CONSOLIDATED STATEMENTS OF OPERATIONS
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
Year Ended December 31
--------------------------------
1997 1996 1995
- ------------------------------------------------------------------------
INTEREST INCOME:
Loans, including fees........... $217,432 $183,724 $150,497
Securities:
Taxable....................... 95,146 99,237 98,521
Tax-exempt.................... 298 325 341
--------------------------------
Total securities........... 95,444 99,562 98,862
Time deposits........................ 1 2
Federal funds sold and securities
purchased under resale agreements.. 11,839 7,226 6,732
--------------------------------
TOTAL INTEREST INCOME... 324,715 290,513 256,093
INTEREST EXPENSE:
Deposits........................ 113,114 103,475 89,809
Federal funds purchased and
securities sold under
repurchase agreements......... 5,411 6,937 13,296
Guaranteed preferred beneficial
interests in the Corporation's
subordinated debentures....... 7,652
Other borrowings................ 1,294 1,019 733
--------------------------------
TOTAL INTEREST
EXPENSE............... 127,471 111,431 103,838
--------------------------------
NET INTEREST INCOME..... 197,244 179,082 152,255
Provision for possible loan losses... 7,900 7,300 6,272
--------------------------------
NET INTEREST INCOME
AFTER PROVISION FOR
POSSIBLE LOAN
LOSSES................ 189,344 171,782 145,983
NON-INTEREST INCOME:
Trust fees...................... 39,971 34,031 31,762
Service charges on deposit
accounts...................... 43,727 38,294 30,382
Other service charges,
collection and exchange
charges, commissions and
fees.......................... 10,148 8,764 11,055
Net gain (loss) on securities
transactions.................. 494 (980) (1,396)
Other........................... 14,992 14,426 15,940
--------------------------------
TOTAL NON-INTEREST
INCOME................ 109,332 94,535 87,743
NON-INTEREST EXPENSE:
Salaries and wages.............. 81,816 71,788 58,177
Pension and other employee
benefits...................... 16,849 15,351 10,905
Net occupancy of banking
premises...................... 19,496 18,782 17,992
Furniture and equipment......... 12,463 11,789 11,259
Intangible amortization......... 11,920 11,306 8,124
Other........................... 57,412 51,564 55,992
--------------------------------
TOTAL NON-INTEREST
EXPENSE............... 199,956 180,580 162,449
--------------------------------
INCOME BEFORE INCOME
TAXES................. 98,720 85,737 71,277
Income taxes......................... 35,235 30,759 24,998
--------------------------------
NET INCOME.............. $ 63,485 $ 54,978 $ 46,279
--------------------------------
Net income per share:
Basic........................... $ 2.84 $ 2.45 $ 2.07
Diluted......................... 2.75 2.40 2.04
Dividends per share.................. .96 .81 .57
See notes to consolidated financial statements.
CONSOLIDATED BALANCE SHEETS
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
December 31
--------------------------
1997 1996
- -----------------------------------------------------------------
ASSETS
Cash and due from banks.............. $ 604,227 $ 872,028
Securities held to maturity (market
value: 1997 -- $153,337;
1996 -- $181,029).................. 148,759 177,139
Securities available for sale........ 1,342,759 1,299,285
Federal funds sold................... 190,000 52,850
Loans, net of unearned discount of
$2,318 in 1997 and $1,154 in
1996............................... 2,643,522 2,253,468
Less: Allowance for possible loan
losses.......................... (41,846) (37,626)
--------------------------
Net loans....................... 2,601,676 2,215,842
Banking premises and equipment....... 109,654 101,625
Accrued interest and other assets.... 233,513 169,615
--------------------------
TOTAL ASSETS.................. $ 5,230,588 $ 4,888,384
--------------------------
LIABILITIES
Demand deposits:
Commercial and individual.......... $ 1,101,862 $ 941,991
Correspondent banks................ 185,228 337,996
Public funds....................... 51,733 51,228
--------------------------
Total demand deposits......... 1,338,823 1,331,215
Time deposits:
Savings and Interest-on-Checking... 766,416 726,700
Money market deposit accounts...... 996,110 876,382
Time accounts...................... 1,102,184 1,026,547
Public funds....................... 280,378 281,750
--------------------------
Total time deposits........... 3,145,088 2,911,379
--------------------------
Total deposits................ 4,483,911 4,242,594
Federal funds purchased and
securities sold under repurchase
agreements......................... 132,112 174,107
Accrued interest and other
liabilities........................ 107,757 92,740
Guaranteed preferred beneficial
interest in the Corporation's
junior subordinated deferrable
interest debentures, net........... 98,403
--------------------------
TOTAL LIABILITIES............. 4,822,183 4,509,441
SHAREHOLDERS' EQUITY
Common stock, par value $5 per
share.............................. 112,710 112,410
Shares authorized:
1997 -- 60,000,000;
1996 -- 30,000,000
Shares issued:
1997 -- 22,541,991;
1996 -- 22,482,113
Surplus.............................. 65,931 63,480
Retained earnings.................... 233,412 195,451
Unrealized gain on securities
available for sale, net of tax....... 8,668 7,602
Treasury stock at cost (276,721
shares).............................. (12,316)
--------------------------
TOTAL SHAREHOLDERS' EQUITY.... 408,405 378,943
--------------------------
TOTAL LIABILITIES AND
SHAREHOLDERS' EQUITY......... $ 5,230,588 $ 4,888,384
--------------------------
See notes to consolidated financial statements.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(DOLLARS IN THOUSANDS)
Year Ended December 31
-------------------------------------
1997 1996 1995
- ----------------------------------------------------------------------------
OPERATING ACTIVITIES
Net income........................... $ 63,485 $ 54,978 $ 46,279
Adjustments to reconcile net income
to net cash provided by operating
activities:
Provision for possible loan
losses........................ 7,900 7,300 6,272
Provision for real estate
losses........................ 43 610
Credit for deferred taxes....... (6,382) (3,952) (1,150)
Accretion of discounts on
loans......................... (1,148) (970) (1,870)
Accretion of securities'
discounts..................... (11,769) (15,568) (17,031)
Amortization of securities'
premiums...................... 3,429 2,827 2,248
Net realized (gain) loss on
securities transactions....... (494) 980 1,396
Net gain on sale of assets...... (348) (1,292) (5,297)
Depreciation and amortization... 23,378 22,440 18,825
Increase in accrued interest
receivable.................... (6,356) (2,850) (3,092)
Increase in accrued interest
payable....................... 4,417 876 2,763
Net change in other assets and
liabilities................... (32,321) (78) 35,936
-------------------------------------
NET CASH PROVIDED BY OPERATING
ACTIVITIES 43,834 64,691 85,889
INVESTING ACTIVITIES
Proceeds from maturities of
securities held to maturity........ 29,078 33,339 106,424
