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CULLEN/FROST BANKERS, INC. - Quarter Report: 2018 June (Form 10-Q)

Table of Contents

United States
Securities and Exchange Commission
Washington, D.C. 20549
Form 10-Q
ý Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
For the quarterly period ended: June 30, 2018
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  ý    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  ý    No  ¨
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act.
Large accelerated filer
ý
Accelerated filer
¨
Non-accelerated filer
¨ (Do not check if a smaller reporting company)
Smaller reporting company
¨
 
 
Emerging growth company
¨
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act.    ¨
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act).    Yes  ¨    No  ý
As of July 19, 2018 there were 63,907,784 shares of the registrant’s Common Stock, $.01 par value, outstanding.


Table of Contents

Cullen/Frost Bankers, Inc.
Quarterly Report on Form 10-Q
June 30, 2018
Table of Contents
 
Page
Item 1.
 
 
 
 
 
 
 
Item 2.
Management's Discussion and Analysis of Financial Condition and Results of Operations
Item 3.
Item 4.
 
 
 
 
Item 1.
Item 1A.
Item 2.
Item 3.
Item 4.
Item 5.
Item 6.
 
 
 

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)
 
June 30,
2018
 
December 31,
2017
Assets:
 
 
 
Cash and due from banks
$
509,191

 
$
545,542

Interest-bearing deposits
2,476,587

 
4,347,538

Federal funds sold and resell agreements
329,692

 
159,967

Total cash and cash equivalents
3,315,470

 
5,053,047

Securities held to maturity, at amortized cost
1,236,511

 
1,432,098

Securities available for sale, at estimated fair value
10,717,743

 
10,489,009

Trading account securities
21,334

 
21,098

Loans, net of unearned discounts
13,711,762

 
13,145,665

Less: Allowance for loan losses
(150,226
)
 
(155,364
)
Net loans
13,561,536

 
12,990,301

Premises and equipment, net
539,861

 
520,958

Goodwill
654,952

 
654,952

Other intangible assets, net
4,316

 
5,073

Cash surrender value of life insurance policies
181,756

 
180,477

Accrued interest receivable and other assets
453,735

 
400,867

Total assets
$
30,687,214

 
$
31,747,880

 
 
 
 
Liabilities:
 
 
 
Deposits:
 
 
 
Non-interest-bearing demand deposits
$
10,525,998

 
$
11,197,093

Interest-bearing deposits
15,470,501

 
15,675,296

Total deposits
25,996,499

 
26,872,389

Federal funds purchased and repurchase agreements
977,470

 
1,147,824

Junior subordinated deferrable interest debentures, net of unamortized issuance costs
136,213

 
136,184

Subordinated notes, net of unamortized issuance costs
98,630

 
98,552

Accrued interest payable and other liabilities
168,890

 
195,068

Total liabilities
27,377,702

 
28,450,017

 
 
 
 
Shareholders’ Equity:
 
 
 
Preferred stock, par value $0.01 per share; 10,000,000 shares authorized; 6,000,000 Series A shares ($25 liquidation preference) issued at June 30, 2018 and December 31, 2017
144,486

 
144,486

Common stock, par value $0.01 per share; 210,000,000 shares authorized; 64,236,306 shares issued at both June 30, 2018 and December 31, 2017
642

 
642

Additional paid-in capital
960,121

 
953,361

Retained earnings
2,297,099

 
2,187,069

Accumulated other comprehensive income, net of tax
(63,319
)
 
79,512

Treasury stock, at cost; 332,722 shares at June 30, 2018 and 760,720 shares at December 31, 2017
(29,517
)
 
(67,207
)
Total shareholders’ equity
3,309,512

 
3,297,863

Total liabilities and shareholders’ equity
$
30,687,214

 
$
31,747,880

See Notes to Consolidated Financial Statements.


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Table of Contents

Cullen/Frost Bankers, Inc.
Consolidated Statements of Income
(Dollars in thousands, except per share amounts)
 
Three Months Ended 
 June 30,
 
Six Months Ended 
 June 30,
 
2018
 
2017
 
2018
 
2017
Interest income:
 
 
 
 
 
 
 
Loans, including fees
$
164,133

 
$
131,073

 
$
315,335

 
$
253,673

Securities:
 
 
 
 
 
 
 
Taxable
21,188

 
23,527

 
41,746

 
48,829

Tax-exempt
57,298

 
55,435

 
114,009

 
112,382

Interest-bearing deposits
13,917

 
9,076

 
28,011

 
15,912

Federal funds sold and resell agreements
1,415

 
163

 
2,176

 
270

Total interest income
257,951

 
219,274

 
501,277

 
431,066

Interest expense:
 
 
 
 
 
 
 
Deposits
17,575

 
2,173

 
28,213

 
4,041

Federal funds purchased and repurchase agreements
631

 
187

 
1,265

 
326

Junior subordinated deferrable interest debentures
1,311

 
962

 
2,453

 
1,870

Other long-term borrowings
1,164

 
1,164

 
2,328

 
1,532

Total interest expense
20,681

 
4,486

 
34,259

 
7,769

Net interest income
237,270

 
214,788

 
467,018

 
423,297

Provision for loan losses
8,251

 
8,426

 
15,196

 
16,378

Net interest income after provision for loan losses
229,019

 
206,362

 
451,822

 
406,919

Non-interest income:
 
 
 
 
 
 
 
Trust and investment management fees
29,121

 
27,727

 
58,708

 
54,197

Service charges on deposit accounts
21,142

 
21,198

 
41,985

 
41,967

Insurance commissions and fees
10,556

 
9,728

 
26,536

 
23,549

Interchange and debit card transaction fees
3,446

 
5,692

 
6,604

 
11,266

Other charges, commissions and fees
9,273

 
9,898

 
18,280

 
19,490

Net gain (loss) on securities transactions
(60
)
 
(50
)
 
(79
)
 
(50
)
Other
11,588

 
6,887

 
24,477

 
14,361

Total non-interest income
85,066

 
81,080

 
176,511

 
164,780

Non-interest expense:
 
 
 
 
 
 
 
Salaries and wages
85,204

 
80,995

 
171,887

 
163,507

Employee benefits
17,907

 
18,198

 
39,902

 
39,823

Net occupancy
19,455

 
19,153

 
39,195

 
38,390

Technology, furniture and equipment
20,459

 
18,250

 
40,138

 
36,240

Deposit insurance
4,605

 
5,570

 
9,484

 
10,485

Intangible amortization
369

 
438

 
757

 
896

Other
40,909

 
45,447

 
84,156

 
86,625

Total non-interest expense
188,908

 
188,051

 
385,519

 
375,966

Income before income taxes
125,177

 
99,391

 
242,814

 
195,733

Income taxes
13,836

 
13,838

 
24,993

 
25,239

Net income
111,341

 
85,553

 
217,821

 
170,494

Preferred stock dividends
2,015

 
2,015

 
4,031

 
4,031

Net income available to common shareholders
$
109,326

 
$
83,538

 
$
213,790

 
$
166,463

 
 
 
 
 
 
 
 
Earnings per common share:
 
 
 
 
 
 
 
Basic
$
1.70

 
$
1.30

 
$
3.33

 
$
2.59

Diluted
1.68

 
1.29

 
3.30

 
2.57

See Notes to Consolidated Financial Statements.

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Table of Contents

Cullen/Frost Bankers, Inc.
Consolidated Statements of Comprehensive Income (Loss)
(Dollars in thousands)
 
Three Months Ended 
 June 30,
 
Six Months Ended 
 June 30,
 
2018
 
2017
 
2018
 
2017
Net income
$
111,341

 
$
85,553

 
$
217,821

 
$
170,494

Other comprehensive income (loss), before tax:
 
 
 
 
 
 
 
Securities available for sale and transferred securities:
 
 
 
 
 
 
 
Change in net unrealized gain/loss during the period
(11,884
)
 
90,390

 
(190,788
)
 
124,201

Change in net unrealized gain on securities transferred to held to maturity
(2,041
)
 
(3,860
)
 
(4,660
)
 
(10,146
)
Reclassification adjustment for net (gains) losses included in net income
60

 
50

 
79

 
50

Total securities available for sale and transferred securities
(13,865
)
 
86,580

 
(195,369
)
 
114,105

Defined-benefit post-retirement benefit plans:
 
 
 
 
 
 
 
Change in the net actuarial gain/loss

 

 

 

Reclassification adjustment for net amortization of actuarial gain/loss included in net income as a component of net periodic cost (benefit)
1,251

 
1,358

 
2,501

 
2,715

Total defined-benefit post-retirement benefit plans
1,251

 
1,358

 
2,501

 
2,715

Other comprehensive income (loss), before tax
(12,614
)
 
87,938

 
(192,868
)
 
116,820

Deferred tax expense (benefit)
(2,649
)
 
30,778

 
(40,502
)
 
40,887

Other comprehensive income (loss), net of tax
(9,965
)
 
57,160

 
(152,366
)
 
75,933

Comprehensive income (loss)
$
101,376

 
$
142,713

 
$
65,455

 
$
246,427

See Notes to Consolidated Financial Statements.

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Table of Contents

Cullen/Frost Bankers, Inc.
Consolidated Statements of Changes in Shareholders’ Equity
(Dollars in thousands, except per share amounts)
 
Six Months Ended 
 June 30,
 
2018
 
2017
Total shareholders’ equity at beginning of period
$
3,297,863

 
$
3,002,528

Cumulative effect of accounting change
(2,285
)
 

Total shareholders' equity at beginning of period, as adjusted
3,295,578

 
3,002,528

Net income
217,821

 
170,494

Other comprehensive income (loss)
(152,366
)
 
75,933

Stock option exercises/stock unit conversions (428,599 shares in 2018 and 752,075 shares in 2017)
25,448

 
44,149

Stock compensation expense recognized in earnings
6,760

 
6,291

Purchase of treasury stock (601 shares in 2018 and 469 shares in 2017)
(70
)
 
(42
)
Cash dividends – preferred stock (approximately $0.67 per share in both 2018 and in 2017)
(4,031
)
 
(4,031
)
Cash dividends – common stock ($1.24 per share in 2018 and $1.11 per share in 2017)
(79,628
)
 
(71,393
)
Total shareholders’ equity at end of period
$
3,309,512

 
$
3,223,929

See Notes to Consolidated Financial Statements.


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Table of Contents

Cullen/Frost Bankers, Inc.
Consolidated Statements of Cash Flows
(Dollars in thousands)
 
Six Months Ended 
 June 30,
 
2018
 
2017
Operating Activities:
 
 
 
Net income
$
217,821

 
$
170,494

Adjustments to reconcile net income to net cash from operating activities:
 
 
 
Provision for loan losses
15,196

 
16,378

Deferred tax expense (benefit)
22,886

 
(4,173
)
Accretion of loan discounts
(6,904
)
 
(7,403
)
Securities premium amortization (discount accretion), net
48,936

 
43,652

Net (gain) loss on securities transactions
79

 
50

Depreciation and amortization
24,581

 
24,055

Net (gain) loss on sale/write-down of assets/foreclosed assets
(5,453
)
 
(1,383
)
Stock-based compensation
6,760

 
6,291

Net tax benefit from stock-based compensation
3,160

 
5,579

Earnings on life insurance policies
(1,663
)
 
(1,565
)
Net change in:
 
 
 
Trading account securities
(2,263
)
 
(7,120
)
Accrued interest receivable and other assets
(42,959
)
 
(20,116
)
Accrued interest payable and other liabilities
(26,176
)
 
(36,277
)
Net cash from operating activities
254,001

 
188,462

 
 
 
 
Investing Activities:
 
 
 
Securities held to maturity:
 
 
 
Purchases
(1,500
)
 

Sales

 

Maturities, calls and principal repayments
183,140

 
634,874

Securities available for sale:
 
 
 
Purchases
(11,453,662
)
 
(8,825,545
)
Sales
10,890,388

 
8,247,439

Maturities, calls and principal repayments
108,316

 
164,182

Proceeds from sale of loans
18,918

 

Net change in loans
(601,101
)
 
(549,408
)
Benefits received on life insurance policies
384

 
462

Proceeds from sales of premises and equipment
12,844

 
1,550

Purchases of premises and equipment
(45,766
)
 
(14,481
)
Proceeds from sales of repossessed properties
986

 
345

Net cash from investing activities
(887,053
)
 
(340,582
)
 
 
 
 
Financing Activities:
 
 
 
Net change in deposits
(875,890
)
 
(198,002
)
Net change in short-term borrowings
(170,354
)
 
(52,125
)
Proceeds from issuance of subordinated notes

 
98,434

Principal payments on subordinated notes

 
(100,000
)
Proceeds from stock option exercises
25,448

 
44,149

Purchase of treasury stock
(70
)
 
(42
)
Cash dividends paid on preferred stock
(4,031
)
 
(4,031
)
Cash dividends paid on common stock
(79,628
)
 
(71,393
)
Net cash from financing activities
(1,104,525
)
 
(283,010
)
 
 
 
 
Net change in cash and cash equivalents
(1,737,577
)
 
(435,130
)
Cash and cash equivalents at beginning of period
5,053,047

 
4,141,445

Cash and cash equivalents at end of period
$
3,315,470

 
$
3,706,315


See Notes to Consolidated Financial Statements.

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Table of Contents

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. The terms “Cullen/Frost,” “the Corporation,” “we,” “us” and “our” mean Cullen/Frost Bankers, Inc. and its subsidiaries, when appropriate. In addition to general commercial and consumer banking, other products and services offered include trust and investment management, insurance, brokerage, mutual funds, leasing, treasury management, capital markets advisory 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. All significant intercompany balances and transactions have been eliminated in consolidation. The accounting and financial reporting policies we follow 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 our 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 our consolidated financial statements, and notes thereto, for the year ended December 31, 2017, included in our Annual Report on Form 10-K filed with the SEC on February 7, 2018 (the “2017 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 and 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:
 
Six Months Ended 
 June 30,
 
2018
 
2017
Cash paid for interest
$
31,962

 
$
6,666

Cash paid for income taxes
3,888

 
22,801

Significant non-cash transactions:
 
 
 
Unsettled purchases/sales of securities
2,186

 
80,586

Loans foreclosed and transferred to other real estate owned and foreclosed assets
2,656

 

Accounting Changes, Reclassifications and Restatements. Certain items in prior financial statements have been reclassified to conform to the current presentation. In addition, we adopted ASU 2018-02, "Income Statement - Reporting Comprehensive Income (Topic 220) - Reclassification of Certain Tax Effects from Accumulated Other Comprehensive Income" as of January 1, 2018. In accordance with ASU 2018-02, we elected to reclassify certain income tax effects related to the change in the U.S. statutory federal income tax rate under the Tax Cuts and Jobs Act, which was enacted on December 22, 2017, from accumulated other comprehensive income to retained earnings. Such amounts, which totaled $9.5 million, related to a net actuarial loss on defined benefit post-retirement plans and unrealized gains on securities available for sale and securities transferred to held to maturity. See Note 14 - Other Comprehensive Income. The effects of the Tax Cuts and Jobs Act on deferred taxes related to amounts initially recorded in accumulated other comprehensive income are provisional. As we finalize the accounting for the tax effects of the Tax Cuts and Jobs Act, additional reclassification adjustments may be recorded in future periods. See Note 13 - Income Taxes. Notwithstanding this election made in accordance with ASU 2018-02, our policy is to release such income tax effects only when the entire portfolio to which the underlying transactions relate is liquidated, sold or extinguished.

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We also adopted ASU 2014-09, "Revenue from Contracts with Customers (Topic 606)” as of January 1, 2018. Using a modified retrospective transition approach for contracts that were not complete as of our adoption, we recognized a cumulative effect reduction to beginning retained earnings totaling $2.3 million. The amount was related to certain revenue streams within trust and investment management fees. Additionally, based on our underlying contracts, ASU 2014-09 requires us to report network costs associated with debit card and ATM transactions netted against the related fee income from such transactions. Previously, such network costs were reported as a component of other non-interest expense. For the three and six months ended June 30, 2018, gross interchange and debit card transaction fees totaled $6.5 million and $12.6 million, respectively, while related network costs totaled $3.0 million and $6.0 million, respectively. On a net basis, we reported $3.4 million and $6.6 million as interchange and debit card transaction fees in the accompanying Consolidated Statement of Income for the three and six months ended June 30, 2018, respectively. For the three and six months ended June 30, 2017, we reported interchange and debit card transaction fees totaling $5.7 million and $11.3 million, respectively, on a gross basis in the accompanying Consolidated Statement of Income while related network costs totaling $2.9 million and $6.1 million were reported as a component of other non-interest expense for the three and six months ended June 30, 2017, respectively. ASU 2014-09 also required us to change the way we recognize certain recurring revenue streams reported as components of trust and investment management fees, insurance commissions and fees and other categories of non-interest income, however, such changes were not significant to our financial statements for the six months ended June 30, 2018.
Under ASU 2014-09, we adopted new policies related to revenue recognition. In general, for revenue not associated with financial instruments, guarantees and lease contracts, we apply the following steps when recognizing revenue from contracts with customers: (i) identify the contract, (ii) identify the performance obligations, (iii) determine the transaction price, (iv) allocate the transaction price to the performance obligations and (v) recognize revenue when performance obligation is satisfied. Our contracts with customers are generally short term in nature, typically due within one year or less or cancellable by us or our customer upon a short notice period. Performance obligations for our customer contracts are generally satisfied at a single point in time, typically when the transaction is complete, or over time. For performance obligations satisfied over time, we primarily use the output method, directly measuring the value of the products/services transferred to the customer, to determine when performance obligations have been satisfied. We typically receive payment from customers and recognize revenue concurrent with the satisfaction of our performance obligations. In most cases, this occurs within a single financial reporting period. For payments received in advance of the satisfaction of performance obligations, revenue recognition is deferred until such time the performance obligations have been satisfied. In cases where we have not received payment despite satisfaction of our performance obligations, we accrue an estimate of the amount due in the period our performance obligations have been satisfied. For contracts with variable components, only amounts for which collection is probable are accrued. We generally act in a principal capacity, on our own behalf, in most of our contracts with customers. In such transactions, we recognize revenue and the related costs to provide our services on a gross basis in our financial statements. In some cases, we act in an agent capacity, deriving revenue through assisting other entities in transactions with our customers. In such transactions, we recognized revenue and the related costs to provide our services on a net basis in our financial statements. These transactions primarily relate to insurance and brokerage commissions and fees derived from our customers' use of various interchange and ATM/debit card networks.

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Note 2 - Securities
Securities. A summary of the amortized cost and estimated fair value of securities, excluding trading securities, is presented below.
 
June 30, 2018
 
December 31, 2017
 
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
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Residential mortgage-backed securities
$
3,317

 
$
9

 
$
73

 
$
3,253

 
$
3,610

 
$
15

 
$
38

 
$
3,587

States and political subdivisions
1,231,694

 
13,100

 
2,394

 
1,242,400

 
1,428,488

 
26,462

 
2,746

 
1,452,204

Other
1,500

 

 
10

 
1,490

 

 

 

 

Total
$
1,236,511

 
$
13,109

 
$
2,477

 
$
1,247,143

 
$
1,432,098

 
$
26,477

 
$
2,784

 
$
1,455,791

Available for Sale
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
U.S. Treasury
$
3,454,387

 
$

 
$
44,306

 
$
3,410,081

 
$
3,453,391

 
$
7,494

 
$
15,732

 
$
3,445,153

Residential mortgage-backed securities
625,897

 
13,540

 
7,779

 
631,658

 
648,288

 
19,048

 
2,250

 
665,086

States and political subdivisions
6,626,495

 
71,701

 
64,807

 
6,633,389

 
6,185,711

 
167,293

 
16,795

 
6,336,209

Other
42,615

 

 

 
42,615

 
42,561

 

 

 
42,561

Total
$
10,749,394

 
$
85,241

 
$
116,892

 
$
10,717,743

 
$
10,329,951

 
$
193,835

 
$
34,777

 
$
10,489,009

All mortgage-backed securities included in the above table were issued by U.S. government agencies and corporations. At June 30, 2018, approximately 98.3% of the securities in our municipal bond portfolio were issued by political subdivisions or agencies within the State of Texas, of which approximately 67.9% are either guaranteed by the Texas Permanent School Fund, which has a “triple A” insurer financial strength rating, or are secured by U.S. Treasury securities via defeasance of the debt by the issuers. Securities with limited marketability and that do not have readily determinable fair values are carried at cost minus impairment, if any, plus or minus changes resulting from observable price changes in orderly transactions for identical or similar securities of the same issuer. These securities include stock in the Federal Reserve Bank and the Federal Home Loan Bank and are reported as other available for sale securities in the table above. 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 $3.3 billion at June 30, 2018 and $3.8 billion at December 31, 2017.
During the fourth quarter of 2012, we reclassified certain securities from available for sale to held to maturity. The securities had an aggregate fair value of $2.3 billion with an aggregate net unrealized gain of $165.7 million ($107.7 million, net of tax) on the date of the transfer. The net unamortized, unrealized gain on the remaining transferred securities included in accumulated other comprehensive income in the accompanying balance sheet as of June 30, 2018 totaled $6.9 million ($5.4 million, net of tax). This amount will be amortized out of accumulated other comprehensive income over the remaining life of the underlying securities as an adjustment of the yield on those securities.
Unrealized Losses. As of June 30, 2018, securities with unrealized losses, segregated by length of impairment, were as follows:
 
Less than 12 Months
 
More than 12 Months
 
Total
 
Estimated
Fair Value
 
Unrealized
Losses
 
Estimated
Fair Value
 
Unrealized
Losses
 
Estimated
Fair Value
 
Unrealized
Losses
Held to Maturity
 
 
 
 
 
 
 
 
 
 
 
Residential mortgage-backed securities
$
1,103

 
$
25

 
$
1,392

 
$
48

 
$
2,495

 
$
73

States and political subdivisions
232,707

 
633

 
44,490

 
1,761

 
277,197

 
2,394

Other
1,490

 
10

 

 

 
1,490

 
10

Total
$
235,300

 
$
668

 
$
45,882

 
$
1,809

 
$
281,182

 
$
2,477

Available for Sale
 
 
 
 
 
 
 
 
 
 
 
U.S. Treasury
$
2,841,825

 
$
34,887

 
$
568,256

 
$
9,419

 
$
3,410,081

 
$
44,306

Residential mortgage-backed securities
238,548

 
4,687

 
58,923

 
3,092

 
297,471

 
7,779

States and political subdivisions
1,907,610

 
25,535

 
813,864

 
39,272

 
2,721,474

 
64,807

Total
$
4,987,983

 
$
65,109

 
$
1,441,043

 
$
51,783

 
$
6,429,026

 
$
116,892


10

Table of Contents

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 our ability to retain our 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 we expect to receive full value for the securities. Furthermore, as of June 30, 2018, 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 we will not have to sell any such securities before a recovery of cost. Any unrealized losses are 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 securities 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 June 30, 2018, management believes the impairments detailed in the table above are temporary and no impairment loss has been realized in our consolidated income statement.
Contractual Maturities. The amortized cost and estimated fair value of securities, excluding trading securities, at June 30, 2018 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.
 
