-13221

Cullen/Frost Bankers, Inc.

(Exact name of registrant as specified in its charter)

 

Texas   74-1751768
(State or other jurisdiction of
incorporation or organization)
  (I.R.S. Employer
Identification No.)
100 W. Houston Street, San Antonio, Texas   78205
(Address of principal executive offices)   (Zip code)

(210) 220-4011

(Registrant’s telephone number, including area code)

N/A

(Former name, former address and former fiscal year, if changed since last report)

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 whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes  x    No  ¨

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

 

Large accelerated filer   x    Accelerated filer   ¨
Non-accelerated filer   ¨  (Do not check if a smaller reporting company)    Smaller reporting company   ¨

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act).    Yes  ¨    No  x

As of April 19, 2012, there were 61,372,763 shares of the registrant’s Common Stock, $.01 par value, outstanding.

 

 

 


Table of Contents

Cullen/Frost Bankers, Inc.

Quarterly Report on Form 10-Q

March 31, 2012

Table of Contents

 

     Page  

Part I - Financial Information

  
   Item 1.    Financial Statements (Unaudited)   
      Consolidated Balance Sheets      3   
      Consolidated Statements of Income      4   
      Consolidated Statements of Comprehensive Income      5   
      Consolidated Statements of Changes in Shareholders’ Equity      6   
      Consolidated Statements of Cash Flows      7   
      Notes to Consolidated Financial Statements      8   
   Item 2.    Management’s Discussion and Analysis of Financial Condition and Results of Operations      38   
   Item 3.    Quantitative and Qualitative Disclosures About Market Risk      59   
   Item 4.    Controls and Procedures      60   

Part II - Other Information

  
   Item 1.    Legal Proceedings      61   
   Item 1A.    Risk Factors      61   
   Item 2.    Unregistered Sales of Equity Securities and Use of Proceeds      61   
   Item 3.    Defaults Upon Senior Securities      61   
   Item 4.    Mine Safety Disclosures      61   
   Item 5.    Other Information      61   
   Item 6.    Exhibits      61   

Signatures

     62   

 

2


Table of Contents

Part I. Financial Information

Item 1. Financial Statements (Unaudited)

Cullen/Frost Bankers, Inc.

Consolidated Balance Sheets

(Dollars in thousands, except per share amounts)

 

     March 31,
2012
    December 31,
2011
    March 31,
2011
 

Assets:

      

Cash and due from banks

   $ 623,204      $ 574,039      $ 587,655   

Interest-bearing deposits

     1,497,478        2,314,251        2,101,014   

Federal funds sold and resell agreements

     8,052        19,302        10,002   
  

 

 

   

 

 

   

 

 

 

Total cash and cash equivalents

     2,128,734        2,907,592        2,698,671   

Securities held to maturity, at amortized cost

     365,603        365,996        341,034   

Securities available for sale, at estimated fair value

     8,568,215        7,789,700        5,662,211   

Trading account securities

     16,846        13,609        20,746   

Loans, net of unearned discounts

     8,126,713        7,995,129        8,025,080   

Less: Allowance for loan losses

     (107,181     (110,147     (124,321
  

 

 

   

 

 

   

 

 

 

Net loans

     8,019,532        7,884,982        7,900,759   

Premises and equipment, net

     321,681        319,042        313,233   

Goodwill

     535,560        528,072        527,684   

Other intangible assets, net

     11,033        10,604        13,215   

Cash surrender value of life insurance policies

     135,035        133,967        130,910   

Accrued interest receivable and other assets

     314,942        363,681        333,181   
  

 

 

   

 

 

   

 

 

 

Total assets

   $ 20,417,181      $ 20,317,245      $ 17,941,644   
  

 

 

   

 

 

   

 

 

 

Liabilities:

      

Deposits:

      

Non-interest-bearing demand deposits

   $ 6,784,112      $ 6,672,555      $ 5,413,002   

Interest-bearing deposits

     10,124,909        10,084,193        9,296,557   
  

 

 

   

 

 

   

 

 

 

Total deposits

     16,909,021        16,756,748        14,709,559   

Federal funds purchased and repurchase agreements

     637,098        722,202        553,571   

Junior subordinated deferrable interest debentures

     123,712        123,712        123,712   

Other long-term borrowings

     100,022        100,026        250,040   

Accrued interest payable and other liabilities

     326,615        331,020        207,411   
  

 

 

   

 

 

   

 

 

 

Total liabilities

     18,096,468        18,033,708        15,844,293   

Shareholders’ Equity:

      

Preferred stock, par value $0.01 per share; 10,000,000 shares authorized; none issued

     —          —          —     

Common stock, par value $0.01 per share; 210,000,000 shares authorized; 61,372,763, shares issued at March 31, 2012, 61,271,603 shares issued at December 31, 2011 and 61,244,157 shares issued at March 31, 2011

     614        613        613   

Additional paid-in capital

     688,150        680,803        668,237   

Retained earnings

     1,387,553        1,354,759        1,273,826   

Accumulated other comprehensive income, net of tax

     244,396        247,734        154,818   

Treasury stock, 7,640 shares at December 31, 2011 and 2,464 shares at March 31, 2011, at cost

     —          (372     (143
  

 

 

   

 

 

   

 

 

 

Total shareholders’ equity

     2,320,713        2,283,537        2,097,351   
  

 

 

   

 

 

   

 

 

 

Total liabilities and shareholders’ equity

   $ 20,417,181      $ 20,317,245      $ 17,941,644   
  

 

 

   

 

 

   

 

 

 

See Notes to Consolidated Financial Statements.

 

3


Table of Contents

Cullen/Frost Bankers, Inc.

Consolidated Statements of Income

(Dollars in thousands, except per share amounts)

 

     Three Months Ended
March 31,
 
     2012     2011  

Interest income:

    

Loans, including fees

   $ 97,351      $ 98,488   

Securities:

    

Taxable

     36,066        31,185   

Tax-exempt

     22,503        22,733   

Interest-bearing deposits

     930        1,171   

Federal funds sold and resell agreements

     15        16   
  

 

 

   

 

 

 

Total interest income

     156,865        153,593   

Interest expense:

    

Deposits

     4,572        5,951   

Federal funds purchased and repurchase agreements

     34        131   

Junior subordinated deferrable interest debentures

     1,674        1,672   

Other long-term borrowings

     878        4,080   
  

 

 

   

 

 

 

Total interest expense

     7,158        11,834   

Net interest income

     149,707        141,759   

Provision for loan losses

     1,100        9,450   
  

 

 

   

 

 

 

Net interest income after provision for loan losses

     148,607        132,309   

Non-interest income:

    

Trust and investment management fees

     20,652        19,471   

Service charges on deposit accounts

     20,794        21,250   

Insurance commissions and fees

     12,377        10,494   

Interchange and debit card transaction fees

     4,117        8,045   

Other charges, commissions and fees

     7,350        7,228   

Net gain (loss) on securities transactions

     (491     5   

Other

     7,180        5,840   
  

 

 

   

 

 

 

Total non-interest income

     71,979        72,333   

Non-interest expense:

    

Salaries and wages

     63,702        62,430   

Employee benefits

     16,701        15,311   

Net occupancy

     11,797        11,652   

Furniture and equipment

     13,420        12,281   

Deposit insurance

     2,497        4,760   

Intangible amortization

     1,011        1,120   

Other

     32,912        32,507   
  

 

 

   

 

 

 

Total non-interest expense

     142,040        140,061   
  

 

 

   

 

 

 

Income before income taxes

     78,546        64,581   

Income taxes

     17,513        12,653   
  

 

 

   

 

 

 

Net income

   $ 61,033      $ 51,928   
  

 

 

   

 

 

 

Earnings per common share:

    

Basic

   $ 0.99      $ 0.85   

Diluted

     0.99       
0.85
  

See Notes to Consolidated Financial Statements.

 

4


Table of Contents

Cullen/Frost Bankers, Inc.

Consolidated Statements of Comprehensive Income

(Dollars in thousands)

 

     Three Months Ended
March 31,
 
     2012     2011  

Net income

   $ 61,033      $ 51,928   

Other comprehensive income (loss), before tax:

    

Securities available for sale:

    

Change in net unrealized gain/loss during the period

     1,882        8,290   

Reclassification adjustment for net (gains) losses included in net income

     491        (5
  

 

 

   

 

 

 

Total securities available for sale

     2,373        8,285   

Defined-benefit post-retirement benefit plans:

    

Change in the net actuarial gain/loss

     1,229        783   

Derivatives:

    

Change in the accumulated gain/loss on effective cash flow hedge derivatives

     (427     65   

Reclassification adjustments for (gains) losses included in net income:

    

Interest rate swaps on variable-rate loans

     (9,345     (9,345

Interest rate swap on junior subordinated deferrable interest debentures

     1,033        1,086   
  

 

 

   

 

 

 

Total derivatives

     (8,739     (8,194
  

 

 

   

 

 

 

Other comprehensive income (loss), before tax

     (5,137     874   

Deferred tax expense (benefit) related to other comprehensive income

     (1,799     306   
  

 

 

   

 

 

 

Other comprehensive income (loss), net of tax

     (3,338     568   
  

 

 

   

 

 

 

Comprehensive income

   $ 57,695      $ 52,496   
  

 

 

   

 

 

 

See Notes to Consolidated Financial Statements.

 

5


Table of Contents

Cullen/Frost Bankers, Inc.

Consolidated Statements of Changes in Shareholders’ Equity

(Dollars in thousands, except per share amounts)

 

     Three Months Ended
March 31,
 
     2012     2011  

Total shareholders’ equity at beginning of period

   $ 2,283,537      $ 2,061,680   

Net income

     61,033        51,928   

Other comprehensive income (loss)

     (3,338     568   

Stock option exercises (108,800 shares in 2012 and 114,293 shares in 2011)

     5,542        5,769   

Stock compensation expense recognized in earnings

     2,555        3,737   

Tax benefits (deficiencies) related to stock compensation

     (377     89   

Purchase of treasury stock (3,464 shares in 2011)

     —          (201

Common stock issued/sold to the 401(k) stock purchase plan (22,680 shares in 2011)

     —          1,360   

Cash dividends ($0.46 per share in 2012 and $0.45 per share in 2011)

     (28,239     (27,579
  

 

 

   

 

 

 

Total shareholders’ equity at end of period

   $ 2,320,713      $ 2,097,351   
  

 

 

   

 

 

 

See Notes to Consolidated Financial Statements.

 

6


Table of Contents

Cullen/Frost Bankers, Inc.

Consolidated Statements of Cash Flows

(Dollars in thousands)

 

     Three Months Ended
March 31,
 
     2012     2011  

Operating Activities:

    

Net income

   $ 61,033      $ 51,928   

Adjustments to reconcile net income to net cash from operating activities:

    

Provision for loan losses

     1,100        9,450   

Deferred tax expense (benefit)

     (2,539     (139

Accretion of loan discounts

     (2,962     (2,366

Securities premium amortization (discount accretion), net

     4,539        2,368   

Net (gain) loss on securities transactions

     491        (5

Depreciation and amortization

     9,497        9,191   

Net loss on sale/write-down of assets/foreclosed assets

     477        1,597   

Stock-based compensation

     2,555        3,737   

Net tax benefit (deficiency) from stock-based compensation

     (418     (65

Excess tax benefits from stock-based compensation

     (41     (154

Earnings on life insurance policies

     (1,068     (988

Net change in:

    

Trading account securities

     (3,237     (5,645

Accrued interest receivable and other assets

     41,769        27,621   

Accrued interest payable and other liabilities

     (9,286     (25,293
  

 

 

   

 

 

 

Net cash from operating activities

     101,910        71,237   

Investing Activities:

    

Securities held to maturity:

    

Purchases

     —          (57,547

Maturities, calls and principal repayments

     315        156   

Securities available for sale:

    

Purchases

     (10,984,308     (6,195,353

Sales

     9,985,078        5,547,541   

Maturities, calls and principal repayments

     218,136        148,979   

Net change in loans

     (133,759     75,427   

Net cash paid in acquisitions

     (7,199     —     

Proceeds from sales of premises and equipment

     214        988   

Purchases of premises and equipment

     (8,276     (3,586

Proceeds from sales of repossessed properties

     4,522        3,599   
  

 

 

   

 

 

 

Net cash from investing activities

     (925,277     (479,796

Financing Activities:

    

Net change in deposits

     152,273        230,217   

Net change in short-term borrowings

     (85,104     77,898   

Principal payments on long-term borrowings

     (4     (5

Proceeds from stock option exercises

     5,542        5,769   

Excess tax benefits from stock-based compensation

     41        154   

Purchase of treasury stock

     —          (201

Cash dividends paid

     (28,239     (27,579
  

 

 

   

 

 

 

Net cash from financing activities

     44,509        286,253   
  

 

 

   

 

 

 

Net change in cash and cash equivalents

     (778,858     (122,306

Cash and equivalents at beginning of period

     2,907,592        2,820,977   
  

 

 

   

 

 

 

Cash and equivalents at end of period

   $ 2,128,734      $ 2,698,671   
  

 

 

   

 

 

 

See Notes to Consolidated Financial Statements.

 

7


Table of Contents

Cullen/Frost Bankers, Inc.

Notes to Consolidated Financial Statements

(Table amounts in thousands, except for share and per share amounts)

Note 1 - Significant Accounting Policies

Nature of Operations. Cullen/Frost Bankers, Inc. (Cullen/Frost) is a financial holding company and a bank holding company headquartered in San Antonio, Texas that provides, through its subsidiaries, a broad array of products and services throughout numerous Texas markets. In addition to general commercial and consumer banking, other products and services offered include trust and investment management, investment banking, insurance, brokerage, leasing, asset-based lending, treasury management and item processing.

Basis of Presentation. The consolidated financial statements in this Quarterly Report on Form 10-Q include the accounts of Cullen/Frost and all other entities in which Cullen/Frost has a controlling financial interest (collectively referred to as the “Corporation”). All significant intercompany balances and transactions have been eliminated in consolidation. The accounting and financial reporting policies the Corporation follows conform, in all material respects, to accounting principles generally accepted in the United States and to general practices within the financial services industry.

The consolidated financial statements in this Quarterly Report on Form 10-Q have not been audited by an independent registered public accounting firm, but in the opinion of management, reflect all adjustments necessary for a fair presentation of the Corporation’s financial position and results of operations. All such adjustments were of a normal and recurring nature. The consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States for interim financial information and with the instructions to Form 10-Q adopted by the Securities and Exchange Commission (SEC). Accordingly, the financial statements do not include all of the information and footnotes required by accounting principles generally accepted in the United States for complete financial statements and should be read in conjunction with the Corporation’s consolidated financial statements, and notes thereto, for the year ended December 31, 2011, included in the Corporation’s Annual Report on Form 10-K filed with the SEC on February 3, 2012 (the “2011 Form 10-K”). Operating results for the interim periods disclosed herein are not necessarily indicative of the results that may be expected for a full year or any future period.

Use of Estimates. The preparation of financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements. Actual results could differ from those estimates. The allowance for loan losses, the fair value of stock-based compensation awards, the fair values of financial instruments and the status of contingencies are particularly subject to change.

Cash Flow Reporting. Additional cash flow information was as follows:

 

      Three Months Ended
March 31,
 
     2012      2011  

Cash paid for interest

   $ 9,377       $ 16,634   

Cash paid for income tax

     —           —     

Significant non-cash transactions:

     

Loans foreclosed and transferred to other real estate owned and foreclosed assets

     1,071         7,434   

Common stock/treasury stock issued to the Corporation’s 401(k) stock purchase plan

     —           1,360   

Reclassifications. Certain items in prior financial statements have been reclassified to conform to the current presentation. Mutual fund investment management fees previously reported as a component of other charges, commissions and fees are now included with trust fees and reported as trust and investment management fees in the consolidated statements of income. Additionally, interchange and debit card transaction fees (including automated teller machine fees) previously reported as components of service charges on deposit accounts; other charges, commissions and fees; or other non-interest income are now reported as interchange and debit card transaction fees in the consolidated statements of income.

 

8


Table of Contents

Note 2 - Securities

A summary of the amortized cost and estimated fair value of securities, excluding trading securities, is presented below.

 

     March 31, 2012      December 31, 2011  
     Amortized
Cost
     Gross
Unrealized
Gains
     Gross
Unrealized
Losses
     Estimated
Fair Value
     Amortized
Cost
     Gross
Unrealized
Gains
     Gross
Unrealized
Losses
     Estimated
Fair Value
 

Held to Maturity

                       

U. S. Treasury

   $ 247,893       $ 29,275       $ —         $ 277,168       $ 247,797       $ 31,715       $ —         $ 279,512   

Residential mortgage-backed securities

     11,547         178         —           11,725         11,874         153         —           12,027   

States and political subdivisions

     105,163         7,773         —           112,936         105,325         6,597         —           111,922   

Other

     1,000         —           —           1,000         1,000         —           —           1,000   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 365,603       $ 37,226       $ —         $ 402,829       $ 365,996       $ 38,465       $ —         $ 404,461   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Available for Sale:

                       

U. S. Treasury

   $ 3,018,660       $ 29,607       $ 219       $ 3,048,048       $ 2,020,621       $ 36,111       $ —         $ 2,056,732   

U.S. government agencies/corporations

     250,000         782         —           250,782         250,000         884         —           250,884   

Residential mortgage-backed securities

     2,967,744         156,222         1         3,123,965         3,135,064         154,386         180         3,289,270   

States and political subdivisions

     1,942,118         165,320         27         2,107,411         1,996,703         158,133         23         2,154,813   

Other

     38,009         —           —           38,009         38,001         —           —           38,001   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 8,216,531       $ 351,931       $ 247       $ 8,568,215       $ 7,440,389       $ 349,514       $ 203       $ 7,789,700   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

All mortgage-backed securities included in the above table were issued by U.S. government agencies and corporations. Securities with limited marketability, such as stock in the Federal Reserve Bank and the Federal Home Loan Bank, are carried at cost and are reported as other available for sale securities in the above table. The carrying value of securities pledged to secure public funds, trust deposits, repurchase agreements and for other purposes, as required or permitted by law was $2.2 billion at March 31, 2012 and $2.4 billion and December 31, 2011.

As of March 31, 2012, securities, with unrealized losses segregated by length of impairment, were as follows:

 

     Less than 12 Months      More than 12 Months      Total  
     Estimated      Unrealized      Estimated      Unrealized      Estimated      Unrealized  
     Fair Value      Losses      Fair Value      Losses      Fair Value      Losses  

Available for Sale

                 

U.S. Treasury

   $ 250,332       $ 219       $ —         $ —         $ 250,332       $ 219   

Residential mortgage-backed securities

     16         —           49         1         65         1   

States and political subdivisions

     2,225         27         —           —           2,225         27   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 252,573       $ 246       $ 49       $ 1       $ 252,622       $ 247   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Declines in the fair value of held-to-maturity and available-for-sale securities below their cost that are deemed to be other than temporary are reflected in earnings as realized losses to the extent the impairment is related to credit losses. The amount of the impairment related to other factors is recognized in other comprehensive income. In estimating other-than-temporary impairment losses, management considers, among other things, (i) the length of time and the extent to which the fair value has been less than cost, (ii) the financial condition and near-term prospects of the issuer, and (iii) the intent and ability of the Corporation to retain its investment in the issuer for a period of time sufficient to allow for any anticipated recovery in cost.

Management has the ability and intent to hold the securities classified as held to maturity in the table above until they mature, at which time the Corporation will receive full value for the securities. Furthermore, as of March 31, 2012, management does not have the intent to sell any of the securities classified as available for sale in the table above and believes that it is more likely than not that the Corporation will not have to sell any such securities before a recovery of cost. Any unrealized losses are largely due to increases in market interest rates over the yields available at the time the underlying securities were purchased. The fair value is expected to recover as the bonds approach their maturity date or repricing date or if market yields for such investments decline. Management does not believe any of the securities are impaired due to reasons of credit quality. Accordingly, as of March 31, 2012, management believes the impairments detailed in the table above are temporary and no impairment loss has been realized in the Corporation’s consolidated income statement.

 

9


Table of Contents

The amortized cost and estimated fair value of securities, excluding trading securities, at March 31, 2012 are presented below by contractual maturity. Expected maturities may differ from contractual maturities because issuers may have the right to call or prepay obligations. Residential mortgage-backed securities and equity securities are shown separately since they are not due at a single maturity date.

 

$0,000,000 $0,000,000 $0,000,000 $0,000,000
     Held to Maturity      Available for Sale  
     Amortized
Cost
     Estimated
Fair Value
     Amortized
Cost
     Estimated
Fair Value
 

Due in one year or less

   $ 1,000       $ 1,000       $ 14,850       $ 15,125   

Due after one year through five years

     247,893         277,168         3,360,602         3,396,548   

Due after five years through ten years

     3,320         3,623         208,835         224,491   

Due after ten years

     101,843         109,313         1,626,491         1,770,077   

Residential mortgage-backed securities

     11,547         11,725         2,967,744         3,123,965   

Equity securities

     —           —           38,009         38,009   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 365,603       $ 402,829       $ 8,216,531       $ 8,568,215   
  

 

 

    

 

 

    

 

 

    

 

 

 

Sales of securities available for sale were as follows:

 

$0,000,000 $0,000,000
     Three Months Ended
March 31,
 
     2012     2011  

Proceeds from sales

   $     9,985,078      $ 5,547,541   

Gross realized gains

     2,137        9   

Gross realized losses

     (2,628     (4

Tax (expense) benefit of securities gains/losses

     172        (2

Trading account securities, at estimated fair value, were as follows:

 

$0,000,000 $0,000,000
     March 31,     December 31,  
     2012     2011  

U.S. Treasury

   $ 13,409      $ 13,609   

States and political subdivisions

     3,437        —     
  

 

 

   

 

 

 

Total

   $ 16,846      $ 13,609   
  

 

 

   

 

 

 

Net gains and losses on trading account securities were as follows:

 

$0,000,000 $0,000,000
      Three Months Ended
March 31,
 
     2012     2011  

Net gain on sales transactions

   $ 323      $ 308   

Net mark-to-market gains (losses)

     (60     —     
  

 

 

   

 

 

 

Net gain on trading account securities

   $ 263      $ 308   
  

 

 

   

 

 

 

 

10


Table of Contents

Note 3 - Loans

Loans were as follows:

 

     March 31,     Percentage     December 31,     Percentage     March 31,     Percentage  
     2012     of Total     2011     of Total     2011     of Total  

Commercial and industrial:

            

Commercial

   $ 3,709,450        45.7   $ 3,553,989        44.5   $ 3,393,769        42.3

Leases

     193,162        2.4        193,412        2.4        194,692        2.4   

Asset-based

     140,240        1.7        169,466        2.1        134,783        1.7   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total commercial and industrial

     4,042,852        49.8        3,916,867        49.0        3,723,244        46.4   

Commercial real estate:

            

Commercial mortgages

     2,357,206        29.0        2,383,479        29.8        2,410,760        30.0   

Construction

     493,600        6.1        434,870        5.5        574,637        7.2   

Land

     184,078        2.2        202,478        2.5        227,297        2.8   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total commercial real estate

     3,034,884        37.3        3,020,827        37.8        3,212,694        40.0   

Consumer real estate:

            

Home equity loans

     288,961        3.6        282,244        3.5        274,952        3.4   

Home equity lines of credit

     190,371        2.4        191,960        2.4        187,573        2.3   

1-4 family residential mortgages

     43,284        0.5        45,943        0.6        53,587        0.7   

Construction

     18,910        0.2        17,544        0.2        23,504        0.3   

Other

     219,760        2.7        225,118        2.8        244,752        3.1   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total consumer real estate

     761,286        9.4        762,809        9.5        784,368        9.8   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total real estate

     3,796,170        46.7        3,783,636        47.3        3,997,062        49.8   

Consumer and other:

            

Consumer installment

     296,057        3.6        301,518        3.8        307,812        3.9   

Other

     8,415        0.1        11,018        0.1        17,310        0.2   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total consumer and other

     304,472        3.7        312,536        3.9        325,122        4.1   

Unearned discounts

     (16,781     (0.2     (17,910     (0.2     (20,348     (0.3
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total loans

   $ 8,126,713        100.0   $ 7,995,129        100.0   $ 8,025,080        100.0
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Loan Origination/Risk Management. The Corporation has certain lending policies and procedures in place that are designed to maximize loan income within an acceptable level of risk. Management reviews and approves these policies and procedures on a regular basis. A reporting system supplements the review process by providing management with frequent reports related to loan production, loan quality, concentrations of credit, loan delinquencies and non-performing and potential problem loans. Diversification in the loan portfolio is a means of managing risk associated with fluctuations in economic conditions.

Commercial and industrial loans are underwritten after evaluating and understanding the borrower’s ability to operate profitably and prudently expand its business. Underwriting standards are designed to promote relationship banking rather than transactional banking. Once it is determined that the borrower’s management possesses sound ethics and solid business acumen, the Corporation’s management examines current and projected cash flows to determine the ability of the borrower to repay their obligations as agreed. Commercial and industrial loans are primarily made based on the identified cash flows of the borrower and secondarily on the underlying collateral provided by the borrower. The cash flows of borrowers, however, may not be as expected and the collateral securing these loans may fluctuate in value. Most commercial and industrial loans are secured by the assets being financed or other business assets such as accounts receivable or inventory and may incorporate a personal guarantee; however, some short-term loans may be made on an unsecured basis. In the case of loans secured by accounts receivable, the availability of funds for the repayment of these loans may be substantially dependent on the ability of the borrower to collect amounts due from its customers.

Commercial real estate loans are subject to underwriting standards and processes similar to commercial and industrial loans, in addition to those of real estate loans. These loans are viewed primarily as cash flow loans and secondarily as loans secured by real estate. Commercial real estate lending typically involves higher loan principal amounts and the repayment of these loans is generally largely dependent on the successful operation of the property securing the loan or the business conducted on the property securing the loan. Commercial real estate loans may be more adversely affected by conditions in the real estate markets or in the general economy. The properties securing the Corporation’s commercial real estate portfolio are diverse in terms of type and geographic location. This diversity helps reduce the Corporation’s exposure to adverse economic events that affect any single market or industry. Management monitors and evaluates commercial real estate loans based on collateral, geography and risk grade criteria. As a general rule, the Corporation avoids financing single-purpose

 

11


Table of Contents

projects unless other underwriting factors are present to help mitigate risk. The Corporation also utilizes third-party experts to provide insight and guidance about economic conditions and trends affecting market areas it serves. In addition, management tracks the level of owner-occupied commercial real estate loans versus non-owner occupied loans. At March 31, 2012, approximately 58% of the outstanding principal balance of the Corporation’s commercial real estate loans were secured by owner-occupied properties.