Purchases of securities held to
maturity........................... (920) (833)
Proceeds from sales of securities
available for sale................. 423,942 215,983 147,468
Proceeds from maturities of
securities available for sale...... 864,269 545,960 677,915
Purchases of securities available for
sale............................... (1,276,661) (648,729) (806,723)
Net increase in loan portfolio....... (291,497) (232,375) (208,107)
Proceeds from sales of equipment..... 48 75 31
Purchases of premises and
equipment.......................... (14,981) (12,169) (6,352)
Proceeds from sales of repossessed
properties......................... 1,195 788 1,719
Net cash and cash equivalents
received from bank acquisitions.... 14,277 19,198 8,734
-------------------------------------
NET CASH USED BY INVESTING
ACTIVITIES.................... (251,250) (77,930) (79,724)
FINANCING ACTIVITIES
Net increase in demand deposits, IOC
accounts, and savings accounts..... 60,262 441,273 305,696
Net (decrease)/increase in
certificates of deposit............ (2,567) (182,067) 68,329
Net (decrease)/increase in Federal
funds purchased and securities sold
under repurchase agreements........ (41,995) 62,712 (267,565)
Net proceeds from issuance of
guaranteed preferred beneficial
interest in the Corporation's
subordinated debentures............ 98,353
Proceeds from employee stock purchase
plan and options................... 1,989 325 691
Purchase of treasury stock........... (17,814)
Dividends paid....................... (21,463) (18,073) (12,723)
-------------------------------------
NET CASH PROVIDED BY FINANCING
ACTIVITIES.................... 76,765 304,170 94,428
-------------------------------------
INCREASE (DECREASE) IN CASH AND
CASH EQUIVALENTS.............. (130,651) 290,931 100,593
Cash and cash equivalents at
beginning of year.................. 924,878 633,947 533,354
-------------------------------------
CASH AND CASH EQUIVALENTS AT END
OF YEAR....................... $ 794,227 $ 924,878 $ 633,947
-------------------------------------
See notes to consolidated financial statements.
CONSOLIDATED STATEMENT OF CHANGES IN SHAREHOLDERS' EQUITY
(DOLLARS IN THOUSANDS)
Unrealized
Gain (Loss) on
Securities
Common Retained Available Treasury
Stock Surplus Earnings for Sale Stock Total
=======================================================================================================================
Balance at January 1,1995.................................... $ 55,615 $116,362 $126,038 $(2,578) $295,437
Net Income for 1995......................................... 46,279 46,279
Proceeds from employee stock purchase plan and options...... 250 475 (34) 691
Tax benefit related to exercise of stock options............ 503 503
Issuance of restricted stock................................ 132 1,078 1,210
Restricted stock plan deferred compensation, net.. ......... (997) (997)
Adjustment to unrealized gain on securities available
for sale, net of tax...................................... 11,064 11,064
Cash dividend............................................... (12,723) (12,723)
---------------------------------------------------------
Balance at December 31, 1995 55,997 118,418 158,563 8,486 341,464
Net Income for 1996......................................... 54,978 54,978
Proceeds from employee stock purchase plan and options...... 300 434 (409) 325
Tax benefit related to exercise of stock options............ 661 661
Issuance of restricted stock................................ 15 65 80
Restricted stock plan deferred compensation, net............ 392 392
Adjustment to unrealized gain on securities available
for sale, net of tax...................................... (884) (884)
Cash dividend............................................... (18,073) (18,073)
Two-for-one stock split..................................... 56,098 (56,098)
---------------------------------------------------------
Balance at December 31, 1996................................. 112,410 63,480 195,451 7,602 378,943
Net Income for 1997......................................... 63,485 63,485
Proceeds from employee stock purchase plan and options...... 300 437 (1,949) $ 3,201 1,989
Tax benefit related to exercise of stock options............ 1,492 1,492
Purchase of treasury stock.................................. (17,814) (17,814)
Issuance of restricted stock................................ 522 2,297 2,819
Restricted stock plan deferred compensation, net............ (2,112) (2,112)
Adjustment to unrealized gain on securities available
for sale, net of tax...................................... 1,066 1,066
Cash dividend............................................... (21,463) (21,463)
---------------------------------------------------------
Balance at December 31, 1997................................. $112,710 $65,931 $233,412 $ 8,668 $(12,316) $408,405
=========================================================
See notes to consolidated financial statements.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE A -- SUMMARY OF ACCOUNTING POLICIES
Cullen/Frost Bankers, Inc., ("Cullen/Frost" or "the Corporation")
through its wholly-owned subsidiary banks provides a broad array of products and
services throughout central and south Texas. In addition to general commercial
banking, other products and services offered include trust and investment
management, mortgage banking, leasing, asset-based lending, treasury management
and item processing.
The accounting and reporting policies followed by Cullen/Frost are in
accordance with generally accepted accounting principles and conform to general
practices within the banking industry. The more significant accounting and
reporting policies are summarized below.
BASIS OF PRESENTATION -- The consolidated financial statements include the
accounts of Cullen/Frost and its wholly-owned subsidiaries. Condensed parent
company financial statements reflect investments in subsidiaries using the
equity method of accounting. All significant intercompany balances and
transactions have been eliminated in consolidation. Certain reclassifications
have been made to make prior years comparable.
USE OF ESTIMATES -- The preparation of financial statements in conformity
with generally accepted accounting principles requires management to make
estimates and assumptions that affect the amounts reported in the consolidated
financial statements and accompanying notes. Actual results could differ from
those estimates.
SECURITIES -- Securities are classified as held to maturity and carried at
amortized cost when the Corporation has the intent and ability to hold the
securities until maturity. Securities to be held for indefinite periods of time
are classified as available for sale and stated at fair value, with the
unrealized gains and losses, net of tax, reported as a separate component of
shareholders' equity. The adjusted carrying value of the specific security sold
is used to compute gain or loss on the sale of securities. Declines in value
other than temporary declines are adjusted against the security with a charge to
operations.