Held to Maturity
 
Available for Sale
 
Amortized
Cost
 
Estimated
Fair Value
 
Amortized
Cost
 
Estimated
Fair Value
Due in one year or less
$
138,403

 
$
140,001

 
$
400,123

 
$
398,992

Due after one year through five years
134,389

 
136,874

 
3,739,862

 
3,705,611

Due after five years through ten years
448,447

 
450,758

 
480,038

 
481,384

Due after ten years
511,955

 
516,257

 
5,460,859

 
5,457,483

Residential mortgage-backed securities
3,317

 
3,253

 
625,897

 
631,658

Equity securities

 

 
42,615

 
42,615

Total
$
1,236,511

 
$
1,247,143

 
$
10,749,394

 
$
10,717,743

Sales of Securities. Sales of securities available for sale were as follows:
 
Three Months Ended 
 June 30,
 
Six Months Ended 
 June 30,
 
2018
 
2017
 
2018
 
2017
Proceeds from sales
$
7,905,521

 
$
8,247,439

 
$
10,890,388

 
$
8,247,439

Gross realized gains
3

 

 
3

 

Gross realized losses
(63
)
 
(50
)
 
(82
)
 
(50
)
Tax (expense) benefit of securities gains/losses
13

 
18

 
17

 
18

Premiums and Discounts. Premium amortization and discount accretion included in interest income on securities was as follows:
 
Three Months Ended 
 June 30,
 
Six Months Ended 
 June 30,
 
2018
 
2017
 
2018
 
2017
Premium amortization
$
(26,689
)
 
$
(24,119
)
 
$
(52,723
)
 
$
(48,147
)
Discount accretion
2,010

 
2,105

 
3,787

 
4,495

Net (premium amortization) discount accretion
$
(24,679
)
 
$
(22,014
)
 
$
(48,936
)
 
$
(43,652
)
Trading Account Securities. Trading account securities, at estimated fair value, were as follows:
 
June 30,
2018
 
December 31,
2017
U.S. Treasury
$
20,755

 
$
19,210

States and political subdivisions
579

 
1,888

Total
$
21,334

 
$
21,098


11

Table of Contents

Net gains and losses on trading account securities were as follows:
 
Three Months Ended 
 June 30,
 
Six Months Ended 
 June 30,
 
2018
 
2017
 
2018
 
2017
Net gain on sales transactions
$
434

 
$
293

 
$
939

 
$
604

Net mark-to-market gains (losses)
23

 
(56
)
 
(13
)
 
(43
)
Net gain (loss) on trading account securities
$
457

 
$
237

 
$
926

 
$
561

Note 3 - Loans
Loans were as follows:
 
June 30,
2018
 
Percentage
of Total
 
December 31,
2017
 
Percentage
of Total
Commercial and industrial
$
5,043,272

 
36.8
%
 
$
4,792,388

 
36.4
%
Energy:
 
 
 
 
 
 
 
Production
1,211,261

 
8.8

 
1,182,326

 
9.0

Service
163,013

 
1.2

 
171,795

 
1.3

Other
153,754

 
1.1

 
144,972

 
1.1

Total energy
1,528,028

 
11.1

 
1,499,093

 
11.4

Commercial real estate:
 
 
 
 
 
 
 
Commercial mortgages
4,097,255

 
29.9

 
3,887,742

 
29.6

Construction
1,106,999

 
8.1

 
1,066,696

 
8.1

Land
305,585

 
2.2

 
331,986

 
2.5

Total commercial real estate
5,509,839

 
40.2

 
5,286,424

 
40.2

Consumer real estate:
 
 
 
 
 
 
 
Home equity loans
352,243

 
2.6

 
355,342

 
2.7

Home equity lines of credit
321,795

 
2.3

 
291,950

 
2.2

Other
400,661

 
3.0

 
376,002

 
2.9

Total consumer real estate
1,074,699

 
7.9

 
1,023,294

 
7.8

Total real estate
6,584,538

 
48.1

 
6,309,718

 
48.0

Consumer and other
555,924

 
4.0

 
544,466

 
4.2

Total loans
$
13,711,762

 
100.0
%
 
$
13,145,665

 
100.0
%
Concentrations of Credit. Most of our 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 our loan portfolio consists of commercial and industrial and commercial real estate loans. As of June 30, 2018, there were no concentrations of loans related to any single industry in excess of 10% of total loans other than energy loans, which totaled 11.1% of total loans. Unfunded commitments to extend credit and standby letters of credit issued to customers in the energy industry totaled $1.1 billion and $47.6 million, respectively, as of June 30, 2018.
Foreign Loans. We have 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 June 30, 2018 or December 31, 2017.
Related Party Loans. In the ordinary course of business, we have granted loans to certain directors, executive officers and their affiliates (collectively referred to as “related parties”). Such loans totaled $213.2 million at June 30, 2018 and $166.4 million at December 31, 2017.

12

Table of Contents

Non-Accrual and Past Due Loans. Non-accrual loans, segregated by class of loans, were as follows:
 
June 30,
2018
 
December 31,
2017
Commercial and industrial
$
17,306

 
$
46,186

Energy
79,963

 
94,302

Commercial real estate:
 
 
 
Buildings, land and other
19,415

 
7,589

Construction

 

Consumer real estate
872

 
2,109

Consumer and other
1,625

 
128

Total
$
119,181

 
$
150,314

As of June 30, 2018, non-accrual loans reported in the table above included $843 thousand related to loans that were restructured as “troubled debt restructurings” during 2018. See the section captioned “Troubled Debt Restructurings” elsewhere in this note.
Had non-accrual loans performed in accordance with their original contract terms, we would have recognized additional interest income, net of tax, of approximately $1.4 million and $2.9 million for the three and six months ended June 30, 2018, compared to $798 thousand and $1.6 million for the three and six months ended June 30, 2017.
An age analysis of past due loans (including both accruing and non-accruing loans), segregated by class of loans, as of June 30, 2018 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
$
19,560

 
$
14,656

 
$
34,216

 
$
5,009,056

 
$
5,043,272

 
$
5,842

Energy
3,775

 
19,914

 
23,689

 
1,504,339

 
1,528,028

 
5,878

Commercial real estate:
 
 
 
 
 
 
 
 
 
 
 
Buildings, land and other
14,208

 
23,300

 
37,508

 
4,365,332

 
4,402,840

 
9,055

Construction
615

 

 
615

 
1,106,384

 
1,106,999

 

Consumer real estate
6,399

 
1,959

 
8,358

 
1,066,341

 
1,074,699

 
1,617

Consumer and other
3,710

 
608

 
4,318

 
551,606

 
555,924

 
608

Total
$
48,267

 
$
60,437

 
$
108,704

 
$
13,603,058

 
$
13,711,762

 
$
23,000

Impaired Loans. Impaired loans are set forth in the following table. No interest income was recognized on impaired loans subsequent to their classification as impaired.
 
Unpaid Contractual
Principal
Balance
 
Recorded Investment
With No
Allowance
 
Recorded Investment
With
Allowance
 
Total
Recorded
Investment
 
Related
Allowance
June 30, 2018
 
 
 
 
 
 
 
 
 
Commercial and industrial
$
23,510

 
$
3,710

 
$
11,671

 
$
15,381

 
$
7,667

Energy
90,744

 
19,461

 
60,228

 
79,689

 
14,371

Commercial real estate:
 
 
 
 
 
 

 
 
Buildings, land and other
18,382

 
2,512

 
15,597

 
18,109

 
999

Construction

 

 

 

 

Consumer real estate
293

 
293

 

 
293

 

Consumer and other
1,625

 

 
1,625

 
1,625

 
1,625

Total
$
134,554

 
$
25,976

 
$
89,121

 
$
115,097

 
$
24,662

December 31, 2017
 
 
 
 
 
 
 
 
 
Commercial and industrial
$
60,781

 
$
28,038

 
$
15,722

 
$
43,760

 
$
7,553

Energy
99,606

 
33,080

 
61,162

 
94,242

 
13,267

Commercial real estate:
 
 
 
 
 
 
 
 
 
Buildings, land and other
10,795

 
6,394

 

 
6,394

 

Construction

 

 

 

 

Consumer real estate
1,214

 
1,214

 

 
1,214

 

Consumer and other

 

 

 

 

Total
$
172,396

 
$
68,726

 
$
76,884

 
$
145,610

 
$
20,820


13

Table of Contents

The average recorded investment in impaired loans was as follows:
 
Three Months Ended 
 June 30,
 
Six Months Ended 
 June 30,
 
2018
 
2017
 
2018

2017
Commercial and industrial
$
15,307

 
$
21,347

 
$
24,791

 
$
23,867

Energy
92,380

 
67,008

 
93,001

 
63,860

Commercial real estate:
 
 
 
 
 
 
 
Buildings, land and other
13,867

 
5,966

 
11,376

 
6,266

Construction

 

 

 

Consumer real estate
860

 
1,376

 
978

 
1,135

Consumer and other
813

 
12

 
542

 
18

Total
$
123,227

 
$
95,709

 
$
130,688

 
$
95,146

Troubled Debt Restructurings. Troubled debt restructurings during the six months ended June 30, 2018 and June 30, 2017 are set forth in the following table.
 
Six Months Ended 
 June 30, 2018
 
Six Months Ended 
 June 30, 2017
 
Balance at
Restructure
 
Balance at
Period-End
 
Balance at
Restructure
 
Balance at
Period-End
Commercial and industrial
$
2,203

 
$
843

 
$
784

 
$
643

Energy
13,708

 

 
12,959

 
12,458

 
$
15,911

 
$
843

 
$
13,743

 
$
13,101

Loan modifications are typically related to extending amortization periods, converting loans to interest only for a limited period of time, deferral of interest payments, waiver of certain covenants, consolidating notes and/or reducing collateral or interest rates. The modifications during the reported periods did not significantly impact our determination of the allowance for loan losses.
Additional information related to restructured loans was as follows:
 
June 30, 2018
 
June 30, 2017
Restructured loans past due in excess of 90 days at period-end:
 
 
 
Number of loans

 

Dollar amount of loans
$

 
$

Restructured loans on non-accrual status at period end
843

 
11,405

Charge-offs of restructured loans:
 
 
 
Recognized in connection with restructuring

 

Recognized on previously restructured loans
1,650

 
9,951

Proceeds from sale of restructured loans
13,350

 

Credit Quality Indicators. As part of the on-going monitoring of the credit quality of our 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.
We utilize a risk grading matrix to assign a risk grade to each of our commercial loans. Loans are graded on a scale of 1 to 14. A description of the general characteristics of the 14 risk grades is set forth in our 2017 Form 10-K. In monitoring credit quality trends in the context of assessing the appropriate level of the allowance for loan losses, we monitor 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 reassess the risk grade on at least an annual basis. When a loan has a 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 risk grade of 10 or higher, a special assets officer monitors the loan on an on-going basis.

14

Table of Contents

The following tables present weighted-average risk grades for all commercial loans by class.
 
June 30, 2018
 
December 31, 2017
 
Weighted
Average
Risk Grade
 
Loans
 
Weighted
Average
Risk Grade
 
Loans
Commercial and industrial:
 
 
 
 
 
 
 
Risk grades 1-8
6.10

 
$
4,737,862

 
6.06

 
$
4,378,839

Risk grade 9
9.00

 
110,377

 
9.00

 
170,285

Risk grade 10
10.00

 
117,623

 
10.00

 
99,260

Risk grade 11
11.00

 
60,104

 
11.00

 
97,818

Risk grade 12
12.00

 
9,639

 
12.00

 
38,633

Risk grade 13
13.00

 
7,667

 
13.00

 
7,553

Total
6.33

 
$
5,043,272

 
6.41

 
$
4,792,388

Energy
 
 
 
 
 
 
 
Risk grades 1-8
5.98

 
$
1,288,490

 
6.01

 
$
1,199,207

Risk grade 9
9.00

 
44,181

 
9.00

 
50,427

Risk grade 10
10.00

 
48,115

 
10.00

 
64,282

Risk grade 11
11.00

 
67,279

 
11.00

 
90,875

Risk grade 12
12.00

 
65,591

 
12.00

 
81,035

Risk grade 13
13.00

 
14,372

 
13.00

 
13,267

Total
6.74

 
$
1,528,028

 
6.97

 
$
1,499,093

Commercial real estate:
 
 

 
 
 
 
Buildings, land and other
 
 
 
 
 
 
 
Risk grades 1-8
6.77

 
$
4,071,883

 
6.75

 
$
3,868,659

Risk grade 9
9.00

 
130,689

 
9.00

 
151,487

Risk grade 10
10.00

 
101,505

 
10.00

 
129,391

Risk grade 11
11.00

 
79,348

 
11.00

 
62,602

Risk grade 12
12.00

 
18,416

 
12.00

 
7,589

Risk grade 13
13.00

 
999

 
13.00

 

Total
7.01

 
$
4,402,840

 
7.00

 
$
4,219,728

Construction
 
 
 
 
 
 
 
Risk grades 1-8
7.13

 
$
1,077,422

 
7.11

 
$
1,019,635

Risk grade 9
9.00

 
10,873

 
9.00

 
18,042

Risk grade 10
10.00

 
17,237

 
10.00

 
23,393

Risk grade 11
11.00

 
1,467

 
11.00

 
5,626

Risk grade 12
12.00

 

 
12.00

 

Risk grade 13
13.00

 

 
13.00

 

Total
7.20

 
$
1,106,999

 
7.23

 
$
1,066,696

Net (charge-offs)/recoveries, segregated by class of loans, were as follows:
 
Three Months Ended 
 June 30,
 
Six Months Ended 
 June 30,
 
2018
 
2017
 
2018
 
2017
Commercial and industrial
$
(3,548
)
 
$
(4,861
)
 
$
(11,223
)
 
$
(7,590
)
Energy
(2,076
)
 
(6,236
)
 
(4,925
)
 
(10,461
)
Commercial real estate:
 
 
 
 
 
 
 
Buildings, land and other
(402
)
 
460

 
(321
)
 
502

Construction
6

 
3

 
8

 
6

Consumer real estate
(164
)
 
111

 
(690
)
 
207

Consumer and other
(1,726
)
 
(1,401
)
 
(3,183
)
 
(2,529
)
Total
$
(7,910
)
 
$
(11,924
)
 
$
(20,334
)
 
$
(19,865
)

15

Table of Contents

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, the components of which are more fully described in our 2017 Form 10-K, totaled 129.7 at June 30, 2018 and 129.4 at December 31, 2017. 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 inherent losses that have been incurred within the existing portfolio of loans. The allowance, in the judgment of management, is necessary to reserve for estimated loan losses and risks inherent in the loan portfolio. Our allowance for loan loss methodology, which is more fully described in our 2017 Form 10-K, 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 U.S. bank regulatory agencies. 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.
The following table presents details of the allowance for loan losses allocated to each portfolio segment as of June 30, 2018 and December 31, 2017 and detailed on the basis of the impairment evaluation methodology we used:
 
Commercial
and
Industrial
 
Energy
 
Commercial
Real Estate
 
Consumer
Real Estate
 
Consumer
and Other
 
Total
June 30, 2018
 
 
 
 
 
 
 
 
 
 
 
Historical valuation allowances
$
25,233

 
$
12,117

 
$
20,072

 
$
2,555

 
$
6,779

 
$
66,756

Specific valuation allowances
7,667

 
14,371

 
999

 

 
1,625

 
24,662

General valuation allowances
9,671

 
6,807

 
4,036

 
1,474

 
(114
)
 
21,874

Macroeconomic valuation allowances
15,142

 
4,018

 
13,811

 
2,307

 
1,656

 
36,934

Total
$
57,713

 
$
37,313

 
$
38,918

 
$
6,336

 
$
9,946

 
$
150,226

Allocated to loans:
 
 
 
 
 
 
 
 
 
 
 
Individually evaluated
$
7,667

 
$
14,371

 
$
999

 
$

 
$
1,625

 
$
24,662

Collectively evaluated
50,046

 
22,942

 
37,919

 
6,336

 
8,321

 
125,564

Total
$
57,713

 
$
37,313

 
$
38,918

 
$
6,336

 
$
9,946

 
$
150,226

December 31, 2017
 
 
 
 
 
 
 
 
 
 
 
Historical valuation allowances
$
26,401

 
$
22,073

 
$
18,931

 
$
2,473

 
$
5,603

 
$
75,481

Specific valuation allowances
7,553

 
13,267

 

 

 

 
20,820

General valuation allowances
9,112

 
7,964

 
4,165

 
2,133

 
(91
)
 
23,283

Macroeconomic valuation allowances
16,548

 
8,224

 
7,852

 
1,051

 
2,105

 
35,780

Total
$
59,614

 
$
51,528

 
$
30,948

 
$
5,657

 
$
7,617

 
$
155,364

Allocated to loans:
 
 
 
 
 
 
 
 
 
 
 
Individually evaluated
$
7,553

 
$
13,267

 
$

 
$

 
$

 
$
20,820

Collectively evaluated
52,061

 
38,261

 
30,948

 
5,657

 
7,617

 
134,544

Total
$
59,614

 
$
51,528

 
$
30,948

 
$
5,657

 
$
7,617

 
$
155,364


16

Table of Contents

Our recorded investment in loans as of June 30, 2018 and December 31, 2017 related to each balance in the allowance for loan losses by portfolio segment and detailed on the basis of the impairment methodology we used was as follows:
 
Commercial
and
Industrial
 
Energy
 
Commercial
Real Estate
 
Consumer
Real Estate
 
Consumer
and Other
 
Total
June 30, 2018
 
 
 
 
 
 
 
 
 
 
 
Individually evaluated
$
15,381

 
$
79,689

 
$
18,109

 
$
293

 
$
1,625

 
$
115,097

Collectively evaluated
5,027,891

 
1,448,339

 
5,491,730

 
1,074,406

 
554,299

 
13,596,665

Total
$
5,043,272

 
$
1,528,028

 
$
5,509,839

 
$
1,074,699

 
$
555,924

 
$
13,711,762

December 31, 2017
 
 
 
 
 
 
 
 
 
 
 
Individually evaluated
$
43,760

 
$
94,242

 
$
6,394

 
$
1,214

 
$

 
$
145,610

Collectively evaluated
4,748,628

 
1,404,851

 
5,280,030

 
1,022,080

 
544,466

 
13,000,055

Total
$
4,792,388

 
$
1,499,093

 
$
5,286,424

 
$
1,023,294

 
$
544,466

 
$
13,145,665

The following table details activity in the allowance for loan losses by portfolio segment for the three and six months ended June 30, 2018 and 2017. 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
 
Energy
 
Commercial
Real Estate
 
Consumer
Real Estate
 
Consumer
and Other
 
Total
Three months ended:
 
 
 
 
 
 
 
 
 
 
 
June 30, 2018
 
 
 
 
 
 
 
 
 
 
 
Beginning balance
$
57,733

 
$
39,039

 
$
38,474

 
$
6,349

 
$
8,290

 
$
149,885

Provision for loan losses
3,528

 
350

 
840

 
151

 
3,382

 
8,251

Charge-offs
(4,153
)
 
(2,689
)
 
(614
)
 
(482
)
 
(3,994
)
 
(11,932
)
Recoveries
605

 
613

 
218

 
318

 
2,268

 
4,022

Net charge-offs
(3,548
)
 
(2,076
)
 
(396
)
 
(164
)
 
(1,726
)
 
(7,910
)
Ending balance
$
57,713

 
$
37,313

 
$
38,918

 
$
6,336

 
$
9,946

 
$
150,226

June 30, 2017
 
 
 
 
 
 
 
 
 
 
 
Beginning balance
$
45,583

 
$
61,793

 
$
34,009

 
$
4,823

 
$
6,848

 
$
153,056

Provision for loan losses
8,184

 
(1,280
)
 
(1,470
)
 
601

 
2,391

 
8,426

Charge-offs
(5,579
)
 
(6,317
)
 
(14
)
 
(2
)
 
(3,623
)
 
(15,535
)
Recoveries
718

 
81

 
477

 
113

 
2,222

 
3,611

Net charge-offs
(4,861
)
 
(6,236
)
 
463

 
111

 
(1,401
)
 
(11,924
)
Ending balance
$
48,906

 
$
54,277

 
$
33,002

 
$
5,535

 
$
7,838

 
$
149,558

 
 
 
 
 
 
 
 
 
 
 
 
Six months ended:
 
 
 
 
 
 
 
 
 
 
 
June 30, 2018
 
 
 
 
 
 
 
 
 
 
 
Beginning balance
$
59,614

 
$
51,528

 
$
30,948

 
$
5,657

 
$
7,617

 
$
155,364

Provision for loan losses
9,322

 
(9,290
)
 
8,283

 
1,369

 
5,512

 
15,196

Charge-offs
(13,405
)
 
(5,539
)
 
(619
)
 
(1,201
)
 
(7,966
)
 
(28,730
)
Recoveries
2,182

 
614

 
306

 
511

 
4,783

 
8,396

Net charge-offs
(11,223
)
 
(4,925
)
 
(313
)
 
(690
)
 
(3,183
)
 
(20,334
)
Ending balance
$
57,713

 
$
37,313

 
$
38,918

 
$
6,336

 
$
9,946

 
$
150,226

June 30, 2017
 
 
 
 
 
 
 
 
 
 
 
Beginning balance
$
52,915

 
$
60,653

 
$
30,213

 
$
4,238

 
$
5,026

 
$
153,045

Provision for loan losses
3,581

 
4,085

 
2,281

 
1,090

 
5,341

 
16,378

Charge-offs
(9,106
)
 
(10,595
)
 
(14
)
 
(13
)
 
(7,171
)
 
(26,899
)
Recoveries
1,516

 
134

 
522

 
220

 
4,642

 
7,034

Net charge-offs
(7,590
)
 
(10,461
)
 
508

 
207

 
(2,529
)
 
(19,865
)
Ending balance
$
48,906

 
$
54,277

 
$
33,002

 
$
5,535

 
$
7,838

 
$
149,558


17

Table of Contents

Note 4 - Goodwill and Other Intangible Assets
Goodwill and other intangible assets are presented in the table below.
 