With respect to loans to developers and builders that are secured by non-owner occupied properties that the Corporation may originate from time to time, the Corporation generally requires the borrower to have had an existing relationship with the Corporation and have a proven record of success. Construction loans are underwritten utilizing feasibility studies, independent appraisal reviews, sensitivity analysis of absorption and lease rates and financial analysis of the developers and property owners. Construction loans are generally based upon estimates of costs and value associated with the complete project. These estimates may be inaccurate. Construction loans often involve the disbursement of substantial funds with repayment substantially dependent on the success of the ultimate project. 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 until permanent financing is obtained. These loans are closely monitored by on-site inspections and are considered to have higher risks than other real estate loans due to their ultimate repayment being sensitive to interest rate changes, governmental regulation of real property, general economic conditions and the availability of long-term financing.

The Corporation originates consumer loans utilizing a computer-based credit scoring analysis to supplement the 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 risk. Additionally, trend and outlook reports are reviewed by management on a regular basis. Underwriting standards for home equity loans are heavily influenced by statutory requirements, which include, but are not limited to, a maximum loan-to-value percentage of 80%, collection remedies, the number of such loans a borrower can have at one time and documentation requirements.

The Corporation maintains an independent loan review department that reviews and validates the credit risk program on a periodic basis. Results of these reviews are presented to management. The loan review process complements and reinforces the risk identification and assessment decisions made by lenders and credit personnel, as well as the Corporation’s policies and procedures.

Concentrations of Credit. Most of the Corporation’s lending activity occurs within the State of Texas, including the four largest metropolitan areas of Austin, Dallas/Ft. Worth, Houston and San Antonio, as well as other markets. The majority of the Corporation’s loan portfolio consists of commercial and industrial and commercial real estate loans. Other than energy loans, as of March 31, 2012 there were no concentrations of loans related to any single industry in excess of 10% of total loans.

Foreign Loans. The Corporation has U.S. dollar denominated loans and commitments to borrowers in Mexico. The outstanding balance of these loans and the unfunded amounts available under these commitments were not significant at March 31, 2012 or December 31, 2011.

Non-Accrual and Past Due Loans. Loans are considered past due if the required principal and interest payments have not been received as of the date such payments were due. Loans are placed on non-accrual status when, in management’s opinion, the borrower may be unable to meet payment obligations as they become due, as well as when required by regulatory provisions. In determining whether or not a borrower may be unable to meet payment obligations for each class of loans, the Corporation considers the borrower’s debt service capacity through the analysis of current financial information, if available, and/or current information with regards to the Corporation’s collateral position. Regulatory provisions would typically require the placement of a loan on non-accrual status if (i) principal or interest has been in default for a period of 90 days or more unless the loan is both well secured and in the process of collection or (ii) full payment of principal and interest is not expected. Loans may be placed on non-accrual status regardless of whether or not such loans are considered past due. When interest accrual is discontinued, all unpaid accrued interest is reversed. Interest income on non-accrual loans is recognized only to the extent that cash payments are received in excess of principal due. A loan may be returned to accrual status when all the principal and interest amounts contractually due are brought current and future principal and interest amounts contractually due are reasonably assured, which is typically evidenced by a sustained period (at least six months) of repayment performance by the borrower.

 

12


Table of Contents

Non-accrual loans, segregated by class of loans, were as follows:

 

     March 31,      December 31,      March 31,  
     2012      2011      2011  

Commercial and industrial:

        

Energy

   $ —         $ —         $ —     

Other commercial

     49,588         43,874         58,681   

Commercial real estate:

        

Buildings, land and other

     41,892         43,820         53,920   

Construction

     1,285         1,329         6,888   

Consumer real estate

     4,322         4,587         3,741   

Consumer and other

     783         728         581   
  

 

 

    

 

 

    

 

 

 

Total

   $ 97,870       $ 94,338       $ 123,811   
  

 

 

    

 

 

    

 

 

 

Had non-accrual loans performed in accordance with their original contract terms, the Corporation would have recognized additional interest income, net of tax, of approximately $642 thousand for the three months ended March 31, 2012, compared to $1.3 million for the same period in 2011.

An age analysis of past due loans (including both accruing and non-accruing loans), segregated by class of loans, as of March 31, 2012 was as follows:

 

     Loans
30-89 Days

Past Due
     Loans
90 or  More
Days
Past Due
     Total
Past Due

Loans
     Current
Loans
    Total
Loans
    Accruing
Loans 90 or

More Days
Past Due
 

Commercial and industrial:

               

Energy

   $ —         $ —         $ —         $ 994,979      $ 994,979      $ —     

Other commercial

     13,297         21,651         34,948         3,012,925        3,047,873        6,805   

Commercial real estate:

               

Buildings, land and other

     23,678         24,308         47,986         2,493,298        2,541,284        9,473   

Construction

     1,247         1,791         3,038         490,562        493,600        1,743   

Consumer real estate

     5,565         4,504         10,069         751,217        761,286        2,408   

Consumer and other

     3,547         288         3,835         300,637        304,472        189   

Unearned discounts

     —           —           —           (16,781     (16,781     —     
  

 

 

    

 

 

    

 

 

    

 

 

   

 

 

   

 

 

 

Total

   $ 47,334       $ 52,542       $ 99,876       $ 8,026,837      $ 8,126,713      $ 20,618   
  

 

 

    

 

 

    

 

 

    

 

 

   

 

 

   

 

 

 

Impaired Loans. Loans are considered impaired when, based on current information and events, it is probable the Corporation will be unable to collect all amounts due in accordance with the original contractual terms of the loan agreement, including scheduled principal and interest payments. Impairment is evaluated in total for smaller-balance loans of a similar nature and on an individual loan basis for other loans. If a loan is impaired, a specific valuation allowance is allocated, if necessary, so that the loan is reported net, at the present value of estimated future cash flows using the loan’s existing rate or at the fair value of collateral if repayment is expected solely from the collateral. Interest payments on impaired loans are typically applied to principal unless collectibility of the principal amount is reasonably assured, in which case interest is recognized on a cash basis. Impaired loans, or portions thereof, are charged off when deemed uncollectible.

Regulatory guidelines require the Corporation to reevaluate the fair value of collateral supporting impaired collateral dependent loans on at least an annual basis. While the Corporation’s policy is to comply with the regulatory guidelines, the Corporation’s general practice is to reevaluate the fair value of collateral supporting impaired collateral dependent loans on a quarterly basis. Thus, appraisals are never considered to be outdated, and the Corporation does not need to make any adjustments to the appraised values. The fair value of collateral supporting impaired collateral dependent loans is evaluated by the Corporation’s internal appraisal services using a methodology that is consistent with the Uniform Standards of Professional Appraisal Practice. The fair value of collateral supporting impaired collateral dependent construction loans is based on an “as is” valuation.

 

13


Table of Contents

Impaired loans are set forth in the following table. No interest income was recognized on impaired loans subsequent to their classification as impaired.

 

     Unpaid      Recorded      Recorded                    Average Recorded  
     Contractual      Investment      Investment      Total             Investment  
     Principal      With No      With      Recorded      Related      Quarter      Year  
     Balance      Allowance      Allowance      Investment      Allowance      To Date      To Date  

March 31, 2012

                    

Commercial and industrial:

                    

Energy

   $ —         $ —         $ —         $ —         $ —         $ —         $ —     

Other commercial

     55,632         28,932         15,804         44,736         5,356         42,034         42,034   

Commercial real estate:

                    

Buildings, land and other

     47,077         36,821         2,243         39,064         1,113         39,996         39,996   

Construction

     1,551         1,237         —           1,237         —           1,259         1,259   

Consumer real estate

     2,623         1,826         751         2,577         95         2,524         2,524   

Consumer and other

     547         535         —           535         —           544         544   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 107,430       $ 69,351       $ 18,798       $ 88,149       $ 6,564       $ 86,357       $ 86,357   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

December 31, 2011

                    

Commercial and industrial:

                    

Energy

   $ —         $ —         $ —         $ —         $ —         $ —         $ —     

Other commercial

     57,723         34,712         4,619         39,331         2,696         46,151         53,830   

Commercial real estate:

                    

Buildings, land and other

     51,163         38,686         2,243         40,929         1,113         41,522         48,635   

Construction

     1,568         1,281         —           1,281         —           1,527         4,339   

Consumer real estate

     2,499         1,719         751         2,470         95         2,484         1,845   

Consumer and other

     562         554         —           554         —           561         265   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 113,515       $ 76,952       $ 7,613       $ 84,565       $ 3,904       $ 92,245       $ 108,914   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

March 31, 2011

                    

Commercial and industrial:

                    

Energy

   $ —         $ —         $ —         $ —         $ —         $ —         $ —     

Other commercial

     70,411         27,742         25,245         52,987         13,066         54,215         54,215   

Commercial real estate:

                    

Buildings, land and other

     62,993         42,021         9,515         51,536         3,626         56,671         56,671   

Construction

     7,124         6,587         —           6,587         —           7,944         7,944   

Consumer real estate

     1,786         1,786         —           1,786         —           1,152         1,152   

Consumer and other

     102         101         —           101         —           51         51   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 142,416       $ 78,237       $ 34,760       $ 112,997       $ 16,692       $ 120,033       $ 120,033   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Troubled Debt Restructurings. The restructuring of a loan is considered a “troubled debt restructuring” if both (i) the borrower is experiencing financial difficulties and (ii) the creditor has granted a concession. Concessions may include interest rate reductions or below market interest rates, principal forgiveness, restructuring amortization schedules and other actions intended to minimize potential losses.

There were no troubled debt restructurings during the three months ended March 31, 2012. During the three months ended March 31, 2011, the Corporation had troubled debt restructurings of commercial real estate loans with an aggregate restructuring date balance of $4.2 million. All of the loans identified as troubled debt restructurings by the Corporation during the three months ended March 31, 2011 were previously on non-accrual status and reported as impaired loans prior to restructuring. The modifications primarily related to extending the amortization periods of the loans. The Corporation did not grant interest-rate concessions on any restructured loan. All loans restructured during the reported periods were on non-accrual status as of the end of those periods. Because the loans were classified and on non-accrual status both before and after restructuring, the modifications did not impact the Corporation’s determination of the allowance for loan losses. During the three months ended March 31, 2012, defaults on loans restructured during 2011 were not significant and such defaults did not significantly impact the Corporation’s determination of the allowance for loan losses.

 

14


Table of Contents

Credit Quality Indicators. As part of the on-going monitoring of the credit quality of the Corporation’s loan portfolio, management tracks certain credit quality indicators including trends related to (i) the weighted-average risk grade of commercial loans, (ii) the level of classified commercial loans, (iii) the delinquency status of consumer loans (see details above) (iv) net charge-offs, (v) non-performing loans (see details above) and (vi) the general economic conditions in the State of Texas.

The Corporation utilizes a risk grading matrix to assign a risk grade to each of its commercial loans. Loans are graded on a scale of 1 to 14. A description of the general characteristics of the 14 risk grades is as follows:

 

   

Grades 1, 2 and 3 - These grades include loans to very high credit quality borrowers of investment or near investment grade. These borrowers are generally publicly traded (grades 1 and 2), have significant capital strength, moderate leverage, stable earnings and growth, and readily available financing alternatives. Smaller entities, regardless of strength, would generally not fit in these grades.

 

   

Grades 4 and 5 - These grades include loans to borrowers of solid credit quality with moderate risk. Borrowers in these grades are differentiated from higher grades on the basis of size (capital and/or revenue), leverage, asset quality and the stability of the industry or market area.

 

   

Grades 6, 7 and 8 - These grades include “pass grade” loans to borrowers of acceptable credit quality and risk. Such borrowers are differentiated from Grades 4 and 5 in terms of size, secondary sources of repayment or they are of lesser stature in other key credit metrics in that they may be over-leveraged, under capitalized, inconsistent in performance or in an industry or an economic area that is known to have a higher level of risk, volatility, or susceptibility to weaknesses in the economy.

 

   

Grade 9 - This grade includes loans on management’s “watch list” and is intended to be utilized on a temporary basis for pass grade borrowers where a significant risk-modifying action is anticipated in the near term.

 

   

Grade 10 – This grade is for “Other Assets Especially Mentioned” in accordance with regulatory guidelines. This grade is intended to be temporary and includes loans to borrowers whose credit quality has clearly deteriorated and are at risk of further decline unless active measures are taken to correct the situation.

 

   

Grade 11 - This grade includes “Substandard” loans, in accordance with regulatory guidelines, for which the accrual of interest has not been stopped. By definition under regulatory guidelines, a “Substandard” loan has defined weaknesses which make payment default or principal exposure likely, but not yet certain. Such loans are apt to be dependent upon collateral liquidation, a secondary source of repayment or an event outside of the normal course of business.

 

   

Grade 12 - This grade includes “Substandard” loans, in accordance with regulatory guidelines, for which the accrual of interest has been stopped. This grade includes loans where interest is more than 120 days past due and not fully secured and loans where a specific valuation allowance may be necessary, but generally does not exceed 30% of the principal balance.

 

   

Grade 13 - This grade includes “Doubtful” loans in accordance with regulatory guidelines. Such loans are placed on non-accrual status and may be dependent upon collateral having a value that is difficult to determine or upon some near-term event which lacks certainty. Additionally, these loans generally have a specific valuation allowance in excess of 30% of the principal balance.

 

   

Grade 14 - This grade includes “Loss” loans in accordance with regulatory guidelines. Such loans are to be charged-off or charged-down when payment is acknowledged to be uncertain or when the timing or value of payments cannot be determined. “Loss” is not intended to imply that the loan or some portion of it will never be paid, nor does it in any way imply that there has been a forgiveness of debt.

 

15


Table of Contents

In monitoring credit quality trends in the context of assessing the appropriate level of the allowance for loan losses, the Corporation monitors portfolio credit quality by the weighted-average risk grade of each class of commercial loan. Individual relationship managers review updated financial information for all pass grade loans to recalculate the risk grade on at least an annual basis. When a loan has a calculated risk grade of 9, it is still considered a pass grade loan; however, it is considered to be on management’s “watch list,” where a significant risk-modifying action is anticipated in the near term. When a loan has a calculated risk grade of 10 or higher, a special assets officer monitors the loan on an on-going basis. The following table presents weighted average risk grades for all commercial loans by class.

 

     March 31, 2012      December 31, 2011      March 31, 2011  
     Weighted             Weighted             Weighted         
     Average             Average             Average         
     Risk Grade      Loans      Risk Grade      Loans      Risk Grade      Loans  

Commercial and industrial:

                 

Energy

                 

Risk grades 1-8

     5.37       $ 992,463         5.21       $ 868,561         5.35       $ 760,093   

Risk grade 9

     9.00         2,516         9.00         2,025         9.00         1,477   

Risk grade 10

     10.00         —           10.00         —           10.00         —     

Risk grade 11

     11.00         —           11.00         —           11.00         —     

Risk grade 12

     12.00         —           12.00         —           12.00         —     

Risk grade 13

     13.00         —           13.00         —           13.00         —     
     

 

 

       

 

 

       

 

 

 

Total energy

     5.38       $ 994,979         5.22       $ 870,586         5.36       $ 761,570   
     

 

 

       

 

 

       

 

 

 

Other commercial

                 

Risk grades 1-8

     6.20       $ 2,803,976         6.20       $ 2,802,037         6.22       $ 2,590,198   

Risk grade 9

     9.00         65,376         9.00         55,105         9.00         101,576   

Risk grade 10

     10.00         35,504         10.00         49,982         10.00         98,865   

Risk grade 11

     11.00         93,415         11.00         96,046         11.00         111,514   

Risk grade 12

     12.00         44,520         12.00         39,826         12.00         35,636   

Risk grade 13

     13.00         5,082         13.00         3,285         13.00         23,885   
     

 

 

       

 

 

       

 

 

 

Total other commercial

     6.55       $ 3,047,873         6.55       $ 3,046,281         6.75       $ 2,961,674   
     

 

 

       

 

 

       

 

 

 

Commercial real estate:

                 

Buildings, land and other

                 

Risk grades 1-8

     6.67       $ 2,233,155         6.69       $ 2,266,576         6.71       $ 2,253,835   

Risk grade 9

     9.00         104,727         9.00         103,894         9.00         138,117   

Risk grade 10

     10.00         33,641         10.00         45,278         10.00         79,306   

Risk grade 11

     11.00         127,869         11.00         126,594         11.00         101,357   

Risk grade 12

     12.00         40,486         12.00         41,747         12.00         58,064   

Risk grade 13

     13.00         1,406         13.00         1,868         13.00         7,378   
     

 

 

       

 

 

       

 

 

 

Total commercial real estate

     7.12       $ 2,541,284         7.14       $ 2,585,957         7.23       $ 2,638,057   
     

 

 

       

 

 

       

 

 

 

Construction

                 

Risk grades 1-8

     6.97       $ 454,674         6.95       $ 378,530         7.15       $ 497,355   

Risk grade 9

     9.00         16,062         9.00         30,376         9.00         28,173   

Risk grade 10

     10.00         15,442         10.00         16,186         10.00         30,128   

Risk grade 11

     11.00         6,137         11.00         8,449         11.00         12,170   

Risk grade 12

     12.00         1,285         12.00         1,329         12.00         6,587   

Risk grade 13

     13.00         —           13.00         —           13.00         —     

Risk grade 14

     14.00         —           14.00         —           14.00         224   
     

 

 

       

 

 

       

 

 

 

Total construction

     7.19       $ 493,600         7.30       $ 434,870         7.53       $ 574,637   
     

 

 

       

 

 

       

 

 

 

The Corporation has established maximum loan to value standards to be applied during the origination process of commercial and consumer real estate loans. The Corporation does not subsequently monitor loan-to-value ratios (either individually or on a weighted-average basis) for loans that are subsequently considered to be of a pass grade (grades 9 or better) and/or current with respect to principal and interest payments. As stated above, when an individual commercial real estate loan has a calculated risk grade of 10 or higher, a special assets officer analyzes the loan to determine whether the loan is impaired. At that time, the Corporation reassesses the loan to value position in the loan. If the loan is determined to be collateral dependent, specific allocations of the allowance for loan losses are made for the amount of any collateral deficiency. If a collateral deficiency is ultimately deemed to be uncollectible, the amount is charged-off. These loans and related assessments of collateral position are monitored on an individual, case-by-case basis. The Corporation does not monitor loan-to-value ratios on a weighted-average basis for commercial real estate loans having a calculated risk grade of 10 or higher. Nonetheless, there were five commercial real estate loans having a calculated risk grade of 10 or higher in excess

 

16


Table of Contents

of $5 million as of March 31, 2012. Four of the loans totaled $42.1million and had a weighted-average loan-to-value ratio of 73.3%. The fifth loan, totaling $6.0 million, is structured as a borrowing base facility secured by numerous rotating lots and single family residences that generally have a loan-to-value of 80% or less. When an individual consumer real estate loan becomes past due by more than 10 days, the assigned relationship manager will begin collection efforts. The Corporation only reassesses the loan to value position in a consumer real estate loan if, during the course of the collections process, it is determined that the loan has become collateral dependent, and any collateral deficiency is recognized as a charge-off to the allowance for loan losses. Accordingly, the Corporation does not monitor loan-to-value ratios on a weighted-average basis for collateral dependent consumer real estate loans.

Generally, a commercial loan, or a portion thereof, is charged-off immediately when it is determined, through the analysis of any available current financial information with regards to the borrower, that the borrower is incapable of servicing unsecured debt, there is little or no prospect for near term improvement and no realistic strengthening action of significance is pending or, in the case of secured debt, when it is determined, through analysis of current information with regards to the Corporation’s collateral position, that amounts due from the borrower are in excess of the calculated current fair value of the collateral. Notwithstanding the foregoing, generally, commercial loans that become past due 180 cumulative days are classified as a loss and charged-off. Generally, a consumer loan, or a portion thereof, is charged-off in accordance with regulatory guidelines which provide that such loans be charged-off when the Corporation becomes aware of the loss, such as from a triggering event that may include new information about a borrower’s intent/ability to repay the loan, bankruptcy, fraud or death, among other things, but in no case should the charge-off exceed specified delinquency timeframes. Such delinquency timeframes state that closed-end retail loans (loans with pre-defined maturity dates, such as real estate mortgages, home equity loans and consumer installment loans) that become past due 120 cumulative days and open-end retail loans (loans that roll-over at the end of each term, such as home equity lines of credit) that become past due 180 cumulative days should be classified as a loss and charged-off.

Net (charge-offs)/recoveries, segregated by class of loans, were as follows:

 

      Three Months Ended
March 31,
 
     2012     2011  

Commercial and industrial:

    

Energy

   $ 4      $ —     

Other commercial

     (1,675     (6,830

Commercial real estate:

    

Buildings, land and other

     (2,360     (3,165

Construction

     10        (156

Consumer real estate

     234        (530

Consumer and other

     (279     (764
  

 

 

   

 

 

 

Total

   $ (4,066   $ (11,445
  

 

 

   

 

 

 

In assessing the general economic conditions in the State of Texas, management monitors and tracks the Texas Leading Index (“TLI”), which is produced by the Federal Reserve Bank of Dallas. The TLI is a single summary statistic that is designed to signal the likelihood of the Texas economy’s transition from expansion to recession and vice versa. Management believes this index provides a reliable indication of the direction of overall credit quality. The TLI is a composite of the following eight leading indicators: (i) Texas Value of the Dollar, (ii) U.S. Leading Index, (iii) real oil prices (iv) well permits, (v) initial claims for unemployment insurance, (vi) Texas Stock Index, (vii) Help-Wanted Index and (viii) average weekly hours worked in manufacturing. The TLI totaled 122.8 at February 28, 2012 (most recent date available), 120.4 at December 31, 2011 and 122.0 at March 31, 2011. A higher TLI value implies more favorable economic conditions.

Allowance for Loan Losses. The allowance for loan losses is a reserve established through a provision for loan losses charged to expense, which represents management’s best estimate of probable losses that have been incurred within the existing portfolio of loans. The allowance, in the judgment of management, is necessary to reserve for estimated loan losses and risks inherent in the loan portfolio. The Corporation’s allowance for loan loss methodology follows the accounting guidance set forth in U.S. generally accepted accounting principles and the Interagency Policy Statement on the Allowance for Loan and Lease Losses, which was jointly issued by the Corporation’s regulatory agencies. In that regard, the Corporation’s allowance for loan losses includes allowance allocations calculated in accordance with ASC Topic 310, “Receivables” and allowance allocations calculated in accordance with ASC Topic 450, “Contingencies.” Accordingly, the methodology is based on historical loss experience by type of credit and internal risk grade, specific homogeneous risk pools and specific loss allocations, with adjustments for current events and conditions. The Corporation’s process for determining the appropriate level of the allowance for loan losses is designed to account for credit deterioration as it occurs. The provision for loan losses reflects loan quality trends, including the levels of and trends related to non-accrual loans, past due loans, potential problem loans, criticized loans and net charge-offs or recoveries, among other factors. The provision for loan losses

 

17


Table of Contents

also reflects the totality of actions taken on all loans for a particular period. In other words, the amount of the provision reflects not only the necessary increases in the allowance for loan losses related to newly identified criticized loans, but it also reflects actions taken related to other loans including, among other things, any necessary increases or decreases in required allowances for specific loans or loan pools.

The level of the allowance reflects management’s continuing evaluation of industry concentrations, specific credit risks, loan loss and recovery experience, current loan portfolio quality, present economic, political and regulatory conditions and unidentified losses inherent in the current loan portfolio. Portions of the allowance may be allocated for specific credits; however, the entire allowance is available for any credit that, in management’s judgment, should be charged off. While management utilizes its best judgment and information available, the ultimate determination of the appropriate level of the allowance is dependent upon a variety of factors beyond the Corporation’s control, including, among other things, the performance of the Corporation’s loan portfolio, the economy, changes in interest rates and the view of the regulatory authorities toward loan classifications. The Corporation monitors whether or not the allowance for loan loss allocation model, as a whole, calculates an appropriate level of allowance for loan losses that moves in direct correlation to the general macroeconomic and loan portfolio conditions the Corporation experiences over time.

The Corporation’s allowance for loan losses consists of three elements: (i) specific valuation allowances determined in accordance with ASC Topic 310 based on probable losses on specific loans; (ii) historical valuation allowances determined in accordance with ASC Topic 450 based on historical loan loss experience for similar loans with similar characteristics and trends, adjusted, as necessary, to reflect the impact of current conditions; and (iii) general valuation allowances determined in accordance with ASC Topic 450 based on general economic conditions and other risk factors both internal and external to the Corporation.

The allowances established for probable losses on specific loans are based on a regular analysis and evaluation of problem loans. Loans are classified based on an internal credit risk grading process that evaluates, among other things: (i) the obligor’s ability to repay; (ii) the underlying collateral, if any; and (iii) the economic environment and industry in which the borrower operates. This analysis is performed at the relationship manager level for all commercial loans. When a loan has a calculated grade of 10 or higher, a special assets officer analyzes the loan to determine whether the loan is impaired and, if impaired, the need to specifically allocate a portion of the allowance for loan losses to the loan. Specific valuation allowances are determined by analyzing the borrower’s ability to repay amounts owed, collateral deficiencies, the relative risk grade of the loan and economic conditions affecting the borrower’s industry, among other things.

Historical valuation allowances are calculated based on the historical gross loss experience of specific types of loans and the internal risk grade of such loans at the time they were charged-off. The Corporation calculates historical gross loss ratios for pools of similar loans with similar characteristics based on the proportion of actual charge-offs experienced to the total population of loans in the pool. The historical gross loss ratios are periodically updated based on actual charge-off experience. A historical valuation allowance is established for each pool of similar loans based upon the product of the historical gross loss ratio and the total dollar amount of the loans in the pool. The Corporation’s pools of similar loans include similarly risk-graded groups of commercial and industrial loans, commercial real estate loans, consumer real estate loans and consumer and other loans.