LOANS -- Interest on loans is accrued and accreted to operations based on
the principal amount outstanding. Interest on certain consumer loans is
recognized over their respective terms using a method which approximates the
interest method. Generally, loans are placed on a non-accrual status if
principal or interest payments become 90 days past due and/or management deems
the collectability of the principal and/or interest to be in question. Once
interest accruals are discontinued, uncollected but accrued interest is charged
to current year operations. Loans which are determined to be uncollectible are
charged to the allowance for possible loan losses. The collectability of loans
is continually reviewed by management.
ALLOWANCE FOR POSSIBLE LOAN LOSSES -- The allowance for possible loan
losses is established through a provision for possible loan losses charged to
current operations. The amount maintained in the allowance reflects management's
continuing assessment of the potential losses inherent in the portfolio based on
evaluations of industry concentrations, specific credit risks, loan loss
experience, current loan portfolio quality, and anticipated economic, political
and regulatory conditions. On January 1, 1995, the Corporation adopted SFAS No.
114, "Accounting by Creditors for Impairment of a Loan," as amended by SFAS
No. 118, "Accounting by Creditors for Impairment of a Loan -- Income
Recognition and Disclosure." The allowance for possible loan losses related to
loans that are impaired is based on discounted cash flows using the loan's
initial effective interest rate or the fair value of the collateral for certain
collateral dependent loans. Income on impaired loans is recognized in accordance
with SFAS No. 118 which is based on the collectability of the principal amount.
FORECLOSED ASSETS -- Foreclosed assets consist of property which has been
formally repossessed. Collateral obtained through foreclosure is recorded at the
lower of fair value less estimated selling costs or the underlying loan amounts.
Write-downs are provided for subsequent declines in value. A loan is classified
as in-substance foreclosure when the Corporation has taken possession of the
collateral regardless of whether formal foreclosure proceedings have taken
place.
BANKING PREMISES AND EQUIPMENT -- Banking premises and equipment are stated
at cost, less accumulated depreciation and amortization. Depreciation and
amortization are generally computed on a straight-line basis over the estimated
useful lives of the assets. Leasehold improvements are generally amortized over
the lesser of the term of the respective leases or the estimated useful lives of
the improvements.
On January 1, 1996, the Company adopted SFAS No. 121, "Accounting for the
Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed Of."
This statement requires that long-lived assets and certain identifiable
intangibles be reviewed for impairment whenever events or changes in
circumstances indicate that the carrying amount of an asset may not be
recoverable on an undiscounted basis. If impairment is indicated the present
value of expected future cash flows from the use of the asset and its eventual
disposition are less than the carrying amount of the asset, an impairment loss
is recognized. The adoption did not have a material impact on financial position
or results of operations.
INTANGIBLE ASSETS -- The excess of cost over fair value of net assets of
businesses acquired (goodwill) is amortized on a straight-line and accelerated
basis (as appropriate) over periods generally not exceeding twenty-five years.
Core deposit and other intangibles are amortized on an accelerated basis over
their estimated remaining lives. Intangible assets are included in other assets.
All such intangible assets are periodically evaluated as to the recoverability
of their carrying value.
FEDERAL INCOME TAXES -- Cullen/Frost files a consolidated federal income
tax return which includes the taxable income of all of its principal
subsidiaries. Applicable federal income taxes of the individual subsidiaries are
generally determined on a separate return basis. Deferred tax assets and
liabilities are recognized for the expected future tax consequences of temporary
differences between the financial reporting bases and the tax bases of assets
and liabilities. If it is more likely than not that some portion or all of a
deferred tax asset will not be realized, a valuation allowance is recognized.
STOCK OPTION PLANS -- On January 1, 1996 the Corporation adopted SFAS No.
123, "Accounting for Stock Based Compensation." The Statement allows the
continued use of Accounting Principles Board. Opinion No. 25, "Accounting for
Stock Issued to Employees," (APB No. 25) and related Interpretations. The
Corporation continues to account for its stock option plans in accordance with
APB No. 25. Under APB No. 25, because the exercise price of the Corporation's
employee stock options equals the market price of the underlying stock on the
date of grant, no compensation expense is recognized. SFAS No. 123 also allows
for the fair value method of accounting for employees stock options. The
continued use of APB No. 25 requires pro forma disclosures of net income and
earnings per share as if the fair value method of accounting had been applied.
STOCK SPLIT -- The number of shares outstanding, related earnings per share
amounts and dividends have been restated to retroactively give effect for the
two-for-one stock split declared and distributed by the Corporation during the
second quarter of 1996.
FINANCIAL DERIVATIVES -- Derivatives are used to hedge interest rate
exposure by modifying the interest rate characteristics of related balance sheet
instruments. The specific criteria required for derivatives used for these
purposes are described below. Derivatives that do not meet these criteria are
carried at market value with changes in value recognized currently in earnings.
Derivatives used as hedges must be effective at reducing the risk
associated with the exposure being hedged and must be designated as a hedge at
the inception of the derivative contract. Derivatives currently used for hedging
purposes include swaps and purchased floors. These swap transactions allow
management to structure the interest rate sensitivity of the asset side of the
Corporation's balance sheet to more closely match its view of the interest rate
sensitivity of the Corporation's funding sources. The fair value of derivative
contracts are carried off-balance sheet and the unrealized gains and losses on
derivative contracts are generally deferred. The interest component associated
with derivatives used as hedges or to modify the interest rate characteristics
of assets and liabilities is recognized over the life of the contract in net
interest income. Upon contract settlement or early termination, the cumulative
change in the market value of such derivatives is recorded as an adjustment to
the carrying value of the underlying asset or liability and
recognized in net interest income over the expected remaining life of the
related asset or liability. In instances where the underlying instrument is
repaid, the cumulative change in the value of the associated derivative is
recognized immediately in earnings.
ACCOUNTING CHANGES -- The following is a brief discussion of the SFAS
pronouncements issued by the FASB in 1996 and 1997 which apply to the
Corporation.
In June 1996, the FASB issued SFAS No. 125, "Accounting for Transfers and
Servicing of Financial Assets and Extinguishments of Liabilities." The
statement provides consistent standards for distinguishing transfers of
financial assets that are sales from transfers that are secured borrowings based
on a control-oriented "financial-components" approach. Under this approach,
after a transfer of financial assets, an entity recognizes the financial and
servicing assets it controls and liabilities it has incurred, derecognizes
financial assets when control has been surrendered and derecognizes liabilities
when extinguished. The provisions of SFAS No. 125 were adopted by the
Corporation prospectively as of January 1, 1997 except for those provisions
relating to repurchase agreements, securities lending, and other similar
transactions and pledged collateral, which were delayed for one year by SFAS No.