June 30,
2018
 
December 31,
2017
Goodwill
$
654,952

 
$
654,952

Other intangible assets:
 
 
 
Core deposits
$
3,466

 
$
4,044

Customer relationships
819

 
986

Non-compete agreements
31

 
43

 
$
4,316

 
$
5,073

The estimated aggregate future amortization expense for intangible assets remaining as of June 30, 2018 is as follows:
Remainder of 2018
667

2019
1,167

2020
918

2021
697

2022
481

Thereafter
386

 
$
4,316

Note 5 - Deposits
Deposits were as follows:
 
June 30,
2018
 
Percentage
of Total
 
December 31,
2017
 
Percentage
of Total
Non-interest-bearing demand deposits:
 
 
 
 
 
Commercial and individual
$
9,976,325

 
38.4
%
 
$
10,412,882

 
38.8
%
Correspondent banks
198,314

 
0.8

 
222,648

 
0.8

Public funds
351,359

 
1.3

 
561,563

 
2.1

Total non-interest-bearing demand deposits
10,525,998

 
40.5

 
11,197,093

 
41.7

Interest-bearing deposits:
 
 
 
 
 
 
 
Private accounts:
 
 
 
 
 
 
 
Savings and interest checking
6,692,025

 
25.7

 
6,788,766

 
25.2

Money market accounts
7,609,681

 
29.3

 
7,624,471

 
28.4

Time accounts of $100,000 or more
464,134

 
1.8

 
453,668

 
1.7

Time accounts under $100,000
324,195

 
1.2

 
324,636

 
1.2

Total private accounts
15,090,035

 
58.0

 
15,191,541

 
56.5

Public funds:
 
 
 
 
 
 
 
Savings and interest checking
301,225

 
1.2

 
410,140

 
1.5

Money market accounts
65,002

 
0.2

 
59,008

 
0.2

Time accounts of $100,000 or more
13,649

 
0.1

 
14,301

 
0.1

Time accounts under $100,000
590

 

 
306

 

Total public funds
380,466

 
1.5

 
483,755

 
1.8

Total interest-bearing deposits
15,470,501

 
59.5

 
15,675,296

 
58.3

Total deposits
$
25,996,499

 
100.0
%
 
$
26,872,389

 
100.0
%
The following table presents additional information about our deposits:
 
June 30,
2018
 
December 31,
2017
Deposits from foreign sources (primarily Mexico)
$
739,213

 
$
716,339

Deposits not covered by deposit insurance
12,198,682

 
13,281,040


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Note 6 - Commitments and Contingencies
Financial Instruments with Off-Balance-Sheet Risk. In the normal course of business, we enter into various transactions, which, in accordance with generally accepted accounting principles are not included in our consolidated balance sheets. We enter into these transactions to meet the financing needs of our customers. As more fully discussed in our 2017 Form 10-K, 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. We minimize our exposure to loss under these commitments by subjecting them to credit approval and monitoring procedures.
Financial instruments with off-balance-sheet risk were as follows:
 
June 30,
2018
 
December 31,
2017
Commitments to extend credit
$
8,081,645

 
$
7,949,400

Standby letters of credit
240,232

 
236,595

Deferred standby letter of credit fees
1,741

 
1,843

Lease Commitments. We lease certain office facilities and office equipment under operating leases. Rent expense for all operating leases totaled $8.1 million and $16.3 million during the three and six months ended June 30, 2018 and $7.5 million and $15.3 million during the three and six months ended June 30, 2017. There has been no significant change in our expected future minimum lease payments since December 31, 2017. See the 2017 Form 10-K for information regarding these commitments.
Litigation. We are subject to various claims and legal actions that have arisen in the course of conducting business. Management does not expect the ultimate disposition of these matters to have a material adverse impact on our financial statements.
Note 7 - Capital and Regulatory Matters
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.
Cullen/Frost’s and Frost Bank’s Common Equity Tier 1 capital includes common stock and related paid-in capital, net of treasury stock, and retained earnings. In connection with the adoption of the Basel III Capital Rules, we elected to opt-out of the requirement to include most components of accumulated other comprehensive income in Common Equity Tier 1. Common Equity Tier 1 for both Cullen/Frost and Frost Bank is reduced by, goodwill and other intangible assets, net of associated deferred tax liabilities, and subject to transition provisions. Frost Bank's Common Equity Tier 1 is also reduced by its equity investment in its financial subsidiary, Frost Insurance Agency (“FIA”).
Tier 1 capital includes Common Equity Tier 1 capital and additional Tier 1 capital. For Cullen/Frost, additional Tier 1 capital at June 30, 2018 and December 31, 2017 includes $144.5 million of 5.375% non-cumulative perpetual preferred stock. Frost Bank did not have any additional Tier 1 capital beyond Common Equity Tier 1 at June 30, 2018 or December 31, 2017.
Total capital includes Tier 1 capital and Tier 2 capital. Tier 2 capital for both Cullen/Frost and Frost Bank includes a permissible portion of the allowance for loan losses. Tier 2 capital for Cullen/Frost also includes $100.0 million of qualified subordinated debt and $133.0 million of trust preferred securities at both June 30, 2018 and December 31, 2017.

19

Table of Contents

The following tables present actual and required capital ratios as of June 30, 2018 and December 31, 2017 for Cullen/Frost and Frost Bank under the Basel III Capital Rules. The minimum required capital amounts presented include the minimum required capital levels as of June 30, 2018 and December 31, 2017 based on the phase-in provisions of the Basel III Capital Rules and the minimum required capital levels as of January 1, 2019 when the Basel III Capital Rules have been fully phased-in. Capital levels required to be considered well capitalized are based upon prompt corrective action regulations, as amended to reflect the changes under the Basel III Capital Rules. See the 2017 Form 10-K for a more detailed discussion of the Basel III Capital Rules.
 
Actual
 
Minimum Capital Required - Basel III Phase-In Schedule
 
Minimum Capital Required - Basel III Fully Phased-In
 
Required to be
Considered Well
Capitalized
 
Capital
Amount
 
Ratio
 
Capital
Amount
 
Ratio
 
Capital
Amount
 
Ratio
 
Capital
Amount
 
Ratio
June 30, 2018
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Common Equity Tier 1 to Risk-Weighted Assets
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Cullen/Frost
$
2,581,196

 
12.69
%
 
$
1,296,280

 
6.38
%
 
$
1,423,366

 
7.00
%
 
$
1,321,697

 
6.50
%
Frost Bank
2,621,188

 
12.92

 
1,293,055

 
6.38

 
1,419,825

 
7.00

 
1,318,409

 
6.50

Tier 1 Capital to Risk-Weighted Assets
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Cullen/Frost
2,725,682

 
13.40

 
1,601,287

 
7.88

 
1,728,373

 
8.50

 
1,626,704

 
8.00

Frost Bank
2,621,188

 
12.92

 
1,597,304

 
7.88

 
1,724,074

 
8.50

 
1,622,658

 
8.00

Total Capital to Risk-Weighted Assets
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Cullen/Frost
3,109,408

 
15.29

 
2,007,963

 
9.88

 
2,135,049

 
10.50

 
2,033,380

 
10.00

Frost Bank
2,771,914

 
13.67

 
2,002,968

 
9.88

 
2,129,738

 
10.50

 
2,028,322

 
10.00

Leverage Ratio
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Cullen/Frost
2,725,682

 
9.02

 
1,208,770

 
4.00

 
1,208,770

 
4.00

 
1,510,963

 
5.00

Frost Bank
2,621,188

 
8.68

 
1,207,880

 
4.00

 
1,207,880

 
4.00

 
1,509,851

 
5.00

December 31, 2017
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Common Equity Tier 1 to Risk-Weighted Assets
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Cullen/Frost
$
2,426,048

 
12.42
%
 
$
1,123,430

 
5.75
%
 
$
1,367,583

 
7.00
%
 
$
1,269,965

 
6.50
%
Frost Bank
2,518,999

 
12.92

 
1,120,663

 
5.75

 
1,364,214

 
7.00

 
1,266,836

 
6.50

Tier 1 Capital to Risk-Weighted Assets
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Cullen/Frost
2,570,534

 
13.16

 
1,416,499

 
7.25

 
1,660,637

 
8.50

 
1,563,033

 
8.00

Frost Bank
2,518,999

 
12.92

 
1,413,010

 
7.25

 
1,656,546

 
8.50

 
1,559,183

 
8.00

Total Capital to Risk-Weighted Assets
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Cullen/Frost
2,959,326

 
15.15

 
1,807,257

 
9.25

 
2,051,375

 
10.50

 
1,953,792

 
10.00

Frost Bank
2,674,791

 
13.72

 
1,802,805

 
9.25

 
2,046,321

 
10.50

 
1,948,979

 
10.00

Leverage Ratio
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Cullen/Frost
2,570,534

 
8.46

 
1,215,227

 
4.00

 
1,215,186

 
4.00

 
1,519,034

 
5.00

Frost Bank
2,518,999

 
8.30

 
1,214,295

 
4.00

 
1,214,254

 
4.00

 
1,517,869

 
5.00

As of June 30, 2018, capital levels at Cullen/Frost and Frost Bank exceed all capital adequacy requirements under the Basel III Capital Rules on a fully phased-in basis. Based on the ratios presented above, capital levels as of June 30, 2018 at Cullen/Frost and Frost Bank exceed the minimum levels necessary to be considered “well capitalized.”
Cullen/Frost and Frost Bank are subject to the regulatory capital requirements administered by the Federal Reserve Board and, for Frost Bank, 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 our financial statements. Management believes, as of June 30, 2018, that Cullen/Frost and Frost Bank meet all capital adequacy requirements to which they are subject.
Stock Repurchase Plans. From time to time, our board of directors has authorized stock repurchase plans. In general, stock repurchase plans allow us to proactively manage our capital position and return excess capital to shareholders. Shares purchased under such plans also provide us with shares of common stock necessary to satisfy obligations related to stock compensation awards. On October 24, 2017, our board of directors authorized a $150.0 million stock repurchase program, allowing us to

20

Table of Contents

repurchase shares of our common stock over a two-year period from time to time at various prices in the open market or through private transactions. No shares were repurchased under this plan during 2018 or 2017. Under a prior plan, we repurchased 1,134,966 shares under the plan at a total cost of $100.0 million during the third quarter of 2017.
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 June 30, 2018, Frost Bank could pay aggregate dividends of up to $507.2 million to Cullen/Frost without prior regulatory approval.
Under the terms of the junior subordinated deferrable interest debentures that Cullen/Frost has issued to Cullen/Frost Capital Trust II and WNB Capital Trust I, Cullen/Frost has the right at any time during the term of the debentures to defer the payment of interest at any time or from time to time for an extension period not exceeding 20 consecutive quarterly periods with respect to each extension period. In the event that we have elected to defer interest on the debentures, we may not, with certain exceptions, declare or pay any dividends or distributions on our capital stock or purchase or acquire any of our capital stock.
Under the terms of our Series A Preferred Stock, in the event that we do not declare and pay dividends on our Series A Preferred Stock for the most recent dividend period, we may not, with certain exceptions, declare or pay dividends on, or purchase, redeem or otherwise acquire, shares of our common stock or any of our securities that rank junior to our Series A Preferred Stock.
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. We utilize interest rate swaps, caps and floors to mitigate exposure to interest rate risk and to facilitate the needs of our customers. Our objectives for utilizing these derivative instruments are described in our 2017 Form 10-K.
The notional amounts and estimated fair values of interest rate derivative contracts are presented in the following table. The fair values of interest rate derivative contracts are estimated utilizing internal valuation models with observable market data inputs, or as determined by the Chicago Mercantile Exchange (“CME”) for centrally cleared derivative contracts. CME rules legally characterize variation margin payments for centrally cleared derivatives as settlements of the derivatives' exposure rather than collateral. As a result, the variation margin payment and the related derivative instruments are considered a single unit of account for accounting and financial reporting purposes. Variation margin, as determined by the CME, is settled daily. As a result, derivative contracts that clear through the CME have an estimated fair value of zero as of June 30, 2018 and December 31, 2017.
 
June 30, 2018
 
December 31, 2017
 
Notional
Amount
 
Estimated
Fair Value
 
Notional
Amount
 
Estimated
Fair Value
Derivatives designated as hedges of fair value:
 
 
 
 
 
 
 
Financial institution counterparties:
 
 
 
 
 
 
 
Loan/lease interest rate swaps – assets
$
11,596

 
$
310

 
$
13,679

 
$
242

Loan/lease interest rate swaps – liabilities
4,561

 
(247
)
 
11,147

 
(593
)
Non-hedging interest rate derivatives:
 
 
 
 
 
 
 
Financial institution counterparties:
 
 
 
 
 
 
 
Loan/lease interest rate swaps – assets
706,088

 
4,832

 
430,449

 
1,418

Loan/lease interest rate swaps – liabilities
380,596

 
(6,307
)
 
541,496

 
(12,820
)
Loan/lease interest rate caps – assets
97,120

 
851

 
114,619

 
480

Customer counterparties:
 
 
 
 
 
 
 
Loan/lease interest rate swaps – assets
380,596

 
9,472

 
541,496

 
17,882

Loan/lease interest rate swaps – liabilities
706,088

 
(16,806
)
 
430,449

 
(4,861
)
Loan/lease interest rate caps – liabilities
97,120

 
(851
)
 
114,619

 
(480
)

21

Table of Contents

The weighted-average rates paid and received for interest rate swaps outstanding at June 30, 2018 were as follows:
 
Weighted-Average
 
Interest
Rate
Paid
 
Interest
Rate
Received
Interest rate swaps:
 
 
 
Fair value hedge loan/lease interest rate swaps
2.49
%
 
2.05
%
Non-hedging interest rate swaps – financial institution counterparties
4.09
%
 
3.67
%
Non-hedging interest rate swaps – customer counterparties
3.67
%
 
4.09
%
The weighted-average strike rate for outstanding interest rate caps was 3.01% at June 30, 2018.
Commodity Derivatives. We enter into commodity swaps and option contracts that are not designated as hedging instruments primarily to accommodate the business needs of our customers. Upon the origination of a commodity swap or option contract with a customer, we simultaneously enter into an offsetting contract with a third party financial institution to mitigate the exposure to fluctuations in commodity prices.
The notional amounts and estimated fair values of non-hedging commodity swap and option derivative positions outstanding are presented in the following table. We obtain dealer quotations and use internal valuation models with observable market data inputs to value our commodity derivative positions.
 
 
 
June 30, 2018
 
December 31, 2017
 
Notional
Units
 
Notional
Amount
 
Estimated
Fair Value
 
Notional
Amount
 
Estimated
Fair Value
Financial institution counterparties:
 
 
 
 
 
 
 
 
 
Oil – assets
Barrels
 
585

 
$
1,520

 
253

 
$
193

Oil – liabilities
Barrels
 
2,761

 
(30,963
)
 
2,731

 
(13,448
)
Natural gas – assets
MMBTUs
 
6,080

 
548

 
5,927

 
1,399

Natural gas – liabilities
MMBTUs
 
5,600

 
(612
)
 
3,917

 
(326
)
Customer counterparties:
 
 
 
 
 
 
 
 
 
Oil – assets
Barrels
 
2,761

 
30,952

 
2,731

 
13,709

Oil – liabilities
Barrels
 
585

 
(1,518
)
 
253

 
(187
)
Natural gas – assets
MMBTUs
 
5,697

 
623

 
3,917

 
340

Natural gas – liabilities
MMBTUs
 
5,983

 
(538
)
 
5,927

 
(1,366
)
Foreign Currency Derivatives. We enter into foreign currency forward contracts that are not designated as hedging instruments primarily to accommodate the business needs of our customers. Upon the origination of a foreign currency denominated transaction with a customer, we simultaneously enter into an offsetting contract with a third party financial institution to negate the exposure to fluctuations in foreign currency exchange rates. We also utilize foreign currency forward contracts that are not designated as hedging instruments to mitigate the economic effect of fluctuations in foreign currency exchange rates on foreign currency holdings and certain short-term, non-U.S. dollar denominated loans. The notional amounts and fair values of open foreign currency forward contracts were as follows:
 
 
 
June 30, 2018
 
December 31, 2017
 
Notional
Currency
 
Notional
Amount
 
Estimated
Fair Value
 
Notional
Amount
 
Estimated
Fair Value
Financial institution counterparties:
 
 
 
 
 
 
 
 
 
Forward contracts – assets
EUR
 
591

 
$
6

 
4,014

 
$
77

Forward contracts – assets
GBP
 

 

 
127

 
1

Forward contracts – assets
AUD
 
57

 
1

 

 

Forward contracts – liabilities
EUR
 
906

 
(5
)
 
4,846

 
(37
)
Forward contracts – liabilities
CAD
 
22,626

 
(208
)
 
25,413

 
(142
)
Forward contracts – liabilities
GBP
 
1,095

 
(3
)
 
1,178

 
(9
)
Customer counterparties:
 
 
 
 
 
 
 
 
 
Forward contracts – assets
EUR
 
400

 
1

 
3,867

 
58

Forward contracts – assets
CAD
 
22,575

 
262

 
25,282

 
279

Forward contracts – liabilities
EUR
 

 

 
4,041

 
(51
)
Forward contracts – liabilities
GBP
 

 

 
127

 


22

Table of Contents

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 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 
 June 30,
 
Six Months Ended 
 June 30,
 
2018
 
2017
 
2018
 
2017
Commercial loan/lease interest rate swaps:
 
 
 
 
 
 
 
Amount of gain (loss) included in interest income on loans
$
31

 
$
(198
)
 
$
(11
)
 
$
(443
)
Amount of (gain) loss included in other non-interest expense
(1
)
 
(2
)
 
(1
)
 
(3
)
As stated above, we enter into non-hedge related derivative positions primarily to accommodate the business needs of our customers. Upon the origination of a derivative contract with a customer, we simultaneously enter into an offsetting derivative contract with a third party financial institution. We recognize immediate income based upon the difference in the bid/ask spread of the underlying transactions with our customers and the third party. Because we act only as an intermediary for our customer, subsequent changes in the fair value of the underlying derivative contracts for the most part offset each other and do not significantly impact our results of operations.
Amounts included in the consolidated statements of income related to non-hedging interest rate, commodity and foreign currency derivative instruments are presented in the table below.
 
Three Months Ended 
 June 30,
 
Six Months Ended 
 June 30,
 
2018
 
2017
 
2018
 
2017
Non-hedging interest rate derivatives:
 
 
 
 
 
 
 
Other non-interest income
$
702

 
$
607

 
$
2,190

 
$
977

Other non-interest expense
17

 
2

 
(4
)
 
1

Non-hedging commodity derivatives:
 
 
 
 
 
 
 
Other non-interest income
(54
)
 
104

 
36

 
156

Non-hedging foreign currency derivatives:
 
 
 
 
 
 
 
Other non-interest income
91

 
9

 
150

 
18

Counterparty Credit Risk. Our credit exposure relating to interest rate swaps, commodity swaps/options and foreign currency forward contracts with bank customers was approximately $38.9 million at June 30, 2018. This credit exposure is partly mitigated as transactions with customers are generally secured by the collateral, if any, securing the underlying transaction being hedged. Our credit exposure, net of collateral pledged, relating to interest rate swaps, commodity swaps/options and foreign currency forward contracts with upstream financial institution counterparties was approximately $747 thousand at June 30, 2018. This amount was primarily related to excess collateral we posted to counterparties. Collateral levels for upstream financial institution counterparties are monitored and adjusted as necessary. See Note 9 – Balance Sheet Offsetting and Repurchase Agreements for additional information regarding our credit exposure with upstream financial institution counterparties.
The aggregate fair value of securities we posted as collateral related to derivative contracts totaled $6.2 million at June 30, 2018. At such date, we also had $25.7 million in cash collateral on deposit with other financial institution counterparties.

23

Table of Contents

Note 9 - Balance Sheet Offsetting and Repurchase Agreements
Balance Sheet Offsetting. Certain financial instruments, including resell and repurchase agreements and derivatives, may be eligible for offset in the consolidated balance sheet and/or subject to master netting arrangements or similar agreements. Our derivative transactions with upstream financial institution counterparties are generally executed under International Swaps and Derivative Association (“ISDA”) master agreements which include “right of set-off” provisions. In such cases there is generally a legally enforceable right to offset recognized amounts and there may be an intention to settle such amounts on a net basis. Nonetheless, we do not generally offset such financial instruments for financial reporting purposes.
Information about financial instruments that are eligible for offset in the consolidated balance sheet as of June 30, 2018 is presented in the following tables.
 
Gross Amount
Recognized
 
Gross Amount
Offset
 
Net Amount
Recognized
June 30, 2018
 
 
 
 
 
Financial assets:
 
 
 
 
 
Derivatives:
 
 
 
 
 
Loan/lease interest rate swaps and caps
$
5,993

 
$

 
$
5,993

Commodity swaps and options
2,068

 

 
2,068

Foreign currency forward contracts
7

 

 
7

Total derivatives
8,068

 

 
8,068

Resell agreements
9,642

 

 
9,642

Total
$
17,710

 
$

 
$
17,710

Financial liabilities:
 
 
 
 
 
Derivatives:
 
 
 
 
 
Loan/lease interest rate swaps
$
6,554

 
$

 
$
6,554

Commodity swaps and options
31,575

 

 
31,575

Foreign currency forward contracts
216

 

 
216

Total derivatives
38,345

 

 
38,345

Repurchase agreements
968,420

 

 
968,420

Total
$
1,006,765

 
$

 
$
1,006,765

 
 
 
Gross Amounts Not Offset
 
 
 
Net Amount
Recognized
 
Financial
Instruments
 
Collateral
 
Net
Amount
June 30, 2018
 
 
 
 
 
 
 
Financial assets:
 
 
 
 
 
 
 
Derivatives:
 
 
 
 
 
 
 
Counterparty A
$
1,234

 
$
(1,234
)
 
$

 
$

Counterparty B
2,211

 
(2,211
)
 

 

Counterparty C
77

 
(77
)
 

 

Other counterparties
4,546

 
(1,448
)
 
(2,873
)
 
225

Total derivatives
8,068

 
(4,970
)
 
(2,873
)
 
225

Resell agreements
9,642

 

 
(9,642
)
 

Total
$
17,710

 
$
(4,970
)
 
$
(12,515
)
 
$
225

Financial liabilities:
 
 
 
 
 
 
 
Derivatives:
 
 
 
 
 
 
 
Counterparty A
$
4,660

 
$
(1,234
)
 
$
(3,426
)
 
$

Counterparty B
5,333

 
(2,211
)
 
(2,358
)
 
764

Counterparty C
1,195

 
(77
)
 
(1,040
)
 
78

Other counterparties
27,157

 
(1,448
)
 
(24,532
)
 
1,177

Total derivatives
38,345

 
(4,970
)
 
(31,356
)
 
2,019

Repurchase agreements
968,420

 

 
(968,420
)
 

Total
$
1,006,765

 
$
(4,970
)
 
$
(999,776
)
 
$
2,019


24

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Information about financial instruments that are eligible for offset in the consolidated balance sheet as of December 31, 2017 is presented in the following tables.
 
Gross Amount
Recognized
 
Gross Amount
Offset
 
Net Amount
Recognized
December 31, 2017
 
 
 
 
 
Financial assets:
 
 
 
 
 
Derivatives:
 
 
 
 
 
Loan/lease interest rate swaps and caps
$
2,140

 
$

 
$
2,140

Commodity swaps and options
1,592

 

 
1,592

Foreign currency forward contracts
78

 

 
78

Total derivatives
3,810

 

 
3,810

Resell agreements
9,642

 

 
9,642

Total
$
13,452

 
$

 
$
13,452

Financial liabilities:
 
 
 
 
 
Derivatives:
 
 
 
 
 
Loan/lease interest rate swaps
$
13,413

 
$

 
$
13,413

Commodity swaps and options
13,774

 

 
13,774

Foreign currency forward contracts
188

 

 
188

Total derivatives
27,375

 

 
27,375

Repurchase agreements
1,117,199

 

 
1,117,199

Total
$
1,144,574

 
$

 
$
1,144,574

 
 
 
Gross Amounts Not Offset
 
 
 
Net Amount
Recognized
 
Financial
Instruments
 
Collateral
 
Net
Amount
December 31, 2017
 
 
 
 
 
 
 
Financial assets:
 
 
 
 
 
 
 
Derivatives:
 
 
 
 
 
 
 
Counterparty A
$
395

 
$
(395
)
 
$

 
$

Counterparty B
1,028

 
(1,028
)
 

 

Counterparty C
55

 
(55
)
 

 

Other counterparties
2,332

 
(1,830
)
 
(387
)
 
115

Total derivatives
3,810

 
(3,308
)
 
(387
)
 
115

Resell agreements
9,642

 

 
(9,642
)
 

Total
$
13,452

 
$
(3,308
)
 
$
(10,029
)
 
$
115

Financial liabilities:
 
 
 
 
 
 
 
Derivatives:
 
 
 
 
 
 
 
Counterparty A
$
7,397

 
$
(395
)
 
$
(7,002
)
 
$

Counterparty B
4,466

 
(1,028
)
 
(3,101
)
 
337

Counterparty C
1,520

 
(55
)
 
(1,450
)
 
15

Other counterparties
13,992

 
(1,830
)
 
(11,215
)
 
947

Total derivatives
27,375

 
(3,308
)
 
(22,768
)
 
1,299

Repurchase agreements
1,117,199

 

 
(1,117,199
)
 

Total
$
1,144,574

 
$
(3,308
)
 
$
(1,139,967
)
 
$
1,299


25

Table of Contents

Repurchase Agreements. We utilize securities sold under agreements to repurchase to facilitate the needs of our customers and to facilitate secured short-term funding needs. Securities sold under agreements to repurchase are stated at the amount of cash received in connection with the transaction. We monitor collateral levels on a continuous basis. We may be required to provide additional collateral based on the fair value of the underlying securities. Securities pledged as collateral under repurchase agreements are maintained with our safekeeping agents.
The remaining contractual maturity of repurchase agreements in the consolidated balance sheets as of June 30, 2018 and December 31, 2017 is presented in the following tables.
 