The components of the general valuation allowance include (i) the additional reserves allocated to specific loan portfolio segments as a result of applying an environmental risk adjustment factor to the base historical loss allocation, (ii) the additional reserves allocated to specific loan portfolio segments for loans to borrowers in distressed industries and (iii) the additional reserves that are not allocated to specific loan portfolio segments including allocations for groups of similar loans with risk characteristics that exceed certain concentration limits established by management.

The environmental adjustment factor is based upon a more qualitative analysis of risk and is calculated through a survey of senior officers who are involved in credit making decisions at a corporate-wide and/or regional level. On a quarterly basis, survey participants rate the degree of various risks utilizing a numeric scale that translates to varying grades of high, moderate or low levels of risk. The results are then input into a risk-weighting matrix to determine an appropriate environmental risk adjustment factor. The various risks that may be considered in the determination of the environmental adjustment factor include, among other things, (i) the experience, ability and effectiveness of the bank’s lending management and staff; (ii) the effectiveness of the Corporation’s loan policies, procedures and internal controls; (iii) changes in asset quality; (iv) the impact of legislative and governmental influences affecting industry sectors; (v) the effectiveness of the internal loan review function; (vi) the impact of competition on loan structuring and pricing; and (vii) the impact of rising interest rates on portfolio risk. In periods where the surveyed risks are perceived to be higher, the risk-weighting matrix will generally result in a higher environmental adjustment factor, which, in turn will result in higher levels of general valuation allowance allocations. The opposite holds true in periods where the surveyed risks are perceived to be lower. The environmental adjustment factor resulted in additional general valuation allowance allocations to the various loan portfolio segments totaling $10.8 million at March 31, 2012, $12.8 million at December 31, 2011 and $12.7 million at March 31, 2011.

 

18


Table of Contents

During the fourth quarter of 2011, the Corporation refined its methodology for the determination of reserves allocated to specific loan portfolio segments to provide reserves for loans to borrowers in distressed industries. To determine the amount of the allocation for each loan portfolio segment, management calculates the weighted-average risk grade for all loans to borrowers in distressed industries by loan portfolio segment. A multiple is then applied to the amount by which the weighted-average risk grade for loans to borrowers in distressed industries exceeds the weighted-average risk grade for all pass-grade loans within the loan portfolio segment to derive an allocation factor for loans to borrowers in distressed industries. The amount of the allocation for each loan portfolio segment is the product of this allocation factor and the outstanding balance of pass-grade loans within the identified distressed industries that have a risk grade of 6 or higher. Reserves allocated for distressed industries totaled $5.7 million ($4.7 million related to commercial and industrial loans and $972 thousand related to commercial real estate loans) at March 31, 2012 and $5.0 million ($4.1 million related to commercial and industrial loans and $922 thousand related to commercial real estate loans) at December 31, 2011. This change in the Corporation’s methodology for the determination of reserves allocated to specific loan portfolio segments did not significantly impact the provision for loan losses recorded during 2011. Management identifies potential distressed industries by analyzing industry trends related to delinquencies, classifications and charge-offs. At March 31, 2012 and December 31, 2011, contractors were considered to be a distressed industry based on elevated levels of delinquencies, classifications and charge-offs relative to other industries within the Corporation’s loan portfolio. Furthermore, the Corporation determined, through a review of borrower financial information that, as a whole, contractors have experienced, among other things, decreased revenues, reduced backlog of work, compressed margins and little, if any, net income.

Certain general valuation allowances are not allocated to specific loan portfolio segments and are reported as the unallocated portion of the allowance for loan losses. Included in these general valuation allowances are allocations for groups of similar loans with risk characteristics that exceed certain concentration limits established by management and/or the Corporation’s board of directors. Concentration risk limits have been established, among other things, for certain industry concentrations, large balance and highly leveraged credit relationships that exceed specified risk grades, and loans originated with policy, credit and/or collateral exceptions that exceed specified risk grades. Additionally, general valuation allowances are provided for loans that did not undergo a separate, independent concurrence review during the underwriting process (generally those loans under $1.0 million at origination). The Corporation’s allowance methodology for general valuation allowances also includes a reduction factor for recoveries of prior charge-offs to compensate for the fact that historical loss allocations are based upon gross charge-offs rather than net.

The following table presents details of the unallocated portion of the allowance for loan losses.

 

     March 31,     December 31,     March 31,  
     2012     2011     2011  

Excessive industry concentrations

   $ 7,820      $ 6,995      $ 2,476   

Large relationship concentrations

     1,885        2,232        2,108   

Highly-leveraged credit relationships

     4,133        3,530        3,798   

Policy exceptions

     2,107        2,121        2,220   

Credit and collateral exceptions

     2,198        1,603        1,921   

Loans not reviewed by concurrence

     8,098        9,030        9,323   

Adjustment for recoveries

     (13,982     (13,071     (11,676

General macroeconomic risk

     16,636        17,846        20,374   
  

 

 

   

 

 

   

 

 

 
   $ 28,895      $ 30,286      $ 30,544   
  

 

 

   

 

 

   

 

 

 

The Corporation monitors whether or not the allowance for loan loss allocation model, as a whole, calculates an appropriate level of allowance for loan losses that moves in direct correlation to the general macroeconomic and loan portfolio conditions the Corporation experiences over time. In assessing the general macroeconomic trends/conditions, the Corporation analyzes trends in the components of the TLI, as well as any available information related to regional, national and international economic conditions and events and the impact such conditions and events may have on the Corporation and its customers. With regard to assessing loan portfolio conditions, the Corporation analyzes trends in weighted-average portfolio risk-grades, classified and non-performing loans and charge-off activity. In periods where general macroeconomic and loan portfolio conditions are in a deteriorating trend or remain at deteriorated levels, based on historical trends, the Corporation would expect to see the allowance for loan loss allocation model, as a whole, calculate higher levels of required allowances than in periods where general macroeconomic and loan portfolio conditions are in an improving trend or remain at an elevated level, based on historical trends.

 

19


Table of Contents

The following table details activity in the allowance for loan losses by portfolio segment for the three months ended March 31, 2012 and 2011. Allocation of a portion of the allowance to one category of loans does not preclude its availability to absorb losses in other categories.

 

     Commercial
and

Industrial
    Commercial
Real Estate
    Consumer
Real  Estate
    Consumer
and Other
    Unallocated     Total  

March 31, 2012

            

Beginning balance

   $ 42,774      $ 20,912      $ 3,540      $ 12,635      $ 30,286      $ 110,147   

Provision for loan losses

     4,766        1,441        (75     (3,641     (1,391     1,100   

Charge-offs

     (3,012     (2,842     (289     (1,985     —          (8,128

Recoveries

     1,341        492        523        1,706        —          4,062   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net charge-offs

     (1,671     (2,350     234        (279     —          (4,066
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Ending balance

   $ 45,869      $ 20,003      $ 3,699      $ 8,715      $ 28,895      $ 107,181   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Period-end amount allocated to:

            

Loans individually evaluated for impairment

   $ 17,842      $ 2,879      $ 95      $ —        $ —        $ 20,816   

Loans collectively evaluated for impairment

     28,027        17,124        3,604        8,715        28,895        86,365   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Ending balance

   $ 45,869      $ 20,003      $ 3,699      $ 8,715      $ 28,895      $ 107,181   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

March 31, 2011

            

Beginning balance

   $ 57,789      $ 28,534      $ 3,223      $ 11,974      $ 24,796      $ 126,316   

Provision for loan losses

     1,841        (662     792        1,731        5,748        9,450   

Charge-offs

     (7,597     (3,877     (820     (2,302     —          (14,596

Recoveries

     767        556        290        1,538        —          3,151   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net charge-offs

     (6,830     (3,321     (530     (764     —          (11,445
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Ending balance

   $ 52,800      $ 24,551      $ 3,485      $ 12,941      $ 30,544      $ 124,321   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Period-end amount allocated to:

            

Loans individually evaluated for impairment

   $ 31,065      $ 7,640      $ —        $ —        $ —        $ 38,705   

Loans collectively evaluated for impairment

     21,735        16,911        3,485        12,941        30,544        85,616   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Ending balance

   $ 52,800      $ 24,551      $ 3,485      $ 12,941      $ 30,544      $ 124,321   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

20


Table of Contents

The Corporation’s recorded investment in loans as of March 31, 2012, December 31, 2011 and March 31, 2011 related to each balance in the allowance for loan losses by portfolio segment and disaggregated on the basis of the Corporation’s impairment methodology was as follows:

 

     Commercial
and
Industrial
     Commercial
Real Estate
     Consumer
Real  Estate
     Consumer
and Other
     Unearned
Discounts
    Total  

March 31, 2012

                

Loans individually evaluated for impairment

   $ 178,521       $ 226,266       $ 2,577       $ 535       $ —        $ 407,899   

Loans collectively evaluated for impairment

     3,864,331         2,808,618         758,709         303,937         (16,781     7,718,814   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

   

 

 

 

Ending balance

   $ 4,042,852       $ 3,034,884       $ 761,286       $ 304,472       $ (16,781   $ 8,126,713   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

   

 

 

 

December 31, 2011

                

Loans individually evaluated for impairment

   $ 189,139       $ 241,451       $ 2,470       $ 554       $ —        $ 433,614   

Loans collectively evaluated for impairment

     3,727,728         2,779,376         760,339         311,982         (17,910     7,561,515   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

   

 

 

 

Ending balance

   $ 3,916,867       $ 3,020,827       $ 762,809       $ 312,536       $ (17,910   $ 7,995,129   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

   

 

 

 

March 31, 2011

                

Loans individually evaluated for impairment

   $ 269,900       $ 295,214       $ —         $ —         $ —        $ 565,114   

Loans collectively evaluated for impairment

     3,453,344         2,917,480         784,368         325,122         (20,348     7,459,966   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

   

 

 

 

Ending balance

   $ 3,723,244       $ 3,212,694       $ 784,368       $ 325,122       $ (20,348   $ 8,025,080   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

   

 

 

 

Note 4 - Goodwill and Other Intangible Assets

Goodwill and other intangible assets are presented in the table below. The increases in goodwill and certain other intangible assets were related to the acquisition of Stone Partners Inc. (“Stone”), a human resource consulting firm that specializes in compensation, benefits and outsourcing services, on January 1, 2012. Stone was based in Houston with additional offices in Dallas and Austin. Stone was fully integrated into Frost Insurance Agency subsequent to acquisition. The acquisition of Stone did not significantly impact the Corporation’s financial statements.

 

     March 31,      December 31,  
     2012      2011  

Goodwill

   $ 535,560       $ 528,072   
  

 

 

    

 

 

 

Other intangible assets:

     

Core deposits

   $ 7,469       $ 8,234   

Customer relationship

     2,798         2,113   

Non-compete agreements

     766         257   
  

 

 

    

 

 

 
   $ 11,033       $ 10,604   
  

 

 

    

 

 

 

The estimated aggregate future amortization expense for intangible assets remaining as of March 31, 2012 is as follows:

 

Remainder of 2012

   $ 2,886   

2013

     3,115   

2014

     2,270   

2015

     1,490   

2016

     777   

Thereafter

     495   
  

 

 

 
   $ 11,033   
  

 

 

 

 

21


Table of Contents

Note 5 - Deposits

Deposits were as follows:

 

     March 31,      Percentage     December 31,      Percentage     March 31,      Percentage  
     2012      of Total     2011      of Total     2011      of Total  

Non-interest-bearing demand deposits:

            

Commercial and individual

   $ 6,006,806         35.5   $ 5,848,840         34.9   $ 4,903,053         33.3

Correspondent banks

     331,114         2.0        370,275         2.2        290,099         2.0   

Public funds

     446,192         2.6        453,440         2.7        219,850         1.5   
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 

Total non-interest-bearing demand

deposits

     6,784,112         40.1        6,672,555         39.8        5,413,002         36.8   

Interest-bearing deposits:

            

Private accounts:

            

Savings and interest checking

     2,950,197         17.4        2,912,937         17.4        2,484,668         16.9   

Money market accounts

     5,750,104         34.0        5,664,780         33.8        5,243,830         35.6   

Time accounts of $100,000 or more

     532,544         3.2        533,682         3.2        609,166         4.2   

Time accounts under $100,000

     500,623         3.0        522,887         3.1        546,167         3.7   
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 

Total private accounts

     9,733,468         57.6        9,634,286         57.5        8,883,831         60.4   

Public funds:

            

Savings and interest checking

     208,760         1.2        265,747         1.6        183,752         1.3   

Money market accounts

     42,488         0.3        44,590         0.3        85,745         0.6   

Time accounts of $100,000 or more

     136,817         0.8        136,422         0.8        139,221         0.9   

Time accounts under $100,000

     3,376         —          3,148         —          4,008         —     
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 

Total public funds

     391,441         2.3        449,907         2.7        412,726         2.8   
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 

Total interest-bearing deposits

     10,124,909         59.9        10,084,193         60.2        9,296,557         63.2   
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 

Total deposits

   $ 16,909,021         100.0   $ 16,756,748         100.0   $ 14,709,559         100.0
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 

The following table presents additional information about the Corporation’s deposits:

 

     March 31,      December 31,      March 31,  
     2012      2011      2011  

Money market deposits obtained through brokers

   $ —         $ 24,500       $ 24,852   

Deposits from the Certificate of Deposit Account Registry Service (CDARS) deposits

     25,541         45,005         48,005   

Deposits from foreign sources (primarily Mexico)

     830,685         744,669         759,297   

Note 6 - Commitments and Contingencies

Financial Instruments with Off-Balance-Sheet Risk. In the normal course of business, the Corporation enters into various transactions, which, in accordance with generally accepted accounting principles are not included in its consolidated balance sheets. The Corporation enters into these transactions to meet the financing needs of its customers. These transactions include commitments to extend credit and standby letters of credit, which involve, to varying degrees, elements of credit risk and interest rate risk in excess of the amounts recognized in the consolidated balance sheets. The Corporation minimizes its exposure to loss under these commitments by subjecting them to credit approval and monitoring procedures.

The Corporation enters into contractual commitments to extend credit, normally with fixed expiration dates or termination clauses, at specified rates and for specific purposes. Substantially all of the Corporation’s commitments to extend credit are contingent upon customers maintaining specific credit standards at the time of loan funding. Standby letters of credit are written conditional commitments issued by the Corporation to guarantee the performance of a customer to a third party. In the event the customer does not perform in accordance with the terms of the agreement with the third party, the Corporation would be required to fund the commitment. The maximum potential amount of future payments the Corporation could be required to make is represented by the contractual amount of the commitment. If the commitment were funded, the Corporation would be entitled to seek recovery from the customer. The Corporation’s policies generally require that standby letter of credit arrangements contain security and debt covenants similar to those contained in loan agreements.

 

22


Table of Contents

The Corporation considers the fees collected in connection with the issuance of standby letters of credit to be representative of the fair value of its obligation undertaken in issuing the guarantee. In accordance with applicable accounting standards related to guarantees, the Corporation defers fees collected in connection with the issuance of standby letters of credit. The fees are then recognized in income proportionately over the life of the standby letter of credit agreement. The deferred standby letter of credit fees represent the fair value of the Corporation’s potential obligations under the standby letter of credit guarantees.

Financial instruments with off-balance-sheet risk were as follows:

 

     March 31,      December 31,  
     2012      2011  

Commitments to extend credit

   $ 5,386,634       $ 5,147,363   

Standby letters of credit

     205,692         235,903   

Deferred standby letter of credit fees

     1,379         1,488   

Lease Commitments. The Corporation leases certain office facilities and office equipment under operating leases. Rent expense for all operating leases totaled $5.5 million during both the three months ended March 31, 2012 and 2011. There has been no significant change in the future minimum lease payments payable by the Corporation since December 31, 2011. See the 2011 Form 10-K for information regarding these commitments.

Litigation. The Corporation is subject to various claims and legal actions that have arisen in the course of conducting business. Management does not expect the ultimate disposition of these matters to have a material adverse impact on the Corporation’s financial statements.

Note 7 - Regulatory Matters

Regulatory Capital Requirements. Banks and bank holding companies are subject to various regulatory capital requirements administered by state and federal banking agencies. Capital adequacy guidelines and, additionally for banks, prompt corrective action regulations, involve quantitative measures of assets, liabilities, and certain off-balance-sheet items calculated under regulatory accounting practices. Capital amounts and classifications are also subject to qualitative judgments by regulators about components, risk weighting and other factors.

Quantitative measures established by regulations to ensure capital adequacy require the maintenance of minimum amounts and ratios (set forth in the table below) of total and Tier 1 capital (as defined in the regulations) to risk-weighted assets (as defined), and of Tier 1 capital to adjusted quarterly average assets (as defined).

Cullen/Frost’s and Frost Bank’s Tier 1 capital consists of shareholders’ equity excluding unrealized gains and losses on securities available for sale, the accumulated gain or loss on effective cash flow hedging derivatives, the net actuarial gain/loss on the Corporation’s defined benefit post-retirement benefit plans, goodwill and other intangible assets. Tier 1 capital for Cullen/Frost also includes $120 million of trust preferred securities issued by its unconsolidated subsidiary trust. Cullen/Frost’s and Frost Bank’s total capital is comprised of Tier 1 capital for each entity plus a permissible portion of the allowance for loan losses. The Corporation’s aggregate $100 million of floating rate subordinated notes are not included in Tier 1 capital but are included in total capital of Cullen/Frost.

The Tier 1 and total capital ratios are calculated by dividing the respective capital amounts by risk-weighted assets. Risk-weighted assets are calculated based on regulatory requirements and include total assets, excluding goodwill and other intangible assets, allocated by risk weight category, and certain off-balance-sheet items (primarily loan commitments). The leverage ratio is calculated by dividing Tier 1 capital by adjusted quarterly average total assets, which exclude goodwill and other intangible assets.

 

23


Table of Contents

Actual and required capital ratios for Cullen/Frost and Frost Bank were as follows:

 

     

Actual
    Minimum Required
for Capital Adequacy
Purposes
    Required to be
Considered Well
Capitalized
 
      Capital
Amount
    
Ratio
    Capital
Amount
    
Ratio
    Capital
Amount
    
Ratio
 

March 31, 2012

               

Total Capital to Risk-Weighted Assets

               

Cullen/Frost

   $ 1,844,944         16.10   $ 916,676         8.00   $ 1,145,845         10.00

Frost Bank

     1,657,936         14.48        916,245         8.00        1,145,307         10.00   

Tier 1 Capital to Risk-Weighted Assets

               

Cullen/Frost

     1,657,763         14.47        458,338         4.00        687,507         6.00   

Frost Bank

     1,550,755         13.54        458,123         4.00        687,184         6.00   

Leverage Ratio

               

Cullen/Frost

     1,657,763         8.68        764,255         4.00        955,319         5.00   

Frost Bank

     1,550,755         8.12        763,906         4.00        954,882         5.00   

December 31, 2011

               

Total Capital to Risk-Weighted Assets

               

Cullen/Frost

   $ 1,835,428         16.24   $ 903,970         8.00   $ 1,129,962         10.00

Frost Bank

     1,641,921         14.54        903,427         8.00        1,129,284         10.00   

Tier 1 Capital to Risk-Weighted Assets

               

Cullen/Frost

     1,625,281         14.38        451,985         4.00        677,977         6.00   

Frost Bank

     1,531,774         13.56        451,713         4.00        677,570         6.00   

Leverage Ratio

               

Cullen/Frost

     1,625,281         8.66        750,643         4.00        938,304         5.00   

Frost Bank

     1,531,774         8.17        750,249         4.00        937,811         5.00   

Management believes that, as of March 31, 2012, Cullen/Frost and its bank subsidiary, Frost Bank, were “well capitalized” based on the ratios presented above.

Cullen/Frost is subject to the regulatory capital requirements administered by the Federal Reserve, while Frost Bank is subject to the regulatory capital requirements administered by the Office of the Comptroller of the Currency (“OCC”) (see the section captioned “Charter Conversion” below) and the Federal Deposit Insurance Corporation (“FDIC”). Regulatory authorities can initiate certain mandatory actions if Cullen/Frost or Frost Bank fail to meet the minimum capital requirements, which could have a direct material effect on the Corporation’s financial statements. Management believes, as of March 31, 2012, that Cullen/Frost and Frost Bank meet all capital adequacy requirements to which they are subject.

Dividend Restrictions. In the ordinary course of business, Cullen/Frost is dependent upon dividends from Frost Bank to provide funds for the payment of dividends to shareholders and to provide for other cash requirements. Banking regulations may limit the amount of dividends that may be paid. Approval by regulatory authorities is required if the effect of dividends declared would cause the regulatory capital of Frost Bank to fall below specified minimum levels. Approval is also required if dividends declared exceed the net profits for that year combined with the retained net profits for the preceding two years. Under the foregoing dividend restrictions and while maintaining its “well capitalized” status, at March 31, 2012, Frost Bank could pay aggregate dividends of up to $233.8 million to Cullen/Frost without prior regulatory approval.

Trust Preferred Securities. In accordance with the applicable accounting standard related to variable interest entities, the accounts of the Corporation’s wholly owned subsidiary trust, Cullen/Frost Capital Trust II, have not been included in the Corporation’s consolidated financial statements. However, the $120.0 million in trust preferred securities issued by this subsidiary trust have been included in the Tier 1 capital of Cullen/Frost for regulatory capital purposes pursuant to guidance from the Federal Reserve. On July 21, 2010, financial regulatory reform legislation entitled the “Dodd-Frank Wall Street Reform and Consumer Protection Act” (the “Dodd-Frank Act”) was signed into law. Certain provisions of the Dodd-Frank Act will require the Corporation to deduct, over three years beginning on January 1, 2013, all trust preferred securities from the Corporation’s Tier 1 capital. Nonetheless, excluding trust preferred securities from Tier 1 capital at March 31, 2012 would not affect the Corporation’s ability to meet all capital adequacy requirements to which it is subject.

Charter Conversion. On February 3, 2012, Frost Bank, the sole banking subsidiary of the Corporation, applied to the Texas Department of Banking to become a Texas state chartered bank and notified the Federal Reserve Bank of Dallas of its intention to become a state chartered bank and a member of the Federal Reserve System. If the applications are approved, the Texas Department of Banking and the Federal Reserve Bank of Dallas will become the primary regulators of Frost Bank, and Frost Bank will no longer be regulated by the OCC. Deposits at Frost Bank that are currently insured by the FDIC will continue to be so insured up to applicable limits.

 

24


Table of Contents

Note 8 - Derivative Financial Instruments

The fair value of derivative positions outstanding is included in accrued interest receivable and other assets and accrued interest payable and other liabilities in the accompanying consolidated balance sheets and in the net change in each of these financial statement line items in the accompanying consolidated statements of cash flows.

Interest Rate Derivatives. The Corporation utilizes interest rate swaps, caps and floors to mitigate exposure to interest rate risk and to facilitate the needs of its customers. The Corporation’s objectives for utilizing these derivative instruments is described below:

The Corporation has entered into certain interest rate swap contracts that are matched to specific fixed-rate commercial loans or leases that the Corporation has entered into with its customers. These contracts have been designated as hedging instruments to hedge the risk of changes in the fair value of the underlying commercial loan/lease due to changes in interest rates. The related contracts are structured so that the notional amounts reduce over time to generally match the expected amortization of the underlying loan/lease.

In October 2007, the Corporation entered into three interest rate swap contracts on variable-rate loans with a total notional amount of $1.2 billion. The interest rate swap contracts were designated as hedging instruments in cash flow hedges with the objective of protecting the overall cash flows from the Corporation’s monthly interest receipts on a rolling portfolio of $1.2 billion of variable-rate loans outstanding throughout the 84-month period beginning in October 2007 and ending in October 2014 from the risk of variability of those cash flows such that the yield on the underlying loans would remain constant. As more fully discussed in the 2011 Form 10-K, the Corporation terminated portions of the hedges and settled portions of the interest rate swap contracts during November 2009 and terminated the remaining portions of the hedges and settled the remaining portions of the interest rate swap contracts during November 2010. The deferred accumulated after-tax gain applicable to the settled interest rate swap contracts included in accumulated other comprehensive income totaled $62.4 million at March 31, 2012. The deferred gain will be reclassified into earnings through October 2014.

In October 2008, the Corporation entered into an interest rate swap contract on junior subordinated deferrable interest debentures with a total notional amount of $120.0 million. The interest rate swap contract was designated as a hedging instrument in a cash flow hedge with the objective of protecting the quarterly interest payments on the Corporation’s $120.0 million of junior subordinated deferrable interest debentures issued to Cullen/Frost Capital Trust II throughout the five-year period beginning in December 2008 and ending in December 2013 from the risk of variability of those payments resulting from changes in the three-month LIBOR interest rate. Under the swap, the Corporation will pay a fixed interest rate of 5.47% and receive a variable interest rate of three-month LIBOR plus a margin of 1.55% on a total notional amount of $120.0 million, with quarterly settlements.

The Corporation has entered into certain interest rate swap, cap and floor contracts that are not designated as hedging instruments. These derivative contracts relate to transactions in which the Corporation enters into an interest rate swap, cap and/or floor with a customer while at the same time entering into an offsetting interest rate swap, cap and/or floor with another financial institution. In connection with each swap transaction, the Corporation agrees to pay interest to the customer on a notional amount at a variable interest rate and receive interest from the customer on a similar notional amount at a fixed interest rate. At the same time, the Corporation agrees to pay another financial institution the same fixed interest rate on the same notional amount and receive the same variable interest rate on the same notional amount. The transaction allows the Corporation’s customer to effectively convert a variable rate loan to a fixed rate. Because the Corporation acts as an intermediary for its customer, changes in the fair value of the underlying derivative contracts for the most part offset each other and do not significantly impact the Corporation’s results of operations.

 

25


Table of Contents

The notional amounts and estimated fair values of interest rate derivative contracts outstanding at March 31, 2012 and December 31, 2011 are presented in the following table. The Corporation obtains dealer quotations to value its interest rate derivative contracts designated as hedges of cash flows, while the fair values of other interest rate derivative contracts are estimated utilizing internal valuation models with observable market data inputs.