127, "Deferral of the Effective Date of Certain Provisions of FASB Statement
No. 125, an amendment of FASB Statement No. 125" and adopted prospectively as
of January 1, 1998. The adoption of these statements did not and is not expected
to have a material impact on financial position or results of operations.
In February 1997, the FASB issued SFAS No. 128, "Earnings per Share." The
statement replaces primary and fully-diluted earnings per share with basic and
diluted earnings per share in an effort to simplify the computation of these
measures and align them more closely with the methodology used internationally.
The statement requires dual presentation of basic and diluted earnings per share
on the face of the income statement and a reconciliation of the numerator and
denominator used in the basic and diluted earnings per share computations. Basic
earnings per share excludes dilution and is computed by dividing income by the
weighted-average number of common shares outstanding for the period. Diluted
earnings per share is similar to the previously reported fully diluted earnings
per share which includes potential dilution and is computed by dividing income
by the weighted-average number of common and common equivalent shares
outstanding during the period. The computations for the dilutive effect of
common stock options are based upon the average market price of common stock
during the reported period. Earnings per share amounts for all periods presented
have been restated.
In June 1997, the FASB issued SFAS No. 130, "Reporting Comprehensive
Income." The statement provides that all items that are required to be
recognized under accounting standards as comprehensive income be reported in a
financial statement that is displayed with the same prominence as other
financial statements. Comprehensive income includes net income as well as
certain items that are reported directly within a separate component of
stockholders' equity and bypass net income. The provisions of SFAS No. 130 are
effective for fiscal years beginning after December 15, 1997. The adoption of
this statement will have no impact on financial position or results of
operations.
In June 1997, the FASB issued SFAS No. 131, "Disclosures about Segments of
an Enterprise and Related Information." The statement establishes standards for
the method that public entities use to report information about operating
segments in annual financial statements and requires that those enterprises
report selected information about operating segments in interim financial
reports issued to shareholders. It also establishes standards for related
disclosures about products and services, geographical areas and major customers.
The provisions of SFAS No. 131 are effective for fiscal years beginning after
December 15, 1997. Adoption in interim financial statements is not required
until the year after initial adoption; however, comparative prior year
information is required. The Corporation is currently evaluating the impact of
this statement on the disclosures included in its annual and interim period
financial statements.
NOTE B -- ACQUISITIONS
The transactions listed below have been accounted for as purchase
transactions with the total cash consideration funded through internal sources.
The purchase price has been allocated to the underlying
assets and liabilities based on estimated fair value at the date of acquisition.
Results of operations are included from the date of acquisition.
1997 ACQUISITION
CORPUS CHRISTI BANCSHARES, INC. -- CORPUS CHRISTI
On March 7, 1997, the Corporation paid approximately $32.2 million to
acquire Corpus Christi Bancshares, Inc., including its subsidiary Citizens State
Bank, in Corpus Christi, Texas. Goodwill associated with the transaction
amounted to approximately $13.8 million and will be amortized on a straight-line
basis over a 15-year life. Approximately $7.1 million of other intangibles
associated with the acquisition will be amortized over their estimated lives
ranging from five to ten years on an accelerated method. The Corporation
acquired loans of approximately $108 million and deposits of approximately $184
million. Cullen/Frost's results of operations would not have been materially
impacted if the Corpus Christi Bancshares acquisition had occurred at the
beginning of 1997 or 1996.
1996 ACQUISITIONS
S.B.T. BANCSHARES, INC. -- SAN MARCOS
On January 5, 1996, the Corporation paid approximately $17.7 million to
acquire S.B.T. Bancshares, Inc., including its subsidiary, State Bank and Trust
Company in San Marcos, Texas. Goodwill associated with the transaction amounted
to approximately $6.5 million and will be amortized on a straight-line basis
over a 15-year life. Approximately $4.5 million of other intangibles associated
with the acquisition will be amortized over their estimated lives ranging from
five to ten years on an accelerated method. The Corporation acquired loans of
approximately $51 million and deposits of approximately $112 million.
Cullen/Frost's results of operations would not have been materially impacted if
the S.B.T. Bancshares acquisition had occurred at the beginning of 1995.
PARK NATIONAL BANK -- HOUSTON
On February 15, 1996, the Corporation paid approximately $33.5 million to
acquire Park National Bank in Houston, Texas. Goodwill associated with the
transaction amounted to approximately $8.4 million and will be amortized on a
straight-line basis over a 15-year life. Approximately $7.6 million of other
intangibles associated with the acquisition will be amortized over their
estimated lives ranging from five to ten years on an accelerated method. The
Corporation acquired loans of approximately $157 million and deposits of
approximately $225 million. Cullen/Frost's results of operations would not have
been materially impacted if the Park National Bank acquisition had occurred at
the beginning of 1996 or 1995.
1995 ACQUISITIONS
VALLEY BANCSHARES, INC. -- MCALLEN
On April 4, 1995, the Corporation paid approximately $9.2 million to
acquire Valley Bancshares, Inc., including its subsidiary, Valley National Bank
in McAllen, Texas. Goodwill associated with the transaction amounted to
approximately $1.7 million and is being amortized on a straight-line basis over
a 15-year life. Approximately $3.3 million of other intangibles associated with
the acquisition are being amortized over their estimated lives ranging from six
to ten years on an accelerated method. The Corporation acquired loans of
approximately $28 million and deposits of approximately $49 million.
Cullen/Frost's results of operations would not have been materially impacted if
the Valley Bancshares acquisition had occurred at the beginning of 1995.
NATIONAL COMMERCE BANK -- HOUSTON
On May 19, 1995, the Corporation paid approximately $24.2 million to
acquire National Commerce Bank in Houston, Texas. Goodwill associated with the
transaction amounted to approximately $10.5 million and is being amortized on a
straight-line basis over a 15-year life. Approximately $5.1 million of other
intangibles associated with the acquisition are being amortized over their
estimated lives ranging from six to eleven years on an accelerated method. The
Corporation acquired loans of approximately $95 million and
deposits of approximately $101 million. Cullen/Frost's results of operations
would not have been materially impacted if the National Commerce acquisition had
occurred at the beginning of 1995.