Remaining Contractual Maturity of the Agreements
 
Overnight and Continuous
 
Up to 30 Days
 
30-90 Days
 
Greater than 90 Days
 
Total
June 30, 2018
 
 
 
 
 
 
 
 
 
Repurchase agreements:
 
 
 
 
 
 
 
 
 
U.S. Treasury
$
956,963

 
$

 
$

 
$

 
$
956,963

Residential mortgage-backed securities
11,457

 

 

 

 
11,457

Total borrowings
$
968,420

 
$

 
$

 
$

 
$
968,420

Gross amount of recognized liabilities for repurchase agreements
 
$
968,420

Amounts related to agreements not included in offsetting disclosures above
 
$

 
 
 
 
 
 
 
 
 
 
December 31, 2017
 
 
 
 
 
 
 
 
 
Repurchase agreements:
 
 
 
 
 
 
 
 
 
U.S. Treasury
$
1,036,891

 
$

 
$

 
$

 
$
1,036,891

Residential mortgage-backed securities
80,308

 

 

 

 
80,308

Total borrowings
$
1,117,199

 
$

 
$

 
$

 
$
1,117,199

Gross amount of recognized liabilities for repurchase agreements
 
$
1,117,199

Amounts related to agreements not included in offsetting disclosures above
 
$

Note 10 - Stock-Based Compensation
A combined summary of activity in our active stock plans is presented in the table. Performance stock units outstanding are presented assuming attainment of the maximum payout rate as set forth by the performance criteria. As of June 30, 2018, there were 1,409,473 shares remaining available for grant for future stock-based compensation awards.
 
 
Director Deferred
Stock Units
Outstanding
 
Non-Vested Stock
Awards/Stock Units
Outstanding
 
Performance Stock Units Outstanding
 
Stock Options
Outstanding
 
 
Number of Units
 
Weighted-
Average
Fair Value
at Grant
 
Number
of Shares/Units
 
Weighted-
Average
Fair Value
at Grant
 
Number of Units
 
Weighted-
Average
Fair Value
at Grant
 
Number
of Shares
 
Weighted-
Average
Exercise
Price
Balance, January 1, 2018
 
53,008

 
$
64.87

 
312,656

 
$
81.71

 
80,103

 
$
79.91

 
2,917,142

 
$
63.34

Authorized
 

 

 

 

 

 

 

 

Granted
 
6,576

 
109.58

 

 

 

 

 

 

Exercised/vested
 
(10,674
)
 
63.68

 
(2,470
)
 
78.92

 

 

 
(415,455
)
 
61.25

Forfeited/expired
 

 

 
(4,424
)
 
87.24

 

 

 
(43,875
)
 
70.19

Balance, June 30, 2018
 
48,910

 
$
71.14

 
305,762

 
$
81.65

 
80,103

 
$
79.91

 
2,457,812

 
$
63.57


26

Table of Contents

Shares issued in connection with stock compensation awards are issued from available treasury shares. If no treasury shares are available, new shares are issued from available authorized shares. Shares issued in connection with stock compensation awards along with other related information were as follows:
 
Three Months Ended 
 June 30,
 
Six Months Ended 
 June 30,
 
2018
 
2017
 
2018
 
2017
New shares issued from available authorized shares

 
310,021

 

 
593,363

Issued from available treasury stock
110,489

 

 
428,599

 
158,712

Total
110,489

 
310,021

 
428,599

 
752,075

 
 
 
 
 
 
 
 
Proceeds from stock option exercises
$
6,283

 
$
19,402

 
$
25,448

 
$
44,149

Stock-based compensation expense is recognized ratably over the requisite service period for all awards. For most stock option awards, the service period generally matches the vesting period. For stock options granted to certain executive officers and for non-vested stock units granted to all participants, the service period does not extend past the date the participant reaches 65 years of age. Deferred stock units granted to non-employee directors generally have immediate vesting and the related expense is fully recognized on the date of grant. For performance stock units, the service period generally matches the three-year performance period specified by the award, however, the service period does not extend past the date the participant reaches 65 years of age. Expense recognized each period is dependent upon our estimate of the number of shares that will ultimately be issued.
Stock-based compensation expense and the related income tax benefit is presented in the following table.
 
Three Months Ended 
 June 30,
 
Six Months Ended 
 June 30,
 
2018
 
2017
 
2018
 
2017
Stock options
$
1,019

 
$
1,573

 
$
2,104

 
$
3,360

Non-vested stock awards/stock units
1,371

 
901

 
2,839

 
1,934

Director deferred stock units
720

 
519

 
720

 
519

Performance stock units
475

 
195

 
1,097

 
478

Total
$
3,585

 
$
3,188

 
$
6,760

 
$
6,291

Income tax benefit
$
753

 
$
1,116

 
$
1,420

 
$
2,202

Unrecognized stock-based compensation expense at June 30, 2018 is presented in the table below. Unrecognized stock-based compensation expense related to performance stock units is presented assuming attainment of the maximum payout rate as set forth by the performance criteria.
Stock options
$
2,943

Non-vested stock awards/stock units
11,728

Performance stock units
4,033

Total
$
18,704


27

Table of Contents

Note 11 - Earnings Per Common Share
Earnings per common share is computed using the two-class method as more fully described in our 2017 Form 10-K. The following table presents a reconciliation of net income available to common shareholders, net earnings allocated to common stock and the number of shares used in the calculation of basic and diluted earnings per common share.
 
Three Months Ended 
 June 30,
 
Six Months Ended 
 June 30,
 
2018
 
2017
 
2018
 
2017
Net income
$
111,341

 
$
85,553

 
$
217,821

 
$
170,494

Less: Preferred stock dividends
2,015

 
2,015

 
4,031

 
4,031

Net income available to common shareholders
109,326

 
83,538

 
213,790

 
166,463

Less: Earnings allocated to participating securities
726

 
436

 
1,431

 
871

Net earnings allocated to common stock
$
108,600

 
$
83,102

 
$
212,359

 
$
165,592

 
 
 
 
 
 
 
 
Distributed earnings allocated to common stock
$
42,791

 
$
36,545

 
$
79,096

 
$
71,020

Undistributed earnings allocated to common stock
65,809

 
46,557

 
133,263

 
94,572

Net earnings allocated to common stock
$
108,600

 
$
83,102

 
$
212,359

 
$
165,592

 
 
 
 
 
 
 
 
Weighted-average shares outstanding for basic earnings per common share
63,836,651

 
64,061,264

 
63,743,442

 
63,900,620

Dilutive effect of stock compensation
1,062,637

 
974,067

 
1,043,712

 
988,198

Weighted-average shares outstanding for diluted earnings per common share
64,899,288

 
65,035,331

 
64,787,154

 
64,888,818

Note 12 - Defined Benefit Plans
The components of the combined net periodic expense (benefit) for our defined benefit pension plans are presented in the table below.
 
Three Months Ended 
 June 30,
 
Six Months Ended 
 June 30,
 
2018
 
2017
 
2018
 
2017
Expected return on plan assets, net of expenses
$
(2,979
)
 
$
(2,780
)
 
$
(5,958
)
 
$
(5,559
)
Interest cost on projected benefit obligation
1,474

 
1,548

 
2,949

 
3,095

Net amortization and deferral
1,251

 
1,358

 
2,501

 
2,715

Net periodic expense (benefit)
$
(254
)
 
$
126

 
$
(508
)
 
$
251

Our non-qualified defined benefit pension plan is not funded. No contributions to the qualified defined benefit pension plan were made during the six months ended June 30, 2018. We do not expect to make any contributions to the qualified defined benefit plan during the remainder of 2018.
Note 13 - Income Taxes
Income tax expense was as follows:
 
Three Months Ended 
 June 30,
 
Six Months Ended 
 June 30,
 
2018
 
2017
 
2018
 
2017
Current income tax expense
$
1,361

 
$
13,710

 
$
2,107

 
$
29,412

Deferred income tax expense (benefit)
12,475

 
128

 
22,886

 
(4,173
)
Income tax expense, as reported
$
13,836

 
$
13,838

 
$
24,993

 
$
25,239

 
 
 
 
 
 
 
 
Effective tax rate
11.1
%
 
13.9
%
 
10.3
%
 
12.9
%
Net deferred tax assets totaled $49.7 million at June 30, 2018 and $31.7 million at December 31, 2017. No valuation allowance for deferred tax assets was recorded at June 30, 2018 as management believes it is more likely than not that all of the deferred tax assets will be realized against deferred tax liabilities and projected future taxable income.
The effective income tax rates differed from the U.S. statutory federal income tax rates of 21% during 2018 and 35% during 2017 primarily due to the effect of tax-exempt income from loans, securities and life insurance policies and the income tax effects

28

Table of Contents

associated with stock-based compensation. 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.
We file income tax returns in the U.S. federal jurisdiction. We are no longer subject to U.S. federal income tax examinations by tax authorities for years before 2014.
Tax Cuts and Jobs Act. The Tax Cuts and Jobs Act was enacted on December 22, 2017 as more fully discussed in the 2017 Form 10-K. Among other things, the new law established a new, flat corporate federal statutory income tax rate of 21%. As a result, we remeasured our deferred tax assets and liabilities based on the new tax rate and recognized a provisional net tax benefit related to the remeasurement totaling $4.0 million. Notwithstanding the foregoing, we are still analyzing certain aspects of the new law and refining our calculations, which could affect the measurement of these assets and liabilities or give rise to new deferred tax amounts. Nonetheless, there has been no change to the provisional net tax benefit we recorded during the fourth quarter of 2017.
Note 14 - Other Comprehensive Income (Loss)
The before and after tax amounts allocated to each component of other comprehensive income (loss) are presented in the following table. Reclassification adjustments related to securities available for sale are included in net gain (loss) on securities transactions in the accompanying consolidated statements of income. Reclassification adjustments related to defined-benefit post-retirement benefit plans are included in the computation of net periodic pension expense (see Note 12 – Defined Benefit Plans).
 
Three Months Ended 
 June 30, 2018
 
Three Months Ended 
 June 30, 2017
 
Before Tax
Amount
 
Tax  Expense,
(Benefit)
 
Net of  Tax
Amount
 
Before Tax
Amount
 
Tax  Expense,
(Benefit)
 
Net of  Tax
Amount
Securities available for sale and transferred securities:
 
 
 
 
 
 
 
 
 
 
 
Change in net unrealized gain/loss during the period
$
(11,884
)
 
$
(2,496
)
 
$
(9,388
)
 
$
90,390

 
$
31,636

 
$
58,754

Change in net unrealized gain on securities transferred to held to maturity
(2,041
)
 
(429
)
 
(1,612
)
 
(3,860
)
 
(1,351
)
 
(2,509
)
Reclassification adjustment for net (gains) losses included in net income
60

 
13

 
47

 
50

 
18

 
32

Total securities available for sale and transferred securities
(13,865
)
 
(2,912
)
 
(10,953
)
 
86,580

 
30,303

 
56,277

Defined-benefit post-retirement benefit plans:
 
 
 
 
 
 
 
 
 
 
 
Change in the net actuarial gain/loss

 

 

 

 

 

Reclassification adjustment for net amortization of actuarial gain/loss included in net income as a component of net periodic cost (benefit)
1,251

 
263

 
988

 
1,358

 
475

 
883

Total defined-benefit post-retirement benefit plans
1,251

 
263

 
988

 
1,358

 
475

 
883

Total other comprehensive income (loss)
$
(12,614
)
 
$
(2,649
)
 
$
(9,965
)
 
$
87,938

 
$
30,778

 
$
57,160


29

Table of Contents

 
Six Months Ended 
 June 30, 2018
 
Six Months Ended 
 June 30, 2017
 
Before Tax
Amount
 
Tax  Expense,
(Benefit)
 
Net of  Tax
Amount
 
Before Tax
Amount
 
Tax  Expense,
(Benefit)
 
Net of  Tax
Amount
Securities available for sale and transferred securities:
 
 
 
 
 
 
 
 
 
 
 
Change in net unrealized gain/loss during the period
$
(190,788
)
 
$
(40,066
)
 
$
(150,722
)
 
$
124,201

 
$
43,470

 
$
80,731

Change in net unrealized gain on securities transferred to held to maturity
(4,660
)
 
(979
)
 
(3,681
)
 
(10,146
)
 
(3,551
)
 
(6,595
)
Reclassification adjustment for net (gains) losses included in net income
79

 
17

 
62

 
50

 
18

 
32

Total securities available for sale and transferred securities
(195,369
)
 
(41,028
)
 
(154,341
)
 
114,105

 
39,937

 
74,168

Defined-benefit post-retirement benefit plans:
 
 
 
 
 
 
 
 
 
 
 
Change in the net actuarial gain/loss

 

 

 

 

 

Reclassification adjustment for net amortization of actuarial gain/loss included in net income as a component of net periodic cost (benefit)
2,501

 
526

 
1,975

 
2,715

 
950

 
1,765

Total defined-benefit post-retirement benefit plans
2,501

 
526

 
1,975

 
2,715

 
950

 
1,765

Total other comprehensive income (loss)
$
(192,868
)
 
$
(40,502
)
 
$
(152,366
)
 
$
116,820

 
$
40,887

 
$
75,933

Activity in accumulated other comprehensive income (loss), net of tax, was as follows:
 
Securities
Available
For Sale
 
Defined
Benefit
Plans
 
Accumulated
Other
Comprehensive
Income
Balance January 1, 2018
$
117,230

 
$
(37,718
)
 
$
79,512

Other comprehensive income (loss) before reclassifications
(154,403
)
 

 
(154,403
)
Reclassification of amounts included in net income
62

 
1,975

 
2,037

Net other comprehensive income (loss) during period
(154,341
)
 
1,975

 
(152,366
)
Reclassification of certain income tax effects related to the change in the U.S. statutory federal income tax rate under the Tax Cuts and Jobs Act to retained earnings
17,557

 
(8,022
)
 
9,535

Balance at June 30, 2018
$
(19,554
)
 
$
(43,765
)
 
$
(63,319
)
 
 
 
 
 
 
Balance January 1, 2017
$
16,153

 
$
(40,776
)
 
$
(24,623
)
Other comprehensive income (loss) before reclassifications
74,136

 

 
74,136

Reclassification of amounts included in net income
32

 
1,765

 
1,797

Net other comprehensive income (loss) during period
74,168

 
1,765

 
75,933

Balance at June 30, 2017
$
90,321

 
$
(39,011
)
 
$
51,310


30

Table of Contents

Note 15 – Operating Segments
We are managed under a matrix organizational structure whereby our two primary operating segments, Banking and Frost Wealth Advisors, overlap a regional reporting structure. See our 2017 Form 10-K for additional information regarding our operating segments. Summarized operating results by segment were as follows:
 
Banking
 
Frost  Wealth
Advisors
 
Non-Banks
 
Consolidated
Revenues from (expenses to) external customers:
 
 
 
 
 
 
 
Three months ended:
 
 
 
 
 
 
 
June 30, 2018
$
290,433

 
$
34,526

 
$
(2,623
)
 
$
322,336

June 30, 2017
261,250

 
36,712

 
(2,094
)
 
295,868

Six months ended:
 
 
 
 
 
 
 
June 30, 2018
$
578,994

 
$
69,607

 
$
(5,072
)
 
$
643,529

June 30, 2017
520,161

 
71,300

 
(3,384
)
 
588,077

Net income (loss):
 
 
 
 
 
 
 
Three months ended:
 
 
 
 
 
 
 
June 30, 2018
$
109,276

 
$
5,901

 
$
(3,836
)
 
$
111,341

June 30, 2017
81,529

 
6,279

 
(2,255
)
 
85,553

Six months ended:
 
 
 
 
 
 
 
June 30, 2018
$
212,917

 
$
11,535

 
$
(6,631
)
 
$
217,821

June 30, 2017
162,398

 
11,573

 
(3,477
)
 
170,494


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Note 16 – 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, we utilize 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 three-level 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. See our 2017 Form 10-K for additional information regarding the fair value hierarchy and a description of our valuation techniques.
Financial Assets and Financial Liabilities. The table below summarizes financial assets and financial liabilities measured at fair value on a recurring basis as of June 30, 2018 and December 31, 2017, segregated by the level of the valuation inputs within the fair value hierarchy of ASC Topic 820 utilized to measure fair value.
 
Level 1
Inputs
 
Level 2
Inputs
 
Level 3
Inputs
 
Total Fair
Value
June 30, 2018
 
 
 
 
 
 
 
Securities available for sale:
 
 
 
 
 
 
 
U.S. Treasury
$
3,410,081

 
$

 
$

 
$
3,410,081

Residential mortgage-backed securities

 
631,658

 

 
631,658

States and political subdivisions

 
6,633,389

 

 
6,633,389

Other

 
42,615

 

 
42,615

Trading account securities:
 
 
 
 
 
 
 
U.S. Treasury
20,755

 

 

 
20,755

States and political subdivisions

 
579

 

 
579

Derivative assets:
 
 
 
 
 
 
 
Interest rate swaps, caps and floors

 
15,465

 

 
15,465

Commodity swaps and options

 
31,638

 
2,005

 
33,643

Foreign currency forward contracts
270

 

 

 
270

Derivative liabilities:
 
 
 
 
 
 
 
Interest rate swaps, caps and floors

 
24,211

 

 
24,211

Commodity swaps and options

 
33,631

 

 
33,631

Foreign currency forward contracts
216

 

 

 
216

December 31, 2017
 
 
 
 
 
 
 
Securities available for sale:
 
 
 
 
 
 
 
U.S. Treasury
$
3,445,153

 
$

 
$

 
$
3,445,153

Residential mortgage-backed securities

 
665,086

 

 
665,086

States and political subdivisions

 
6,336,209

 

 
6,336,209

Other

 
42,561

 

 
42,561

Trading account securities:
 
 
 
 
 
 
 
U.S. Treasury
19,210

 

 

 
19,210

States and political subdivisions

 
1,888

 

 
1,888

Derivative assets:
 
 
 
 
 
 
 
Interest rate swaps, caps and floors

 
20,022

 

 
20,022

Commodity swaps and options

 
14,408

 
1,233

 
15,641

Foreign currency forward contracts
415

 

 

 
415

Derivative liabilities:
 
 
 
 
 
 
 
Interest rate swaps, caps and floors

 
18,754

 

 
18,754

Commodity swaps and options

 
15,327

 

 
15,327

Foreign currency forward contracts
239

 

 

 
239


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Derivative assets, measured at fair value on a recurring basis using significant unobservable (Level 3) inputs during the reported periods consist of commodity swaps sold to loan customers. The significant unobservable (Level 3) inputs used in the fair value measurement of these commodity swaps sold to loan customers 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 commodity 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 commodity 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. The weighted-average risk grade of loans underlying commodity swaps measured at fair value using significant unobservable (Level 3) inputs was 12.0 for both periods ended June 30, 2018 and December 31, 2017. The weighted-average loss severity in the event of default on the commodity swaps was 19.7% and 15.4% for the periods ended June 30, 2018 and December 31, 2017 respectively. A reconciliation of the beginning and ending balances of derivative assets measured at fair value on a recurring basis using significant unobservable (Level 3) inputs is not presented as such amounts were not significant during the reported periods.
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. 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 reported periods.
 
Six Months Ended 
 June 30, 2018
 
Six Months Ended 
 June 30, 2017
 
Level 2
 
Level 3
 
Level 2
 
Level 3
Carrying value of impaired loans before allocations
$
14,359

 
$
52,048

 
$

 
$
21,686

Specific valuation allowance (allocations) reversals of prior allocations
(799
)
 
(1,149
)
 

 
(561
)
Fair value
$
13,560

 
$
50,899

 
$

 
$
21,125

Non-Financial Assets and Non-Financial Liabilities. We do not have any non-financial assets or non-financial liabilities measured at fair value on a recurring basis. 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 following table presents foreclosed assets that were remeasured and reported at fair value during the reported periods:
 
Six Months Ended 
 June 30, 2018
 
2018
 
2017
Foreclosed assets remeasured at initial recognition:
 
 
 
Carrying value of foreclosed assets prior to remeasurement
$
2,656

 
$

Charge-offs recognized in the allowance for loan losses

 

Fair value
$
2,656

 
$

Foreclosed assets remeasured subsequent to initial recognition:
 
 
 
Carrying value of foreclosed assets prior to remeasurement
$
1,823

 
$
89

Write-downs included in other non-interest expense
(473
)
 
(16
)
Fair value
$
1,350

 
$
73


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Table of Contents

Financial Instruments Reported at Amortized Cost. The estimated fair values of financial instruments that are reported at amortized cost in our consolidated balance sheets, segregated by the level of the valuation inputs within the fair value hierarchy utilized to measure fair value, were as follows:
 
June 30, 2018
 
December 31, 2017
 
Carrying
Amount
 
Estimated
Fair Value
 
Carrying
Amount
 
Estimated
Fair Value
Financial assets:
 
 
 
 
 
 
 
Level 2 inputs:
 
 
 
 
 
 
 
Cash and cash equivalents
$
3,315,470

 
$
3,315,470

 
$
5,053,047

 
$
5,053,047

Securities held to maturity
1,236,511

 
1,247,143

 
1,432,098

 
1,455,791

Cash surrender value of life insurance policies
181,756

 
181,756

 
180,477

 
180,477

Accrued interest receivable
173,394

 
173,394

 
167,508

 
167,508

Level 3 inputs:
 
 
 
 
 
 
 
Loans, net
13,561,536

 
13,515,854

 
12,990,301

 
12,981,165

Financial liabilities:
 
 
 
 
 
 
 
Level 2 inputs:
 
 
 
 
 
 
 
Deposits
25,996,499

 
25,989,689

 
26,872,389

 
26,866,676

Federal funds purchased and repurchase agreements
977,470

 
977,470

 
1,147,824

 
1,147,824

Junior subordinated deferrable interest debentures
136,213

 
137,115

 
136,184

 
137,115

Subordinated notes payable and other borrowings
98,630

 
100,250

 
98,552

 
105,311

Accrued interest payable
5,655

 
5,655

 
3,358

 
3,358

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, we had no financial instruments measured at fair value under the fair value measurement option.
Note 17 - Accounting Standards Updates
Information about certain recently issued accounting standards updates is presented below. Also refer to Note 20 - Accounting Standards Updates in our 2017 Form 10-K for additional information related to previously issued accounting standards updates.
Accounting Standards Update (“ASU”) 2014-09, “Revenue from Contracts with Customers (Topic 606).” ASU 2014-09 implements a common revenue standard that clarifies the principles for recognizing revenue. The core principle of ASU 2014-09 is that an entity should recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. To achieve that core principle, an entity should apply the following steps: (i) identify the contract(s) with a customer, (ii) identify the performance obligations in the contract, (iii) determine the transaction price, (iv) allocate the transaction price to the performance obligations in the contract and (v) recognize revenue when (or as) the entity satisfies a performance obligation. We adopted ASU 2014-09 effective January 1, 2018. See Note 1 - Significant Accounting Policies for additional information.
ASU 2016-02, “Leases (Topic 842).” ASU 2016-02 will, among other things, require lessees to recognize a lease liability, which is a lessee's obligation to make lease payments arising from a lease, measured on a discounted basis; and a right-of-use asset, which is an asset that represents the lessee’s right to use, or control the use of, a specified asset for the lease term. ASU 2016-02 does not significantly change lease accounting requirements applicable to lessors; however, certain changes were made to align, where necessary, lessor accounting with the lessee accounting model and ASC Topic 606, “Revenue from Contracts with Customers.” ASU 2016-02 will be effective for us on January 1, 2019 and will require transition using a modified retrospective approach for leases existing at, or entered into after, the beginning of the earliest comparative period presented in the financial statements. Notwithstanding the foregoing, in January 2018, the Financial Accounting Standards Board issued a proposal to provide an additional transition method that would allow entities to not apply the guidance in ASU 2016-02 in the comparative periods presented in the financial statements and instead recognize a cumulative-effect adjustment to the opening balance of retained earnings in the period of adoption. We are currently implementing a third-party vendor solution to assist us in the application of ASU 2016-02. While we are currently unable to reasonably estimate the impact of adopting ASU 2016-02 until such time as we have implemented the solution, the adoption will result in an increase in right-of-use assets and lease liabilities recorded on our balance sheet.