 

     March 31, 2012     December 31, 2011  
      Notional
Amount
     Estimated
Fair Value
    Notional
Amount
     Estimated
Fair Value
 

Interest rate derivatives designated as hedges of fair value:

          

Commercial loan/lease interest rate swaps

   $ 67,517       $ (7,736   $ 71,181       $ (8,376

Interest rate derivatives designated as hedges of cash flows:

          

Interest rate swap on junior subordinated deferrable interest debentures

     120,000         (7,205     120,000         (7,807

Non-hedging interest rate derivatives:

          

Commercial loan/lease interest rate swaps

     637,356         57,105        613,883         61,137   

Commercial loan/lease interest rate swaps

     637,356         (57,314     613,883         (61,393

Commercial loan/lease interest rate caps

     20,000         28        20,000         50   

Commercial loan/lease interest rate caps

     20,000         (28     20,000         (50

The weighted-average rates paid and received for interest rate swaps outstanding at March 31, 2012 were as follows:

 

     Weighted-Average  
     Interest
Rate
Paid
    Interest
Rate
Received
 

Interest rate swaps:

    

Fair value hedge commercial loan/lease interest rate swaps

     4.30     0.24

Cash flow hedge interest rate swaps on junior subordinated deferrable interest debentures

     5.47        1.86   

Non-hedging interest rate swaps

     1.81        4.89   

Non-hedging interest rate swaps

     4.89        1.81   

The weighted-average strike rate for outstanding interest rate caps was 3.10% at March 31, 2012.

Commodity Derivatives. The Corporation enters into commodity swaps and option contracts that are not designated as hedging instruments primarily to accommodate the business needs of its customers. Upon the origination of a commodity swap or option contract with a customer, the Corporation simultaneously enters into an offsetting contract with a third party to mitigate the exposure to fluctuations in commodity prices.

The notional amounts and estimated fair values of commodity derivative positions outstanding are presented in the following table. The Corporation obtains dealer quotations to value its commodity derivative positions.

 

       March 31, 2012     December 31, 2011  
      Notional
Units
     Notional
Amount
     Estimated
Fair Value
    Notional
Amount
     Estimated
Fair Value
 

Non-hedging commodity swaps:

             

Oil

     Barrels         521       $ 2,505        459       $ 1,068   

Oil

     Barrels         521         (2,387     459         (963

Natural gas

     MMBTUs         990         2,321        1,905         3,540   

Natural gas

     MMBTUs         990         (2,289     1,905         (3,480

Non-hedging commodity options:

             

Oil

     Barrels         2,610         12,327        2,920         18,206   

Oil

     Barrels         2,610         (12,327     2,920         (18,206

Natural gas

     MMBTUs         600         581        480         490   

Natural gas

     MMBTUs         600         (581     480         (490

 

26


Table of Contents

Foreign Currency Derivatives. The Corporation enters into foreign currency forward contracts that are not designated as hedging instruments primarily to accommodate the business needs of its customers. Upon the origination of a foreign currency denominated transaction with a customer, the Corporation simultaneously enters into an offsetting contract with a third party to negate the exposure to fluctuations in foreign currency exchange rates. The Corporation also utilizes foreign currency forward contracts that are not designated as hedging instruments to mitigate the economic effect of fluctuations in foreign currency exchange rates on certain short-term, non-U.S. dollar denominated loans. The notional amounts and fair values of open foreign currency forward contracts were not significant at March 31, 2012 and December 31, 2011.

Gains, Losses and Derivative Cash Flows. For fair value hedges, the changes in the fair value of both the derivative hedging instrument and the hedged item are included in other non-interest income or other non-interest expense. The extent that such changes in fair value do not offset represents hedge ineffectiveness. Net cash flows from interest rate swaps on commercial loans/leases designated as hedging instruments in effective hedges of fair value are included in interest income on loans. For cash flow hedges, the effective portion of the gain or loss due to changes in the fair value of the derivative hedging instrument is included in other comprehensive income, while the ineffective portion (indicated by the excess of the cumulative change in the fair value of the derivative over that which is necessary to offset the cumulative change in expected future cash flows on the hedge transaction) is included in other non-interest income or other non-interest expense. Net cash flows from interest rate swaps on variable-rate loans designated as hedging instruments in effective hedges of cash flows and the reclassification from other comprehensive income of deferred gains associated with the termination of those hedges are included in interest income on loans. Net cash flows from the interest rate swap on junior subordinated deferrable interest debentures designated as a hedging instrument in an effective hedge of cash flows are included in interest expense on junior subordinated deferrable interest debentures. For non-hedging derivative instruments, gains and losses due to changes in fair value and all cash flows are included in other non-interest income and other non-interest expense.

Amounts included in the consolidated statements of income related to interest rate derivatives designated as hedges of fair value were as follows:

 

      Three Months Ended
March  31,
 
     2012     2011  

Commercial loan/lease interest rate swaps:

    

Amount of gain (loss) included in interest income on loans

   $ (667   $ (1,005

Amount of (gain) loss included in other non-interest expense

     (12     (9

Amounts included in the consolidated statements of income and in other comprehensive income for the period related to interest rate derivatives designated as hedges of cash flows were as follows:

 

     Three Months Ended
March 31,
 
     2012     2011  

Interest rate swaps on variable-rate loans:

    

Amount reclassified from accumulated other comprehensive income to interest income on loans

   $  9,345      $  9,345   

Interest rate swaps on junior subordinated deferrable interest debentures:

    

Amount reclassified from accumulated other comprehensive income to interest expense on junior subordinated deferrable interest debentures

     1,033        1,086   

Amount of gain (loss) recognized in other comprehensive income

     (427     65   

No ineffectiveness related to interest rate derivatives designated as hedges of cash flows was recognized in the consolidated statements of income during the reported periods. The accumulated net after-tax gain related to effective cash flow hedges included in accumulated other comprehensive income totaled $58.0 million at March 31, 2012 and $63.6 million at December 31, 2011. The Corporation currently expects approximately $16.1 million of the net after-tax gain related to effective cash flow hedges included in accumulated other comprehensive income at March 31, 2012 will be reclassified into earnings during the remainder of 2012. This amount represents management’s best estimate given current expectations about market interest rates and volumes related to loan pools underlying the terminated cash flow hedges. Because actual market interest rates and volumes related to loan pools underlying the terminated cash flow hedges may differ from management’s expectations, there can be no assurance as to the ultimate amount that will be reclassified into earnings during 2012.

 

27


Table of Contents

As stated above, the Corporation enters into non-hedge related derivative positions primarily to accommodate the business needs of its customers. Upon the origination of a derivative contract with a customer, the Corporation simultaneously enters into an offsetting derivative contract with a third party. The Corporation recognizes immediate income based upon the difference in the bid/ask spread of the underlying transactions with its customers and the third party. Because the Corporation acts only as an intermediary for its customer, subsequent changes in the fair value of the underlying derivative contracts for the most part offset each other and do not significantly impact the Corporation’s results of operations.

Amounts included in the consolidated statements of income related to non-hedging interest rate and commodity derivative instruments are presented in the table below. Amounts included in the consolidated statements of income related to foreign currency derivatives during the reported periods were not significant.

 

      Three Months Ended
March 31,
 
     2012     2011  

Non-hedging interest rate derivatives:

    

Other non-interest income

   $ 782      $ 274   

Other non-interest expense

     (47     (39

Non-hedging commodity derivatives:

    

Other non-interest income

     37        383   

Counterparty Credit Risk. Derivative contracts involve the risk of dealing with both bank customers and institutional derivative counterparties and their ability to meet contractual terms. Institutional counterparties must have an investment grade credit rating and be approved by the Corporation’s Asset/Liability Management Committee. The Corporation’s credit exposure on interest rate swaps is limited to the net favorable value and interest payments of all swaps by each counterparty, while the Corporation’s credit exposure on commodity swaps/options is limited to the net favorable value of all swaps/options by each counterparty. Credit exposure may be reduced by the amount of collateral pledged by the counterparty. There are no credit-risk-related contingent features associated with any of the Corporation’s derivative contracts. Certain derivative contracts with upstream financial institution counterparties may be terminated with respect to a party in the transaction, if such party does not have at least a minimum level rating assigned to either its senior unsecured long-term debt or its deposit obligations by certain third-party rating agencies.

The Corporation’s credit exposure relating to interest rate swaps and commodity swaps/options with bank customers was approximately $63.7 million at March 31, 2012. This credit exposure is partly mitigated as transactions with customers are generally secured by the collateral, if any, securing the underlying transaction being hedged. The Corporation had no credit exposure, net of collateral pledged, relating to interest rate swaps and commodity swaps/options with upstream financial institution counterparties at March 31, 2012. Collateral levels for upstream financial institution counterparties are monitored and adjusted as necessary.

The aggregate fair value of securities posted as collateral by the Corporation related to derivative contracts totaled $71.9 million at March 31, 2012. At such date, the Corporation also had $6.3 million in cash collateral on deposit with other financial institution counterparties.

Note 9 - Earnings Per Common Share

Earnings per common share is computed using the two-class method. Basic earnings per common share is computed by dividing net earnings allocated to common stock by the weighted-average number of common shares outstanding during the applicable period, excluding outstanding participating securities. Participating securities include non-vested stock awards/stock units and deferred stock units, though no actual shares of common stock related to non-vested stock units and deferred stock units have been issued. Non-vested stock awards/stock units and deferred stock units are considered participating securities because holders of these securities receive non-forfeitable dividends at the same rate as holders of the Corporation’s common stock. Diluted earnings per common share is computed using the weighted-average number of shares determined for the basic earnings per common share computation plus the dilutive effect of stock compensation using the treasury stock method.

 

28


Table of Contents

The following table presents a reconciliation of the number of shares used in the calculation of basic and diluted earnings per common share.

 

      Three Months Ended
March 31,
 
     2012      2011  

Distributed earnings allocated to common stock

   $ 28,152       $ 27,470   

Undistributed earnings allocated to common stock

     32,691         24,252   
  

 

 

    

 

 

 

Net earnings allocated to common stock

   $ 60,843       $ 51,722   
  

 

 

    

 

 

 

Weighted-average shares outstanding for basic earnings per
common share

     61,200,627         61,018,169   

Dilutive effect of stock compensation

     332,674         316,295   
  

 

 

    

 

 

 

Weighted-average shares outstanding for diluted earnings
per common share

     61,533,301         61,334,464   
  

 

 

    

 

 

 

Note 10 - Stock-Based Compensation

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

 

                  Non-Vested Stock
Awards/Stock Units
Outstanding
     Stock Options
Outstanding
 
     Shares
Available
for Grant
    Director
Deferred
Stock Units
Outstanding
     Number
of Shares
     Weighted-
Average
Grant-Date
Fair Value
     Number of
Shares
    Weighted-
Average

Exercise
Price
 

Balance, January 1, 2012

     1,963,455        22,092         169,530       $ 50.33         4,968,822      $ 51.49   

Granted

     —          —           —           —           —          —     

Stock options exercised

     —          —           —           —           (108,800     50.94   

Stock awards vested

     —          —           —           —           —          —     

Forfeited

     1,875        —           —           —           (1,875     51.81   

Cancelled/expired

     (125     —           —           —           —       
  

 

 

   

 

 

    

 

 

       

 

 

   

Balance, March 31, 2012

     1,965,205        22,092         169,530       $ 50.33         4,858,147      $ 51.50   
  

 

 

   

 

 

    

 

 

       

 

 

   

During the three months ended March 31, 2012 and 2011, proceeds from stock option exercises totaled $5.5 million and $5.8 million. During the three months ended March 31, 2012, 101,160 shares issued in connection with stock option exercises were new shares issued from available authorized shares, while 7,640 shares were issued from available treasury stock.

Stock-based compensation expense is recognized ratably over the requisite service period for all awards. Stock-based compensation expense was as follows:

 

      Three Months Ended
March 31,
 
     2012      2011  

Stock options

   $ 2,201       $ 2,310   

Non-vested stock awards/stock units

     354         1,427   
  

 

 

    

 

 

 

Total

   $ 2,555       $ 3,737   
  

 

 

    

 

 

 

Unrecognized stock-based compensation expense at March 31, 2012 was as follows:

 

Stock options

   $ 16,811   

Non-vested stock awards/stock units

     2,742   
  

 

 

 

Total

   $ 19,553   
  

 

 

 

 

29


Table of Contents

Note 11 - Defined Benefit Plans

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

 

      Three Months Ended
March 31,
 
     2012     2011  

Expected return on plan assets, net of expenses

   $ (2,603   $ (2,859

Interest cost on projected benefit obligation

     1,950        1,973   

Net amortization and deferral

     1,229        783   
  

 

 

   

 

 

 

Net periodic cost (benefit)

   $ 576      $ (103
  

 

 

   

 

 

 

The Corporation’s non-qualified defined benefit pension plan is not funded. No contributions to the qualified defined benefit pension plan were made during the three months ended March 31, 2012. The Corporation does not expect to make any contributions to the qualified defined benefit plan during the remainder of 2012.

Note 12 - Income Taxes

Income tax expense was as follows:

 

      Three Months Ended
March 31,
 
     2012     2011  

Current income tax expense

   $ 20,052      $ 12,792   

Deferred income tax benefit

     (2,539     (139
  

 

 

   

 

 

 

Income tax expense, as reported

   $ 17,513      $ 12,653   
  

 

 

   

 

 

 

Effective tax rate

     22.3     19.6
  

 

 

   

 

 

 

Net deferred tax liabilities totaled $119.3 million at March 31, 2012 and $123.7 million at December 31, 2011. No valuation allowance was recorded against deferred tax assets at March 31, 2012 as management believes that it is more likely than not that all of the deferred tax assets will be realized because they were supported by recoverable taxes paid in prior years. There were no unrecognized tax benefits during any of the reported periods. Interest and/or penalties related to income taxes are reported as a component of income tax expense. Such amounts were not significant during the reported periods.

The Corporation files income tax returns in the U.S. federal jurisdiction. The Company is no longer subject to U.S. federal income tax examinations by tax authorities for years before 2008.

 

30


Table of Contents

Note 13 - Other Comprehensive Income (Loss)

The tax effects allocated to each component of other comprehensive income (loss) were as follows:

 

      Before Tax
Amount
    Tax Expense
(Benefit)
    Net of Tax
Amount
 

Three months ended March 31, 2012:

      

Securities available for sale:

      

Change in net unrealized gain/loss during the period

   $ 1,882      $ 658      $ 1,224   

Reclassification adjustment for net (gains) losses included in net income

     491        172        319   
  

 

 

   

 

 

   

 

 

 

Total securities available for sale

     2,373        830        1,543   

Defined-benefit post-retirement benefit plans:

      

Change in the net actuarial gain/loss

     1,229        430        799   

Derivatives:

      

Change in the accumulated gain/loss on effective cash flow hedge derivatives

     (427     (150     (277

Reclassification adjustments for (gains) losses included in net income:

      

Interest rate swaps on variable-rate loans

     (9,345     (3,271     (6,074

Interest rate swap on junior subordinated deferrable interest debentures

     1,033        362        671   
  

 

 

   

 

 

   

 

 

 

Total derivatives

     (8,739     (3,059     (5,680
  

 

 

   

 

 

   

 

 

 

Total other comprehensive income

   $ (5,137   $ (1,799   $ (3,338
  

 

 

   

 

 

   

 

 

 

Three months ended March 31, 2011:

      

Securities available for sale:

      

Change in net unrealized gain/loss during the period

   $ 8,290      $ 2,902      $ 5,388   

Reclassification adjustment for net (gains) losses included in net income

     (5     (2     (3
  

 

 

   

 

 

   

 

 

 

Total securities available for sale

     8,285        2,900        5,385   

Defined-benefit post-retirement benefit plans:

      

Change in the net actuarial gain/loss

     783        274        509   

Derivatives:

      

Change in the accumulated gain/loss on effective cash flow hedge derivatives

     65        23        42   

Reclassification adjustments for (gains) losses included in net income:

      

Interest rate swaps on variable-rate loans

     (9,345     (3,271     (6,074

Interest rate swap on junior subordinated deferrable interest debentures

     1,086        380        706   
  

 

 

   

 

 

   

 

 

 

Total derivatives

     (8,194     (2,868     (5,326
  

 

 

   

 

 

   

 

 

 

Total other comprehensive income

   $ 874      $ 306      $ 568   
  

 

 

   

 

 

   

 

 

 

Activity in accumulated other comprehensive income, net of tax, was as follows:

 

                        Accumulated  
     Securities      Defined           Other  
     Available      Benefit           Comprehensive  
     For Sale      Plans     Derivatives     Income  

Balance January 1, 2012

   $ 227,052       $ (42,958   $ 63,640      $ 247,734   

Other comprehensive income (loss)

     1,543         799        (5,680     (3,338
  

 

 

    

 

 

   

 

 

   

 

 

 

Balance March 31, 2012

   $ 228,595       $ (42,159   $ 57,960      $ 244,396   
  

 

 

    

 

 

   

 

 

   

 

 

 

Balance January 1, 2011

   $ 96,012       $ (28,357   $ 86,595      $ 154,250   

Other comprehensive income

     5,385         509        (5,326     568   
  

 

 

    

 

 

   

 

 

   

 

 

 

Balance March 31, 2011

   $ 101,397       $ (27,848   $ 81,269      $ 154,818   
  

 

 

    

 

 

   

 

 

   

 

 

 

 

31


Table of Contents

Note 14 - Operating Segments

The Corporation is managed under a matrix organizational structure whereby significant lines of business, including Banking and Frost Wealth Advisors (formerly Financial Management Group or “FMG”), overlap a regional reporting structure. The regions are primarily based upon geographic location and include Austin, Corpus Christi, Dallas, Fort Worth, Houston, Rio Grande Valley, San Antonio and Statewide. The Corporation is primarily managed based on the line of business structure. In that regard, all regions have the same lines of business, which have the same product and service offerings, have similar types and classes of customers and utilize similar service delivery methods. Pricing guidelines for products and services are the same across all regions. The regional reporting structure is primarily a means to scale the lines of business to provide a local, community focus for customer relations and business development.

The Corporation has two primary operating segments, Banking and Frost Wealth Advisors, that are delineated by the products and services that each segment offers. The Banking operating segment includes both commercial and consumer banking services, Frost Securities, Inc. and Frost Insurance Agency. Commercial banking 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 lending and depository services. Frost Insurance Agency provides insurance brokerage services to individuals and businesses covering corporate and personal property and casualty products, as well as group health and life insurance products. Frost Securities, Inc. provides advisory and private equity services to middle market companies. The Frost Wealth Advisors operating segment includes fee-based services within private trust, retirement services, and financial management services, including personal wealth management and brokerage services. The third operating segment, Non-Banks, is for the most part the parent holding company, as well as certain other insignificant non-bank subsidiaries of the parent that, for the most part, have little or no activity. The parent company’s principal activities include the direct and indirect ownership of the Corporation’s banking and non-banking subsidiaries and the issuance of debt and equity. Its principal source of revenue is dividends from its subsidiaries.

The accounting policies of each reportable segment are the same as those of the Corporation except for the following items, which impact the Banking and Frost Wealth Advisors segments: (i) expenses for consolidated back-office operations and general overhead-type expenses such as executive administration, accounting and internal audit are allocated to operating segments based on estimated uses of those services, (ii) income tax expense for the individual segments is calculated essentially at the statutory rate, and (iii) the parent company records the tax expense or benefit necessary to reconcile to the consolidated total.

The Corporation uses a match-funded transfer pricing process to assess operating segment performance. The process helps the Corporation to (i) identify the cost or opportunity value of funds within each business segment, (ii) measure the profitability of a particular business segment by relating appropriate costs to revenues, (iii) evaluate each business segment in a manner consistent with its economic impact on consolidated earnings, and (iv) enhance asset and liability pricing decisions.

Summarized operating results by segment were as follows:

 

     Banking      Frost Wealth
Advisors
     Non-Banks     Consolidated  

Revenues from (expenses to) external customers:

          

Three months ended:

          

March 31, 2012

   $ 196,273       $ 25,997       $ (584   $ 221,686   

March 31, 2011

     192,265         24,434         (2,607     214,092   

Net income (loss):

          

Three months ended:

          

March 31, 2012

   $ 58,290       $ 3,391       $ (648   $ 61,033   

March 31, 2011

     51,853         1,670         (1,595     51,928   

 

32


Table of Contents

Note 15 - Fair Value Measurements

The fair value of an asset or liability is the price that would be received to sell that asset or paid to transfer that liability in an orderly transaction occurring in the principal market (or most advantageous market in the absence of a principal market) for such asset or liability. In estimating fair value, the Corporation utilizes valuation techniques that are consistent with the market approach, the income approach and/or the cost approach. Such valuation techniques are consistently applied. Inputs to valuation techniques include the assumptions that market participants would use in pricing an asset or liability. ASC Topic 820 establishes a fair value hierarchy for valuation inputs that gives the highest priority to quoted prices in active markets for identical assets or liabilities and the lowest priority to unobservable inputs. The fair value hierarchy is as follows:

 

   

Level 1 Inputs - Unadjusted quoted prices in active markets for identical assets or liabilities that the reporting entity has the ability to access at the measurement date.

 

   

Level 2 Inputs - Inputs other than quoted prices included in Level 1 that are observable for the asset or liability, either directly or indirectly. These might include quoted prices for similar assets or liabilities in active markets, quoted prices for identical or similar assets or liabilities in markets that are not active, inputs other than quoted prices that are observable for the asset or liability (such as interest rates, volatilities, prepayment speeds, credit risks, etc.) or inputs that are derived principally from or corroborated by market data by correlation or other means.

 

   

Level 3 Inputs - Unobservable inputs for determining the fair values of assets or liabilities that reflect an entity’s own assumptions about the assumptions that market participants would use in pricing the assets or liabilities.

In general, fair value is based upon quoted market prices, where available. If such quoted market prices are not available, fair value is based upon internally developed models that primarily use, as inputs, observable market-based parameters. Valuation adjustments may be made to ensure that financial instruments are recorded at fair value. These adjustments may include amounts to reflect counterparty credit quality and the Corporation’s creditworthiness, among other things, as well as unobservable parameters. Any such valuation adjustments are applied consistently over time. The Corporation’s valuation methodologies may produce a fair value calculation that may not be indicative of net realizable value or reflective of future fair values. While management believes the Corporation’s valuation methodologies are appropriate and consistent with other market participants, the use of different methodologies or assumptions to determine the fair value of certain financial instruments could result in a different estimate of fair value at the reporting date. Furthermore, the reported fair value amounts have not been comprehensively revalued since the presentation dates, and therefore, estimates of fair value after the balance sheet date may differ significantly from the amounts presented herein. A more detailed description of the valuation methodologies used for assets and liabilities measured at fair value is set forth below. Transfers between levels of the fair value hierarchy are recognized on the actual date of the event or circumstances that caused the transfer, which generally coincides with the Corporation’s monthly and/or quarterly valuation process.

Financial Assets and Financial Liabilities: Financial assets and financial liabilities measured at fair value on a recurring basis include the following:

Securities Available for Sale. U.S. Treasury securities are reported at fair value utilizing Level 1 inputs. Other securities classified as available for sale are reported at fair value utilizing Level 2 inputs. For these securities, the Corporation obtains fair value measurements from an independent pricing service. The fair value measurements consider observable data that may include dealer quotes, market spreads, cash flows, the U.S. Treasury yield curve, live trading levels, trade execution data, market consensus prepayment speeds, credit information and the bond’s terms and conditions, among other things.

The Corporation reviews the prices supplied by the independent pricing service, as well as their underlying pricing methodologies, for reasonableness and to ensure such prices are aligned with traditional pricing matrices. In general, the Corporation does not purchase investment portfolio securities that are esoteric or that have a complicated structure. The Corporation’s entire portfolio consists of traditional investments, nearly all of which are U.S. Treasury obligations, federal agency bullet or mortgage pass-through securities, or general obligation or revenue based municipal bonds. Pricing for such instruments is fairly generic and is easily obtained. From time to time, the Corporation will validate, on a sample basis, prices supplied by the independent pricing service by comparison to prices obtained from third-party sources or derived using internal models.

Trading Securities. U.S. Treasury securities and exchange-listed common stock are reported at fair value utilizing Level 1 inputs. Other securities classified as trading are reported at fair value utilizing Level 2 inputs in the same manner as described above for securities available for sale.

Derivatives. Derivatives are generally reported at fair value utilizing Level 2 inputs, except for foreign currency contracts, which are reported at fair value utilizing Level 1 inputs. The Corporation obtains dealer quotations to value its prime-rate loan swaps, the swap related to its junior subordinated deferrable interest debentures and commodity swaps/options. The

 

33


Table of Contents

Corporation utilizes internally developed valuation models and/or third-party models with observable market data inputs to validate the valuations provided by the dealers. Though there has never been a significant discrepancy in the valuations, should such a significant discrepancy arise, the Corporation would obtain price verification from a third-party dealer. The Corporation utilizes internal valuation models with observable market data inputs to estimate fair values of customer interest rate swaps, caps and floors. The Corporation also obtains dealer quotations for these derivatives for comparative purposes to assess the reasonableness of the model valuations. In cases where significant credit valuation adjustments are incorporated into the estimation of fair value, reported amounts are considered to have been derived utilizing Level 3 inputs.

For purposes of potential valuation adjustments to its derivative positions, the Corporation evaluates the credit risk of its counterparties as well as that of the Corporation. Accordingly, the Corporation has considered factors such as the likelihood of default by the Corporation and its counterparties, its net exposures, and remaining contractual life, among other things, in determining if any fair value adjustments related to credit risk are required. Counterparty exposure is evaluated by netting positions that are subject to master netting arrangements, as well as considering the amount of collateral securing the position. The Corporation reviews its counterparty exposure on a regular basis, and, when necessary, appropriate business actions are taken to adjust the exposure. The Corporation also utilizes this approach to estimate its own credit risk on derivative liability positions. To date, the Corporation has not realized any significant losses due to a counterparty’s inability to pay any net uncollateralized position. The change in value of derivative assets and derivative liabilities attributable to credit risk was not significant during the reported periods.