COMERICA BANK BRANCHES -- SAN ANTONIO
On July 21, 1995, the Corporation acquired the two San Antonio branches of
Comerica Bank Texas. The Corporation acquired loans of approximately $2 million
and deposits of approximately $34 million.
NOTE C -- CASH AND DUE FROM BANKS
Cullen/Frost subsidiary banks are required to maintain cash or non-interest
bearing reserves with the Federal Reserve Bank which are equal to specified
percentages of deposits. The average amounts of reserve and contractual balances
were $65,121,000 for 1997 and $73,813,000 for 1996.
NOTE D -- SECURITIES
A summary of the amortized cost and estimated fair value of securities is
presented below.
December 31, 1997 December 31, 1996
============================================== ==============================================
Amortized Unrealized Unrealized Estimated Amortized Unrealized Unrealized Estimated
(in thousands) Cost Gains Losses Fair Value Cost Gains Losses Fair Value
==============================================================================================================================
Securities Held to
Maturity:
U.S. Government
agencies and
corporations........... $ 143,691 $ 4,244 $ 18 $ 147,917 $ 171,845 $ 3,642 $ 64 $ 175,423
States and political
subdivisions........... 5,043 352 5,395 5,269 312 5,581
Other................... 25 25 25 25
---------------------------------------------- ---------------------------------------------
Total.............. $ 148,759 $ 4,596 $ 18 $ 153,337 $ 177,139 $ 3,954 $ 64 $ 181,029
============================================== =============================================
Securities Available
for Sale:
U.S. Treasury.......... $ 310,441 $ 38 $ 98 $ 310,381 $ 231,326 $ 102 $ 77 $ 231,351
U.S. Government
agencies and
corporations.......... 1,011,603 16,097 2,701 1,024,999 1,049,722 16,058 4,387 1,061,393
State and political
subdivisions.......... 50 50 180 3 4 179
Other.................. 7,329 7,329 6,361 1 6,362
---------------------------------------------- ---------------------------------------------
Total............ $1,329,423 $16,135 $2,799 $1,342,759 $1,287,589 $ 16,164 $ 4,468 $1,299,285
============================================== =============================================
The amortized cost and estimated fair value of securities at December 31,
1997 are presented below by contractual maturity. Actual maturities will differ
from contractual maturities because borrowers may have the right to call or
prepay obligations with or without prepayment penalties.
December 31, 1997
=============================================================
Securities Held to Maturity Securities Available for Sale
-------------------------------------------------------------
Amortized Estimated Amortized Estimated
(in thousands) Cost Fair Value Cost Fair Value
=========================================================================================================
Due in one year or less..................... $ 55 $ 55 $ 310,491 $ 310,431
Due after one year through five years....... 260 263 25 25
Due after five years through ten years...... 1,958 1,994
Due after ten years......................... 2,795 3,107 7,304 7,304
------------------------- ------------------------
5,068 5,419 317,820 317,760
Mortgage-backed securities and
collateralized mortgage obligations....... 143,691 147,918 1,011,603 1,024,999
------------------------- ------------------------
Total................................... $ 148,759 $ 153,337 $1,329,423 $1,342,759
========================= ========================
On November 15, 1995, the FASB staff issued a special report, "A Guide to
Implementation of Statement 115 on Accounting for Certain Investments in Debt
and Equity Securities." In accordance with
provisions in this report, the Corporation took advantage of a one-time
reassessment of the classification of all securities and reclassified securities
with an amortized cost of $733,206,000 from the held to maturity category to the
available for sale category. The unrealized loss on the securities at the time
of the transfer was $2,351,000.
Proceeds from sales of securities available for sale during 1997 were
$423,942,000. During 1997, gross gains of $523,000 and gross losses of $29,000
were realized on those sales. Proceeds from sales of securities available for
sale during 1996 were $215,983,000. During 1996, gross gains of $42,000 and
gross losses of $1,022,000 were realized on those sales. Proceeds from sales of
securities available for sale during 1995 were $147,468,000. During 1995, gross
gains of $100,000 and gross losses of $1,496,000 were realized on those sales.
The carrying value of securities pledged to secure public funds, trust
deposits, securities sold under repurchase agreements and for other purposes as
required or permitted by law amounted to $999,499,000 at December 31, 1997 and
$752,039,000 at December 31, 1996.
NOTE E -- LOANS AND ALLOWANCE FOR POSSIBLE LOAN LOSSES
A summary of loans outstanding follows:
December 31
--------------------------
(in thousands) 1997 1996
- -----------------------------------------------------------------
Real estate:
Construction.................... $ 116,100 $ 84,146
Land............................ 54,142 50,208
Permanent mortgages:
Commercial................. 254,716 225,845
Residential................ 461,635 422,985
Other........................... 247,824 261,207
Commercial and industrial............ 804,257 650,114
Consumer............................. 602,415 491,086
Financial institutions............... 3,767 12,749
Foreign.............................. 72,911 45,562
Purchasing or carrying securities.... 788 1,812
Other................................ 27,285 8,908
Unearned discount.................... (2,318) (1,154)
--------------------------
Total loans................... $ 2,643,522 $ 2,253,468
--------------------------
In the normal course of business, in order to meet the financial needs of
its customers, the Corporation is a party to financial instruments with
off-balance sheet risk. These include commitments to extend credit and standby
letters of credit which commit the Corporation to make payments on behalf of
customers when certain specified future events occur. Both arrangements have
credit risk essentially the same as that involved in extending loans to
customers and are subject to the Corporation's normal credit policies.
Collateral is obtained based on management's credit assessment of the customer.
No material losses are anticipated as a result of these commitments. Commitments
to extend credit and standby letters of credit amounted to $1,066,929,000 and
$48,671,000, respectively, at December 31, 1997. Commitments to extend credit
and standby letters of credit amounted to $851,342,000 and $43,293,000,
respectively, at December 31, 1996. Commercial and industrial loan commitments
represent approximately 74 percent and 77 percent of the total loan commitments
outstanding at December 31, 1997 and 1996, respectively.
The majority of the Corporation's real estate loans are secured by real
estate in San Antonio and Houston. Mortgage loans of approximately $6.5 million
and $4.4 million were held for sale by the Corporation and are included in
residential permanent mortgages at December 31, 1997 and 1996, respectively.
These loans are valued at the lower of cost or market, on an aggregate basis.