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ASU 2016-13, “Financial Instruments - Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments.” ASU 2016-13 requires the measurement of all expected credit losses for financial assets held at the reporting date based on historical experience, current conditions, and reasonable and supportable forecasts and requires enhanced disclosures related to the significant estimates and judgments used in estimating credit losses, as well as the credit quality and underwriting standards of an organization’s portfolio. In addition, ASU 2016-13 amends the accounting for credit losses on available-for-sale debt securities and purchased financial assets with credit deterioration. ASU 2016-13 will be effective on January 1, 2020. We are currently evaluating the potential impact of ASU 2016-13 on our financial statements. In that regard, we have formed a cross-functional working group, under the direction of our Chief Financial Officer and our Chief Risk Officer. The working group is comprised of individuals from various functional areas including credit, risk management, finance and information technology, among others. We are currently developing an implementation plan to include assessment of processes, portfolio segmentation, model development, system requirements and the identification of data and resource needs, among other things. We are also in the process of implementing a third-party vendor solution to assist us in the application of the ASU 2016-13. The adoption of the ASU 2016-13 could result in an increase in the allowance for loan losses as a result of changing from an “incurred loss” model, which encompasses allowances for current known and inherent losses within the portfolio, to an “expected loss” model, which encompasses allowances for losses expected to be incurred over the life of the portfolio. Furthermore, ASU 2016-13 will necessitate that we establish an allowance for expected credit losses for certain debt securities and other financial assets. While we are currently unable to reasonably estimate the impact of adopting ASU 2016-13, we expect that the impact of adoption will be significantly influenced by the composition, characteristics and quality of our loan and securities portfolios as well as the prevailing economic conditions and forecasts as of the adoption date.
ASU 2017-08, “Receivables - Nonrefundable Fees and Other Costs (Subtopic 310-20) - Premium Amortization on Purchased Callable Debt Securities.” ASU 2017-08 shortens the amortization period for certain callable debt securities held at a premium to require such premiums to be amortized to the earliest call date unless applicable guidance related to certain pools of securities is applied to consider estimated prepayments. Under prior guidance, entities were generally required to amortize premiums on individual, non-pooled callable debt securities as a yield adjustment over the contractual life of the security. ASU 2017-08 does not change the accounting for callable debt securities held at a discount. ASU 2017-08 will be effective for us on January 1, 2019, with early adoption permitted. While we are currently evaluating the potential impact of ASU 2017-08 on our financial statements, we expect that the impact of adoption will be significantly influenced by the composition of our securities portfolio as of the adoption date.
ASU 2018-02, "Income Statement - Reporting Comprehensive Income (Topic 220) - Reclassification of Certain Tax Effects from Accumulated Other Comprehensive Income." Under ASU 2018-02, entities may elect to reclassify certain income tax effects related to the change in the U.S. statutory federal income tax rate under the Tax Cuts and Jobs Act, which was enacted on December 22, 2017, from accumulated other comprehensive income to retained earnings. ASU 2018-02 also requires certain accounting policy disclosures. We elected to adopt the provisions of ASU 2018-02 as of January 1, 2018 in advance of the required application date of January 1, 2019. See Note 1 - Significant Accounting Policies.
ASU 2018-05, "Income Taxes (Topic 740) - Amendments to SEC Paragraphs Pursuant to SEC Staff Accounting Bulletin (SAB) No. 118." ASU 2018-05 amends the Accounting Standards Codification to incorporate various SEC paragraphs pursuant to the issuance of SAB 118. SAB 118 addresses the application of generally accepted accounting principles in situations when a registrant does not have the necessary information available, prepared, or analyzed (including computations) in reasonable detail to complete the accounting for certain income tax effects of the Tax Cuts and Jobs Act. See Note 13 - Income Taxes.


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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 our consolidated financial statements, and notes thereto, for the year ended December 31, 2017, and the other information included in the 2017 Form 10-K. Operating results for the three and six months ended June 30, 2018 are not necessarily indicative of the results for the year ending December 31, 2018 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 our future filings with the SEC, in press releases, and in oral and written statements made by us or with our approval that are not statements of historical fact and constitute forward-looking statements within the meaning of the Act. Examples of forward-looking statements include, but are not limited to: (i) projections of revenues, expenses, income or loss, earnings or loss per share, the payment or nonpayment of dividends, capital structure and other financial items; (ii) statements of plans, objectives and expectations of Cullen/Frost or its management or Board of Directors, including those relating to products, services or operations; (iii) statements of future economic performance; and (iv) statements of assumptions underlying such statements. Words such as “believes”, “anticipates”, “expects”, “intends”, “targeted”, “continue”, “remain”, “will”, “should”, “may” and other similar expressions are intended to identify forward-looking statements but are not the exclusive means of identifying such statements.
Forward-looking statements involve risks and uncertainties that may cause actual results to differ materially from those in such statements. Factors that could cause actual results to differ from those discussed in the forward-looking statements include, but are not limited to:
Local, regional, national and international economic conditions and the impact they may have on us and our customers and our assessment of that impact.
Volatility and disruption in national and international financial and commodity markets.
Government intervention in the U.S. financial system.
Changes in the mix of loan geographies, sectors and types or the level of non-performing assets and charge-offs.
Changes in estimates of future reserve requirements based upon the periodic review thereof under relevant regulatory and accounting requirements.
The effects of and changes in trade and monetary and fiscal policies and laws, including the interest rate policies of the Federal Reserve Board.
Inflation, interest rate, securities market and monetary fluctuations.
The effect of changes in laws and regulations (including laws and regulations concerning taxes, banking, securities and insurance) with which we and our subsidiaries must comply.
The soundness of other financial institutions.
Political instability.
Impairment of our goodwill or other intangible assets.
Acts of God or of war or terrorism.
The timely development and acceptance of new products and services and perceived overall value of these products and services by users.
Changes in consumer spending, borrowings and savings habits.
Changes in the financial performance and/or condition of our borrowers.
Technological changes.
The cost and effects of failure, interruption, or breach of security of our systems.
Acquisitions and integration of acquired businesses.
Our ability to increase market share and control expenses.
Our ability to attract and retain qualified employees.
Changes in the competitive environment in our markets and among banking organizations and other financial service providers.
The effect of changes in accounting policies and practices, as may be adopted by the regulatory agencies, as well as the Public Company Accounting Oversight Board, the Financial Accounting Standards Board and other accounting standard setters.
Changes in the reliability of our vendors, internal control systems or information systems.

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Table of Contents

Changes in our liquidity position.
Changes in our organization, compensation and benefit plans.
The costs and effects of legal and regulatory developments, the resolution of legal proceedings or regulatory or other governmental inquiries, the results of regulatory examinations or reviews and the ability to obtain required regulatory approvals.
Greater than expected costs or difficulties related to the integration of new products and lines of business.
Our success at managing the risks involved in the foregoing items.
Forward-looking statements speak only as of the date on which such statements are made. We do not undertake any obligation to update any forward-looking statement to reflect events or circumstances after the date on which such statement is made, or to reflect the occurrence of unanticipated events.
Application of Critical Accounting Policies and Accounting Estimates
We follow accounting and reporting policies that conform, in all material respects, to accounting principles generally accepted in the United States and to general practices within the financial services industry. The preparation of financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. While we base estimates on historical experience, current information and other factors deemed to be relevant, actual results could differ from those estimates.
We consider accounting estimates to be critical to reported financial results if (i) the accounting estimate requires management to make assumptions about matters that are highly uncertain and (ii) different estimates that management reasonably could have used for the accounting estimate in the current period, or changes in the accounting estimate that are reasonably likely to occur from period to period, could have a material impact on our financial statements. Accounting policies related to the allowance for loan losses are considered to be critical as these policies involve considerable subjective judgment and estimation by management.
For additional information regarding critical accounting policies, refer to Note 1 - Summary of Significant Accounting Policies and Note 3 - Loans in the notes to consolidated financial statements and the sections captioned “Application of Critical Accounting Policies and Accounting Estimates” and “Allowance for Loan Losses” in Management’s Discussion and Analysis of Financial Condition and Results of Operations included in the 2017 Form 10-K. There have been no significant changes in our application of critical accounting policies related to the allowance for loan losses since December 31, 2017.
Overview
A discussion of our 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 investments by an amount equal to the taxes that would be paid if the income were fully taxable based on the applicable 21% federal tax rate in 2018 and 35% federal tax rate in 2017, thus making tax-exempt yields comparable to taxable asset yields.

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Table of Contents

Results of Operations
Net income available to common shareholders totaled $109.3 million, or $1.68 per diluted common share and $213.8 million, or $3.30 per diluted common share, for the three and six months ended June 30, 2018 compared to $83.5 million, or $1.29 per diluted common share, and $166.5 million, or $2.57 per diluted common share, for the three and six months ended June 30, 2017.
Selected data for the comparable periods was as follows:
 
Three Months Ended 
 June 30,
 
Six Months Ended 
 June 30,
 
2018
 
2017
 
2018
 
2017
Taxable-equivalent net interest income
$
260,531

 
$
258,020

 
$
513,067

 
$
510,413

Taxable-equivalent adjustment
23,261

 
43,232

 
46,049

 
87,116

Net interest income
237,270

 
214,788

 
467,018

 
423,297

Provision for loan losses
8,251

 
8,426

 
15,196

 
16,378

Net interest income after provision for loan losses
229,019

 
206,362

 
451,822

 
406,919

Non-interest income
85,066

 
81,080

 
176,511

 
164,780

Non-interest expense
188,908

 
188,051

 
385,519

 
375,966

Income before income taxes
125,177

 
99,391

 
242,814

 
195,733

Income taxes
13,836

 
13,838

 
24,993

 
25,239

Net income
111,341

 
85,553

 
217,821

 
170,494

Preferred stock dividends
2,015

 
2,015

 
4,031

 
4,031

Net income available to common shareholders
$
109,326

 
$
83,538

 
$
213,790

 
$
166,463

Earnings per common share – basic
$
1.70

 
$
1.30

 
$
3.33

 
$
2.59

Earnings per common share – diluted
1.68

 
1.29

 
3.30

 
2.57

Dividends per common share
0.67

 
0.57

 
1.24

 
1.11

Return on average assets
1.43
%
 
1.11
%
 
1.39
%
 
1.11
%
Return on average common equity
14.03

 
11.07

 
13.83

 
11.31

Average shareholders’ equity to average assets
10.63

 
10.53

 
10.55

 
10.33

Net income available to common shareholders increased $25.8 million, or 30.9%, for the three months ended June 30, 2018 and increased $47.3 million, or 28.4%, for the six months ended June 30, 2018 compared to the same periods in 2017. The increase during the three months ended June 30, 2018 was primarily the result of a $22.5 million increase in net interest income, a $4.0 million increase in non-interest income and a $175 thousand decrease in the provision for loan losses partly offset by an $857 thousand increase in non-interest expense. The increase during the six months ended June 30, 2018 was primarily the result of a $43.7 million increase in net interest income, an $11.7 million increase in non-interest income and a $1.2 million decrease in the provision for loan losses partly offset by a $9.6 million increase in non-interest expense.
Details of the changes in the various components of net income are further discussed below.
Net Interest Income
Net interest income is the difference between interest income on earning assets, such as loans and securities, and interest expense on liabilities, such as deposits and borrowings, which are used to fund those assets. Net interest income is our largest source of revenue, representing 72.6% of total revenue during the first six months of 2018. Net interest margin is the ratio of taxable-equivalent net interest income to average earning assets for the period. The level of interest rates and the volume and mix of earning assets and interest-bearing liabilities impact net interest income and net interest margin.
The Federal Reserve influences the general market rates of interest, including the deposit and loan rates offered by many financial institutions. Our loan portfolio is significantly affected by changes in the prime interest rate. The prime rate began 2017 at 3.75% and remained at that level until March 2017, when it increased 25 basis points to 4.00%. During the remainder of 2017, the prime rate increased an additional 50 basis points (25 basis points in each of June and December) to end 2017 at 4.50%. During the first six months of 2018, the prime rate increased 50 basis points (25 basis points in each of March and June) to end the period at 5.00%. Our loan portfolio is also impacted by changes in the London Interbank Offered Rate (LIBOR). At June 30, 2018, the one-month and three-month U.S. dollar LIBOR interest rates were 2.09% and 2.34%, respectively, while at June 30, 2017, the one-month and three-month U.S. dollar LIBOR interest rates were 1.22% and 1.30%, respectively. The effective federal funds rate, which is the cost of immediately available overnight funds, began 2017 at 0.75% and subsequently increased 75 basis points (25 basis points in each of March, June and December) to end 2017 at 1.50%. During the first six months of 2018, the effective federal funds rate increased 50 basis points (25 basis points in each of March and June) to end the period at 2.00%.

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We are primarily funded by core deposits, with non-interest-bearing demand deposits historically being a significant source of funds. This lower-cost funding base is expected to have a positive impact on our net interest income and net interest margin in a rising interest rate environment. 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. To date, we have not experienced any significant additional interest costs as a result of the repeal. However, as market interest rates have increased, we have increased the interest rates we pay on most of our interest-bearing deposit products. See Item 3. Quantitative and Qualitative Disclosures About Market Risk elsewhere in this report for information about the expected impact of this legislation on our sensitivity to interest rates. Further analysis of the components of our net interest margin is presented below.
The following table presents the changes in taxable-equivalent net interest income and identifies the changes due to differences in the average volume of earning assets and interest-bearing liabilities and the changes due to changes in the average interest rate on those assets and liabilities. The changes in net interest income due to changes in both average volume and average interest rate have been allocated to the average volume change or the average interest rate change in proportion to the absolute amounts of the change in each. The comparison between the periods includes an additional change factor detailing the effect of the reduction in the U.S. statutory federal income tax rate under the Tax Cuts and Jobs Act, which was enacted on December 22, 2017, as further discussed in our 2017 Form 10-K.
 
Three Months Ended
 
June 30, 2018 vs. June 30, 2017
 
Increase (Decrease) Due to Change in
 
 
 
Rate
 
Volume
 
Tax Rate
 
Total
Interest-bearing deposits
$
6,249

 
$
(1,408
)
 
$

 
$
4,841

Federal funds sold and resell agreements
102

 
1,150

 

 
1,252

Securities:
 
 
 
 
 
 
 
Taxable
1,682

 
(4,021
)
 

 
(2,339
)
Tax-exempt
(3,073
)
 
6,199

 
(21,249
)
 
(18,123
)
Loans, net of unearned discounts
19,375

 
14,341

 
(641
)
 
33,075

Total earning assets
24,335

 
16,261

 
(21,890
)
 
18,706

Savings and interest checking
1,017

 
15

 

 
1,032

Money market deposit accounts
12,708

 
35

 

 
12,743

Time accounts
965

 
4

 

 
969

Public funds
673

 
(15
)
 

 
658

Federal funds purchased and repurchase agreements
421

 
23

 

 
444

Junior subordinated deferrable interest debentures
349

 

 

 
349

Subordinated notes payable and other notes
(2
)
 
2

 

 

Total interest-bearing liabilities
16,131

 
64

 

 
16,195

Net change
$
8,204

 
$
16,197

 
$
(21,890
)
 
$
2,511


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Six Months Ended
 
June 30, 2018 vs. June 30, 2017
 
Increase (Decrease) Due to Change in
 
 
 
Rate
 
Volume
 
Tax Rate
 
Total
Interest-bearing deposits
$
12,368

 
$
(269
)
 
$

 
$
12,099

Federal funds sold and resell agreements
259

 
1,647

 

 
1,906

Securities:
 
 
 
 
 
 
 
Taxable
2,199

 
(9,282
)
 

 
(7,083
)
Tax-exempt
(6,555
)
 
10,023

 
(42,832
)
 
(39,364
)
Loans, net of unearned discounts
35,588

 
27,275

 
(1,277
)
 
61,586

Total earning assets
43,859

 
29,394

 
(44,109
)
 
29,144

Savings and interest checking
1,861

 
35

 

 
1,896

Money market deposit accounts
19,250

 
55

 

 
19,305

Time accounts
1,646

 

 

 
1,646

Public funds
1,368

 
(43
)
 

 
1,325

Federal funds purchased and repurchase agreements
891

 
48

 

 
939

Junior subordinated deferrable interest debentures
582

 
1

 

 
583

Subordinated notes payable and other notes
436

 
360

 

 
796

Total interest-bearing liabilities
26,034

 
456

 

 
26,490

Net change
$
17,825

 
$
28,938

 
$
(44,109
)
 
$
2,654

Taxable-equivalent net interest income for the three months ended June 30, 2018 increased $2.5 million, or 1.0%, while taxable-equivalent net interest income for the six months ended June 30, 2018 increased $2.7 million, or 0.5%, compared to the same periods in 2017. Taxable-equivalent net interest income for the three and six months ended June 30, 2018 was impacted by the reduction in the U.S. federal statutory income tax rate from 35% to 21% under the Tax Cuts and Jobs Act enacted on December 22, 2017. Taxable-equivalent net interest income for the three and six months ended June 30, 2017 would have been lower by approximately $21.9 million and $44.1 million, respectively, based on a 21% tax rate rather than the 35% tax rate then in effect. Excluding the effect of the tax rate reduction, taxable-equivalent net interest income effectively increased approximately $24.4 million and $46.8 million during the three and six months ended June 30, 2018, respectively, compared to the same periods in 2017. These effective increases in taxable-equivalent net interest income were primarily related to increases in the average yields on loans and interest-bearing deposits combined with increases in the average volumes of loans, tax-exempt securities and federal funds sold and resell agreements. The impact of these items was partly offset by increases in the average rates paid on interest-bearing deposits and other borrowed funds, decreases in the average volume of taxable securities and interest bearing deposits and decreases in the average yield on tax-exempt securities, notwithstanding the effect of the tax rate reduction.
The average volume of interest-earning assets for the three months ended June 30, 2018 increased $582.4 million, while the average volume of interest-earning assets for the six months ended June 30, 2018 increased $787.6 million compared to the same periods in 2017. The increase in the average volume of interest-earning assets during the three months ended June 30, 2018 included a $1.3 billion increase in average loans and a $445.9 million increase in average tax-exempt securities partly offset by a $907.6 million decrease in average taxable securities and a $217.4 million decrease in average interest-bearing deposits and federal funds sold and resell agreements. The increase in the average volume of interest-earning assets during the six months ended June 30, 2018 included a $1.2 billion increase in average loans, a $417.2 million increase in average tax-exempt securities and a $138.3 million increase in average interest-bearing deposits and federal funds sold and resell agreements partly offset by a $1.0 billion decrease in average taxable securities.
The taxable-equivalent net interest margin decreased 6 basis points from 3.70% during the three months ended June 30, 2017 to 3.64% during the three months ended June 30, 2018 and decreased 9 basis points from 3.67% during the six months ended June 30, 2017 to 3.58% during the six months ended June 30, 2018. The taxable-equivalent net interest margin for the three and six months ended June 30, 2018 was impacted by the aforementioned reduction in the U.S. federal statutory income tax rate. The taxable-equivalent net interest margin for the three and six months ended June 30, 2017 would have been lower by approximately 32 basis points in each period, respectively, based on a 21% tax rate rather than the 35% tax rate then in effect. Excluding the effect of the tax rate reduction, the taxable-equivalent net interest margin effectively increased 26 and 23 basis points during the three and six months ended June 30, 2018, respectively, compared to the same periods in 2017. These effective increases were primarily related to increases in the average yields on loans, interest-bearing deposits and federal funds sold and resell agreements partly offset by increases in the average cost of interest-bearing deposits and other borrowed funds and decreases in the average yields on tax-exempt securities, notwithstanding the effects of the tax rate reduction.