The following table summarizes financial assets and financial liabilities measured at fair value on a recurring basis as of March 31, 2012 and December 31, 2011, segregated by the level of the valuation inputs within the fair value hierarchy utilized to measure fair value:

 

     Level 1
Inputs
     Level 2
Inputs
     Level 3
Inputs
     Total Fair
Value
 

March 31, 2012

           

Securities available for sale:

           

U.S. Treasury

   $ 3,048,048       $ —         $ —         $ 3,048,048   

U.S. government agencies/corporations

     —           250,782         —           250,782   

Residential mortgage-backed securities

     —           3,123,965         —           3,123,965   

States and political subdivisions

     —           2,107,411         —           2,107,411   

Other

     —           38,009         —           38,009   

Trading account securities:

           

U.S. Treasury

     13,409         —           —           13,409   

States and political subdivisions

     —           3,437         —           3,437   

Derivative assets:

           

Interest rate swaps, caps and floors

     —           56,523         610         57,133   

Commodity and foreign exchange derivatives

     —           17,734         —           17,734   

Derivative liabilities:

           

Interest rate swaps, caps and floors

     —           72,283         —           72,283   

Commodity and foreign exchange derivatives

     6         17,584         —           17,590   

December 31, 2011

           

Securities available for sale:

           

U.S. Treasury

   $ 2,056,732       $ —         $ —         $ 2,056,732   

U.S. government agencies/corporations

     —           250,884         —           250,884   

Residential mortgage-backed securities

     —           3,289,270         —           3,289,270   

States and political subdivisions

     —           2,154,813         —           2,154,813   

Other

     —           38,001         —           38,001   

Trading account securities:

           

U.S. Treasury

     13,609         —           —           13,609   

Derivative assets:

           

Interest rate swaps, caps and floors

     —           60,498         689         61,187   

Commodity and foreign exchange derivatives

     7         23,304         —           23,311   

Derivative liabilities:

           

Interest rate swaps, caps and floors

     —           77,626         —           77,626   

Commodity and foreign exchange derivatives

     —           23,139         —           23,139   

 

34


Table of Contents

The following table reconciles the beginning and ending balances of derivative assets, which consist of interest rate swaps sold to loan customers, measured at fair value on a recurring basis using significant unobservable (Level 3) inputs during the three months ended March 31, 2012 and 2011:

 

     Three Months Ended
March 31,
 
     2012     2011  

Balance, beginning of period

   $ 689      $ 1,090   

Cash settlements

     (97     (112

Realized gains (losses) included in other non-interest income

     (22     (35

Realized gains (losses) included in other non-interest expense

     40        39   
  

 

 

   

 

 

 

Balance, end of period

   $ 610      $ 982   
  

 

 

   

 

 

 

The significant unobservable (Level 3) inputs used in the fair value measurement of the Corporation’s interest rate swaps sold to loan customers included in the above table primarily relate to the probability of default and loss severity in the event of default. The probability of default is determined by the underlying risk grade of the loan (see Note 3 – Loans) underlying the interest rate swap in that the probability of default increases as a loan’s risk grade deteriorates, while the loss severity is estimated through an analysis of the collateral supporting both the underlying loan and interest rate swap. Generally, a change in the assumption used for the probability of default is accompanied by a directionally similar change in the assumption used for the loss severity. As March 31, 2012, the weighted-average risk grade of loans underlying interest rate swaps measured at fair value using significant unobservable (Level 3) inputs was 11.2. The loss severity in the event of default on the interest rate swaps ranged from 10.0% to 50.0%, with the weighted-average loss severity being 22.5%.

Certain financial assets and financial liabilities are measured at fair value on a nonrecurring basis; that is, the instruments are not measured at fair value on an ongoing basis but are subject to fair value adjustments in certain circumstances (for example, when there is evidence of impairment). Financial assets measured at fair value on a non-recurring basis during the reported periods include certain impaired loans reported at the fair value of the underlying collateral if repayment is expected solely from the collateral. Collateral values are estimated using Level 2 inputs based on observable market data, typically in the case of real estate collateral, or Level 3 inputs based on customized discounting criteria, typically in the case of non-real estate collateral such as inventory, accounts receivable, equipment or other business assets.

The following table presents impaired loans that were remeasured and reported at fair value through a specific valuation allowance allocation of the allowance for loan losses based upon the fair value of the underlying collateral during the three months ended March 31, 2012 and 2011.

 

      Three Months Ended
March 31, 2012
     Three Months Ended
March 31, 2011
 
     Level 2     Level 3      Level 2     Level 3  

Carrying value of impaired loans before allocations

   $ 10,943      $ —         $ 11,787      $ 2,633   

Specific valuation allowance allocations

     (2,497     —           (3,205     (752
  

 

 

   

 

 

    

 

 

   

 

 

 

Fair value

   $ 8,446      $ —         $ 8,582      $ 1,881   
  

 

 

   

 

 

    

 

 

   

 

 

 

The significant unobservable (Level 3) inputs used in the fair value measurement of collateral for collateral-dependent impaired loans included in the above table primarily relate to customized discounting criteria applied to the customer’s reported amount of collateral. The amount of the collateral discount depends upon the marketability of the underlying collateral. As the Corporation’s primary objective in the event of default would be to monetize the collateral to settle the outstanding balance of the loan, less marketable collateral would receive a larger discount. During the reported periods, collateral discounts ranged from 20% in the case of accounts receivable collateral to 50% in the case of inventory collateral.

Non-Financial Assets and Non-Financial Liabilities: The Corporation has no non-financial assets or non-financial liabilities measured at fair value on a recurring basis. Certain non-financial assets measured at fair value on a non-recurring basis include foreclosed assets (upon initial recognition or subsequent impairment), non-financial assets and non-financial liabilities measured at fair value in the second step of a goodwill impairment test, and intangible assets and other non-financial long-lived assets measured at fair value for impairment assessment. Non-financial assets measured at fair value on a non-recurring basis during the reported periods include certain foreclosed assets which, upon initial recognition, were remeasured and reported at fair value through a charge-off to the allowance for loan losses and certain foreclosed assets which, subsequent to their initial recognition, were remeasured at fair value through a write-down included in other non-interest expense. The fair value of a foreclosed asset is estimated using Level 2 inputs based on observable market data or Level 3 inputs based on customized discounting criteria. During the reported periods, all fair value measurements for foreclosed assets utilized Level 2 inputs.

 

35


Table of Contents

The following table presents foreclosed assets that were remeasured and reported at fair value during the three months ended March 31, 2012 and 2011:

 

      Three Months Ended
March 31,
 
     2012     2011  

Foreclosed assets remeasured at initial recognition:

    

Carrying value of foreclosed assets prior to remeasurement

   $ 1,386      $ 8,804   

Charge-offs recognized in the allowance for loan losses

     (315     (1,370
  

 

 

   

 

 

 

Fair value

   $ 1,071      $ 7,434   
  

 

 

   

 

 

 

Foreclosed assets remeasured subsequent to initial recognition:

    

Carrying value of foreclosed assets prior to remeasurement

   $ 372      $ 936   

Write-downs included in other non-interest expense

     (75     (241
  

 

 

   

 

 

 

Fair value

   $ 297      $ 695   
  

 

 

   

 

 

 

Charge-offs recognized upon loan foreclosures are generally offset by general or specific allocations of the allowance for loan losses and generally do not, and did not during the reported periods, significantly impact the Corporation’s provision for loan losses. Regulatory guidelines require the Corporation to reevaluate the fair value of other real estate owned on at least an annual basis. While the Corporation’s policy is to comply with the regulatory guidelines, the Corporation’s general practice is to reevaluate the fair value of other real estate owned on a quarterly basis. Thus, appraisals are never considered to be outdated, and the Corporation does not make any adjustments to the appraised values. The fair value of other real estate owned is monitored/evaluated by a third-party service and reviewed with management on a quarterly basis.

FASB ASC Topic 825 requires disclosure of the fair value of financial assets and financial liabilities, including those financial assets and financial liabilities that are not measured and reported at fair value on a recurring basis or non-recurring basis. A detailed description of the valuation methodologies used in estimating the fair value of financial instruments is set forth in the 2011 Form 10-K.

The estimated fair values of financial instruments that are reported at amortized cost in the Corporation’s consolidated balance sheets, segregated by the level of the valuation inputs within the fair value hierarchy utilized to measure fair value, were as follows:

 

     March 31, 2012      December 31, 2011  
     Carrying
Amount
     Estimated
Fair Value
     Carrying
Amount
     Estimated
Fair Value
 

Financial assets:

           

Level 2 inputs:

           

Cash and cash equivalents

   $ 2,128,734       $ 2,128,734       $ 2,907,592       $ 2,907,592   

Securities held to maturity

     365,603         402,829         365,996         404,461   

Cash surrender value of life insurance policies

     135,035         135,035         133,967         133,967   

Accrued interest receivable

     61,833         61,833         78,869         78,869   

Level 3 inputs:

           

Loans, net

     8,019,532         8,119,248         7,884,982         7,951,742   

Financial liabilities:

           

Level 2 inputs:

           

Deposits

     16,909,021         16,909,615         16,756,748         16,757,708   

Federal funds purchased and repurchase agreements

     637,098         637,098         722,202         722,202   

Junior subordinated deferrable interest debentures

     123,712         123,712         123,712         123,712   

Subordinated notes payable and other borrowings

     100,022         86,094         100,026         100,101   

Accrued interest payable

     2,212         2,212         4,431         4,431   

Under ASC Topic 825, entities may choose to measure eligible financial instruments at fair value at specified election dates. The fair value measurement option (i) may be applied instrument by instrument, with certain exceptions, (ii) is generally irrevocable and (iii) is applied only to entire instruments and not to portions of instruments. Unrealized gains and losses on items for which the fair value measurement option has been elected must be reported in earnings at each subsequent reporting date. During the reported periods, the Corporation had no financial instruments measured at fair value under the fair value measurement option.

 

36


Table of Contents

Note 16 - Accounting Standards Updates

ASU No. 2011-03, “Transfers and Servicing (Topic 860) - Reconsideration of Effective Control for Repurchase Agreements.” ASU 2011-03 is intended to improve financial reporting of repurchase agreements and other agreements that both entitle and obligate a transferor to repurchase or redeem financial assets before their maturity. ASU 2011-03 removes from the assessment of effective control (i) the criterion requiring the transferor to have the ability to repurchase or redeem the financial assets on substantially the agreed terms, even in the event of default by the transferee, and (ii) the collateral maintenance guidance related to that criterion. ASU 2011-03 became effective for the Corporation on January 1, 2012 and did not have a significant impact on the Corporation’s financial statements.

ASU 2011-04, “Fair Value Measurement (Topic 820) - Amendments to Achieve Common Fair Value Measurements and Disclosure Requirements in U.S. GAAP and IFRSs.” ASU 2011-04 amends Topic 820, “Fair Value Measurements and Disclosures,” to converge the fair value measurement guidance in U.S. generally accepted accounting principles and International Financial Reporting Standards. ASU 2011-04 clarifies the application of existing fair value measurement requirements, changes certain principles in Topic 820 and requires additional fair value disclosures. ASU 2011-04 became effective for the Corporation on January 1, 2012 and, aside from new disclosures included in Note 15 – Fair Value Measurements, did not have a significant impact on the Corporation’s financial statements.

ASU 2011-05, “Comprehensive Income (Topic 220) - Presentation of Comprehensive Income.” ASU 2011-05 amends Topic 220, “Comprehensive Income,” to require that all non-owner changes in stockholders’ equity be presented in either a single continuous statement of comprehensive income or in two separate but consecutive statements. Additionally, ASU 2011-05 requires entities to present, on the face of the financial statements, reclassification adjustments for items that are reclassified from other comprehensive income to net income in the statement or statements where the components of net income and the components of other comprehensive income are presented. The option to present components of other comprehensive income as part of the statement of changes in stockholders’ equity was eliminated. ASU 2011-05 became effective for the Corporation on January 1, 2012; however, certain provisions related to the presentation of reclassification adjustments have been deferred by ASU 2011-12 “Comprehensive Income (Topic 220) Deferral of the Effective Date for Amendments to the Presentation of Reclassifications of Items Out of Accumulated Other Comprehensive Income in Accounting Standards Update No. 2011-05,” as further discussed below. In connection with the application of ASU 2011-05, the Corporation’s financial statements now include separate statements of comprehensive income and additional footnote disclosures (see Note 13 - Other Comprehensive Income).

ASU 2011-08, “Intangibles – Goodwill and Other (Topic 350) - Testing Goodwill for Impairment.” ASU 2011-08 amends Topic 350, “Intangibles – Goodwill and Other,” to give entities the option to first assess qualitative factors to determine whether the existence of events or circumstances leads to a determination that it is more likely than not that the fair value of a reporting unit is less than its carrying amount. If, after assessing the totality of events or circumstances, an entity determines it is not more likely than not that the fair value of a reporting unit is less than its carrying amount, then performing the two-step impairment test is unnecessary. However, if an entity concludes otherwise, then it is required to perform the first step of the two-step impairment test by calculating the fair value of the reporting unit and comparing the fair value with the carrying amount of the reporting unit. ASU 2011-08 became effective for the Corporation on January 1, 2012 and did not have a significant impact on the Corporation’s financial statements.

ASU 2011-11, “Balance Sheet (Topic 210) - “Disclosures about Offsetting Assets and Liabilities.” ASU 2011-11 amends Topic 210, “Balance Sheet,” to require an entity to disclose both gross and net information about financial instruments, such as sales and repurchase agreements and reverse sale and repurchase agreements and securities borrowing/lending arrangements, and derivative instruments that are eligible for offset in the statement of financial position and/or subject to a master netting arrangement or similar agreement. ASU 2011-11 is effective for annual and interim periods beginning on January 1, 2013, and is not expected to have a significant impact on the Corporation’s financial statements.

ASU 2011-12 “Comprehensive Income (Topic 220) - Deferral of the Effective Date for Amendments to the Presentation of Reclassifications of Items Out of Accumulated Other Comprehensive Income in Accounting Standards Update No. 2011-05.” ASU 2011-12 defers changes in ASU No. 2011-05 that relate to the presentation of reclassification adjustments to allow the FASB time to redeliberate whether to require presentation of such adjustments on the face of the financial statements to show the effects of reclassifications out of accumulated other comprehensive income on the components of net income and other comprehensive income. ASU 2011-12 allows entities to continue to report reclassifications out of accumulated other comprehensive income consistent with the presentation requirements in effect before ASU No. 2011-05. All other requirements in ASU No. 2011-05 are not affected by ASU No. 2011-12. ASU 2011-12 became effective for the Corporation on January 1, 2012 and did not have a significant impact on the Corporation’s financial statements.

 

37


Table of Contents

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

Financial Review

Cullen/Frost Bankers, Inc.

The following discussion should be read in conjunction with the Corporation’s consolidated financial statements, and notes thereto, for the year ended December 31, 2011, included in the 2011 Form 10-K. Operating results for the three months ended March 31, 2012 are not necessarily indicative of the results for the year ending December 31, 2012 or any future period.

Dollar amounts in tables are stated in thousands, except for per share amounts.

Forward-Looking Statements and Factors that Could Affect Future Results

Certain statements contained in this Quarterly Report on Form 10-Q that are not statements of historical fact constitute forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995 (the “Act”), notwithstanding that such statements are not specifically identified as such. In addition, certain statements may be contained in the Corporation’s future filings with the SEC, in press releases, and in oral and written statements made by or with the approval of the Corporation that are not statements of historical fact and constitute forward-looking statements within the meaning of the Act. Examples of forward-looking statements include, but are not limited to: (i) projections of revenues, expenses, income or loss, earnings or loss per share, the payment or nonpayment of dividends, capital structure and other financial items; (ii) statements of plans, objectives and expectations of Cullen/Frost or its management or Board of Directors, including those relating to products or services; (iii) statements of future economic performance; and (iv) statements of assumptions underlying such statements. Words such as “believes”, “anticipates”, “expects”, “intends”, “targeted”, “continue”, “remain”, “will”, “should”, “may” and other similar expressions are intended to identify forward-looking statements but are not the exclusive means of identifying such statements.

Forward-looking statements involve risks and uncertainties that may cause actual results to differ materially from those in such statements. Factors that could cause actual results to differ from those discussed in the forward-looking statements include, but are not limited to:

 

   

Local, regional, national and international economic conditions and the impact they may have on the Corporation and its customers and the Corporation’s assessment of that impact.

 

   

Volatility and disruption in national and international financial markets.

 

   

Government intervention in the U.S. financial system.

 

   

Changes in the mix of loan geographies, sectors and types or the level of non-performing assets and charge-offs.

 

   

Changes in estimates of future reserve requirements based upon the periodic review thereof under relevant regulatory and accounting requirements.

 

   

The effects of and changes in trade and monetary and fiscal policies and laws, including the interest rate policies of the Federal Reserve Board.

 

   

Inflation, interest rate, securities market and monetary fluctuations.

 

   

The effect of changes in laws and regulations (including laws and regulations concerning taxes, banking, securities and insurance) with which the Corporation and its subsidiaries must comply.

 

   

The soundness of other financial institutions.

 

   

Political instability.

 

   

Impairment of the Corporation’s goodwill or other intangible assets.

 

   

Acts of God or of war or terrorism.

 

   

The timely development and acceptance of new products and services and perceived overall value of these products and services by users.

 

   

Changes in consumer spending, borrowings and savings habits.

 

   

Changes in the financial performance and/or condition of the Corporation’s borrowers.

 

   

Technological changes.

 

   

Acquisitions and integration of acquired businesses.

 

   

The ability to increase market share and control expenses.

 

   

The Corporation’s ability to attract and retain qualified employees.

 

   

Changes in the competitive environment in the Corporation’s markets and among banking organizations and other financial service providers.

 

   

The effect of changes in accounting policies and practices, as may be adopted by the regulatory agencies, as well as the Public Company Accounting Oversight Board, the Financial Accounting Standards Board and other accounting standard setters.

 

   

Changes in the reliability of the Corporation’s vendors, internal control systems or information systems.

 

   

Changes in the Corporation’s liquidity position.

 

38


Table of Contents
   

Changes in the Corporation’s organization, compensation and benefit plans.

 

   

The costs and effects of legal and regulatory developments including the resolution of legal proceedings or regulatory or other governmental inquiries and the results of regulatory examinations or reviews.

 

   

Greater than expected costs or difficulties related to the integration of new products and lines of business.

 

   

The Corporation’s success at managing the risks involved in the foregoing items.

Forward-looking statements speak only as of the date on which such statements are made. The Corporation undertakes no obligation to update any forward-looking statement to reflect events or circumstances after the date on which such statement is made, or to reflect the occurrence of unanticipated events.

Application of Critical Accounting Policies and Accounting Estimates

The accounting and reporting policies followed by the Corporation conform, in all material respects, to accounting principles generally accepted in the United States and to general practices within the financial services industry. The preparation of financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. While the Corporation bases estimates on historical experience, current information and other factors deemed to be relevant, actual results could differ from those estimates.

The Corporation considers accounting estimates to be critical to reported financial results if (i) the accounting estimate requires management to make assumptions about matters that are highly uncertain and (ii) different estimates that management reasonably could have used for the accounting estimate in the current period, or changes in the accounting estimate that are reasonably likely to occur from period to period, could have a material impact on the Corporation’s financial statements. Accounting policies related to the allowance for loan losses are considered to be critical, as these policies involve considerable subjective judgment and estimation by management.

For additional information regarding critical accounting policies, refer to Note 1 - Summary of Significant Accounting Policies in the notes to consolidated financial statements and the sections captioned “Application of Critical Accounting Policies” and “Allowance for Loan Losses” in Management’s Discussion and Analysis of Financial Condition and Results of Operations included in the 2011 Form 10-K. There have been no significant changes in the Corporation’s application of critical accounting policies related to the allowance for loan losses since December 31, 2011.

Overview

A discussion of the Corporation’s results of operations is presented below. Certain reclassifications have been made to make prior periods comparable. Taxable-equivalent adjustments are the result of increasing income from tax-free loans and securities by an amount equal to the taxes that would be paid if the income were fully taxable based on a 35% federal income tax rate, thus making tax-exempt asset yields comparable to taxable asset yields.

 

39


Table of Contents

Results of Operations

Net income totaled $61.0 million, or $0.99 diluted per common share, for the three months ended March 31, 2012 compared to $51.9 million, or $0.85 diluted per common share, for the three months ended March 31, 2011 and $55.4 million, or $0.90 diluted per common share, for the three months ended December 31, 2011.

Selected income statement data and other selected data for the comparable periods was as follows:

 

     Three Months Ended  
     March 31,     December 31,     March 31,  
     2012     2011     2011  

Taxable-equivalent net interest income

   $ 164,707      $ 165,340      $ 156,638   

Taxable-equivalent adjustment

     15,000        15,017        14,879   
  

 

 

   

 

 

   

 

 

 

Net interest income

     149,707        150,323        141,759   

Provision for loan losses

     1,100        —          9,450   
  

 

 

   

 

 

   

 

 

 

Net interest income after provision for loan losses

     148,607        150,323        132,309   

Non-interest income

     71,979        67,660        72,333   

Non-interest expense

     142,040        143,833        140,061   
  

 

 

   

 

 

   

 

 

 

Income before income taxes

     78,546        74,150        64,581   

Income taxes

     17,513        18,736        12,653   
  

 

 

   

 

 

   

 

 

 

Net income

   $ 61,033      $ 55,414      $ 51,928   
  

 

 

   

 

 

   

 

 

 

Earnings per common share - basic

   $ 0.99      $ 0.90      $ 0.85   

Earnings per common share - diluted

     0.99        0.90        0.85   

Dividends per common share

     0.46        0.46        0.45   

Return on average assets

     1.23     1.12     1.19

Return on average equity

     10.59        9.74        10.11   

Average shareholders’ equity to average total assets

     11.63        11.53        11.78   

Net income for the three months ended March 31, 2012 increased $9.1 million, or 17.5%, compared to the same period in 2011. The increase was primarily the result of a $8.4 million decrease in the provision for loan losses and a $7.9 million increase in net interest income partly offset by a $4.9 million increase in income tax expense, a $2.0 million increase in non-interest expense and a $354 thousand decrease in non-interest income.

Net income for the first quarter of 2012 increased $5.6 million, or 10.1%, from the fourth quarter of 2011. The increase was primarily the result of a $4.3 million increase in non-interest income, a $1.8 million decrease in non-interest expense and a $1.2 million decrease in income tax expense partly offset by a $1.1 million increase in the provision for loan losses and a $616 thousand decrease in net interest income.

Details of the changes in the various components of net income are further discussed below.

Net Interest Income

Net interest income is the difference between interest income on earning assets, such as loans and securities, and interest expense on liabilities, such as deposits and borrowings, which are used to fund those assets. Net interest income is the Corporation’s largest source of revenue, representing 67.5% of total revenue during the first three months of 2012. Net interest margin is the ratio of taxable-equivalent net interest income to average earning assets for the period. The level of interest rates and the volume and mix of earning assets and interest-bearing liabilities impact net interest income and net interest margin.

The Federal Reserve influences the general market rates of interest, including the deposit and loan rates offered by many financial institutions. The Corporation’s loan portfolio is significantly affected by changes in the prime interest rate. The prime interest rate, which is the rate offered on loans to borrowers with strong credit, remained at 3.25% for the entire year in 2011 and through the first quarter of 2012. The Corporation’s loan portfolio is also impacted, to a lesser extent, by changes in the London Interbank Offered Rate (LIBOR). At March 31, 2012, the one-month and three-month U.S. dollar LIBOR rates were 0.24% and 0.47%, respectively, while at March 31, 2011, the one-month and three-month U.S. dollar LIBOR rates were 0.24% and 0.31%, respectively. The intended federal funds rate, which is the cost of immediately available overnight funds, remained at zero to 0.25% for the entire year in 2011 and through the first quarter of 2012.

 

40


Table of Contents

The Corporation’s balance sheet has historically been asset sensitive, meaning that earning assets generally reprice more quickly than interest-bearing liabilities. Therefore, the Corporation’s net interest margin was likely to increase in sustained periods of rising interest rates and decrease in sustained periods of declining interest rates. During the fourth quarter of 2007, in an effort to make the Corporation’s balance sheet less sensitive to changes in interest rates, the Corporation entered into various interest rate swaps which effectively converted certain variable-rate loans into fixed-rate instruments for a period of time. During the fourth quarter of 2008, the Corporation also entered into an interest rate swap which effectively converted variable-rate debt into fixed-rate debt for a period of time. As a result of these actions, the Corporation’s balance sheet was more interest-rate neutral and changes in interest rates had a less significant impact on the Corporation’s net interest margin than would have otherwise been the case. During the fourth quarter of 2009, a portion of the interest rate swaps on variable-rate loans were terminated, while the remaining interest rate swaps on variable-rate loans were terminated during the fourth quarter of 2010. These actions increased the asset sensitivity of the Corporation’s balance sheet. The deferred accumulated after-tax gain applicable to the settled interest rate contracts included in accumulated other comprehensive income totaled $62.4 million at March 31, 2012. The deferred gain will be reclassified into earnings through October 2014. See Note 8 - Derivative Financial Instruments in the accompanying notes to consolidated financial statements included elsewhere in this report for additional information related to these interest rate swaps.

The Corporation is primarily funded by core deposits, with non-interest-bearing demand deposits historically being a significant source of funds. This lower-cost funding base is expected to have a positive impact on the Corporation’s net interest income and net interest margin in a rising interest rate environment. As discussed in the section captioned “Supervision and Regulation” included in Item 1. Business, of the 2011 Form 10-K, the Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act”) repealed the federal prohibitions on the payment of interest on demand deposits, thereby permitting depository institutions to pay interest on business transaction and other accounts beginning July 21, 2011. Although the ultimate impact of this legislation on the Corporation has not yet been determined, the Corporation may begin to incur interest costs associated with demand deposits in the future as market conditions warrant. See Item 3. Quantitative and Qualitative Disclosures About Market Risk elsewhere in this report for information about the expected impact of this legislation on the Corporation’s sensitivity to interest rates. Further analysis of the components of the Corporation’s net interest margin is presented below.

The following table presents the changes in taxable-equivalent net interest income and identifies the changes due to differences in the average volume of earning assets and interest-bearing liabilities and the changes due to changes in the average interest rate on those assets and liabilities. The changes in net interest income due to changes in both average volume and average interest rate have been allocated to the average volume change or the average interest rate change in proportion to the absolute amounts of the change in each. The comparisons between the quarters include an additional change factor that shows the effect of the difference in the number of days in each period, as further discussed below.