In the normal course of business, Cullen/Frost subsidiary banks make loans
to directors and officers of both Cullen/Frost and its subsidiaries. These loans
are made on substantially the same terms, including interest rates and
collateral, as those prevailing at the time for comparable transactions with
other persons. Loans made to directors and executive officers of Cullen/Frost
and its significant subsidiaries, including loans made to their associates,
amounted to $51,914,000 and $53,393,000 at December 31, 1997 and 1996,
respectively. During 1997, additions to these loans amounted to $51,921,000,
repayments totaled $51,590,000 and other changes totaled $1,810,000. These other
changes consist primarily of changes in related-party status. Standby letters of
credit extended to directors and executive officers of Cullen/Frost and its
significant subsidiaries and their associates amounted to $692,000 and $684,000
at December 31, 1997 and 1996, respectively.
A summary of the changes in the allowance for possible loan losses follows:
Year Ended December 31
-------------------------------
(in thousands) 1997 1996 1995
- -------------------------------------------------------------------------
Balance at the beginning of the year.... $ 37,626 $ 32,268 $ 26,002
Provision for possible loan losses...... 7,900 7,300 6,272
Loan loss reserve of acquired
institutions.......................... 2,105 627 430
Net charge-offs:
Losses charged to the allowance.... (9,590) (10,245) (4,681)
Recoveries......................... 3,805 7,676 4,245
-------------------------------
Net charge-offs............... (5,785) (2,569) (436)
-------------------------------
Balance at the end of the year.......... $ 41,846 $ 37,626 $ 32,268
-------------------------------
A loan within the scope of SFAS No. 114 is considered impaired when, based
on current information and events, it is probable that the Corporation will be
unable to collect all amounts due according to the contractual terms of the loan
agreement, including scheduled principal and interest payments. At December 31,
1997, the majority of the impaired loans were real estate loans and
collectability was measured based on the fair value of the collateral. Interest
payments on impaired loans are typically applied to principal unless
collectability of the principal amount is fully assured, in which case interest
is recognized on the cash basis. Interest revenue recognized on impaired loans
for 1997 and 1996 was $82,000 and $55,000, respectively. The total allowance for
possible loan losses includes activity related to allowances calculated in
accordance with SFAS No. 114 and activity related to other loan loss allowances
determined in accordance with SFAS No. 5.
The following is a summary of loans considered to be impaired:
December 31
--------------------
(in thousands) 1997 1996
- --------------------------------------------------------------
Impaired loans with no valuation
reserve............................... $ 1,940 $ 4,333
Impaired loans with a valuation
reserve............................... 3,265
--------------------
Total recorded investment in impaired
loans................................. $ 5,205 $ 4,333
--------------------
Valuation reserve....................... $ 2,199
The average recorded investment in impaired loans was $5,500,000 and $7,290,000
for the years ended December 31, 1997 and 1996, respectively.
NOTE F -- NON-PERFORMING ASSETS
A summary of non-performing assets follows:
December 31
--------------------
(in thousands) 1997 1996
- --------------------------------------------------------------
Non-accrual and restructured loans...... $ 12,702 $ 10,129
Foreclosed assets....................... 4,511 2,242
--------------------
$ 17,213 $ 12,371
--------------------
Cullen/Frost recognized interest income on non-accrual and restructured
loans of approximately $564,000, $292,000 and $165,000 in 1997, 1996 and 1995,
respectively. Had these reduced earning and non-earning loans performed
according to their original contract terms, Cullen/Frost would have recognized
additional interest income of approximately $1,131,000 in 1997, $1,182,000 in
1996 and $1,403,000 in 1995.
NOTE G -- BANKING PREMISES AND EQUIPMENT
A summary of banking premises and equipment follows:
December 31
===============================================================
1997 1996
---------------------------- ------------------------------
Accumulated Accumulated
Depreciation Net Depreciation Net
and Carrying and Carrying
(in thousands) Cost Amortization Value Cost Amortization Value
=========================================================================================================
Land....................................... $ 40,343 $ 40,343 $ 38,464 $ 38,464
Buildings.................................. 50,858 $19,026 31,832 46,460 $17,291 29,169
Furniture and equipment.................... 83,841 64,940 18,901 77,664 60,363 17,301
Leasehold improvements..................... 30,304 15,103 15,201 26,738 12,453 14,285
Construction in progress................... 3,377 3,377 2,406 2,406
-------------------------------------------------------------
Total banking premises and equipment..... $208,723 $99,069 $109,654 $191,732 $90,107 $101,625
=============================================================
NOTE H -- DEPOSITS
A summary of deposits outstanding by category follows:
December 31
--------------------------
(in thousands) 1997 1996
- -----------------------------------------------------------------
Demand deposits...................... $ 1,338,823 $ 1,331,215
Savings and Interest-on-Checking..... 766,416 726,700
Money market deposit accounts........ 996,110 876,382
Time accounts of $100,000 or more.... 546,580 478,397
Time accounts under $100,000......... 555,604 548,150
Other................................ 280,378 281,750
--------------------------
Total deposits.................. $ 4,483,911 $ 4,242,594
--------------------------
Foreign deposits totaled $632,477,000 and $570,357,000 at December 31, 1997
and 1996, respectively.
NOTE I -- BORROWED FUNDS
Cullen/Frost has a $7,500,000 revolving credit facility with another
financial institution. The line of credit bears interest at prime. There were no
borrowings outstanding on this line at December 31, 1997 and 1996.
The following table represents balances as they relate to securities sold
under repurchase agreements:
Year Ended December 31
----------------------
(in thousands) 1997 1996
- -------------------------------------------------------------
Balance at year end.................. $ 107,787 $ 88,782
Maximum month-end balance............ 107,787 105,992
For the year:
Average daily balance.............. 88,011 74,472
Cullen/Frost Capital Trust I, a Delaware statutory business trust (the
"Issuer Trust") and wholly-owned subsidiary of the Corporation, issued on
February 6, 1997, $100 million of its 8.42 percent Capital Securities, Series A
(the "Capital Securities"), which represent beneficial interests in the Issuer
Trust, in an offering exempt from registration under the Securities Act of 1933
pursuant to Rule 144A. The Capital Securities will mature on February 1, 2027
and are redeemable in whole or in part at the option of the Corporation at any
time after February 1, 2007 with the approval of the Federal Reserve and in
whole at any time upon the occurrence of certain events affecting their tax or
regulatory capital treatment. The Issuer Trust used the proceeds of the offering
of the Capital Securities to purchase Junior Subordinated Debentures of the
Corporation which constitute its only assets and which have terms substantially
similar to the Capital Securities. Payments of distributions on the Capital
Securities and payments on liquidation or redemption of the Capital Securities
are guaranteed by the Corporation on a limited basis pursuant to a Guarantee.