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The average taxable-equivalent yield on interest-earning assets increased 17 basis points from 3.76% during the three months ended June 30, 2017 to 3.93% during the three months ended June 30, 2018 and increased 10 basis points from 3.72% during the six months ended June 30, 2017 to 3.82% during the six months ended June 30, 2018. The increases in the average yield on interest earning assets during the three and six months ended June 30, 2018 were primarily due to increases in the average yields on loans, interest-bearing deposits and federal funds sold and resell agreements mostly offset by decreases in the average taxable-equivalent yield on tax exempt securities, primarily because of the tax rate reduction, as further discussed below. The average taxable-equivalent yield on interest-earning assets is primarily impacted by changes in market interest rates, changes in the volume and relative mix of interest-earning assets and statutory tax rates.
The average taxable-equivalent yield on loans increased 54 basis points from 4.24% during the six months ended June 30, 2017 to 4.78% during the six months ended June 30, 2018. The average taxable-equivalent yield on loans was positively impacted by the increases in market interest rates discussed above. Due to the relative proportion of our tax-exempt loan portfolio to total loans, the reduction in the U.S. federal statutory income tax rate did not significantly impact the overall average taxable-equivalent yield on loans during the six months ended June 30, 2018. The average volume of loans for the six months ended June 30, 2018 increased $1.2 billion, or 10.1%, compared to the same period in 2017. Loans made up approximately 46.5% of average interest-earning assets during the six months ended June 30, 2018 compared to 43.5% during the same period in 2017.
The average taxable-equivalent yield on securities was 3.36% during the six months ended June 30, 2018, decreasing 60 basis points from 3.96% during the six months ended June 30, 2017. The decrease in the average taxable-equivalent yield on securities was primarily related to a decrease in the average taxable-equivalent yield on tax exempt securities partly offset by an increase in the relative proportion of higher-yielding tax exempt securities to total securities and, to a lesser extent, an increase in the average yield on taxable securities. The average taxable-equivalent yield on tax-exempt securities decreased 130 basis points from 5.41% during the six months ended June 30, 2017 to 4.11% during the six months ended June 30, 2018. This decrease was primarily related to the aforementioned reduction in the U.S. federal statutory income tax rate.
The taxable-equivalent yield on tax exempt securities for the six months ended June 30, 2017 would have been 118 basis points lower based on a 21% tax rate rather than the 35% tax rate then in effect. Excluding the effect of the tax rate reduction, the taxable-equivalent yield on tax exempt securities effectively decreased 12 basis points during the six months ended June 30, 2018 compared to the same period in 2017. The overall average yield on total securities was positively impacted by a higher proportion of average securities invested in higher-yielding tax exempt securities during the six months ended June 30, 2018 compared to the same period in 2017. Tax exempt securities made up approximately 64.8% of total average securities during the six months ended June 30, 2018, compared to 58.4% during the same period in 2017. The average yield on taxable securities increased 9 basis points from 1.91% during the six months ended June 30, 2017 to 2.00% during the six months ended June 30, 2018. The average volume of total securities during the six months ended June 30, 2018 decreased $584.2 million, or 4.7%, compared to the same period in 2017. Securities made up approximately 41.2% of average interest-earning assets during the six months ended June 30, 2018 compared to 44.5% during the same period in 2017.
Average interest-bearing deposits, federal funds sold and resell agreements for the six months ended June 30, 2018 increased $138.3 million, or 4.1%, compared to the same period in 2017. Interest-bearing deposits, federal funds sold and resell agreements made up approximately 12.2% of average interest-earning assets during the six months ended June 30, 2018 compared to 12.1% during the same period in 2017. The combined average yield on interest-bearing deposits, federal funds sold and resell agreements was 1.73% during the six months ended June 30, 2018 compared to 0.96% during the same period in 2017. As discussed above, the effective federal funds rate began 2017 at 0.75% and subsequently increased 75 basis points (25 basis points in each of March, June and December) to end 2017 at 1.50%. During the first six months of 2018, the effective federal funds rate increased 50 basis points (25 basis points in each of March and June) to end the period at 2.00%.
The average rate paid on interest-bearing liabilities was 0.41% during the six months ended June 30, 2018, increasing 31 basis points from 0.10% during the same period in 2017. Average deposits increased $507.3 million ($89.2 million non-interest bearing and $418.0 million interest-bearing) during the six months ended June 30, 2018 compared to the same period in 2017. The ratio of average interest-bearing deposits to total average deposits was 58.9% during the first six months of 2018 compared to 58.4% during the same period of 2017. 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 0.37% and 0.22%, respectively, during the six months ended June 30, 2018 compared to 0.05% and 0.03%, respectively, during the six months ended June 30, 2017. The average cost of deposits during 2018 was impacted by increases in the interest rates we pay on most of our interest-bearing deposit products as a result of the aforementioned increases in market interest rates.
Our net interest spread, which represents the difference between the average rate earned on earning assets and the average rate paid on interest-bearing liabilities, was 3.41% during the first six months of 2018 compared to 3.62% during the same period in 2017. Our net interest spread during the six months ended June 30, 2018 was negatively impacted by the aforementioned reduction in the U.S. federal statutory income tax rate, which limited growth in the average taxable-equivalent yield on interest earning

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assets despite increases in market interest rates. The net interest spread during the six months ended June 30, 2018 was further negatively impacted by the increases in the average cost of interest-bearing deposits and other borrowed funds. 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.
Our hedging policies permit the use of various derivative financial instruments, including interest rate swaps, swaptions, caps and floors, to manage exposure to changes in interest rates. Details of our derivatives and hedging activities are set forth in Note 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 our 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 inherent losses within the existing loan portfolio. The provision for loan losses totaled $8.3 million and $15.2 million for the three and six months ended June 30, 2018 compared to $8.4 million and $16.4 million for the three and six months ended June 30, 2017. 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 
 June 30,
 
Six Months Ended 
 June 30,
 
2018
 
2017
 
2018
 
2017
Trust and investment management fees
$
29,121

 
$
27,727

 
$
58,708

 
$
54,197

Service charges on deposit accounts
21,142

 
21,198

 
41,985

 
41,967

Insurance commissions and fees
10,556

 
9,728

 
26,536

 
23,549

Interchange and debit card transaction fees
3,446

 
5,692

 
6,604

 
11,266

Other charges, commissions and fees
9,273

 
9,898

 
18,280

 
19,490

Net gain (loss) on securities transactions
(60
)
 
(50
)
 
(79
)
 
(50
)
Other
11,588

 
6,887

 
24,477

 
14,361

Total
$
85,066

 
$
81,080

 
$
176,511

 
$
164,780

Total non-interest income for the three and six months ended June 30, 2018 increased $4.0 million, or 4.9%, and increased $11.7 million, or 7.1%, compared to the same periods in 2017, respectively. Changes in the various components of non-interest income are discussed in more detail below.
Trust and Investment Management Fees. Trust and investment management fees for the three and six months ended June 30, 2018 increased $1.4 million, or 5.0%, and increased $4.5 million, or 8.3%, compared to the same periods in 2017, respectively. Investment fees are the most significant component of trust and investment management fees, making up approximately 82.4% and 82.7% of total trust and investment management fees for the first six months of 2018 and 2017, respectively. Investment and other custodial account fees are generally based on the market value of assets within a trust account. Volatility in the equity and bond markets impacts the market value of trust assets and the related investment fees.
The increase in trust and investment management fees during the three and six months ended June 30, 2018 compared to the same periods in 2017 was primarily the result of increases in trust investment fees (up $991 thousand and $3.5 million, respectively) and increases in oil and gas fees (up $853 thousand and $1.2 million, respectively). The increase in trust investment fees during 2018 was due to higher average equity valuations. The increase in oil and gas fees during 2018 was related to an increase in energy prices.
At June 30, 2018, trust assets, including both managed assets and custody assets, were primarily composed of equity securities (50.0% of assets), fixed income securities (37.9% of assets) and cash equivalents (7.2% of assets). The estimated fair value of these assets was $33.4 billion (including managed assets of $14.4 billion and custody assets of $19.0 billion) at June 30, 2018, compared to $32.8 billion (including managed assets of $14.1 billion and custody assets of $18.7 billion) at December 31, 2017 and $30.5 billion (including managed assets of $13.6 billion and custody assets of $16.9 billion) at June 30, 2017.

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Service Charges on Deposit Accounts. Service charges on deposit accounts for the three months ended June 30, 2018 decreased $56 thousand, or 0.3%, compared to the same period in 2017. The decrease was primarily due to a decrease in commercial service charges (down $751 thousand) mostly offset by increases in overdraft/insufficient funds charges on consumer and commercial accounts (up $445 thousand and $129 thousand, respectively) and an increase in consumer service charges (up $127 thousand). Service charges on deposit accounts for the six months ended June 30, 2018 did not significantly fluctuate compared to the same period in 2017 as increases in overdraft/insufficient funds charges on consumer and commercial accounts (up $634 thousand and $224 thousand, respectively) and consumer service charges (up $549 thousand) were for the most part offset by a decrease in commercial service charges (down $1.4 million). Overdraft/insufficient funds charges totaled $9.2 million ($7.1 million consumer and $2.1 million commercial) during the three months ended June 30, 2018 compared to $8.6 million ($6.6 million consumer and $2.0 million commercial) during the same period in 2017. Overdraft/insufficient funds charges totaled $18.0 million ($13.8 million consumer and $4.2 million commercial) during the six months ended June 30, 2018 compared to $17.1 million ($13.2 million consumer and $3.9 million commercial) during the same period in 2017.
Insurance Commissions and Fees. Insurance commissions and fees for the three months ended June 30, 2018 increased $828 thousand, or 8.5%, compared to the same period in 2017. The increase was related to increases in commission income (up $1.0 million) partly offset by a decrease in contingent income (down $200 thousand). Insurance commissions and fees for the six months ended June 30, 2018 increased $3.0 million, or 12.7%, compared to the same period in 2017. The increase was related to increases in commission income (up $2.1 million) and contingent income (up $858 thousand). The increases in commission income during the three and six months ended June 30, 2018 were primarily related to increases in commissions on property and casualty policies and benefit plan commissions due to increased business volumes. Insurance commissions and fees include contingent income totaling $492 thousand and $3.9 million during the three and six months ended June 30, 2018, respectively, and $692 thousand and $3.0 million during the same periods in 2017. Contingent income primarily consists of amounts received from various property and casualty insurance carriers related to the loss performance of insurance policies previously placed. These performance related contingent payments are seasonal in nature and are mostly received during the first quarter of each year. This performance related contingent income totaled $3.0 million and $2.0 million during the six months ended June 30, 2018 and 2017, respectively. The increase in performance related contingent income during 2018 was related to growth within the portfolio and improvement in the loss performance of insurance policies previously placed. Contingent income also includes amounts received from various benefit plan insurance companies related to the volume of business generated and/or the subsequent retention of such business. This benefit plan related contingent income totaled $313 thousand and $865 thousand during the three and six months ended June 30, 2018, respectively, and $398 thousand and $1.0 million during the same periods in 2017.
Interchange and Debit Card Transaction Fees. Interchange fees, or “swipe” fees, are charges that merchants pay to us and other card-issuing banks for processing electronic payment transactions. Interchange and debit card transaction fees consist of income from check card usage, point of sale income from PIN-based debit card transactions and ATM service fees. Beginning in 2018, in connection with the adoption of Accounting Standards Update (“ASU”) No. 2014-09, “Revenue from Contracts with Customers (Topic 606),” interchange and debit card transaction fees are reported net of related network costs. See Note 1 - Significant Accounting Policies. Previously, such network costs were reported as a component of other non-interest expense. Interchange and debit card transaction fees for the three and six months ended June 30, 2018 reported on a net basis totaled $3.4 million and $6.6 million, respectively, while interchange and debit card transaction fees for the three and six months ended June 30, 2017 reported on a gross basis totaled $5.7 million and $11.3 million, respectively. A comparison of gross and net interchange and debit card transaction fees for the reported periods is presented in the table below:
 
Three Months Ended 
 June 30,
 
Six Months Ended 
 June 30,
 
2018
 
2017
 
2018
 
2017
Income from debit card transactions
$
5,467

 
$
4,707

 
$
10,591

 
$
9,402

ATM service fees
1,016

 
985

 
1,963

 
1,864

Gross interchange and debit card transaction fees
6,483

 
5,692

 
12,554

 
11,266

Network costs
3,037

 
2,891

 
5,950

 
6,114

Net interchange and debit card transaction fees
$
3,446

 
$
2,801

 
$
6,604

 
$
5,152

The increase in interchange and debit card transaction fees during 2018, on a net basis, was primarily related to increased transaction volumes.
Federal Reserve rules applicable to financial institutions that have assets of $10 billion or more provide that the maximum permissible interchange fee for an electronic debit transaction is the sum of 21 cents per transaction and 5 basis points multiplied by the value of the transaction. An upward adjustment of no more than 1 cent to an issuer's debit card interchange fee is allowed if the card issuer develops and implements policies and procedures reasonably designed to achieve certain fraud-prevention

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standards. The Federal Reserve also has rules governing routing and exclusivity that require issuers to offer two unaffiliated networks for routing transactions on each debit or prepaid product.
Other Charges, Commissions and Fees. Other charges, commissions and fees for the three months ended June 30, 2018 decreased $625 thousand, or 6.3%, compared to the same period in 2017. The decrease was primarily related to decreases in loan processing fees (down $547 thousand) and income from the sale of mutual funds (down $154 thousand). Other charges, commissions and fees for the six months ended June 30, 2018 decreased $1.2 million, or 6.2%, compared to the same period in 2017. The decrease was primarily related to decreases in loan processing fees (down $1.2 million).
Net Gain/Loss on Securities Transactions. During the six months ended June 30, 2018, and 2017 we sold certain available-for-sale U.S Treasury securities with amortized costs totaling $10.9 billion and $8.2 billion and realized net losses of $79 thousand and $50 thousand on those sales, respectively. The sales were primarily related to securities purchased and subsequently sold in the same period of their purchase in connection with our tax planning strategies related to the Texas franchise tax. The gross proceeds from the sales of these securities outside of Texas are included in total revenues/receipts from all sources reported for Texas franchise tax purposes, which results in a reduction in the overall percentage of revenues/receipts apportioned to Texas and subjected to taxation under the Texas franchise tax.
Other Non-Interest Income. Other non-interest income for the three months ended June 30, 2018 increased $4.7 million, or 68.3%, compared to the same period in 2017. The increase during the three months ended June 30, 2018 was primarily related to increases in sundry and other miscellaneous income (up $3.0 million), gains on the sale of foreclosed and other assets (up $885 thousand), public finance underwriting fees (up $625 thousand) and income from customer derivative and trading activities (up $240 thousand). Other non-interest income for the six months ended June 30, 2018 increased $10.1 million, or 70.4%, compared to the same period in 2017. The increase during the six months ended June 30, 2018 was primarily related to increases in gains on the sale of foreclosed and other assets (up $4.6 million), sundry and other miscellaneous income (up $3.1 million), income from customer derivative and trading activities (up $1.6 million), public finance underwriting fees (up $497 thousand) and income from customer foreign currency transactions (up $336 thousand), among other things. During the first six months of 2018, gains on the sale of foreclosed and other assets included $4.2 million related to gains on the sale of various branch and operational facilities. Sundry and other miscellaneous income during the first six months of 2018 included $2.4 million related to the recovery of prior write-offs and $1.2 million related to a distribution from a private equity investment. The fluctuations in income from customer derivative and trading activities, public finance underwriting fees and income from customer foreign currency transactions during the first six months of 2018 were primarily related to changes in business volumes.
Non-Interest Expense
The components of non-interest expense were as follows:
 
Three Months Ended 
 June 30,
 
Six Months Ended 
 June 30,
 
2018
 
2017
 
2018
 
2017
Salaries and wages
$
85,204

 
$
80,995

 
$
171,887

 
$
163,507

Employee benefits
17,907

 
18,198

 
39,902

 
39,823

Net occupancy
19,455

 
19,153

 
39,195

 
38,390

Technology, furniture and equipment
20,459

 
18,250

 
40,138

 
36,240

Deposit insurance
4,605

 
5,570

 
9,484

 
10,485

Intangible amortization
369

 
438

 
757

 
896

Other
40,909

 
45,447

 
84,156

 
86,625

Total
$
188,908

 
$
188,051

 
$
385,519

 
$
375,966

Total non-interest expense for the three and six months ended June 30, 2018 increased $857 thousand, or 0.5%, and increased $9.6 million, or 2.5%, compared to the same periods in 2017. Changes in the various components of non-interest expense are discussed below.
Salaries and Wages. Salaries and wages for the three and six months ended June 30, 2018 increased $4.2 million, or 5.2%, and increased $8.4 million, or 5.1%, compared to the same periods in 2017. The increase was primarily related to an increase in salaries, due to an increase in the number of employees and normal annual merit and market increases, as well as an increase in incentive compensation.
Employee Benefits. Employee benefits expense for the three months ended June 30, 2018 decreased $291 thousand, or 1.6%, compared to the same period in 2017. The decrease was primarily due to a decrease in expenses related to our defined benefit retirement plans, as further discussed below, partly offset by an increase in expenses related to our 401(k) and profit sharing plans

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(up $133 thousand). Employee benefits expense for the six months ended June 30, 2018 increased $79 thousand, or 0.2%, compared to the same period in 2017. The increase was primarily due to increases in payroll taxes (up $545 thousand) and expenses related to our 401(k) and profit sharing plans (up $490 thousand) partly offset by decreases in expenses related to our defined benefit retirement plans, as further discussed below, and medical insurance (down $148 thousand).
During the three and six months ended June 30, 2018, we recognized a combined net periodic pension benefit of $254 thousand and $508 thousand, respectively, related to our defined benefit retirement plans compared to a combined net periodic pension expense of $126 thousand and $251 thousand during the same periods in 2017. Our 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, we still have funding obligations related to the defined benefit and restoration plans and could recognize retirement expense related to these plans in future years, which would be dependent on the return earned on plan assets, the level of interest rates and employee turnover. See Note 12 - Defined Benefit Plans for additional information related to our net periodic pension benefit/cost.
Net Occupancy. Net occupancy expense for the three and six months ended June 30, 2018 increased $302 thousand, or 1.6%, and $805 thousand, or 2.1%, respectively, compared to the same periods in 2017. The increase during the three months ended June 30, 2018 was primarily related to increases in lease expense (up $479 thousand) partly offset by a decrease in property taxes (down $188 thousand). The increase during the six months ended June 30, 2018 was primarily related to increases in lease expense (up $982 thousand) and repairs and maintenance/service contracts expense (up $218 thousand) partly offset by a decrease in property taxes (down $376 thousand).
Technology, Furniture and Equipment. Technology, furniture and equipment expense for the three and six months ended June 30, 2018 increased $2.2 million, or 12.1%, and $3.9 million, or 10.8%, respectively, compared to the same periods in 2017. The increases were primarily related to increases in software maintenance (up $1.6 million and $2.9 million for the three and six months ended June 30, 2018, respectively), software amortization (up $449 thousand and $860 thousand for the three and six months ended June 30, 2018, respectively) and service contracts expense (up $118 thousand and $429 thousand for the three and six months ended June 30, 2018, respectively). The increase during the six months ended June 30, 2018 was partly offset by a decrease in depreciation on furniture and equipment (down $254 thousand).
Deposit Insurance. Deposit insurance expense totaled $4.6 million and $9.5 million for the three and six months ended June 30, 2018 compared to $5.6 million and $10.5 million for the three and six months ended June 30, 2017. The decrease in deposit insurance expense during 2018 was mostly related to a decrease in our base assessment rate resulting from an improvement in our performance score. The level of deposit insurance expense during the comparable periods was impacted by a surcharge that became applicable during the third quarter of 2016. In August 2016, the Federal Deposit Insurance Corporation (“FDIC”) announced that the Deposit Insurance Fund (“DIF”) reserve ratio had surpassed 1.15% as of June 30, 2016. As a result, beginning in the third quarter of 2016, the range of initial assessment rates for all institutions was adjusted downward and institutions with $10 billion or more in assets were assessed a quarterly surcharge. The quarterly surcharge will continue to be assessed until such time as the reserve ratio reaches the statutory minimum of 1.35% required by the Dodd-Frank Wall Street Reform and Consumer Protection Act.
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 and six months ended June 30, 2018 decreased $69 thousand, or 15.8%, and $139 thousand, or 15.5%, respectively, compared to the same periods in 2017. The decrease in amortization was primarily related to the completion of amortization of certain previously recognized intangible assets as well as a reduction in the annual amortization rate of certain previously recognized intangible assets as we use an accelerated amortization approach which results in higher amortization rates during the earlier years of the useful lives of intangible assets.
Other Non-Interest Expense. Other non-interest expense for the three and six months ended June 30, 2018 decreased $4.5 million, or 10.0%, and decreased $2.5 million, or 2.9%, compared to the same periods in 2017. As discussed above in the section captioned “Interchange and Debit Card Transaction Fees,” in connection with the adoption of ASU 2014-09 in 2018, network costs associated with debit card and ATM transactions are now reported netted against the related fees from such transactions and included in Interchange and Debit Card Transaction Fees in the accompanying Consolidated Statement of Income for the three and six months ended June 30, 2018. Previously, such network costs were reported as a component of other non-interest expense. Network costs associated with debit card and ATM transactions during the three and six months ended June 30, 2018 totaled $3.0 million and $6.0 million, respectively, compared to $2.9 million and $6.1 million during the same periods in 2017. Excluding network costs from the three months ended June 30, 2017, other non-interest expense effectively decreased $1.6 million, or 3.9%, during the three months ended June 30, 2018. This effective decrease included decreases in fraud losses, primarily related to check cards, (down $2.2 million); advertising/promotions expense (down $1.9 million); and travel/meals and entertainment expense (down $666 thousand); among other things. These items were partly offset by increases in professional services expense (up $2.6 million), sundry and other miscellaneous expenses (up $545 thousand) and donations expense related to a contribution to our charitable

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foundation (up $444 thousand), among other things. Excluding network costs from the six months ended June 30, 2017, other non-interest expense effectively increased $3.6 million , or 4.5%, during the six months ended June 30, 2018. This increase included increases in professional services expense (up $4.6 million), donations expense related to a contributions to our charitable foundation (up $4.2 million) and outside computer services expense (up $508 thousand), among other things. These items were partly offset by decreases in advertising/promotions expense (down $2.4 million); fraud losses, primarily related to check cards, (down $2.1 million); travel/meals and entertainment expense (down $870 thousand); and data communications expense (down $722 thousand); among other things.
The increase in professional services expense during 2018 was partly related to a data security incident during the first quarter of 2018 which resulted in unauthorized access to a third-party lockbox software program used by certain of our commercial lockbox customers to store digital images. We have stopped the identified unauthorized access and are working with a leading cybersecurity firm. We have reported the incident to, and are cooperating with, law-enforcement authorities and our investigation is ongoing. We have contacted each of the affected commercial customers and are working with them to support them in taking appropriate actions. The identified incident did not impact other Frost systems. As of June 30, 2018, costs incurred related to this incident totaled $1.4 million, of which $937 thousand was incurred in second quarter of 2018.
Results of Segment Operations
Our operations are managed along two primary operating segments: Banking and Frost Wealth Advisors. A description of each business and the methodologies used to measure financial performance is described in Note 15 - 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 
 June 30,
 
Six Months Ended 
 June 30,
 
2018
 
2017
 
2018
 
2017
Banking
$
109,276

 
$
81,529

 
$
212,917

 
$
162,398

Frost Wealth Advisors
5,901

 
6,279

 
11,535

 
11,573

Non-Banks
(3,836
)
 
(2,255
)
 
(6,631
)
 