 

     First Quarter     First Quarter  
     2012 vs.     2012 vs.  
     Fourth Quarter     First Quarter  
     2011     2011  

Due to changes in average volume

   $ 2,291      $ 18,940   

Due to changes in average interest rates

     (1,127     (12,681

Due to difference in the number of days in each of the comparable periods

     (1,797     1,810   
  

 

 

   

 

 

 

Total change

   $ (633   $ 8,069   
  

 

 

   

 

 

 

Taxable-equivalent net interest income for the three months ended March 31, 2012 increased $8.1 million, or 5.2%, compared to the same period in 2011. Taxable-equivalent net interest income for the first quarter of 2012 included 91 days compared to 90 days for the first quarter of 2011 as a result of leap year. The additional day added approximately $1.8 million to taxable-equivalent net interest income during the first quarter of 2012. Excluding the impact of the additional day during the first quarter of 2012 results in an effective increase in taxable-equivalent net interest income of approximately $6.3 million during the first quarter of 2012, which was primarily related to an increase in the average volume of interest-earning assets partly offset by a decrease in the net interest margin. The average volume of interest-earning assets for the first quarter of 2012 increased $2.3 billion compared to the same period in 2011. Over the same time frame, the net interest margin decreased 30 basis points from 4.03% in 2011 to 3.73% in 2012. The decrease in the net interest margin was partly due to an increase in the relative proportion of average interest-earning assets invested in lower-yielding, taxable securities during 2012 compared to 2011 while the relative proportion of average interest-earning assets invested in higher-yielding loans decreased. The impact of this shift was partly mitigated by a decrease in the relative proportion of average interest-earning assets invested in lower-yielding interest-bearing deposits. The net interest margin was also negatively impacted by a decrease in the average yield on securities, as further discussed below. The average yield on interest-earning assets decreased 45 basis points from 4.34% in the first quarter of 2011 to 3.89% in the first quarter of 2012 while the average cost of funds decreased 21 basis points from 0.47% in the first quarter of 2011 to 0.26% in the first quarter of 2012. The average yield on

 

41


Table of Contents

interest-earning assets is primarily impacted by changes in market interest rates as well as changes in the volume and relative mix of interest-earning assets. As stated above, market interest rates have remained at historically low levels during the reported periods. The effect of lower average market interest rates during the reported periods on the average yield on average interest-earning assets was partly limited by the aforementioned interest rate swaps on variable-rate loans.

Taxable-equivalent net interest income for the first quarter of 2012 decreased $633 thousand, or 0.4%, from the fourth quarter of 2011. Taxable-equivalent net interest income for the first quarter of 2012 was impacted by a decrease in the number of days compared to the fourth quarter of 2011. Taxable-equivalent net interest income for the fourth quarter of 2011 included 92 days compared to 91 days for the first quarter of 2012. The additional day added approximately $1.8 million to taxable-equivalent net interest income during the fourth quarter of 2011. Excluding the impact of the additional day during the fourth quarter of 2011 results in an effective increase in taxable-equivalent net interest income of approximately $1.2 million during the first quarter of 2012. This effective increase was primarily related to an increase in the average volume of interest-earning assets combined with a shift in the relative mix of average interest-earning assets as lower-yielding interest bearing deposits were reinvested into higher-yielding taxable securities partly offset by a decrease in the net interest margin. The average volume of funds invested in interest-bearing deposits decreased $1.4 billion from $2.5 billion during the fourth quarter of 2011 to $1.1 billion during first quarter of 2012. The average volume of funds invested in taxable securities increased $1.6 billion from $5.1 billion during the fourth quarter of 2011 to $6.7 billion during first quarter of 2012. The net interest margin decreased 3 basis points from 3.76% in the fourth quarter of 2011 to 3.73% in the first quarter of 2012. The average yield on interest-earning assets decreased 6 basis points from 3.95% in the fourth quarter of 2011 to 3.89% in the first quarter of 2012 primarily due to decreases in the average yields on taxable securities (down 55 basis points) and loans (down 10 basis points). The majority of the growth in taxable securities was in lower-yielding U.S. Treasury securities, which had a dampening effect on the overall yield on taxable securities. Taxable-equivalent net interest income for the first quarter of 2012 was favorably impacted by a 5 basis point decrease in the average cost of funds from 0.31% in the fourth quarter of 2011 to 0.26% in the first quarter of 2012.

The average volume of loans during the first quarter of 2012 decreased $31.4 million compared to the first quarter of 2011 and increased $74.8 million compared to the fourth quarter of 2011. Loans made up approximately 44.5% of average interest-earning assets during the first quarter of 2012 compared to 51.1% during the first quarter of 2011 and 44.8% during the fourth quarter of 2011. The average yield on loans was 4.94% during the first quarter of 2012 compared to 5.01% during the first quarter of 2011 and 5.04% during the fourth quarter of 2011. Loans generally have significantly higher yields compared to securities, interest-bearing deposits and federal funds sold and resell agreements and, as such, have a more positive effect on the net interest margin.

The average volume of securities increased $3.1 billion and $1.6 billion during the first quarter of 2012 compared to the first and fourth quarters of 2011, respectively. Securities made up approximately 49.3% of average interest-earning assets during the first quarter of 2012 compared to 37.0% during the first quarter of 2011 and 41.0% during the fourth quarter of 2011. The average yield on securities was 3.37% in the first quarter of 2012 compared to 4.73% in the first quarter of 2011 and 4.02% in the fourth quarter of 2011. The decrease in the average yield on securities was partly due to a decrease in the yield on taxable securities as proceeds from principal repayments were reinvested at lower market rates. Furthermore, a large portion of the growth in taxable securities was in lower-yielding U.S. Treasury securities. The decrease in the average yield on securities was also partly related to a decrease in the relative proportion of higher-yielding, tax-exempt municipal securities in the first quarter of 2012 compared to the prior periods. The relative proportion of higher-yielding, tax-exempt municipal securities totaled 25.3% of average securities during the first quarter of 2012 compared to 35.3% during in the first quarter of 2011 and 30.4% during the fourth quarter of 2011. The average yield on taxable securities was 2.23% in the first quarter of 2012 compared to 3.39% in first quarter of 2011 and 2.78% in the fourth quarter of 2011, while the average taxable-equivalent yield on tax-exempt securities was 6.94% in the first quarter of 2012 compared to 7.15% in first quarter of 2011 and 6.94% in the fourth quarter of 2011.

Average federal funds sold, resell agreements and interest-bearing deposits during the first quarter of 2012 decreased $769.5 million compared to the first quarter of 2011 and decreased $1.4 billion compared to the fourth quarter of 2011. Federal funds sold, resell agreements and interest-bearing deposits made up approximately 6.2% of average interest-earning assets during the first quarter of 2012 compared to 11.9% during the first quarter of 2011 and 14.2% during the fourth quarter of 2011. The combined average yield on federal funds sold, resell agreements and interest-bearing deposits was 0.34% during the first quarter of 2012 compared to 0.26% during the first quarter of 2011 and 0.30% during the fourth quarter of 2011. The decrease in average federal funds sold, resell agreements and interest-bearing deposits compared to the first and fourth quarters of 2011 was due to the reinvestment of funds into higher-yielding securities.

Average deposits increased $1.9 billion during the first quarter of 2012 compared to the first quarter of 2011 and increased $268.0 million compared to the fourth quarter of 2011. Average interest-bearing deposits for the first quarter of 2012 increased $777.1 million and $194.4 million compared to the first and fourth quarters of 2011, respectively, while average non-interest-bearing deposits increased $1.2 billion and $73.6 million compared to the first and fourth quarters of 2011, respectively. The ratio of average interest-bearing deposits to total average deposits was 61.0% during the first quarter of

 

42


Table of Contents

2012 compared to 63.7% during the first quarter of 2011 and 60.8% during the fourth quarter of 2011. The average cost of deposits is primarily impacted by changes in market interest rates as well as changes in the volume and relative mix of interest-bearing deposits. The average cost of interest-bearing deposits and total deposits was 0.18% and 0.11% during the first quarter of 2012 compared to 0.26% and 0.17% during the first quarter of 2011 and 0.20% and 0.12% during the fourth quarter of 2011. The decrease in the average cost of interest-bearing deposits during the comparable periods was primarily the result of decreases in interest rates offered on certain deposit products due to decreases in average market interest rates and decreases in renewal interest rates on maturing certificates of deposit given the current low interest rate environment. Additionally, the relative proportion of higher-cost certificates of deposit to total average interest-bearing deposits decreased from 12.6% and 11.1% during the first and fourth quarters of 2011, respectively, to 10.5% during the first quarter of 2012.

The Corporation’s net interest spread, which represents the difference between the average rate earned on earning assets and the average rate paid on interest-bearing liabilities, was 3.63% during the first quarter of 2012 compared to 3.87% and 3.64% during the first and fourth quarters of 2011, respectively. The net interest spread, as well as the net interest margin, will be impacted by future changes in short-term and long-term interest rate levels, as well as the impact from the competitive environment. A discussion of the effects of changing interest rates on net interest income is set forth in Item 3. Quantitative and Qualitative Disclosures About Market Risk included elsewhere in this report.

The Corporation’s hedging policies permit the use of various derivative financial instruments, including interest rate swaps, swaptions, caps and floors, to manage exposure to changes in interest rates. Details of the Corporation’s derivatives and hedging activities are set forth in Note 8 - Derivative Financial Instruments in the accompanying notes to consolidated financial statements included elsewhere in this report. Information regarding the impact of fluctuations in interest rates on the Corporation’s derivative financial instruments is set forth in Item 3. Quantitative and Qualitative Disclosures About Market Risk included elsewhere in this report.

Provision for Loan Losses

The provision for loan losses is determined by management as the amount to be added to the allowance for loan losses after net charge-offs have been deducted to bring the allowance to a level which, in management’s best estimate, is necessary to absorb probable losses within the existing loan portfolio. The provision for loan losses totaled $1.1 million for the first quarter of 2012 compared $9.5 million for the first quarter of 2011. No provision for loan losses was recognized during the fourth quarter of 2011. See the section captioned “Allowance for Loan Losses” elsewhere in this discussion for further analysis of the provision for loan losses.

Non-Interest Income

The components of non-interest income were as follows:

 

     Three Months Ended  
     March 31,     December 31,      March 31,  
     2012     2011      2011  

Trust and investment management fees

   $ 20,652      $ 18,861       $ 19,471   

Service charges on deposit accounts

     20,794        21,475         21,250   

Insurance commissions and fees

     12,377        7,450         10,494   

Interchange and debit card transaction fees

     4,117        4,166         8,045   

Other charges, commissions and fees

     7,350        7,125         7,228   

Net gain (loss) on securities transactions

     (491     —           5   

Other

     7,180        8,583         5,840   
  

 

 

   

 

 

    

 

 

 

Total

   $ 71,979      $ 67,660       $ 72,333   
  

 

 

   

 

 

    

 

 

 

Total non-interest income for the three months ended March 31, 2012 decreased $354 thousand, or 0.5%, compared to the same period in 2011 and increased $4.3 million, or 6.4%, compared to the fourth quarter of 2011. Changes in the components of non-interest income are discussed below.

Trust and Investment Management Fees. Trust and investment management fees for the three months ended March 31, 2012 increased $1.2 million, or 6.1%, compared to the same period in 2011. Trust investment fees are the most significant component of trust and investment management fees, making up approximately 67% of total trust and investment management fees for the first three months of 2012. Investment and other custodial account fees are generally based on the market value of assets within a trust account. Volatility in the equity and bond markets impacts the market value of trust assets and the related trust investment fees.

 

43


Table of Contents

The $1.2 million increase in trust and investment management fee income during the three months ended March 31, 2012 compared to the same period in 2011 was primarily the result of an increase in estate fees (up $422 thousand), trust investment fees (up $404 thousand), mutual fund management fees (up $180 thousand) and oil and gas trust management fees (up $147 thousand). Trust and investment management fee income for the first quarter of 2012 increased $1.8 million, or 9.5%, from the fourth quarter of 2011. The increase was primarily due to increases in estate fees (up $773 thousand), trust investment fees (up $550 thousand), custody fees (up $193 thousand) and mutual fund management fees (up $179 thousand). Estate fees are transactional in nature and can vary from quarter to quarter. The increase in trust investment fees was partly due to improvements in equity valuations during the first quarter of 2012

At March 31, 2012, trust assets, including both managed assets and custody assets, were primarily composed of equity securities (43.2% of trust assets), fixed income securities (41.0% of trust assets) and cash equivalents (10.2% of trust assets). The estimated fair value of trust assets was $26.3 billion (including managed assets of $10.8 billion and custody assets of $15.5 billion) at March 31, 2012, compared to $25.2 billion (including managed assets of $10.3 billion and custody assets of $14.9 billion) at December 31, 2011 and $25.5 billion (including managed assets of $10.1 billion and custody assets of $15.4 billion) at March 31, 2011.

Service Charges on Deposit Accounts. Service charges on deposit accounts for the three months ended March 31, 2012 decreased $456 thousand, or 2.1%, compared to the same period in 2011. The decrease was primarily due to decreases in overdraft/insufficient funds charges on both consumer and commercial accounts (down $400 thousand on a combined basis). Overdraft/insufficient funds charges totaled $8.2 million ($6.5 million consumer and $1.7 million commercial) during the first quarter of 2012 compared to $8.6 million ($6.6 million consumer and $2.0 million commercial) during the first quarter of 2011.

Service charges on deposit accounts for the first quarter of 2012 decreased $681 thousand, or 3.2%, compared to the fourth quarter of 2011. The decrease was primarily due to decreases in overdraft/insufficient funds charges on both consumer and commercial accounts, down $711 thousand on a combined basis, from $8.9 million ($7.1 million consumer and $1.8 million commercial) during the fourth quarter of 2011. Overdraft/insufficient funds charges are generally seasonally higher in the fourth quarter.

Insurance Commissions and Fees. Insurance commissions and fees for the three months ended March 31, 2012 increased $1.9 million, or 17.9%, compared to the same period in 2011. The increase is related to an increase in commission income (up $2.1 million). The increase in commission income was primarily related to an increase in employee benefit commissions and fees, which was partly related to the acquisitions of Clark Benefits Group during the second quarter of 2011 and Stone Partners, Inc. during the first quarter of 2012. The increase in commission income was also partly related to an increase in property and casualty commissions resulting from normal variation in the market demand for insurance products.

Insurance commissions and fees include contingent commissions totaling $2.3 million during the three months ended March 31, 2012 and $2.6 million during the three months ended March 31, 2011. Contingent commissions primarily consist of amounts received from various property and casualty insurance carriers related to the loss performance of insurance policies previously placed. Such commissions are seasonal in nature and are generally received during the first quarter of each year. These commissions totaled $1.9 million and $2.2 million during the three months ended March 31, 2012 and 2011. Contingent commissions also include amounts received from various benefit plan insurance companies related to the volume of business generated and/or the subsequent retention of such business. These commissions totaled $385 thousand and $387 thousand during the three months ended March 31, 2012 and 2011.

Insurance commissions and fees for the first quarter of 2012 increased $4.9 million, or 66.1%, compared to the fourth quarter of 2011. Commission income for the first quarter of 2012 increased $2.9 million compared to the fourth quarter of 2011 partly due to an increase in benefit plan commissions and fees, which was related to the normal variation in the timing of renewals as well as the additional revenues related to the acquisition of Stone Partners, Inc. during the first quarter of 2012. The increase in insurance commissions and fees was also partly due to the seasonal increase in contingent commissions (up $2.0 million) received from various insurance carriers related to the performance of insurance policies previously placed.

Interchange and Debit Card Transaction Fees. Interchange and debit card transaction fees consist of income from Visa check card usage, point of sale income from PIN-based debit card transactions and ATM service fees. Interchange and debit card transaction fees for the three months ended March 31, 2012 decreased $3.9 million, or 48.8%, compared to the same period in 2011. Income from Visa check card usage decreased $3.3 million, or 60.6% from $5.5 million during the first quarter of 2011 to $2.2 million during the first quarter of 2012, while point of sale income from PIN-based debit card transactions decreased $536 thousand, or 30.8%, from $1.7 million during the first quarter of 2011 to $1.2 million during the first quarter of 2012. These decreases were primarily related to new rules that significantly impacted the level of interchange fees that may be charged, as further discussed below. Interchange and debit card transaction fees for the first quarter of 2012 did not significantly fluctuate compared to the fourth quarter of 2011.

 

44


Table of Contents

As discussed in the section captioned “Supervision and Regulation” included in Item 1. Business, of the 2011 Form 10-K, the Dodd-Frank Act amended the Electronic Fund Transfer Act (“EFTA”) which, among other things, gave the Federal Reserve the authority to establish rules regarding interchange fees charged for electronic debit transactions by payment card issuers, such as Frost Bank. In June 2011, the Federal Reserve issued a final rule that, among other things, established standards for determining whether an interchange fee received or charged by an issuer with respect to an electronic debit transaction is reasonable and proportional to the cost incurred by the issuer with respect to the transaction. These new standards took effect on October 1, 2011 and apply to issuers, such as the Corporation, that, together with their affiliates, have assets of $10 billion or more. Under the rule, the maximum permissible interchange fee for an electronic debit transaction will be the sum of 21 cents per transaction and 5 basis points multiplied by the value of the transaction. The Federal Reserve also issued an interim final rule that allows for an upward adjustment of no more than 1 cent to an issuer’s debit card interchange fee if the issuer develops and implements policies and procedures reasonably designed to achieve the fraud-prevention standards set out in the interim final rule. The fraud-prevention adjustment was effective on October 1, 2011, concurrent with the debit card interchange fee limits.

Other Charges, Commissions and Fees. Other charges, commissions and fees for the three months ended March 31, 2012 increased $122 thousand, or 1.7%, compared to the same period in 2011. The increase in other charges, commissions and fees included increases in early termination fees on lines of credit held by Frost Capital, (up $476 thousand); consulting revenues, primarily related the acquisition of Stone Partners, Inc., (up $385 thousand); an increase in unused balance fees on loan commitments (up $187 thousand) and an increase in service charges on funds transfers (up $139 thousand), among other things. These increases were partly offset by decreases in investment banking fees related to corporate advisory services (down $614 thousand), income related to sale of annuities (down $282 thousand) and receivables factoring income (down $233 thousand). Investment banking fees related to corporate advisory services are transaction based and can vary significantly from quarter to quarter.

Other charges, commissions and fees for the first quarter of 2012 increased $225 thousand, or 3.2%, compared to the fourth quarter of 2011. The increase was primarily due to an increase in consulting revenues, primarily related the acquisition of Stone Partners, Inc., (up $385 thousand); other service charges (up $372 thousand) and income from the sale of mutual funds (up $218 thousand), among other things. These increases were partly offset by decreases in investment banking fees related to corporate advisory services (down $729 thousand) and loan processing fees (down $188 thousand).

Net Gain/Loss on Securities Transactions. During the first quarter of 2012, the Corporation realized a net loss of $491 thousand on the sale of available-for-sale securities. During January 2012, the Corporation purchased $996.4 million of U.S. Treasury securities utilizing excess liquidity as a defensive strategy to lock in the yield on those funds in case the Federal Reserve lowered the rate paid on funds deposited in the Federal Reserve account. Shortly thereafter, U.S. Treasury prices rallied and the Corporation sold the securities, realizing a $2.1 million gain, and concurrently purchased $998.4 million of U.S. Treasury securities having a shorter term to maturity. In March 2012, U.S. Treasury yields increased and the Corporation sold the aforementioned position in U.S. Treasury securities and recognized a $2.6 million loss The proceeds were concurrently reinvested in U.S. Treasury securities that had a similar yield to the original, longer-term position purchased in January 2012, but with a shorter term to maturity. During the first quarter of 2012, the Corporation also sold available-for-sale securities with an amortized cost totaling $8.0 billion and realized a net loss of $2 thousand on those sales. These securities were primarily purchased during 2012 and subsequently sold in connection with the Corporation’s tax planning strategies related to the Texas franchise tax. The gross proceeds from the sales of these securities outside of Texas are included in total revenues/receipts from all sources reported for Texas franchise tax purposes, which results in a reduction in the overall percentage of revenues/receipts apportioned to Texas and subjected to taxation under the Texas franchise tax. During the first quarter of 2011, the Corporation sold available-for-sale securities with an amortized cost totaling $5.5 billion and realized a net gain of $5 thousand on those sales. These securities were purchased and subsequently sold during the first quarter of 2011 in connection with the aforementioned tax planning strategies related to the Texas franchise tax.

Other Non-Interest Income. Other non-interest income increased $1.3 million, or 22.9%, for the three months ended March 31, 2012 compared to the same period in 2011. The increase was primarily related to an increase in mineral interest income related to bonus, rental and shut-in payments and oil and gas royalties received from severed mineral interests on property owned by Main Plaza Corporation, a wholly owned non-banking subsidiary of the Corporation (up $1.5 million). This increase was partly offset by decreases in sundry income from various miscellaneous items (down $275 thousand) and gains on the sale of assets/foreclosed assets (down $168 thousand).

Other non-interest income for the first quarter of 2012 decreased $1.4 million, or 16.3%, compared to the fourth quarter of 2011. The decrease was primarily related to decreases in income from securities trading and customer derivative activities (down $1.3 million), sundry income from various miscellaneous items (down $938 thousand) and gains on the sale of assets/foreclosed assets (down $701 thousand). These decreases were partly offset by an increase mineral interest income (up $1.6 million).

 

45


Table of Contents

Non-Interest Expense

The components of non-interest expense were as follows:

 

     Three Months Ended  
     March 31,      December 31,      March 31,  
     2012      2011      2011  

Salaries and wages

   $ 63,702       $ 66,126       $ 62,430   

Employee benefits

     16,701         12,574         15,311   

Net occupancy

     11,797         11,413         11,652   

Furniture and equipment

     13,420         13,454         12,281   

Deposit insurance

     2,497         2,773         4,760   

Intangible amortization

     1,011         1,052         1,120   

Other

     32,912         36,441         32,507   
  

 

 

    

 

 

    

 

 

 

Total

   $ 142,040       $ 143,833       $ 140,061   
  

 

 

    

 

 

    

 

 

 

Total non-interest expense for the three months ended March 31, 2012 increased $2.0 million, or 1.4%, and decreased $1.8 million, or 1.3%, compared to the first and fourth quarters of 2011, respectively. Changes in the components of non-interest expense are discussed below.

Salaries and Wages. Salaries and wages for the three months ended March 31, 2012 increased $1.3 million, or 2.0%, compared to the same period in 2011 and decreased $2.4 million, or 3.7%, compared to the fourth quarter of 2011. The increase from the first quarter of 2011 was primarily related to normal annual merit and market increases and increased commissions related to higher insurance revenues partly offset by a decrease in stock-based compensation expense, a decrease in incentive compensation and an increase in cost deferrals related to lending activity. The decrease from the fourth quarter of 2011 was primarily related a decrease in stock-based compensation expense partly offset by normal annual merit and market increases and an increase in cost deferrals related to lending activity. Stock-based compensation expense was higher in the fourth quarter of 2011 as the total expense related to certain option and restricted stock unit awards was recognized as of the grant date in October 2011.

Employee Benefits. Employee benefits for the three months ended March 31, 2012 increased $1.4 million, or 9.1%, compared to the same period in 2011. The increase was primarily related to increases in expenses related to the Corporation’s defined benefit retirement plans (up $877 thousand) and medical insurance expense (up $685 thousand) partly offset by a decrease in expense related to the Corporation’s 401(k) and profit sharing plans (down $508 thousand).

Employee benefits for the first quarter of 2012 increased $4.1 million, or 32.8%, compared to the fourth quarter of 2011 primarily due to increases in payroll taxes (up $2.5 million), expenses related to the Corporation’s defined benefit retirement plans (up $877 thousand) and medical insurance expense (up $524 thousand). The Corporation generally experiences a decline in payroll taxes during the fourth quarter of each year as certain employees reach maximum taxable salary levels earlier in the year and higher levels of payroll taxes and 401(k) plan matching contributions during the first quarter each year due to annual incentive compensation payments.

The Corporation’s defined benefit retirement and restoration plans were frozen effective as of December 31, 2001 and were replaced by a profit sharing plan. Management believes these actions helped to reduce the volatility in retirement plan expense. However, the Corporation still has funding obligations related to the defined benefit and restoration plans and could recognize retirement expense related to these plans in future years, which would be dependent on the return earned on plan assets, the level of interest rates and employee turnover.

Net Occupancy. Net occupancy expense for the three months ended March 31, 2012 increased $145 thousand, or 1.2%, compared to the same period in 2011. The increase was primarily related to an increase in repairs expense (up $111 thousand) as well as increases in depreciation on leasehold improvements, property taxes and building maintenance expense, among other things. These increases were partly offset by decreases in lease expense and utilities expense, among other things. Net occupancy expense for the first quarter of 2012 increased $384 thousand, or 3.4%, compared to the fourth quarter of 2011. The increase was primarily related to an increase in property taxes (up $666 thousand) partly offset by a decrease in service contracts expense (down $144 thousand).

Furniture and Equipment. Furniture and equipment expense for the three months ended March 31, 2012 increased $1.1 million, or 9.3%, compared to the same period in 2011. The increase was primarily related to increases in software maintenance (up $475 thousand), software amortization (up $371 thousand) and service contract expenses (up $314 thousand). Furniture and equipment expense for the first quarter of 2012 did not significantly fluctuate compared to the fourth quarter of 2011 as a decrease in software maintenance expense (down $232 thousand) was offset by an increase service contract expenses (up $223 thousand).

 

46


Table of Contents

Deposit Insurance. Deposit insurance expense totaled $2.5 million for the three months ended March 31, 2012, compared to $4.8 million for the three months ended March 31, 2011 and $2.8 million for the three months ended December 31, 2011. The decrease in deposit insurance expense during the first quarter of 2012 compared to the same period in 2011 was primarily related to a change in the deposit insurance assessment base and a change in the method by which the assessment rate is determined for large financial institutions, as more fully discussed in the 2011 Form 10-K. The decrease in deposit insurance expense during the first quarter of 2012 compared to the fourth quarter of 2011 was primarily related to a decrease in the assessment rate.

Intangible Amortization. Intangible amortization is primarily related to core deposit intangibles and, to a lesser extent, intangibles related to customer relationships and non-compete agreements. Intangible amortization for the three months ended March 31, 2012 decreased $109 thousand, or 9.7%, compared to the same period in 2011 and $41 thousand, or 3.9%, compared to the fourth quarter of 2011. The decreases in amortization expense are primarily the result of the completion of amortization of certain intangible assets and a reduction in the annual amortization rate of certain intangible assets as the Corporation uses an accelerated amortization approach which results in higher amortization rates during the earlier years of the useful lives of intangible assets. The decreases in amortization were partly offset by the additional amortization related to intangible assets recorded in connection with an acquisition in 2011 and the acquisition of Stone Partners Inc. on January 1, 2012.