The Corporation has also entered into an Agreement as to Expenses and
Liabilities with the Issuer Trust pursuant to which it has agreed on a
subordinated basis to pay any costs, expenses or liabilities of the Issuer Trust
other than those arising under the Capital Securities. The obligations of the
Corporation under the Junior Subordinated Debentures, the related Indenture, the
trust agreement establishing the Issuer Trust, the Guarantee and the Agreement
as to Expenses and Liabilities, in the aggregate, constitute a full and
unconditional guarantee by the Corporation of the Issuer Trust's obligations
under the Capital Securities.
The Corporation has used the majority of the proceeds of the sale of the
Junior Subordinated Debentures for acquisitions, see Note U "Subsequent
Events" on page 53, and the repurchase of the Corporation's common stock. The
Capital Securities are included in the Tier 1 capital of the Corporation for
regulatory capital purposes and are reported as debt on the balance sheet, net
of deferred issuance costs. The Corporation records distributions payable on the
Capital Securities as interest expense. The Corporation has the right to defer
payments of interest on the Junior Subordinated Debentures at any time or from
time to time for a period of up to ten consecutive semi-annual periods with
respect to each deferral period. Under the terms of the Junior Subordinated
Debentures, in the event that under certain circumstances there is an event of
default under the Junior Subordinated Debentures or the Corporation has elected
to defer interest on the Junior Subordinated Debentures, the Corporation may
not, with certain exceptions, declare or pay any dividends or distributions on
its capital stock or purchase or acquire any of its capital stock.
On March 13, 1997, the Corporation and the Issuer Trust, filed a
Registration Statement on Form S-4 with the Securities and Exchange Commission
to register under the Securities Act of 1933 the exchange of up to $100 million
aggregate Liquidation Amount of "new" 8.42 percent Capital Securities, Series
A for the then outstanding Capital Securities. On April 25, 1997, the
Corporation exchanged all of the outstanding Capital Securities for registered
Capital Securities. The "new" Capital Securities have the same terms as the
"old" Capital Securities. This exchange enhanced the transferability of the
Capital Securities and will have no impact on redemption of the Capital
Securities, the Junior subordinated Debentures issued by the Company, the
Company's guarantee of the Capital Securities, or other matters described above.
NOTE J -- COMMON STOCK AND EARNINGS PER COMMON SHARE
In accordance with SFAS 128, the reconciliation of earnings per share for
1997, 1996 and 1995 follows:
December 31
-------------------------------------------
1997 1996 1995
- -------------------------------------------------------------------------------------
Numerators for both basic and diluted
earnings per share, net income........ $ 63,485,000 $ 54,978,000 $ 46,279,000
-------------------------------------------
Denominators:
Denominators for basic earnings per
share, average outstanding common
shares................................ 22,368,744 22,443,915 22,308,718
Dilutive effect of stock options........ 696,508 461,827 366,930
-------------------------------------------
Denominator for diluted earnings per
share................................. 23,065,252 22,905,742 22,675,648
-------------------------------------------
Earnings per share:
Basic................................... $ 2.84 $ 2.45 $ 2.07
Diluted................................. 2.75 2.40 2.04
NOTE K -- DIVIDENDS
In the ordinary course of business Cullen/Frost is dependent upon dividends
from its subsidiary banks to provide funds for the payment of dividends to
shareholders and to provide for other cash requirements. The amount of dividends
that subsidiary banks may declare is subject to regulations. Without prior
regulatory approval, the subsidiary banks had approximately $31,062,000
available for the payment of dividends to Cullen/Frost at December 31, 1997.
NOTE L -- CAPITAL
The table below reflects various measures of regulatory capital at year end
1997 and 1996 for the Corporation. As a result of the issuance of the $100
million Trust Preferred Capital Securities see (see Note I "Borrowed Funds")
all the regulatory capital ratios are up when compared to a year ago.
December 31, 1997 December 31, 1996
-------------------- --------------------
(in thousands) AMOUNT Ratio Amount Ratio
- ----------------------------------------------------------------------------------
Risk-Based
Tier 1 Capital.................. $ 426,480 13.89% $ 307,285 11.58%
Tier 1 Capital Minimum
requirement..................... 122,834 4.00 106,114 4.00
Total Capital................... $ 464,908 15.14% $ 340,485 12.83%
Total Capital Minimum
requirement..................... 245,668 8.00 212,228 8.00
Risk-adjusted assets, net of
goodwill...................... $ 3,070,854 $ 2,652,846
Leverage ratio....................... 8.45% 6.76%
Average equity as a percentage of
average assets..................... 7.99 7.98
The FDIC Improvement Act of 1991 ("FDICIA") established five capital
tiers for depository institutions and final rules relating to these tiers were
adopted by the federal banking agencies. Effective December 16, 1992, federal
banking agencies adopted final rules relating to these tiers. At December 31,
1997 and 1996, the Corporation's subsidiary banks were considered "well
capitalized" as defined by FDICIA, the highest rating, and the Corporation's
capital ratios were in excess of "well capitalized" levels. A financial
institution is deemed to be well capitalized if the institution has a total
risk-based capital ratio of 10.0 percent or greater, a Tier 1 risk-based capital
ratio of 6.0 percent or greater, and a Tier 1 leverage ratio of 5.0 percent or
greater and the institution is not subject to an order, written agreement,
capital directive or prompt corrective action directive to meet and maintain a
specific capital level for any capital measure. The Corporation and its
subsidiary banks currently exceed all minimum capital requirements. Management
is
not aware of any conditions or events that would have changed the Corporation's
capital rating since December 31, 1997.
The Corporation is subject to the regulatory capital requirements
administered by the Federal Reserve Bank. Regulators can initiate certain
mandatory actions, if the Corporation fails to meet the minimum requirements,
that could have a direct material effect on the Corporation's financial
statements.
NOTE M -- LEASES AND RENTAL AGREEMENTS
Rental expense for all leases amounted to $11,048,000, $10,589,000 and
$9,842,000 for the years ended December 31, 1997, 1996 and 1995, respectively.