(3,477
)
Consolidated net income
$
111,341

 
$
85,553

 
$
217,821

 
$
170,494

Banking
Net income for the three and six months ended June 30, 2018 increased $27.7 million, or 34.0%, and increased $50.5 million, or 31.1%, compared to the same periods in 2017, respectively. The increases during the three and six months ended June 30, 2018 compared to the same periods in 2017 were primarily the result of increases in net interest income (up $26.1 million and $51.2 million respectively) and non-interest income (up $3.1 million and $7.6 million respectively) and decreases in the provision for loan losses (down $175 thousand and $1.2 million respectively) partly offset by increases in non-interest expense (up $224 thousand and $7.4 million respectively) and income tax expense (up $1.4 million and $2.1 million respectively).
Net interest income for the three and six months ended June 30, 2018 increased $26.1 million, or 12.3%, and increased $51.2 million, or 12.2%, compared to the same periods in 2017, respectively. The increases during the three and six months ended June 30, 2018 were primarily related to increases in the average yields on loans, interest-bearing deposits and taxable securities combined with increases in the average volumes of loans, tax-exempt securities and federal funds sold and resell agreements. The impact of these items were partly offset by increases in the average rates paid on interest-bearing deposits and other borrowed funds, decreases in the average volume of taxable securities and decreases in the average yield on tax-exempt securities. See the analysis of net interest income included in the section captioned “Net Interest Income” included elsewhere in this discussion.
The provision for loan losses for the three and six months ended June 30, 2018 totaled $8.3 million and $15.2 million compared to $8.4 million and $16.4 million for the same periods in 2017. 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 and six months ended June 30, 2018 increased $3.1 million, or 6.3%, and increased $7.6 million, or 7.5%, compared to the same periods in 2017. The increases were primarily due to increases in other non-interest income and insurance commissions and fees partly offset by decreases in interchange and debit card transaction fees and other charges, commissions and fees. The increases in other non-interest income were primarily related to increases in sundry and other miscellaneous income, gains on the sale of foreclosed and other assets, public finance underwriting fees and income from customer derivative and trading activities. Sundry and other miscellaneous income during the first six months of 2018 included $2.4 million related to the recovery of prior write-offs and $1.2 million related to a distribution from a private equity investment. During the first six months of 2018, gains on the sale of foreclosed and other assets included $4.2 million related to gains on the sale of various branch and operational facilities. The fluctuations in income from customer derivative and trading activities and public finance

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underwriting fees were primarily related to changes in business volumes. The increases in insurance commission and fees were primarily related to increases in commission income related to property and casualty policies and benefit plan commissions due to increased business volumes. Insurance commissions and fees during the six months ended June 30, 2018 was also partly impacted by an increase in performance-related contingent income related to growth within the portfolio and improvement in the loss performance of insurance policies previously placed. In connection with the adoption of a new accounting standard in 2018, network costs associated with debit card and ATM transactions are now reported netted against the related fees from such transactions. Previously, such network costs were reported as a component of other non-interest expense. If such network costs had been netted against interchange and debit card transaction fees in 2017, interchange and debit card transaction fees would have reflected an increase in 2018 as a result of increased transaction volumes. The decreases in other charges, commissions and fees were primarily related to decreases in loan processing fees and, for the six months ended June 30, 2018, a decrease in income from capital markets advisory services. 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 and six months ended June 30, 2018 increased $224 thousand, or 0.1%, and increased $7.4 million, or 2.3%, compared to the same periods in 2017. The increases during three and six months ended June 30, 2018 were primarily related to increases in salaries and wages and technology, furniture and equipment expense partly offset by decreases in other non-interest expense and deposit insurance expense. The increases in salaries and wage were primarily due to an increase in the number of employees and normal annual merit and market increases, as well as increases in incentive compensation. The increases in technology, furniture and equipment expense were primarily related to increases in software maintenance, software amortization and service contracts expense. The increase in technology, furniture and equipment expense during the six months ended June 30, 2018 was partly offset by a decrease in depreciation on furniture and equipment. As discussed above, network costs associated with debit card and ATM transactions are now reported netted against the related fees from such transactions, rather than as a component of other non-interest expense as was previously the case. Excluding network costs from the three and six months ended June 30, 2017, other non-interest expense for the three months ended June 30, 2018 effectively decreased $1.2 million while other non-interest expense for the six months ended June 30, 2018 effectively increased $3.4 million. This effective decrease for the three months ended June 30, 2018 included decreases in fraud losses, primarily related to check cards; advertising/promotions expense; and travel/meals and entertainment expense; among other things. These items were partly offset by increases in professional services expense, sundry and other miscellaneous expenses and donations expense related to a contribution to our charitable foundation, among other things. The effective increase in other non-interest expense for the six months ended June 30, 2018, included increases in professional services expense and donations expense related to a contributions to our charitable foundation, among other things. These items were partly offset by decreases in advertising/promotions expense; fraud losses, primarily related to check cards; travel/meals and entertainment expense; and data communications expense; among other things. The decrease in deposit insurance expense during 2018 was mostly related to a decrease in our base assessment rate resulting from an improvement in our performance score. See the analysis of these categories of non-interest expense 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 $10.6 million and $26.7 million during the three and six months ended June 30, 2018 and $9.7 million and $23.7 million during the three and six months ended June 30, 2017. The increases were primarily related to increases in commissions on property and casualty policies and benefit plan commissions due to increased business volumes and, during the six months ended June 30, 2018, an increase in performance-related contingent income primarily related to growth within the portfolio and improvement in the loss performance of insurance policies previously placed. 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 and six months ended June 30, 2018 decreased $378 thousand, or 6.0%, and decreased $38 thousand, or 0.3%, compared to the same periods in 2017. The decrease during the three months ended June 30, 2018 was primarily due to a $3.3 million decrease in net interest income partly offset by a $1.8 million decrease in income tax expense and a $1.1 million increase in non-interest income. The decrease during the six months ended June 30, 2018 was primarily due to a $6.1 million decrease in net interest income and a $1.5 million increase in non-interest expense mostly offset by a $4.4 million increase in non-interest income and a $3.2 million decrease in income tax expense.
Net interest income for the three and six months ended June 30, 2018 decreased $3.3 million, or 75.3%, and decreased $6.1 million, or 75.2%, compared to the same periods in 2017. Beginning in 2018, certain repurchase agreements that were previously allocated to the Frost Wealth Advisors segment are now allocated to the Banking segment which resulted in the decreases in net interest income.
Non-interest income for the three and six months ended June 30, 2018 increased $1.1 million, or 3.4%, and increased $4.4 million, or 7.0%, compared to the same periods in 2017. The increases in non-interest income during the three and six months

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ended June 30, 2018 were primarily related to increases in trust and investment management fees partly offset by decreases in other charges, commissions and fees. 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 82.4% of total trust and investment management fees for the first six months of 2018. 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 increases in trust and investment management fees during the three and six months ended June 30, 2018 compared to the same periods in 2017 were primarily the result of increases in trust investment fees and oil and gas fees. The increase in trust investment fees during 2018 was due to higher average equity valuations while the increase in oil and gas fees was related to an increase in energy prices. The decreases in other charges, commissions and fees during the three and six months ended June 30, 2018 were primarily related to decreases in income related to the sale of mutual funds and annuities partly offset by increases in income related to the sale of money market accounts. See the analysis of trust and investment management fees and other charges, commissions and fees included in the section captioned “Non-Interest Income” included elsewhere in this discussion.
Non-interest expense for the three months ended June 30, 2018 did not significantly fluctuate compared to the same period in 2017 as increases in salaries and wages; technology, furniture and equipment expense and net occupancy expense were mostly offset by a decrease in other non-interest expense. Non-interest expense for the six months ended June 30, 2018 increased $1.5 million, or 2.8%, compared to the same period in 2017. The increase was primarily related to increases in salaries and wages and employee benefits; technology, furniture and equipment expense; and net occupancy expense. The increases in salaries and wages were primarily due to an increase in the number of employees and normal annual merit and market increases, as well as increases in incentive compensation. The increase in employee benefits was primarily due to increases in expenses related to our 401(k) and profit sharing plans and payroll taxes partly offset by a decrease in medical insurance expense. The increase in technology, furniture and equipment expense was primarily related to increases in service contracts expense, software maintenance and software amortization. The increase in net occupancy expense was primarily related to an increase in lease expense.
Non-Banks
The Non-Banks operating segment had net losses of $3.8 million and $6.6 million for the three and six months ended June 30, 2018, respectively, compared to net losses of $2.3 million and $3.5 million for the same periods in 2017. The increased net losses for the three and six months ended June 30, 2018 were primarily due to increases in net interest expense due to increases in the interest rates paid on our long-term borrowings, decreases in net income tax benefits due to a decrease in the U.S. federal statutory income tax rate and increases in salaries and wages.
Income Taxes
We recognized income tax expense of $13.8 million and $25.0 million, for effective tax rates of 11.1% and 10.3% for the three and six months ended June 30, 2018 compared to $13.8 million and $25.2 million, for effective tax rates of 13.9% and 12.9% for the three and six months ended June 30, 2017. The effective income tax rates differed from the U.S. statutory federal income tax rates of 21% during 2018 and 35% during 2017 primarily due to the effect of tax-exempt income from loans, securities and life insurance policies and the income tax effects associated with stock-based compensation. Income tax expense and the effective tax rate during the three and six months ended June 30, 2018 were impacted by the decrease in U.S. statutory federal income tax rate under the Tax Cuts and Jobs Act which is more fully discussed in our 2017 Form 10-K. The effect of this decrease was mostly offset by increases in total income during 2018 with a higher proportion of taxable income relative to tax-exempt income and the impact of certain expenses related to meals and entertainment, executive compensation and deposit insurance, among other things, that are no longer deductible as a result of the Tax Cuts and Jobs Act.


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Average Balance Sheet
Average assets totaled $30.9 billion for the six months ended June 30, 2018 representing an increase of $805.0 million, or 2.7%, compared to average assets for the same period in 2017. The growth in average assets was primarily funded by deposit growth, an increase in average federal funds purchased and repurchase agreements and earnings retention. The increase was primarily reflected in earning assets, which increased $787.6 million, or 2.8%, during the first six months of 2018 compared to the same period in 2017. The increase in earning assets included a $1.2 billion increase in average loans, a $417.2 million increase in average tax-exempt securities, a $138.3 million increase in average interest-bearing deposits, federal funds sold and resell agreements partly offset by a $1.0 billion decrease in average taxable securities. Average deposit growth included an $89.2 million increase in non-interest bearing deposits and a $418.0 million increase in interest-bearing deposit accounts. Average non-interest bearing deposits made up 41.1% and 41.6% of average total deposits during the first six months of 2018 and 2017, respectively.
Loans
Loans were as follows as of the dates indicated:
 
June 30,
2018
 
Percentage
of Total
 
December 31,
2017
 
Percentage
of Total
Commercial and industrial
$
5,043,272

 
36.8
%
 
$
4,792,388

 
36.4
%
Energy:
 
 
 
 
 
 
 
Production
1,211,261

 
8.8

 
1,182,326

 
9.0

Service
163,013

 
1.2

 
171,795

 
1.3

Other
153,754

 
1.1

 
144,972

 
1.1

Total energy
1,528,028

 
11.1

 
1,499,093

 
11.4

Commercial real estate:
 
 
 
 
 
 
 
Commercial mortgages
4,097,255

 
29.9

 
3,887,742

 
29.6

Construction
1,106,999

 
8.1

 
1,066,696

 
8.1

Land
305,585

 
2.2

 
331,986

 
2.5

Total commercial real estate
5,509,839

 
40.2

 
5,286,424

 
40.2

Consumer real estate:
 
 
 
 
 
 
 
Home equity loans
352,243

 
2.6

 
355,342

 
2.7

Home equity lines of credit
321,795

 
2.3

 
291,950

 
2.2

Other
400,661

 
3.0

 
376,002

 
2.9

Total consumer real estate
1,074,699

 
7.9

 
1,023,294

 
7.8

Total real estate
6,584,538

 
48.1

 
6,309,718

 
48.0

Consumer and other
555,924

 
4.0

 
544,466

 
4.2

Total loans
$
13,711,762

 
100.0
%
 
$
13,145,665

 
100.0
%
Loans increased $566.1 million, or 4.3%, compared to December 31, 2017. The majority of our loan portfolio is comprised of commercial and industrial loans, energy loans and real estate loans. Commercial and industrial loans made up 36.8% and 36.4% of total loans at June 30, 2018 and December 31, 2017, respectively, while energy loans made up 11.1% and 11.4% of total loans, respectively, and real estate loans made up 48.1% and 48.0% of total loans, respectively, at those dates. Real estate loans include both commercial and consumer balances. Selected details related to our loan portfolio segments are presented below. Refer to our 2017 Form 10-K for a more detailed discussion of our loan origination and risk management processes.
Commercial and industrial. Commercial and industrial loans increased $250.9 million, or 5.2%, during the first six months of 2018. Our 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 our loan policy guidelines. The commercial and industrial loan portfolio also includes commercial leases and purchased shared national credits ("SNC"s).
Energy. Energy loans include loans to entities and individuals that are engaged in various energy-related activities including (i) the development and production of oil or natural gas, (ii) providing oil and gas field servicing, (iii) providing energy-related transportation services (iv) providing equipment to support oil and gas drilling (v) refining petrochemicals, or (vi) trading oil, gas and related commodities. Energy loans increased $28.9 million, or 1.9%, during the first six months of 2018 compared to December 31, 2017. The increase was related to increases in production and other loans partly offset by a decrease in service loans. The average loan size, the significance of the portfolio and the specialized nature of the energy industry requires a highly

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prescriptive underwriting policy. Exceptions to this policy are rarely granted. Due to the large borrowing requirements of this customer base, the energy loan portfolio includes participations and SNCs.
Purchased Shared National Credits. Purchased shared national credits are participations purchased from upstream financial organizations and tend to be larger in size than our originated portfolio. Our purchased SNC portfolio totaled $778.7 million at June 30, 2018, decreasing $56.3 million, or 6.7%, from $835.0 million at December 31, 2017. At June 30, 2018, 52.3% of outstanding purchased SNCs were related to the energy industry, while 12.9% related to the construction industry and 11.2% related to the investment management 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 energy and 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 our customers. As a matter of policy, we generally only participate in SNCs for companies headquartered in or which have significant operations within our market areas. In addition, we 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.
Commercial Real Estate. Commercial real estate loans totaled $5.5 billion at June 30, 2018, increasing $223.4 million compared to $5.3 billion at December 31, 2017. At such dates, commercial real estate loans represented 83.7% and 83.8% of total real estate loans, respectively. The majority of this portfolio consists of commercial real estate mortgages, which includes both permanent and intermediate term loans. 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. At June 30, 2018, approximately 50% of the outstanding principal balance of our commercial real estate loans were secured by owner-occupied properties.
Consumer Real Estate and Other Consumer Loans. The consumer loan portfolio, including all consumer real estate and consumer installment loans, totaled $1.6 billion at both June 30, 2018 and December 31, 2017. Consumer real estate loans, increased $51.4 million, or 5.0%, from December 31, 2017. Combined, home equity loans and lines of credit made up 62.7% and 63.3% of the consumer real estate loan total at June 30, 2018 and December 31, 2017, respectively. We offer 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, we do not originate 1-4 family mortgage loans; however, from time to time, we may invest in such loans to meet the needs of our customers or for other regulatory compliance purposes. Consumer and other loans, increased $11.5 million, or 2.1%, from December 31, 2017. The consumer and other loan portfolio primarily consists of automobile loans, overdrafts, unsecured revolving credit products, personal loans secured by cash and cash equivalents and other similar types of credit facilities.

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Non-Performing Assets
Non-performing assets and accruing past due loans are presented in the table below. Troubled debt restructurings on non-accrual status are reported as non-accrual loans. Troubled debt restructurings on accrual status are reported separately.
 
June 30,
2018
 
December 31,
2017
Non-accrual loans:
 
 
 
Commercial and industrial
$
17,306

 
$
46,186

Energy
79,963

 
94,302

Commercial real estate:
 
 
 
Buildings, land and other
19,415

 
7,589

Construction

 

Consumer real estate
872

 
2,109

Consumer and other
1,625

 
128

Total non-accrual loans
119,181

 
150,314

Restructured loans

 
4,862

Foreclosed assets:
 
 
 
Real estate
3,643

 
2,116

Other

 

Total foreclosed assets
3,643

 
2,116

Total non-performing assets
$
122,824

 
$
157,292

 
 
 
 
Ratio of non-performing assets to:
 
 
 
Total loans and foreclosed assets
0.90
%
 
1.20
%
Total assets
0.40

 
0.50

Accruing past due loans:
 
 
 
30 to 89 days past due
$
44,362

 
$
93,428

90 or more days past due
23,000

 
14,432

Total accruing past due loans
$
67,362

 
$
107,860

Ratio of accruing past due loans to total loans:
 
 
 
30 to 89 days past due
0.32
%
 
0.71
%
90 or more days past due
0.17

 
0.11

Total accruing past due loans
0.49
%
 
0.82
%
Non-performing assets include non-accrual loans, troubled debt restructurings and foreclosed assets. Non-performing assets at June 30, 2018 decreased $34.5 million from December 31, 2017 primarily due to decreases in non-accrual commercial and industrial loans and energy loans partly offset by an increase in non-accrual commercial real estate loans. There were no non-accrual commercial industrial loans in excess of $5.0 million at June 30, 2018. Non-accrual commercial and industrial loans at December 31, 2017 included two credit relationships in excess of $5 million totaling $34.2 million. We charged-off $8.2 million related to these two credit relationships during the first six months of 2018. Subsequent to the charge-offs, one credit relationship paid off and the other had a remaining outstanding balance totaling $4.1 million at June 30, 2018. Non-accrual energy loans included four credit relationships in excess of $5 million totaling $76.7 million at June 30, 2018. Each of these credit relationships was previously reported as non-accrual at December 31, 2017 with an aggregate balance totaling $83.5 million. We charged-off$3.2 million related to one of these credit relationships during the first six months of 2018. 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 relationship in excess of $5.0 million totaling $14.0 million at June 30, 2018. This entire relationship was previously reported as a potential problem as of March 31, 2018 and one of the credits in this relationship was previously reported as a potential problem loan as of December 31, 2017.
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.
Restructured loans totaled $4.9 million at December 31, 2017 and consisted of one energy loan relationship restructured during the second quarter of 2017 totaling $1.3 million, one commercial and industrial credit relationship restructured during the third

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quarter of 2017 totaling $3.1 million and one construction loan relationship restructured during the fourth quarter of 2017 totaling $388 thousand.
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. Regulatory guidelines require us to reevaluate the fair value of foreclosed assets on at least an annual basis. Our policy is to comply with the regulatory guidelines. 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. Write-downs of foreclosed assets totaled $473 thousand and $16 thousand during the six months ended June 30, 2018 and 2017, respectively.
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 June 30, 2018 and December 31, 2017, we had $50.5 million and $61.4 million in loans of this type which are not included in any one of the non-accrual, restructured or 90 days past due loan categories. At June 30, 2018, potential problem loans consisted of seven credit relationships. Of the total outstanding balance at June 30, 2018, 39.7% was related to the restaurant industry, 20.5% was related to the energy industry, 16.9% was related to the real estate industry and 9.8% was related to the medical industry. Weakness in these organizations’ operating performance and financial condition, among other factors, have caused us 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 inherent losses that have been incurred within the existing portfolio of loans. The allowance, in the judgment of management, is necessary to reserve for estimated loan losses and risks inherent in the loan portfolio. Our allowance for loan loss methodology, which is more fully described in our 2017 Form 10-K, 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 U.S. bank regulatory agencies. 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.
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:
 
June 30,
2018
 
December 31,
2017
Commercial and industrial
$
57,713

 
$
59,614

Energy
37,313

 
51,528

Commercial real estate
38,918

 
30,948

Consumer real estate
6,336

 
5,657

Consumer and other
9,946

 
7,617

Total
$
150,226

 
$
155,364

The reserve allocated to commercial and industrial loans at June 30, 2018 decreased $1.9 million compared to December 31, 2017. The decrease was primarily due to decreases in macroeconomic valuation allowances and historical valuation allowances. Macroeconomic valuation allowances for commercial and industrial loans decreased $1.4 million from $16.5 million at December 31, 2017 to $15.1 million at June 30, 2018. The decrease was primarily related to a decrease in the general macroeconomic risk allocation (down $1.6 million), which was partly related to improvements in the weighted-average risk grade of the portfolio and the level of classified loans, as further discussed below. Historical valuation allowances decreased $1.2 million from $26.4 million at December 31, 2017 to $25.2 million at June 30, 2018. The decrease was primarily related to a decrease in the volume of classified loans graded as "substandard - accrual" (risk grade 11) and loans graded "watch" (risk grade 9) partly offset by the impact of an increase in the volume of pass-graded loans. Classified loans consist of loans having a risk grade of 11, 12 or 13. Classified commercial and industrial loans totaled $77.4 million at June 30, 2018 compared to $144.0 million at December 31, 2017. The weighted-average risk grade of commercial and industrial loans was 6.33 at June 30, 2018 compared to 6.41 at December 31, 2017. Commercial loan net charge-offs totaled $11.2 million during the first six months of 2018 compared to $7.6 million during the first six months of 2017. Charge-offs in 2018 included $8.2 million related to two credit relationships that, as of December 31, 2017, had associated specific valuation allowances totaling $5.9 million. Specific valuation allowances for commercial and industrial loans increased $114 thousand from $7.6 million at December 31, 2017 to $7.7 million at June 30,

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2018. General valuation allowances for commercial and industrial loans increased $559 thousand from $9.1 million at December 31, 2017 to $9.7 million at June 30, 2018. The increase was primarily related to increases in the allocations for highly-leveraged transactions and excessive industry concentrations partly offset by an increase in the adjustment for recoveries combined with decreases in the allocations for loans not reviewed by concurrence and large credit relationships.
The reserve allocated to energy loans at June 30, 2018 decreased $14.2 million compared to December 31, 2017. As a result, reserves allocated to energy loans as a percentage of total energy loans totaled 2.44% at June 30, 2018 compared to 3.44% at December 31, 2017. This decrease was primarily related to decreases in historical valuation allowances, macroeconomic valuation allowances and general valuation allowances and partly offset by an increase in specific valuation allowances. Historical valuation allowances decreased $10.0 million from $22.1 million at December 31, 2017 to $12.1 million at June 30, 2018. The decrease was primarily related to decreases in the historical loss allocation factors for non-classified energy loans and classified energy loans graded “substandard - accrual” (risk grade 11). The decrease was also partly related to a decrease in the volume of certain categories of non-classified energy loans and a decrease in the volume of classified energy loans. Non-classified energy loans graded as “watch” and “special mention” totaled $92.3 million at June 30, 2018 compared to $114.7 million at December 31, 2017, decreasing $22.4 million. The impact of this was partly offset by an increase in "pass" grade energy loans which increased $89.3 million from December 31, 2017. Classified energy loans decreased $37.9 million from $185.2 million at December 31, 2017 to $147.2 million at June 30, 2018. The weighted-average risk grade of energy loans decreased to 6.74 at June 30, 2018 from 6.97 at December 31, 2017. Macroeconomic valuation allowances related to energy loans decreased $4.2 million from $8.2 million at December 31, 2017 to $4.0 million at June 30, 2018, primarily due to a decrease in the general macroeconomic risk allocation (down $2.6 million), in part due to stabilization within the energy loan portfolio, decreased oil price volatility and the decline in the portfolio weighted average risk grade; and a decrease in the environmental risk adjustment (down $1.6 million) due to decreases in the historical loss valuation allowances to which the environmental risk adjustment factor is applied. General valuation allowances for energy loans decreased $1.2 million from $8.0 million at December 31, 2017 to $6.8 million at June 30, 2018. The decrease was primarily related to a decrease in the allocation for highly-leveraged transactions and an increase in the adjustment for recoveries, among other things. Specific valuation allowances for energy loans increased $1.1 million from $13.3 million at December 31, 2017 to $14.4 million at June 30, 2018. Specific valuation allowances at June 30, 2018 and December 31, 2017 primarily related to two credit relationships totaling $58.5 million and $61.2 million at such dates, respectively. We recognized charge-offs totaling $3.2 million related to one of these credit relationships during the first six months of 2018. Total energy loan net charge-offs were $4.9 million during the six months ended June 30, 2018 compared to net charge-offs of $10.5 million during the same period in 2017.
The reserve allocated to commercial real estate loans at June 30, 2018 increased $8.0 million compared to December 31, 2017. The increase was primarily related to increases in macroeconomic valuation allowances, historical valuation allowances and specific valuation allowances. Macroeconomic valuation allowances increased $6.0 million from $7.9 million at December 31, 2017 to $13.8 million at June 30, 2018. The increase was primarily related to an increase in the general macroeconomic risk allocation (up $6.0 million), which reflects growth in the portfolio and increased inherent risk due to rising interest rates and the related impact on capitalization rates and real estate valuations. Historical valuation allowances increased $1.1 million primarily due to an increase in the volume of “pass” grade commercial real estate loans, which increased $261.0 million during the first six months of 2018. Classified commercial real estate loans increased $24.4 million from $75.8 million at December 31, 2017 to $100.2 million at June 30, 2018. The weighted-average risk grade of commercial real estate loans was 7.05 at both June 30, 2018 and December 31, 2017. Specific valuation allowances totaled $1.0 million at June 30, 2018 and related to three credit relationships totaling $15.6 million. There were no specific valuation allowances related to commercial real estate loans at December 31, 2017.
The reserve allocated to consumer real estate loans at June 30, 2018 increased $679 thousand compared to December 31, 2017. This increase was primarily due to a $1.3 million increase in macroeconomic valuation allowances, which reflects growth in the portfolio and increased inherent risk due to rising interest rates, partly offset by a $659 thousand decrease in general valuation allowances, which was primarily related to a decrease in allowances allocated for loans not reviewed by concurrence and an increase in the reduction for recoveries.
The reserve allocated to consumer and other loans at June 30, 2018 increased $2.3 million compared to December 31, 2017. The increase was partly related to a $1.6 million increase in specific valuation allowances, which was related to one credit relationship totaling $1.6 million. The increase was also partly related to a $1.2 million increase in historical valuation allowances primarily due to an increase in the historical loss allocation factor.