Other Non-Interest Expense. Other non-interest expense for the three months ended March 31, 2012 increased $405 thousand, or 1.2%, compared to the same period in 2011. Components of other non-interest expense with significant increases included advertising/promotions expense (up $1.0 million), professional services expense (up $462 thousand), travel expense (up $368 thousand) and web-site maintenance expense (up $337 thousand). The increase in advertising/promotions expense is primarily related to the continuation of the marketing campaign that began during the first quarter of 2011. The Corporation expects advertising/promotions expense for the remainder of 2012 to be at levels comparable to 2011. The increases in the aforementioned items were partly offset by decreases in losses on the sale/write-down of assets/foreclosed assets (down $1.3 million) and sundry losses from various miscellaneous items (down $573 thousand). The decrease in losses on the sale/write-down of assets/foreclosed assets was primarily related to a $900 thousand write-down of a branch facility that was in the process of being sold in 2011.

Other non-interest expense for the first quarter of 2012 decreased $3.5 million, or 9.7%, compared to the fourth quarter of 2011. Components of other non-interest expense with significant decreases included donation expense, due to a $2 million donation to the Frost Charitable Foundation in the fourth quarter of 2011, (down $2.2 million), advertising/promotions expense (down $1.1 million) and losses on the sale/write-down of assets/foreclosed assets (down $657 thousand), among other things. These decreases were partly offset by increases in dues and membership fees expense (up $348 thousand), director fees expense (up $149 thousand) and Visa check card expense (up $145 thousand), among other things.

Results of Segment Operations

The Corporation’s operations are managed along two operating segments: Banking and Frost Wealth Advisors. A description of each business and the methodologies used to measure financial performance is described in Note 14 - Operating Segments in the accompanying notes to consolidated financial statements included elsewhere in this report. Net income (loss) by operating segment is presented below:

 

     Three Months Ended  
    

March 31,
2012

   

December 31,
2011

   

March 31,
2011

 

Banking

   $ 58,290      $ 55,631      $ 51,853   

Frost Wealth Advisors

     3,391        1,751        1,670   

Non-Banks

     (648     (1,968     (1,595
  

 

 

   

 

 

   

 

 

 

Consolidated net income

   $ 61,033      $ 55,414      $ 51,928   
  

 

 

   

 

 

   

 

 

 

Banking

Net income for the three months ended March 31, 2012 increased $6.4 million, or 12.4%, compared to the same period in 2011. The increase was primarily the result of a $6.7 million increase in net interest income and an $8.4 million decrease in the provision for loan losses partly offset by a $3.4 million increase in income tax expense, a $2.7 million decrease in non-interest income and a $2.6 million increase in non-interest expense.

Net interest income for the three months ended March 31, 2012 increased $6.7 million, or 4.7%, compared to the same period in 2011. The increase primarily resulted from an increase in the average volume of interest-earning assets combined with the effect of an additional day in the first quarter of 2012 due to leap year partly offset by a decrease in the net interest margin. See the analysis of net interest income included in the section captioned “Net Interest Income” included elsewhere in this discussion.

 

47


Table of Contents

The provision for loan losses for the three months ended March 31, 2012 totaled $1.1 million compared to $9.5 million for the same period in 2011. See the analysis of the provision for loan losses included in the section captioned “Allowance for Loan Losses” included elsewhere in this discussion.

Non-interest income for the three months ended March 31, 2012 decreased $2.7 million, or 5.5%, compared to the same period in 2011. The decrease was primarily due to decreases in interchange and debit card transaction fees, an increase in net loss on securities transactions and a decrease in service charges on deposit accounts partly offset by increases in insurance commissions and fees and other charges, commissions and fees. See the analysis of these categories of non-interest income included in the section captioned “Non-Interest Income” included elsewhere in this discussion.

Non-interest expense for the three months ended March 31, 2012 increased $2.6 million, or 2.2%, compared to the same period in 2011. The increase was primarily related to increases in employee benefits, salaries and wages, other non-interest expense and furniture and equipment expense partly offset by a decrease in deposit insurance expense. The increase in employee benefits expense was primarily related to increases in expenses related to the Corporation’s defined benefit retirement plans and medical insurance expense partly offset by a decrease in expense related to the Corporation’s 401(k) and profit sharing plans. The increase in salaries and wages was primarily related to normal annual merit and market increases and increased commissions related to higher insurance revenues partly offset by a decrease in stock-based compensation expense, a decrease in incentive compensation and an increase in cost deferrals related to lending activity. The increase in other non-interest expense was partly related to increases in overhead cost allocations. The increase in furniture and equipment expense was due to increases in software maintenance, software amortization and service contract expenses. See the analysis of these items included in the section captioned “Non-Interest Expense” included elsewhere in this discussion.

Frost Insurance Agency, which is included in the Banking operating segment, had gross commission revenues of $12.5 million during the three months ended March 31, 2012 and $10.6 million during the three months ended March 31, 2011. The increase during the three months ended March 31, 2012 is primarily related to an increase in employee benefit commissions and fees, which was partly related to the acquisitions of Clark Benefits Group during the second quarter of 2011 and Stone Partners, Inc. during the first quarter of 2012. See the analysis of insurance commissions and fees included in the section captioned “Non-Interest Income” included elsewhere in this discussion.

Frost Wealth Advisors

Net income for the three months ended March 31, 2012 increased $1.7 million, or 103.1%, compared to the same period in 2011. The increase was primarily due to a $1.1 million decrease in non-interest expense, a $904 thousand increase in non-interest income and a $659 thousand increase in net interest income partly offset by a $927 thousand increase in income tax expense.

Non-interest income for the three months ended March 31, 2012 increased $904 thousand, or 3.9%, compared to the same period in 2011. The increase was primarily due to an increase in trust and investment management fees (up $1.3 million) partly offset by a decrease in other charges, commissions and fees (down $293 thousand).

Trust and investment management fee income is the most significant income component for Frost Wealth Advisors. Investment fees are the most significant component of trust and investment management fees, making up approximately 67% of total trust and investment management fees for the first three months of 2012. Investment and other custodial account fees are generally based on the market value of assets within a trust account. Volatility in the equity and bond markets impacts the market value of trust assets and the related investment fees. The increase in trust and investment management fee income during the three months ended March 31, 2012 compared to the same period in 2011 was primarily the result of an increase in estate fees, trust investment fees, mutual fund management fees and oil and gas trust management fees. See the analysis of trust and investment management fees included in the section captioned “Non-Interest Income” included elsewhere in this discussion.

The decrease in other charges, commissions and fees during the three months ended March 31, 2012 compared to the same period in 2011 was primarily due to a decrease in income related to sale of annuities.

Non-interest expense for the three months ended March 31, 2012 decreased $1.1 million, or 5.0%, compared to the same period in 2011 primarily due to a decrease in other non-interest expense (down $1.3 million). The decrease in other non-interest expense was related to decreases in various overhead cost allocations as well as decreases in sundry losses from various miscellaneous items, professional services expense and sub-advisor investment management fees related to Frost Investment Advisors, LLC,, among other things.

 

48


Table of Contents

Non-Banks

The net loss for the Non-Banks operating segment for the three months ended March 31, 2012 decreased $947 thousand, or 59.4%, compared to the same period in 2011. The decrease was primarily due to a $1.4 million increase in non-interest income, which was primarily related to increased mineral interest income related to bonus, rental and shut-in payments and oil and gas royalties received from severed mineral interests on property owned by Main Plaza Corporation, a wholly-owned non-banking subsidiary of the Corporation. The decrease in the net loss for the Non-Banks segment was also due to a $606 thousand decrease in net interest expense partly offset by a $559 thousand decrease in income tax benefits and a $517 thousand increase in non-interest expense.

Income Taxes

The Corporation recognized income tax expense of $17.5 million, for an effective rate of 22.3%, for the three months ended March 31, 2012 compared to $12.7 million, for an effective rate of 19.6%, for the three months ended March 31, 2011. The effective income tax rates differed from the U.S. statutory rate of 35% during the comparable periods primarily due to the effect of tax-exempt income from loans, securities and life insurance policies.

Average Balance Sheet

Average assets totaled $19.9 billion for the three months ended March 31, 2012 representing an increase of $2.2 billion, or 12.7%, compared to average assets for the same period in 2011. The increase was primarily reflected in earning assets, which increased $2.3 billion, or 14.3%, during the first quarter of 2012 compared to the first quarter of 2011. The increase in earning assets was primarily due to a $3.1 billion increase in average securities partly offset by a $767.0 million decrease in average interest-bearing deposits and federal funds sold and resale agreements. The growth in average interest-earning assets was primarily funded by an increase in deposits. Total deposits averaged $16.4 billion for the first three months of 2012, increasing $1.9 billion, or 13.3%, compared to the same period in 2011. Average interest-bearing accounts totaled 61.0% and 63.7% of average total deposits during the first three months of 2012 and 2011, respectively.

Loans

Loans were as follows as of the dates indicated:

 

     March 31,
2012
    Percentage
of Total
    December 31,
2011
    March 31,
2011
 

Commercial and industrial:

        

Commercial

   $ 3,709,450        45.7   $ 3,553,989      $ 3,393,769   

Leases

     193,162        2.4        193,412        194,692   

Asset-based

     140,240        1.7        169,466        134,783   
  

 

 

   

 

 

   

 

 

   

 

 

 

Total commercial and industrial

     4,042,852        49.8        3,916,867        3,723,244   

Commercial real estate:

        

Commercial mortgages

     2,357,206        29.0        2,383,479        2,410,760   

Construction

     493,600        6.1        434,870        574,637   

Land:

     184,078        2.2        202,478        227,297   
  

 

 

   

 

 

   

 

 

   

 

 

 

Total commercial real estate

     3,034,884        37.3        3,020,827        3,212,694   

Consumer real estate:

        

Home equity loans

     288,961        3.6        282,244        274,952   

Home equity lines of credit

     190,371        2.4        191,960        187,573   

1-4 family residential mortgages

     43,284        0.5        45,943        53,587   

Construction

     18,910        0.2        17,544        23,504   

Other

     219,760        2.7        225,118        244,752   
  

 

 

   

 

 

   

 

 

   

 

 

 

Total consumer real estate

     761,286        9.4        762,809        784,368   

Total real estate

     3,796,170        46.7        3,783,636        3,997,062   

Consumer and other:

        

Consumer installment

     296,057        3.6        301,518        307,812   

Other

     8,415        0.1        11,018        17,310   
  

 

 

   

 

 

   

 

 

   

 

 

 

Total consumer real estate

     304,472        3.7        312,536        325,122   

Unearned discounts

     (16,781     (0.2     (17,910     (20,348
  

 

 

   

 

 

   

 

 

   

 

 

 

Total loans

   $ 8,126,713        100.0   $ 7,995,129      $ 8,025,080   
  

 

 

   

 

 

   

 

 

   

 

 

 

 

49


Table of Contents

Loans increased $131.6 million, or 1.6%, compared to December 31, 2011. The majority of the Corporation’s loan portfolio is comprised of commercial and industrial loans and real estate loans. Commercial and industrial loans made up 49.8% and 49.0% of total loans at March 31, 2012 and December 31, 2011, respectively while real estate loans made up 46.7% and 47.3% of total loans, respectively, at those dates. Real estate loans include both commercial and consumer balances.

Commercial and industrial loans increased $126.0 million, or 3.2%, during the first quarter of 2012. The Corporation’s commercial and industrial loans are a diverse group of loans to small, medium and large businesses. The purpose of these loans varies from supporting seasonal working capital needs to term financing of equipment. While some short-term loans may be made on an unsecured basis, most are secured by the assets being financed with collateral margins that are consistent with the Corporation’s loan policy guidelines. The commercial and industrial loan portfolio also includes the commercial lease and asset-based lending portfolios as well as purchased shared national credits (“SNC”s) which are discussed in more detail below.

Purchased shared national credits are participations purchased from upstream financial organizations and tend to be larger in size than the Corporation’s originated portfolio. The Corporation’s purchased SNC portfolio totaled $599.5 million at March 31, 2012, increasing $62.1 million, or 11.5%, from $537.4 million at December 31, 2011. At March 31, 2012, 64.1% of outstanding purchased SNCs was related to the energy industry. The remaining purchased SNCs were diversified throughout various other industries, with no other single industry exceeding 10% of the total purchased SNC portfolio. Additionally, almost all of the outstanding balance of purchased SNCs was included in the commercial and industrial portfolio, with the remainder included in the real estate categories. SNC participations are originated in the normal course of business to meet the needs of the Corporation’s customers. As a matter of policy, the Corporation generally only participates in SNCs for companies headquartered in or which have significant operations within the Corporation’s market areas. In addition, the Corporation must have direct access to the company’s management, an existing banking relationship or the expectation of broadening the relationship with other banking products and services within the following 12 to 24 months. SNCs are reviewed at least quarterly for credit quality and business development successes.

Real estate loans increased $12.5 million, or 0.3%, during the first quarter of 2012. Real estate loans include both commercial and consumer balances. Commercial real estate loans totaled $3.0 billion at March 31, 2012 and represented 79.9% of total real estate loans. The majority of this portfolio consists of commercial real estate mortgages, which includes both permanent and intermediate term loans. The Corporation’s primary focus for its commercial real estate portfolio has been growth in loans 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 undergo the analysis and underwriting process of a commercial and industrial loan, as well as that of a real estate loan.

The consumer loan portfolio, including all consumer real estate, decreased $7.0 million, or 0.7%, from December 31, 2011. As the following table illustrates, the consumer loan portfolio has three distinct segments, including consumer real estate (excluding 1-4 family residential mortgages), consumer installment and 1-4 family residential mortgages.

 

     March 31,
2012
     December 31,
2011
     March 31,
2011
 

Consumer real estate:

        

Home equity loans

   $ 288,961       $ 282,244       $ 274,952   

Home equity lines of credit

     190,371         191,960         187,573   

Construction

     18,910         17,544         23,504   

Other

     219,760         225,118         244,752   
  

 

 

    

 

 

    

 

 

 

Total consumer real estate

     718,002         716,866         730,781   

Consumer installment

     296,057         301,518         307,812   

1-4 family residential mortgages

     43,284         45,943         53,587   
  

 

 

    

 

 

    

 

 

 

Total consumer loans

   $ 1,057,343       $ 1,064,327       $ 1,092,180   
  

 

 

    

 

 

    

 

 

 

Consumer real estate loans, increased $1.1 million, or 0.2%, from December 31, 2011. Combined, home equity loans and lines of credit made up 66.8% and 66.1% of the consumer real estate loan total at March 31, 2012 and December 31, 2011, respectively. The Corporation offers home equity loans up to 80% of the estimated value of the personal residence of the borrower, less the value of existing mortgages and home improvement loans. In general, the Corporation no longer originates 1-4 family mortgage loans, however, from time to time, the Corporation may invest in such loans to meet the needs of its customers.

The consumer installment loan portfolio primarily consists of automobile loans, unsecured revolving credit products, personal loans secured by cash and cash equivalents, and other similar types of credit facilities.

 

50


Table of Contents

Non-Performing Assets

Non-performing assets and accruing past due loans are presented in the table below. All troubled debt restructurings are reported as non-accrual loans.

 

     March 31,
2012
    December 31,
2011
    March 31,
2011
 

Non-accrual loans:

      

Commercial and industrial

   $ 49,588      $ 43,874      $ 58,681   

Commercial real estate

     43,177        45,149        60,808   

Consumer real estate

     4,322        4,587        3,741   

Consumer and other

     783        728        581   
  

 

 

   

 

 

   

 

 

 

Total non-accrual loans

     97,870        94,338        123,811   

Foreclosed assets:

      

Real estate

     22,671        26,608        30,442   

Other

     5        —          450   
  

 

 

   

 

 

   

 

 

 

Total foreclosed assets

     22,676        26,608        30,892   
  

 

 

   

 

 

   

 

 

 

Total non-performing assets

   $ 120,546      $ 120,946      $ 154,703   
  

 

 

   

 

 

   

 

 

 

Ratio of non-performing assets to:

      

Total loans and foreclosed assets

     1.48     1.51     1.92

Total assets

     0.59        0.60        0.86   

Accruing past due loans:

      

30 to 89 days past due

   $ 38,710      $ 42,463      $ 64,600   

90 or more days past due

     20,618        17,417        24,499   
  

 

 

   

 

 

   

 

 

 

Total accruing loans past due

   $ 59,328      $ 59,880      $ 89,099   
  

 

 

   

 

 

   

 

 

 

Ratio of accruing past due loans to total loans:

      

30 to 89 days past due

     0.48     0.53     0.80

90 or more days past due

     0.25        0.22        0.31   
  

 

 

   

 

 

   

 

 

 

Total accruing loans past due

     0.73     0.75     1.11
  

 

 

   

 

 

   

 

 

 

Non-performing assets include non-accrual loans and foreclosed assets. Non-performing assets at March 31, 2012 decreased $400 thousand from December 31, 2011 and $34.2 million from March 31, 2011. While down significantly from a year ago, in general, the level of non-performing assets during the comparable periods is reflective of weaker economic conditions which began in the latter part of 2008, although the Corporation has experienced decreases in the levels of classified assets in recent quarters. Non-accrual commercial loans included three credit relationships in excess of $5 million totaling $24.4 million at March 31, 2012 and two credit relationships in excess of $5 million totaling $17.3 million at December 31, 2011. Non-accrual real estate loans primarily consist of land development, 1-4 family residential construction credit relationships and loans secured by office buildings and religious facilities. Non-accrual commercial real estate loans included one credit relationship in excess of $5 million totaling $5.7 million at March 31, 2012 and one credit relationship in excess of $5 million totaling $5.8 million at December 31, 2011.

Generally, loans are placed on non-accrual status if principal or interest payments become 90 days past due and/or management deems the collectibility of the principal and/or interest to be in question, as well as when required by regulatory requirements. Once interest accruals are discontinued, accrued but uncollected interest is charged to current year operations. Subsequent receipts on non-accrual loans are recorded as a reduction of principal, and interest income is recorded only after principal recovery is reasonably assured. Classification of a loan as non-accrual does not preclude the ultimate collection of loan principal or interest.

Foreclosed assets represent property acquired as the result of borrower defaults on loans. Foreclosed assets are recorded at estimated fair value, less estimated selling costs, at the time of foreclosure. Write-downs occurring at foreclosure are charged against the allowance for loan losses. Subsequent to foreclosure, the fair value of property held is monitored/evaluated by a third-party service and reviewed with management on a quarterly basis. Write-downs are provided for subsequent declines in value and are included in other non-interest expense along with other expenses related to maintaining the properties. During 2011, foreclosed assets, particularly among certain classes of property (primarily land), experienced significant deterioration in fair values as a result of the prevailing weaker economic conditions. Write-downs of foreclosed assets totaled $75 thousand and $241 thousand, during the three months ended March 31, 2012 and 2011, respectively. There were no significant concentrations of any properties, to which the aforementioned write-downs relate, in any single geographic region.

 

51


Table of Contents

Potential problem loans consist of loans that are performing in accordance with contractual terms but for which management has concerns about the ability of an obligor to continue to comply with repayment terms because of the obligor’s potential operating or financial difficulties. Management monitors these loans closely and reviews their performance on a regular basis. At March 31, 2012 and December 31, 2011, the Corporation had $41.0 million and $42.6 million in loans of this type which are not included in either of the non-accrual or 90 days past due loan categories. At March 31, 2012, potential problem loans consisted of seven credit relationships. Of the total outstanding balance at March 31, 2012, 70.3% related to a customer in the construction industry and 14.7% related to two customers in manufacturing. Weakness in these companies’ operating performance has caused the Corporation to heighten the attention given to these credits.

Allowance for Loan Losses

The allowance for loan losses is a reserve established through a provision for loan losses charged to expense, which represents management’s best estimate of probable losses that have been incurred within the existing portfolio of loans. The allowance, in the judgment of management, is necessary to reserve for estimated loan losses and risks inherent in the loan portfolio. The Corporation’s allowance for loan loss methodology includes allowance allocations calculated in accordance with ASC Topic 310, “Receivables” and allowance allocations calculated in accordance with ASC Topic 450, “Contingencies.” Accordingly, the methodology is based on historical loss experience by type of credit and internal risk grade, specific homogeneous risk pools and specific loss allocations, with adjustments for current events and conditions. The Corporation’s process for determining the appropriate level of the allowance for loan losses is designed to account for credit deterioration as it occurs. The provision for loan losses reflects loan quality trends, including the levels of and trends related to non-accrual loans, past due loans, potential problem loans, classified and criticized loans and net charge-offs or recoveries, among other factors. The provision for loan losses also reflects the totality of actions taken on all loans for a particular period. In other words, the amount of the provision reflects not only the necessary increases in the allowance for loan losses related to newly identified criticized loans, but it also reflects actions taken related to other loans including, among other things, any necessary increases or decreases in required allowances for specific loans or loan pools. See Note 3 - Loans in the accompanying notes to consolidated financial statements included elsewhere in this report for further details regarding the Corporation’s methodology for estimating the appropriate level of the allowance for loan losses.

The table below provides, as of the dates indicated, an allocation of the allowance for loan losses by loan type; however, allocation of a portion of the allowance to one category of loans does not preclude its availability to absorb losses in other categories:

 

     March 31,      December 31,      March 31,  
     2012      2011      2011  

Commercial and industrial

   $ 45,869       $ 42,774       $ 52,800   

Commercial real estate

     20,003         20,912         24,551   

Consumer real estate

     3,699         3,540         3,485   

Consumer and other

     8,715         12,635         12,941   

Unallocated

     28,895         30,286         30,544   
  

 

 

    

 

 

    

 

 

 

Total

   $ 107,181       $ 110,147       $ 124,321   
  

 

 

    

 

 

    

 

 

 

As of March 31, 2012, the reserve allocated to commercial and industrial loans increased $3.1 million compared to December 31, 2011 and decreased $6.9 million compared to March 31, 2011. The increase from December 31, 2011 was primarily due to an increase in allocations for specific loans, an increase in the allocation for distressed industries, an increase in classified loans and the effect of an increase in the volume of commercial and industrial loans partly offset by a decrease in the environmental adjustment factor. The decrease from March 31, 2011 was primarily related to a decrease in the level of classified loans, a decrease in allocations for specific loans and a decrease in the environmental adjustment factor partly offset by the effect of an increase in the volume of commercial and industrial loans and an increase in the allocation for distressed industries. Classified commercial and industrial loans (loans having a risk grade of 11, 12 or 13) totaled $143.0 million at March 31, 2012 compared to $139.2 million at December 31, 2011 and $171.0 million at March 31, 2011. Specific allocations of the allowance for loan losses related to commercial and industrial loans totaled $5.4 million at March 31, 2012 compared to $2.7 million at December 31, 2011 and $13.1 million at March 31, 2011. The environmental adjustment factor resulted in additional general valuation allowances for commercial and industrial loans totaling $5.1 million at March 31, 2012, $5.6 million at December 31, 2011 and $5.7 million at March 31, 2011. As more fully discussed in Note 3 – Loans in the accompanying notes to consolidated financial statements, the distressed industries allocation was added to the Corporation’s methodology for the determination of reserves allocated to specific loan portfolio segments in the fourth quarter of 2011. The distressed industries allocation related to commercial and industrial loans totaled $4.7 million at March 31, 2012 and $4.1 million at December 31, 2011.

 

52


Table of Contents

As of March 31, 2012, the reserve allocated to commercial real estate loans decreased $909 thousand compared to December 31, 2011 and $4.5 million compared to March 31, 2011. The decrease from December 31, 2011 was due to a decrease in the level of classified and other high risk grade non-classified loans, a decrease in the historical loss allocation factors applied to certain categories of non-classified and classified commercial real estate loans and a decrease in the environmental adjustment factor partly offset by the effect of an increase in the volume of commercial real estate loans. The decrease from March 31, 2011 was primarily related to a decrease in the level of classified and other high risk grade non-classified loans, a decrease in the historical loss allocation factors applied to certain categories of non-classified and classified commercial real estate loans, a decrease in allocations for specific loans and a decrease in the environmental adjustment factor combined with the effect of a decrease in the volume of commercial real estate loans. The decrease in the reserve allocated to commercial real estate loans as a result of the aforementioned items was partly offset by an increase in the allocation for distressed industries. Classified commercial real estate loans totaled $177.2 million at March 31, 2012 compared to $180.0 million at December 31, 2011 and $185.8 million at March 31, 2011. Specific allocations of the allowance for loan losses related to commercial real estate loans totaled $1.1 million at both March 31, 2012 and December 31, 2011 compared to $3.6 million at March 31, 2011. The environmental adjustment factor resulted in additional general valuation allowances for commercial real estate loans totaling $3.3 million at March 31, 2012 and $3.7 million at both December 31, 2011 and March 31, 2011. The distressed industries allocation related to commercial real estate loans totaled $972 thousand at March 31, 2012 and $922 thousand at December 31, 2011.

The reserve allocated to consumer real estate loans at March 31, 2012 increased $159 thousand compared to December 31, 2011 and $214 thousand compared to March 31, 2011. The increases in the reserve allocated to consumer real estate loans were primarily due to an increase in the historical loss allocation factor applied to consumer real estate loans partly offset by a decrease in the environmental adjustment factor and the effect of a decrease in the volume of consumer real estate loans. The reserve allocated to consumer and other loans at March 31, 2012 decreased $3.9 million compared to December 31, 2011 and decreased $4.2 million compared to March 31, 2011. The decreases were primarily related to a decrease in the historical loss allocation factor applied to consumer and other loans combined with a decrease in the environmental adjustment factor and the effect of a decrease in the volume of consumer and other loans.