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Activity in the allowance for loan losses is presented in the following table.
 
Three Months Ended 
 June 30,
 
Six Months Ended 
 June 30,
 
2018
 
2017
 
2018
 
2017
Balance at beginning of period
$
149,885

 
$
153,056

 
$
155,364

 
$
153,045

Provision for loan losses
8,251

 
8,426

 
15,196

 
16,378

Charge-offs:
 
 
 
 
 
 
 
Commercial and industrial
(4,153
)
 
(5,579
)
 
(13,405
)
 
(9,106
)
Energy
(2,689
)
 
(6,317
)
 
(5,539
)
 
(10,595
)
Commercial real estate
(614
)
 
(14
)
 
(619
)
 
(14
)
Consumer real estate
(482
)
 
(2
)
 
(1,201
)
 
(13
)
Consumer and other
(3,994
)
 
(3,623
)
 
(7,966
)
 
(7,171
)
Total charge-offs
(11,932
)
 
(15,535
)
 
(28,730
)
 
(26,899
)
Recoveries:
 
 
 
 
 
 
 
Commercial and industrial
605

 
718

 
2,182

 
1,516

Energy
613

 
81

 
614

 
134

Commercial real estate
218

 
477

 
306

 
522

Consumer real estate
318

 
113

 
511

 
220

Consumer and other
2,268

 
2,222

 
4,783

 
4,642

Total recoveries
4,022

 
3,611

 
8,396

 
7,034

Net charge-offs
(7,910
)
 
(11,924
)
 
(20,334
)
 
(19,865
)
Balance at end of period
$
150,226

 
$
149,558

 
$
150,226

 
$
149,558

 
 
 
 
 
 
 
 
Ratio of allowance for loan losses to:
 
 
 
 
 
 
 
Total loans
1.10
%
 
1.20
%
 
1.10
%
 
1.20
%
Non-accrual loans
126.05

 
173.07

 
126.05

 
173.07

Ratio of annualized net charge-offs to average total loans
0.23

 
0.39

 
0.31

 
0.33

The provision for loan losses decreased $1.2 million, or 7.2%, during the six months ended June 30, 2018 compared to the same period in 2017. Despite increases in net charge-offs and specific valuation allowances during the six months ended June 30, 2018 compared to the same period in 2017, the provision for loan losses decreased due to a decrease in the calculated reserves necessary as a result of the aforementioned decreases in our historical loss allocation factors for energy loans, decreases in the level of classified loans and positive trends in the overall weighted-average risk grade of our energy and commercial and industrial loan portfolios. Classified energy, commercial and industrial and commercial real estate loans totaled $324.9 million at June 30, 2018 compared to $405.0 million at December 31, 2017 and $466.6 million at June 30, 2017. The overall weighted-average risk grade of our energy, commercial and industrial and commercial real estate loan portfolios was 6.71 at June 30, 2018 compared to 6.77 at December 31, 2017 and 6.81 at June 30, 2017. Net charge-offs totaled $20.3 million for six months ended June 30, 2018 compared to $19.9 million for the same period in 2017. Specific valuation allowances totaled $24.7 million at June 30, 2018 compared to $20.8 million at December 31, 2017 and $2.1 million at June 30, 2017.
The ratio of the allowance for loan losses to total loans was 1.10% at June 30, 2018 compared to 1.18% at December 31, 2017. 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, our estimate of probable loan losses could also change, which could affect the level of future provisions for loan losses.
Capital and Liquidity
Capital. Shareholders’ equity totaled $3.3 billion at both June 30, 2018 and December 31, 2017. In addition to net income of $217.8 million, other sources of capital during the six months ended June 30, 2018 included $25.4 million in proceeds from stock option exercises and $6.8 million related to stock-based compensation. Uses of capital during the six months ended June 30, 2018 included an other comprehensive loss, net of tax, of $152.4 million, $83.7 million of dividends paid on preferred and common stock and $2.3 million related to the cumulative effect of a new accounting principle adopted during the first quarter of 2018. See Note 1 - Significant Accounting Policies.
The accumulated other comprehensive income/loss component of shareholders’ equity totaled a net, after-tax, unrealized loss of $63.3 million at June 30, 2018 compared to a net, after-tax, unrealized gain of $79.5 million at December 31, 2017. The change

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was primarily due to a $150.7 million net, after-tax, decrease in the net unrealized gain/loss on securities available for sale. Accumulated other comprehensive income at December 31, 2017 included $9.5 million related to certain income tax effects from the remeasurement of deferred tax assets and liabilities in connection with the change in the U.S. statutory federal income tax rate under the Tax Cuts and Jobs Act enacted on December 22, 2017. This amount was reclassified to retained earnings as of January 1, 2018 in accordance with an accounting standard update issued during the first quarter of 2018. See Note 1 - Significant Accounting Policies and Note 18 - Accounting Standards Updates.
Under the Basel III Capital Rules, we have elected to opt-out of the requirement to include most components of accumulated other comprehensive income in regulatory capital. Accordingly, amounts reported as accumulated other comprehensive income/loss 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 capital and take into consideration the risk inherent in both on-balance sheet and off-balance sheet items. See Note 7 - Capital and Regulatory Matters in the accompanying notes to consolidated financial statements included elsewhere in this report. In addition, financial institutions, such as Cullen/Frost and Frost Bank, with average total consolidated assets greater than $10 billion were previously required by the Dodd-Frank Act to conduct an annual company-run stress test of capital, report the results thereof to the regulators and publicly disclose such results. As a result of regulatory reform signed into law during the second quarter of 2018, Cullen/Frost and Frost Bank are no longer required to conduct an annual stress test of capital under the Dodd-Frank Act.
We paid a quarterly dividend of $0.57 and $0.67 per common share during the first and second quarters of 2018, respectively, and a quarterly dividend of $0.54 and $0.57 per common share during the first and second quarters of 2017. This equates to a common stock dividend payout ratio of 37.2% and 42.9% during the first six months of 2018 and 2017, respectively. Our ability to declare or pay dividends on, or purchase, redeem or otherwise acquire, shares of our capital stock may be impacted by certain restrictions under the terms of our junior subordinated deferrable interest debentures and our Series A Preferred Stock as described in Note 7 - Capital and Regulatory Matters in the accompanying notes to consolidated financial statements included elsewhere in this report.
Stock Repurchase Plans. From time to time, our board of directors has authorized stock repurchase plans. In general, stock repurchase plans allow us to proactively manage our capital position and return excess capital to shareholders. Shares purchased under such plans also provide us with shares of common stock necessary to satisfy obligations related to stock compensation awards. On October 24, 2017, our board of directors authorized a $150.0 million stock repurchase program, allowing us to repurchase shares of our common stock over a two-year period from time to time at various prices in the open market or through private transactions. No shares were repurchased under this plan during 2018 or 2017. Under a prior plan, we repurchased 1,134,966 shares under the plan at a total cost of $100.0 million during third quarter of 2017. See Part II, Item 2 - Unregistered Sales of Equity Securities and Use of Proceeds, included elsewhere in this report.
Liquidity. As more fully discussed in our 2017 Form 10-K, our liquidity position is continuously monitored and adjustments are made to the balance between sources and uses of funds as deemed appropriate. Liquidity risk management is an important element in our asset/liability management process. We regularly model liquidity stress scenarios to assess potential liquidity outflows or funding problems resulting from economic disruptions, volatility in the financial markets, unexpected credit events or other significant occurrences deemed problematic by management. These scenarios are incorporated into our contingency funding plan, which provides the basis for the identification of our liquidity needs. As of June 30, 2018, management is not aware of any events that are reasonably likely to have a material adverse effect on our liquidity, capital resources or operations. In addition, management is not aware of any regulatory recommendations regarding liquidity that would have a material adverse effect on us.
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 - Capital and Regulatory Matters in the accompanying notes to consolidated financial statements included elsewhere in this report regarding such dividends. At June 30, 2018, Cullen/Frost had liquid assets, including cash and resell agreements, totaling $312.5 million.
Accounting Standards Updates
See Note 17 - 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 our financial statements.

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Consolidated Average Balance Sheets and Interest Income Analysis - Quarter To Date
(Dollars in thousands - taxable-equivalent basis)
 
June 30, 2018
 
June 30, 2017
 
Average
Balance
 
Interest
Income/
Expense
 
Yield/
Cost
 
Average
Balance
 
Interest
Income/
Expense
 
Yield/
Cost
Assets:
 
 
 
 
 
 
 
 
 
 
 
Interest-bearing deposits
$
2,885,455

 
$
13,917

 
1.93
%
 
$
3,349,997

 
$
9,076

 
1.09
%
Federal funds sold and resell agreements
296,335

 
1,415

 
1.92

 
49,232

 
163

 
1.33

Securities:
 
 
 
 
 
 
 
 
 
 
 
Taxable
4,197,627

 
21,188

 
2.01

 
5,105,249

 
23,527

 
1.87

Tax-exempt
7,730,597

 
79,278

 
4.10

 
7,284,731

 
97,401

 
5.38

Total securities
11,928,224

 
100,466

 
3.36

 
12,389,980

 
120,928

 
3.93

Loans, net of unearned discounts
13,536,590

 
165,414

 
4.90

 
12,275,030

 
132,339

 
4.32

Total Earning Assets and Average Rate Earned
28,646,604

 
281,212

 
3.93

 
28,064,239

 
262,506

 
3.76

Cash and due from banks
476,212

 
 
 
 
 
495,954

 
 
 
 
Allowance for loan losses
(150,551
)
 
 
 
 
 
(151,784
)
 
 
 
 
Premises and equipment, net
531,410

 
 
 
 
 
521,275

 
 
 
 
Accrued interest and other assets
1,254,506

 
 
 
 
 
1,194,275

 
 
 
 
Total Assets
$
30,758,181

 
 
 
 
 
$
30,123,959

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Liabilities:
 
 
 
 
 
 
 
 
 
 
 
Non-interest-bearing demand deposits:
 
 
 
 
 
 
 
 
 
 
 
Commercial and individual
$
10,062,771

 
 
 
 
 
$
10,043,532

 
 
 
 
Correspondent banks
190,879

 
 
 
 
 
242,920

 
 
 
 
Public funds
374,817

 
 
 
 
 
407,830

 
 
 
 
Total non-interest-bearing demand deposits
10,628,467

 
 
 
 
 
10,694,282

 
 
 
 
Interest-bearing deposits:
 
 
 
 
 
 
 
 
 
 
 
Private accounts
 
 
 
 
 
 
 
 
 
 
 
Savings and interest checking
6,687,540

 
1,304

 
0.08

 
6,399,008

 
272

 
0.02

Money market deposit accounts
7,577,963

 
14,023

 
0.74

 
7,383,394

 
1,280

 
0.07

Time accounts
787,450

 
1,290

 
0.66

 
778,728

 
321

 
0.17

Public funds
387,141

 
958

 
0.99

 
405,658

 
300

 
0.30

Total interest-bearing deposits
15,440,094

 
17,575

 
0.46

 
14,966,788

 
2,173

 
0.06

Total deposits
26,068,561

 
 
 
 
 
25,661,070

 
 
 
 
Federal funds purchased and repurchase agreements
1,019,961

 
631

 
0.25

 
915,607

 
187

 
0.08

Junior subordinated deferrable interest debentures
136,208

 
1,311

 
3.85

 
136,150

 
962

 
2.83

Subordinated notes payable and other notes
98,615

 
1,164

 
4.72

 
98,459

 
1,164

 
4.73

Total Interest-Bearing Funds and Average Rate Paid
16,694,878

 
20,681

 
0.50

 
16,117,004

 
4,486

 
0.11

Accrued interest and other liabilities
164,995

 
 
 
 
 
140,945

 
 
 
 
Total Liabilities
27,488,340

 
 
 
 
 
26,952,231

 
 
 
 
Shareholders’ Equity
3,269,841

 
 
 
 
 
3,171,728

 
 
 
 
Total Liabilities and Shareholders’ Equity
$
30,758,181

 
 
 
 
 
$
30,123,959

 
 
 
 
Net interest income
 
 
$
260,531

 
 
 
 
 
$
258,020

 
 
Net interest spread
 
 
 
 
3.43
%
 
 
 
 
 
3.65
%
Net interest income to total average earning assets
 
 
 
 
3.64
%
 
 
 
 
 
3.70
%
For these computations: (i) average balances are presented on a daily average basis, (ii) information is shown on a taxable-equivalent basis assuming a 21% tax rate in 2018 and a 35% tax rate in 2017, (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.

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Consolidated Average Balance Sheets and Interest Income Analysis - Year To Date
(Dollars in thousands - taxable-equivalent basis)
 
June 30, 2018
 
June 30, 2017
 
Average
Balance
 
Interest
Income/
Expense
 
Yield/
Cost
 
Average
Balance
 
Interest
Income/
Expense
 
Yield/
Cost
Assets:
 
 
 
 
 
 
 
 
 
 
 
Interest-bearing deposits
$
3,281,979

 
$
28,011

 
1.72
%
 
$
3,336,695

 
$
15,912

 
0.96
%
Federal funds sold and resell agreements
241,610

 
2,176

 
1.82

 
48,622

 
270

 
1.12

Securities:
 
 
 
 
 
 
 
 
 
 
 
Taxable
4,182,596

 
41,746

 
2.00

 
5,183,956

 
48,829

 
1.91

Tax-exempt
7,701,055

 
157,612

 
4.11

 
7,283,866

 
196,976

 
5.41

Total securities
11,883,651

 
199,358

 
3.36

 
12,467,822

 
245,805

 
3.96

Loans, net of unearned discounts
13,416,282

 
317,781

 
4.78

 
12,182,820

 
256,195

 
4.24

Total Earning Assets and Average Rate Earned
28,823,522

 
547,326

 
3.82

 
28,035,959

 
518,182

 
3.72

Cash and due from banks
493,981

 
 
 
 
 
514,146

 
 
 
 
Allowance for loan losses
(153,518
)
 
 
 
 
 
(152,791
)
 
 
 
 
Premises and equipment, net
527,515

 
 
 
 
 
522,948

 
 
 
 
Accrued interest and other assets
1,248,863

 
 
 
 
 
1,215,147

 
 
 
 
Total Assets
$
30,940,363

 
 
 
 
 
$
30,135,409

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Liabilities:
 
 
 
 
 
 
 
 
 
 
 
Non-interest-bearing demand deposits:
 
 
 
 
 
 
 
 
 
 
 
Commercial and individual
$
10,171,916

 
 
 
 
 
$
10,001,032

 
 
 
 
Correspondent banks
207,813

 
 
 
 
 
263,641

 
 
 
 
Public funds
419,585

 
 
 
 
 
445,397

 
 
 
 
Total non-interest-bearing demand deposits
10,799,314

 
 
 
 
 
10,710,070

 
 
 
 
Interest-bearing deposits:
 
 
 
 
 
 
 
 
 
 
 
Private accounts
 
 
 
 
 
 
 
 
 
 
 
Savings and interest checking
6,661,661

 
2,441

 
0.07

 
6,357,312

 
545

 
0.02

Money market deposit accounts
7,584,045

 
21,721

 
0.58

 
7,430,600

 
2,416

 
0.07

Time accounts
782,905

 
2,274

 
0.59

 
782,724

 
628

 
0.16

Public funds
419,773

 
1,777

 
0.85

 
459,706

 
452

 
0.20

Total interest-bearing deposits
15,448,384

 
28,213

 
0.37

 
15,030,342

 
4,041

 
0.05

Total deposits
26,247,698

 
 
 
 
 
25,740,412

 
 
 
 
Federal funds purchased and repurchase agreements
1,035,101

 
1,265

 
0.25

 
910,333

 
326

 
0.07

Junior subordinated deferrable interest debentures
136,200

 
2,453

 
3.60

 
136,143

 
1,870

 
2.75

Subordinated notes payable and other notes
98,596

 
2,328

 
4.72

 
81,416

 
1,532

 
3.76

Total Interest-Bearing Funds and Average Rate Paid
16,718,281

 
34,259

 
0.41

 
16,158,234

 
7,769

 
0.10

Accrued interest and other liabilities
160,089

 
 
 
 
 
153,320

 
 
 
 
Total Liabilities
27,677,684

 
 
 
 
 
27,021,624

 
 
 
 
Shareholders’ Equity
3,262,679

 
 
 
 
 
3,113,785

 
 
 
 
Total Liabilities and Shareholders’ Equity
$
30,940,363

 
 
 
 
 
$
30,135,409

 
 
 
 
Net interest income
 
 
$
513,067

 
 
 
 
 
$
510,413

 
 
Net interest spread
 
 
 
 
3.41
%
 
 
 
 
 
3.62
%
Net interest income to total average earning assets
 
 
 
 
3.58
%
 
 
 
 
 
3.67
%
For these computations: (i) average balances are presented on a daily average basis, (ii) information is shown on a taxable-equivalent basis assuming a 21% tax rate in 2018 and a 35% tax rate in 2017, (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.



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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 2017 Form 10-K. There has been no significant change in the types of market risks we face since December 31, 2017.
We utilize 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 flat-rate 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 June 30, 2018, the model simulations projected that 100 and 200 basis point ratable increases in interest rates would result in positive variances in net interest income of 0.5% and 1.8%, respectively, relative to the flat-rate case over the next 12 months, while 100 and 200 basis point ratable decreases in interest rates would result in negative variances in net interest income of 3.2% and 8.6%, respectively, relative to the flat-rate case over the next 12 months. The June 30, 2018 model simulations for increased interest rates were impacted by the assumption, for modeling purposes, that we will begin to pay interest on commercial demand deposits (those not already receiving an earnings credit rate) in the third quarter of 2018, as further discussed below. For modeling purposes, as of June 30, 2017, the model simulations projected that 100 and 200 basis point ratable increases in interest rates would result in positive variances in net interest income of 1.0% and 2.8%, respectively, relative to the flat-rate case over the next 12 months, while 100 and 125 basis point ratable decreases in interest rates would result in a negative variance in net interest income of 4.8% and 10.1%, respectively, relative to the flat-rate case over the next 12 months. The June 30, 2017 model simulations for increased interest rates were impacted by the assumption, for modeling purposes, that we would begin to pay interest on commercial demand deposits (those not already receiving an earnings credit rate) in the third quarter of 2017, as further discussed below. The likelihood of a decrease in interest rates beyond 200 basis points as of June 30, 2018 and 125 basis points as of June 30, 2017 was considered to be remote given prevailing interest rate levels.
The model simulations as of June 30, 2018 indicate that our balance sheet is less asset sensitive in comparison to our balance sheet as of June 30, 2017. The shift to a less asset sensitive position was primarily due to a decrease in the relative proportion of interest-bearing deposits and federal funds sold to projected average interest-earning assets. Interest-bearing deposits and federal funds sold are more immediately impacted by changes in interest rates in comparison to our other categories of earning assets. Additionally, our model simulations in 2018 assume that the full impact of increases in the federal funds rate will not be reflected in the yields earned on interest-bearing deposits maintained at the Federal Reserve.
We do not currently pay interest on a significant portion of our commercial demand deposits. If we began to pay interest on commercial demand deposits (those not already receiving an earnings credit rate), our balance sheet would likely become less asset sensitive. Any interest rate that would ultimately be paid on these commercial demand deposits would likely depend upon a variety of factors, some of which are beyond our control. For modeling purposes, we have assumed an aggressive pricing structure with interest payments for commercial demand deposits (those not already receiving an earnings credit) beginning in the third quarters of 2017 and 2018, respectively, for each simulation. Should the actual interest rate paid on commercial demand deposits be less than the rate assumed in the model simulations, or should the interest rate paid for commercial demand deposits become an administered rate with less direct correlation to movements in general market interest rates, our balance sheet could be more asset sensitive than the model simulations might otherwise indicate.
As of June 30, 2018, the effects of a 200 basis point increase and a 200 basis point decrease in interest rates on our derivative holdings would not result in a significant variance in our net interest income.
The effects of hypothetical fluctuations in interest rates on our 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.

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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 management, with the participation of its Chief Executive Officer and Chief Financial Officer, of the effectiveness of our 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 our 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, our internal control over financial reporting.

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Part II. Other Information
Item 1. Legal Proceedings
We are subject to various claims and legal actions that have arisen in the course of conducting business. Management does not expect the ultimate disposition of these matters to have a material adverse impact on our financial statements.
Item 1A. Risk Factors
There has been no material change in the risk factors disclosed under Item 1A. of our 2017 Form 10-K.
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
The following table provides information with respect to purchases we made or were made on our behalf or any “affiliated purchaser” (as defined in Rule 10b-18(a)(3) under the Securities Exchange Act of 1934), of our common stock during the three months ended June 30, 2018. Dollar amounts in thousands.
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
(or Approximate
Dollar Value)
That May Yet Be
Purchased Under
the Plan at the
End of the Period
April 1, 2018 to April 30, 2018

 
$

 

 
$
150,000

May 1, 2018 to May 31, 2018

 

 

 
150,000

June 1, 2018 to June 30, 2018
601

(1) 
115.83

 

 
150,000

Total
601

 
$
115.83

 

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

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
31.2
32.1+
32.2+
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.

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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:
July 26, 2018
 
By:  
/s/ Jerry Salinas
 
 
 
 
 
Jerry Salinas
 
 
 
 
 
Group Executive Vice President
 
 
 
 
 
and Chief Financial Officer
 
 
 
 
 
(Duly Authorized Officer, Principal Financial
 
 
 
 
 
Officer and Principal Accounting Officer)
 

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