The unallocated portion of the allowance for loan losses represents general valuation allowances that are not allocated to specific loan portfolio segments. See Note 3 – Loans in the accompanying notes to consolidated financial statements for information regarding the components of the unallocated portion of the allowance. The unallocated portion of the allowance for loan losses at March 31, 2012 decreased $1.4 million compared to December 31, 2011. This decrease was primarily due to a decrease in the allocation for general macroeconomic risk (down $1.2 million), a decrease in the allocation for loans that did not undergo a separate, independent concurrence review during the underwriting process (down $932 thousand) and an increase in the reduction adjustment for recoveries (up $911 thousand) partly offset by an increase in the allocation for excessive industry concentrations (up $825 thousand), an increase in the allocation for highly-leveraged credit relationships (up $603 thousand) and an increase in the allocation for credit and/or collateral exceptions that exceed specified risk grades (up $595 thousand). The unallocated portion of the allowance for loan losses at March 31, 2012 decreased $1.6 million compared to March 31, 2011. This decrease was primarily due to a decrease in the allocation for general macroeconomic risk (down $3.7 million), an increase in the reduction adjustment for recoveries (up $2.3 million) and a decrease in the allocation for loans that did not undergo a separate, independent concurrence review during the underwriting process (down $1.2 million) partly offset by an increase in the allocation for excessive industry concentrations (up $5.3 million). The increase in allocations related to excessive industry concentrations was primarily related to new industry concentrations that were not considered to be excessive during the first quarter of 2011.

 

53


Table of Contents

Activity in the allowance for loan losses is presented in the following table.

 

     Three Months Ended  
     March 31,
2012
    December 31,
2011
    March 31,
2011
 

Balance at beginning of period

   $ 110,147      $ 115,433      $ 126,316   

Provision for loan losses

     1,100        —          9,450   

Charge-offs:

      

Commercial and industrial

     (3,012     (5,421     (7,597

Commercial real estate

     (2,842     (515     (3,877

Consumer real estate

     (289     (677     (820

Consumer and other

     (1,985     (2,383     (2,302
  

 

 

   

 

 

   

 

 

 

Total charge-offs

     (8,128     (8,996     (14,596

Recoveries:

      

Commercial and industrial

     1,341        1,404        767   

Commercial real estate

     492        243        556   

Consumer real estate

     523        25        290   

Consumer and other

     1,706        2,038        1,538   
  

 

 

   

 

 

   

 

 

 

Total recoveries

     4,062        3,710        3,151   
  

 

 

   

 

 

   

 

 

 

Net charge-offs

     (4,066     (5,286     (11,445
  

 

 

   

 

 

   

 

 

 

Balance at end of period

   $ 107,181      $ 110,147      $ 124,321   
  

 

 

   

 

 

   

 

 

 

Ratio of allowance for loan losses to:

      

Total loans

     1.32     1.38     1.55

Non-accrual loans

     109.51        116.76        100.41   

Ratio of annualized net charge-offs to average total loans

     0.20        0.26        0.57   

The provision for loan losses decreased by $8.4 million during the first quarter of 2012 compared to the first quarter of 2011. The decrease in the provision for loan losses during the first quarter of 2012 compared to the same period in 2011 and the fact that no provision was recorded during the fourth quarter of 2011 is reflective of the decreasing trend in classified loans and a decrease in net charge-offs. Management believes the recorded amount of the allowance for loan losses is appropriate based upon management’s best estimate of probable losses that have been incurred within the existing portfolio of loans. Should any of the factors considered by management in evaluating the appropriate level of the allowance for loan losses change, the Corporation’s estimate of probable loan losses could also change, which could affect the level of future provisions for loan losses.

Net charge-offs during the first quarter of 2012 decreased $7.4 million compared to the first quarter of 2011 and decreased $1.2 million compared to the fourth quarter of 2011. Net charge-offs as a percentage of average loans (on an annualized basis) totaled 0.20% during the first quarter of 2012 decreasing 37 basis points compared to 0.57% during the first quarter of 2011 and 6 basis points compared 0.26% during the fourth quarter of 2011. The ratio of the allowance for loan losses to total loans decreased 6 basis points from 1.38% at December 31, 2011 to 1.32% at March 31, 2012. The overall trend in net charge-offs reflects the continued improvement in the level of classified loans. The Corporation expects the level of net charge-offs to continue to trend downward as the overall credit quality of the loan portfolio continues to improve.

Capital and Liquidity

Capital. Shareholders’ equity totaled $2.3 billion at both March 31, 2012 and December 31, 2011 and $2.1 billion at March 31, 2011. In addition to net income of $61.0 million, other changes in shareholders’ equity during the first three months of 2012 included $28.2 million of dividends paid, $5.5 million in proceeds from stock option exercises and the related tax deficiency of $377 thousand, other comprehensive income, net of tax, of $3.3 million and $2.6 million related to stock-based compensation.

The accumulated other comprehensive income/loss component of shareholders’ equity totaled a net, after-tax, unrealized gain of $244.4 million at March 31, 2012 compared to a net, after-tax, unrealized gain of $247.7 million at December 31, 2011. During the first quarter of 2012, a $5.7 million net after-tax decrease in the accumulated net gain on effective cash flow hedges was partly offset by a $1.5 million net after-tax increase in the accumulated net unrealized gain on securities available for sale and a $799 thousand net after-tax decrease in the accumulated net actuarial loss on defined-benefit post-retirement benefit plans.

 

54


Table of Contents

Under current regulatory requirements, amounts reported as accumulated other comprehensive income/loss related to securities available for sale, effective cash flow hedges and defined benefit post-retirement benefit plans do not increase or reduce regulatory capital and are not included in the calculation of risk-based capital and leverage ratios. Regulatory agencies for banks and bank holding companies utilize 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. See Note 7 - Regulatory Matters in the accompanying notes to consolidated financial statements included elsewhere in this report.

The Corporation paid quarterly dividends of $0.46 per common share during the first quarter of 2012 and the fourth quarter of 2011 and a quarterly dividend of $0.45 per common share in the first quarter of 2011. This equates to a dividend payout ratio of 46.3%, 50.9% and 53.1% for each of these periods, respectively.

From time to time, the Corporation’s board of directors has authorized stock repurchase plans. Stock repurchase plans allow the Corporation to proactively manage its capital position and return excess capital to shareholders. Shares purchased under such plans also provide the Corporation with shares of common stock necessary to satisfy obligations related to stock compensation awards. No shares were repurchased under stock repurchase plans during any of the reported periods. See Part II, Item 2 - Unregistered Sales of Equity Securities and Use of Proceeds, included elsewhere in this report, for details of stock repurchases during the quarter.

Liquidity. Liquidity measures the ability to meet current and future cash flow needs as they become due. The liquidity of a financial institution reflects its ability to meet loan requests, to accommodate possible outflows in deposits and to take advantage of interest rate market opportunities. The ability of a financial institution to meet its current financial obligations is a function of its balance sheet structure, its ability to liquidate assets, and its access to alternative sources of funds. The Corporation seeks to ensure its funding needs are met by maintaining a level of liquid funds through asset/liability management.

Asset liquidity is provided by liquid assets which are readily marketable or pledgeable or which will mature in the near future. Liquid assets include cash, interest-bearing deposits in banks, securities available for sale, maturities and cash flow from securities held to maturity, and federal funds sold and resell agreements.

Liability liquidity is provided by access to funding sources which include core deposits and correspondent banks in the Corporation’s natural trade area that maintain accounts with and sell federal funds to Frost Bank, as well as federal funds purchased and repurchase agreements from upstream banks and deposits obtained through financial intermediaries.

Since Cullen/Frost is a holding company and does not conduct operations, its primary sources of liquidity are dividends upstreamed from Frost Bank and borrowings from outside sources. Banking regulations may limit the amount of dividends that may be paid by Frost Bank. See Note 7 - Regulatory Matters in the accompanying notes to consolidated financial statements included elsewhere in this report regarding such dividends. At March 31, 2012, Cullen/Frost had liquid assets, including cash and resell agreements, totaling $197.3 million, which included $6.3 million in cash collateral on deposit with other financial institution counterparties to interest rate swap transactions.

The liquidity position of the Corporation is continuously monitored and adjustments are made to the balance between sources and uses of funds as deemed appropriate. Management is not aware of any events that are reasonably likely to have a material adverse effect on the Corporation’s liquidity, capital resources or operations. In addition, management is not aware of any regulatory recommendations regarding liquidity, which if implemented, would have a material adverse effect on the Corporation.

Accounting Standards Updates

See Note 16 - Accounting Standards Updates in the accompanying notes to consolidated financial statements included elsewhere in this report for details of recently issued accounting pronouncements and their expected impact on the Corporation’s financial statements.

 

55


Table of Contents

Consolidated Average Balance Sheets and Interest Income Analysis-By-Quarter

(Dollars in thousands - taxable-equivalent basis)

 

      March 31, 2012     December 31, 2011  
     Average
Balance
    Interest
Income/
Expense
     Yield/
Cost
    Average
Balance
    Interest
Income/
Expense
     Yield/
Cost
 

Assets:

              

Interest-bearing deposits

   $ 1,100,867      $ 930         0.34   $ 2,515,512      $ 1,903         0.30

Federal funds sold and resell agreements

     14,021        15         0.43        14,055        17         0.48   

Securities:

              

Taxable

     6,665,378        36,066         2.23        5,080,515        34,130         2.78   

Tax-exempt

     2,256,766        36,023         6.94        2,220,231        36,221         6.94   
  

 

 

   

 

 

      

 

 

   

 

 

    

Total securities

     8,922,144        72,089         3.37        7,300,746        70,351         4.02   

Loans, net of unearned discounts

     8,049,968        98,831         4.94        7,975,198        101,258         5.04   
  

 

 

   

 

 

      

 

 

   

 

 

    

Total Earning Assets and Average Rate Earned

     18,087,000        171,865         3.89        17,805,511        173,529         3.95   

Cash and due from banks

     577,936             545,367        

Allowance for loan losses

     (111,788          (117,006     

Premises and equipment, net

     322,831             321,776        

Accrued interest and other assets

     1,044,067             1,023,297        
  

 

 

        

 

 

      

Total Assets

   $ 19,920,046           $ 19,578,945        
  

 

 

        

 

 

      

Liabilities:

              

Non-interest-bearing demand deposits:

              

Commercial and individual

   $ 5,643,167           $ 5,584,493        

Correspondent banks

     330,440             327,053        

Public funds

     425,363             413,854        
  

 

 

        

 

 

      

Total non-interest-bearing demand deposits

     6,398,970             6,325,400        

Interest-bearing deposits:

              

Private accounts

              

Savings and interest checking

     2,854,493        425         0.06        2,698,273        432         0.06   

Money market deposit accounts

     5,682,663        2,969         0.21        5,634,846        3,286         0.23   

Time accounts

     1,045,009        1,026         0.39        1,088,230        1,102         0.40   

Public funds

     415,959        152         0.15        382,349        156         0.16   
  

 

 

   

 

 

      

 

 

   

 

 

    

Total interest-bearing deposits

     9,998,124        4,572         0.18        9,803,698        4,976         0.20   
  

 

 

        

 

 

      

Total deposits

     16,397,094             16,129,098        

Federal funds purchased and repurchase agreements

     633,303        34         0.02        644,662        35         0.02   

Junior subordinated deferrable interest debentures

     123,712        1,674         5.41        123,712        1,710         5.53   

Subordinated notes payable and other notes

     100,000        878         3.51        100,000        1,468         5.87   

Federal Home Loan Bank advances

     23        —           6.00        28        —           6.00   
  

 

 

   

 

 

      

 

 

   

 

 

    

Total Interest-Bearing Funds and Average Rate Paid

     10,855,162        7,158         0.26        10,672,100        8,189         0.31   
  

 

 

   

 

 

    

 

 

   

 

 

   

 

 

    

 

 

 

Accrued interest and other liabilities

     348,807             323,513        
  

 

 

        

 

 

      

Total Liabilities

     17,602,939             17,321,013        

Shareholders’ Equity

     2,317,107             2,257,932        
  

 

 

        

 

 

      

Total Liabilities and Shareholders’ Equity

   $ 19,920,046           $ 19,578,945        
  

 

 

        

 

 

      

Net interest income

     $ 164,707           $ 165,340      
    

 

 

        

 

 

    

Net interest spread

          3.63          3.64
       

 

 

        

 

 

 

Net interest income to total average earning assets

          3.73          3.76
       

 

 

        

 

 

 

For these computations: (i) average balances are presented on a daily average basis, (ii) information is shown on a taxable-equivalent basis assuming a 35% tax rate, (iii) average loans include loans on non-accrual status, and (iv) average securities include unrealized gains and losses on securities available for sale while yields are based on average amortized cost.

 

56


Table of Contents

Consolidated Average Balance Sheets and Interest Income Analysis-By-Quarter

(Dollars in thousands - taxable-equivalent basis)

 

      September 30, 2011     June 30, 2011  
     Average
Balance
    Interest
Income/
Expense
     Yield/
Cost
    Average
Balance
    Interest
Income/
Expense
     Yield/
Cost
 

Assets:

              

Interest-bearing deposits

   $ 3,243,562      $ 1,811         0.22   $ 2,339,671      $ 1,472         0.25

Federal funds sold and resell agreements

     15,957        15         0.38        11,517        13         0.45   

Securities:

              

Taxable

     3,538,329        30,089         3.57        3,739,158        31,668         3.51   

Tax-exempt

     2,219,092        36,916         6.98        2,185,129        36,955         6.99   
  

 

 

   

 

 

      

 

 

   

 

 

    

Total securities

     5,757,421        67,005         4.88        5,924,287        68,623         4.79   

Loans, net of unearned discounts

     8,036,183        101,166         4.99        8,080,375        101,201         5.02   
  

 

 

   

 

 

      

 

 

   

 

 

    

Total Earning Assets and Average Rate Earned

     17,053,123        169,997         4.03        16,355,850        171,309         4.25   

Cash and due from banks

     582,192             608,521        

Allowance for loan losses

     (120,908          (125,455     

Premises and equipment, net

     318,443             314,758        

Accrued interest and other assets

     992,153             1,015,939        
  

 

 

        

 

 

      

Total Assets

   $ 18,825,003           $ 18,169,613        
  

 

 

        

 

 

      

Liabilities:

              

Non-interest-bearing demand deposits:

              

Commercial and individual

   $ 5,232,235           $ 4,867,999        

Correspondent banks

     319,471             317,236        

Public funds

     353,660             278,782        
  

 

 

        

 

 

      

Total non-interest-bearing demand deposits

     5,905,366             5,464,017        

Interest-bearing deposits:

              

Private accounts

              

Savings and interest checking

     2,527,855        430         0.07        2,500,098        668         0.11   

Money market deposit accounts

     5,501,921        3,498         0.25        5,325,824        3,794         0.29   

Time accounts

     1,122,534        1,211         0.43        1,136,221        1,293         0.46   

Public funds

     371,440        167         0.18        417,022        191         0.18   
  

 

 

   

 

 

      

 

 

   

 

 

    

Total interest-bearing deposits

     9,523,750        5,306         0.22        9,379,165        5,946         0.25   
  

 

 

        

 

 

      

Total deposits

     15,429,116             14,843,182        

Federal funds purchased and repurchase agreements

     645,794        63         0.04        570,552        83         0.06   

Junior subordinated deferrable interest debentures

     123,712        1,710         5.53        123,712        1,691         5.47   

Subordinated notes payable and other notes

     150,543        2,338         6.21        250,000        4,080         6.53   

Federal Home Loan Bank advances

     33        1         6.00        37        —           6.00   
  

 

 

   

 

 

      

 

 

   

 

 

    

Total Interest-Bearing Funds and Average Rate Paid

     10,443,832        9,418         0.36        10,323,466        11,800         0.46   
  

 

 

   

 

 

    

 

 

   

 

 

   

 

 

    

 

 

 

Accrued interest and other liabilities

     267,016             245,596        
  

 

 

        

 

 

      

Total Liabilities

     16,616,214             16,033,079        

Shareholders’ Equity

     2,208,789             2,136,534        
  

 

 

        

 

 

      

Total Liabilities and Shareholders’ Equity

   $ 18,825,003           $ 18,169,613        
  

 

 

        

 

 

      

Net interest income

     $ 160,579           $ 159,509      
    

 

 

        

 

 

    

Net interest spread

          3.67          3.79
       

 

 

        

 

 

 

Net interest income to total average earning assets

          3.81          3.95
       

 

 

        

 

 

 

For these computations: (i) average balances are presented on a daily average basis, (ii) information is shown on a taxable-equivalent basis assuming a 35% tax rate, (iii) average loans include loans on non-accrual status, and (iv) average securities include unrealized gains and losses on securities available for sale while yields are based on average amortized cost.

 

57


Table of Contents

Consolidated Average Balance Sheets and Interest Income Analysis-By-Quarter

(Dollars in thousands - taxable-equivalent basis)

 

      March 31, 2011  
     Average
Balance
    Interest
Income/
Expense
     Yield/
Cost
 

Assets:

       

Interest-bearing deposits

   $ 1,867,858      $ 1,171         0.25

Federal funds sold and resell agreements

     16,517        16         0.39   

Securities:

       

Taxable

     3,789,497        31,185         3.39   

Tax-exempt

     2,067,194        36,246         7.15   
  

 

 

   

 

 

    

Total securities

     5,856,691        67,431         4.73   

Loans, net of unearned discounts

     8,081,356        99,854         5.01   
  

 

 

   

 

 

    

Total Earning Assets and Average Rate Earned

     15,822,422        168,472         4.34   

Cash and due from banks

     652,399        

Allowance for loan losses

     (127,328     

Premises and equipment, net

     316,036        

Accrued interest and other assets

     1,014,253        
  

 

 

      

Total Assets

   $ 17,677,782        
  

 

 

      

Liabilities:

       

Non-interest-bearing demand deposits:

       

Commercial and individual

   $ 4,679,602        

Correspondent banks

     336,218        

Public funds

     231,651        
  

 

 

      

Total non-interest-bearing demand deposits

     5,247,471        

Interest-bearing deposits:

       

Private accounts

       

Savings and interest checking

     2,437,774        585         0.10   

Money market deposit accounts

     5,159,976        3,753         0.29   

Time accounts

     1,164,835        1,409         0.49   

Public funds

     458,489        204         0.18   
  

 

 

   

 

 

    

Total interest-bearing deposits

     9,221,074        5,951         0.26   
  

 

 

      

Total deposits

     14,468,545        

Federal funds purchased and repurchase agreements

     521,731        131         0.10   

Junior subordinated deferrable interest debentures

     123,712        1,672         5.41   

Subordinated notes payable and other notes

     250,000        4,079         6.53   

Federal Home Loan Bank advances

     42        1         6.00   
  

 

 

   

 

 

    

Total Interest-Bearing Funds and Average Rate Paid

     10,116,559        11,834         0.47   
  

 

 

   

 

 

    

 

 

 

Accrued interest and other liabilities

     230,951        
  

 

 

      

Total Liabilities

     15,594,981        

Shareholders’ Equity

     2,082,801        
  

 

 

      

Total Liabilities and Shareholders’ Equity

   $ 17,677,782        
  

 

 

      

Net interest income

     $ 156,638      
    

 

 

    

Net interest spread

          3.87
       

 

 

 

Net interest income to total average earning assets

          4.03
       

 

 

 

For these computations: (i) average balances are presented on a daily average basis, (ii) information is shown on a taxable-equivalent basis assuming a 35% tax rate, (iii) average loans include loans on non-accrual status, and (iv) average securities include unrealized gains and losses on securities available for sale while yields are based on average amortized cost.

 

58


Table of Contents
Item 3. Quantitative and Qualitative Disclosures About Market Risk

The disclosures set forth in this item are qualified by the section captioned “Forward-Looking Statements and Factors that Could Affect Future Results” included in Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations of this report and other cautionary statements set forth elsewhere in this report.

Refer to the discussion of market risks included in Item 7A. Quantitative and Qualitative Disclosures About Market Risk in the 2011 Form 10-K. There has been no significant change in the types of market risks faced by the Corporation since December 31, 2011.

The Corporation utilizes an earnings simulation model as the primary quantitative tool in measuring the amount of interest rate risk associated with changing market rates. The model quantifies the effects of various interest rate scenarios on projected net interest income and net income over the next 12 months. The model measures the impact on net interest income relative to a base case scenario of hypothetical fluctuations in interest rates 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. The impact of interest rate derivatives, such as interest rate swaps, caps and floors, is also included in the model. Other interest rate-related risks such as prepayment, basis and option risk are also considered.

For modeling purposes, as of March 31, 2012, the model simulations projected that 100 and 200 basis point increases in interest rates would result in negative variances in net interest income of 1.8% and 2.7%, respectively, relative to the base case over the next 12 months, while a decrease in interest rates of 25 basis points would result in a negative variance in net interest income of 1.5% relative to the base case over the next 12 months. The March 31, 2012 model simulations were impacted by the assumption, for modeling purposes, that the Corporation will begin to pay interest on demand deposits in the second quarter of 2012, as further discussed below. As of March 31, 2011, the model simulations projected that 100 and 200 basis point increases in interest rates would result in negative variances in net interest income of 0.5% and 0.6%, respectively, relative to the base case over the next 12 months, while a decrease in interest rates of 25 basis points would result in a negative variance in net interest income of 0.4% relative to the base case over the next 12 months. The likelihood of a decrease in interest rates beyond 25 basis points as of March 31, 2012 and 2011 was considered remote given prevailing interest rate levels.

The Corporation has experienced significant growth in deposits in 2012 compared to 2011 which funded a significant increase in fixed-rate securities. This increase in fixed-rate securities coupled with the assumption, for modeling purposes, that the Corporation will begin paying interest on demand deposits that were previously non-interest-bearing as a result of recent legislation, as further discussed below, resulted in the model simulations indicating that the Corporation’s balance sheet will become more liability sensitive relative to the base case over the next 12 months.

As mentioned above, financial regulatory reform legislation entitled the “Dodd-Frank Wall Street Reform and Consumer Protection Act” (the “Dodd-Frank Act”) repealed the federal prohibition on the payment of interest on demand deposits, thereby permitting depository institutions to pay interest on business transaction and other accounts beginning July 21, 2011. Although the ultimate impact of this legislation on the Corporation has not yet been determined, the Corporation may begin to incur interest costs associated with demand deposits in the future as market conditions warrant. If this were to occur, the Corporation’s balance sheet would likely become more liability sensitive. Because the interest rate that will ultimately be paid on these demand deposits depends upon a variety of factors, some of which are beyond the Corporation’s control, the Corporation assumed an aggressive pricing structure for the purposes of the model simulations discussed above with interest payments beginning in the second quarter of 2012. Should the actual interest rate paid on demand deposits be less than the rate assumed in the model simulations, or should the interest rate paid for such deposits become an administered rate with less direct correlation to movements in general market interest rates, the Corporation’s balance sheet could be less liability sensitive than the model simulations currently indicate.

As of March 31, 2012, the effects of a 200 basis point increase and a 25 basis point decrease in interest rates on the Corporation’s derivative holdings would not result in a significant variance in the Corporation’s net interest income.

The effects of hypothetical fluctuations in interest rates on the Corporation’s securities classified as “trading” under ASC Topic 320, “Investments—Debt and Equity Securities,” are not significant, and, as such, separate quantitative disclosure is not presented.

 

59


Table of Contents
Item 4. Controls and Procedures

As of the end of the period covered by this Quarterly Report on Form 10-Q, an evaluation was carried out by the Corporation’s management, with the participation of its Chief Executive Officer and Chief Financial Officer, of the effectiveness of the Corporation’s disclosure controls and procedures (as defined in Rule 13a-15(e) under the Securities Exchange Act of 1934). Based upon that evaluation, the Chief Executive Officer and Chief Financial Officer concluded that the disclosure controls and procedures were effective as of the end of the period covered by this report. No change in the Corporation’s internal control over financial reporting (as defined in Rule 13a-15(f) under the Securities Exchange Act of 1934) occurred during the last fiscal quarter that materially affected, or is reasonably likely to materially affect, the Corporation’s internal control over financial reporting.

 

60


Table of Contents

Part II. Other Information

 

Item 1. Legal Proceedings

The Corporation and its subsidiaries are subject to various claims and legal actions that have arisen in the course of conducting business. Management does not expect the ultimate disposition of these matters to have a material adverse impact on the Corporation’s financial statements.

 

Item 1A. Risk Factors

There has been no material change in the risk factors previously disclosed under Item 1A. of the Corporation’s 2011 Form 10-K.

 

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds

The following table provides information with respect to purchases made by or on behalf of the Corporation or any “affiliated purchaser” (as defined in Rule 10b-18(a)(3) under the Securities Exchange Act of 1934), of the Corporation’s common stock during the three months ended March 31, 2012.

 

Period   Total Number of
Shares Purchased
    Average Price
Paid Per Share
    Total Number of
Shares Purchased
as Part of Publicly
Announced Plan
    Maximum
Number of Shares
That May Yet Be
Purchased Under
the Plan at the
End of the Period
 

January 1, 2012 to January 31, 2012

    —        $ —          —          —     

February 1, 2012 to February 29, 2012

    —          —          —          —     

March 1, 2012 to March 31, 2012

    —          —          —          —     
 

 

 

     

 

 

   

Total

    —        $ —          —       
 

 

 

     

 

 

   

 

Item 3. Defaults Upon Senior Securities

None.

 

Item 4. Mine Safety Disclosures

None.

 

Item 5. Other Information

None.

 

Item 6. Exhibits

(a) Exhibits

 

Exhibit
Number

  

Description

31.1    Rule 13a-14(a) Certification of the Corporation’s Chief Executive Officer
31.2    Rule 13a-14(a) Certification of the Corporation’s Chief Financial Officer
32.1+    Section 1350 Certification of the Corporation’s Chief Executive Officer
32.2+    Section 1350 Certification of the Corporation’s Chief Financial Officer
101++    Interactive Data File

 

+ This exhibit shall not be deemed “filed” for purposes of Section 18 of the Securities Exchange Act of 1934, or otherwise subject to the liability of that section, and shall not be deemed to be incorporated by reference into any filing under the Securities Act of 1933 or the Securities Exchange Act of 1934.
++ As provided in Rule 406T of Regulation S-T, this information is furnished and not filed for purposes of Sections 11 and 12 of the Securities Act of 1933 and Section 18 of the Securities Exchange Act of 1934

 

61


Table of Contents

Signatures

Pursuant to the requirements 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.

 

  Cullen/Frost Bankers, Inc.
  (Registrant)
Date: April 25, 2012   By:     /s/     Phillip D. Green        
  Phillip D. Green
  Group Executive Vice President
  and Chief Financial Officer
  (Duly Authorized Officer, Principal Financial
  Officer and Principal Accounting Officer)

 

62