A summary of the total future minimum rental commitments due under
non-cancelable equipment leases and long-term agreements on banking premises at
December 31, 1997 follows:
Total
(in thousands) Commitments
- ---------------------------------------------------
1998................................. $11,304
1999................................. 10,392
2000................................. 7,407
2001................................. 5,161
2002................................. 4,367
Subsequent to 2002................... 19,077
-----------
Total future minimum rental
commitments..................... $57,708
-----------
It is expected that certain leases will be renewed, or equipment replaced
with new leased equipment, as these leases expire.
NOTE N -- EMPLOYEE BENEFIT PLANS
RETIREMENT PLANS --
Cullen/Frost has a non-contributory defined benefit plan which covers
substantially all employees who have completed at least one year of service and
have attained the age of 21. Defined benefits are provided based on an
employee's final average compensation, age at retirement and years of service.
Cullen/Frost's funding policy is to contribute quarterly an amount necessary to
satisfy the Employee Retirement Income Security Act (ERISA) funding standards.
An eligible employee's right to receive benefits under the plan becomes fully
vested upon the earlier of the date on which such employee has completed five
years of service or the date on which such employee attains 65 years of age.
Retirement benefits under the plan are paid to vested employees upon their (i)
normal retirement at age 65 or later or (ii) early retirement at or after age
55, but before age 65. In addition, Cullen/Frost has a Restoration of Retirement
Income Plan (providing benefits in excess of the limits under Section 415 of the
Internal Revenue Code of 1986, as amended) for eligible employees which is
designed to comply with the requirements of ERISA and the entire cost of which
is provided by Cullen/Frost contributions. Both plans, as amended, provide for
the payment of monthly retirement income pursuant to a formula based on an
eligible employee's highest three consecutive years of final average
compensation during the last ten consecutive years of employment.
The funded status of the plans and the amounts recognized in Cullen/Frost's
consolidated balance sheets at December 31, 1997 and 1996 are presented below:
(in thousands) 1997 1996
==========================================================================================================
Actuarial present value of benefit obligations:
Accumulated benefit obligation, including vested
benefits of $32,694 in 1997 and $28,432 in 1996...................................... $34,707 $29,934
=================
Projected benefit obligation for service rendered to date.............................. $51,776 $44,796
Plan assets at fair value (primarily listed stocks and U.S. and corporate bonds)....... 42,356 31,676
-----------------
Projected benefit obligation in excess of plan assets.................................. 9,420 13,120
Unrecognized net loss from past experience different from
that assumed and effects of changes in assumptions.................................... (7,876) (7,608)
Unrecognized prior service cost........................................................ (4,292) (4,849)
Unrecognized net transitional asset.................................................... 590 690
-----------------
(Prepaid) accrued pension cost included in other liabilities.................... $(2,158) $ 1,353
=================
Net pension cost included the following components:
(in thousands) 1997 1996 1995
=========================================================================================
Service cost for benefits earned during the year............ $2,741 $2,035 $1,731
Actual return on plan assets, net of expenses............... (4,551) (2,755) (3,837)
Interest cost on projected benefit obligation............... 3,319 2,947 2,607
Net amortization and deferral............................... 2,293 1,715 2,788
---------------------------
Net pension cost.......................................... $3,802 $3,942 $3,289
===========================
The weighted-average discount rate used for calculating the pension
obligation at December 31, 1997 was 7.25 percent, and the assumed rate of future
compensation increases was 5 percent. These assumptions will be used for
calculating the 1998 net periodic pension cost. The weighted-average discount
rate used for calculating the pension obligation at December 31, 1996 and for
calculating the net periodic pension cost for 1997 was 7.5 percent and the
assumed rate of future compensation increases was 5 percent. The expected
long-term rate of return on plan assets for 1997, 1996, and 1995 was 9 percent.
The Corporation has a supplemental executive retirement plan ("SERP") for
certain key executives. The plan provides for target retirement benefits, as a
percentage of pay, beginning at age 55. The target percentage is 45 percent of
pay at age 55, increasing to 60 percent at age 60 and later. Benefits under the
SERP are reduced, dollar-for-dollar, by benefits received under the Retirement
and Restoration Plans, described above, and any social security benefits.
SAVINGS PLANS --
The Corporation maintains a 401(k) stock purchase plan (the "401(k)
Plan"). The 401(k) Plan permits each participant to make before- or after-tax
contributions up to 16 percent of eligible compensation. Cullen/Frost makes
matching contributions to the 401(k) Plan based on the amount of each
participant's contributions up to a maximum of six percent of eligible
compensation. Eligible employees must complete 90 days of service to be eligible
for enrollment and vest in the Corporation's matching contributions over a
five-year period. The Corporation's gross expenses related to the 401(k) Plan
were $2,346,000, $1,965,000 and $1,521,000 for 1997, 1996 and 1995,
respectively. During 1997, 1996 and 1995, the Corporation utilized forfeitures
of $308,000, $449,000 and $1,439,000, respectively, to offset this expense.
The 1991 Thrift Incentive Stock Purchase Plan ("1991 Stock Purchase
Plan") was adopted to offer those employees whose participation in the 401(k)
Plan is limited an alternative means of receiving comparable benefits. The
Corporation's expenses related to the 1991 Stock Purchase Plan were $743,000,
$754,000 and $595,000 for 1997, 1996 and 1995, respectively.
EXECUTIVE STOCK PLANS --
The Corporation has four executive stock plans and one outside director
stock plan; the 1983 Nonqualified Stock Option Plan ("1983 Plan"), the 1988
Nonqualified Stock Option Plan ("1988 Plan"), the Restricted Stock Plan, the
1992 Stock Plan and the 1997 Outside Directors Stock plan ("1997 Plan"). The
1992 Stock Plan is an all-inclusive plan, with an aggregate of 2,805,000 shares
of common stock authorized for award. The 1992 Stock Plan has replaced all other
previously approved executive stock plans. In general, options awarded have a
ten-year life with a five-year vesting period. These plans which were approved
by shareholders were established to enable the Corporation to retain and
motivate key employees. A committee of non-participating directors has sole
authority to select the employees, establish the awards to be issued, and
approve the terms and conditions of each award contract. The Corporation has
common stock reserved for future issuance upon the grant and exercise of options
of 2,752,493 shares.
The 1992 Stock Plan allows the Corporation to grant restricted stock,
incentive stock options, nonqualified stock options, stock appreciation rights,
or any combination thereof to certain key executives of the Corporation.
The 1997 Outside Directors Plan allows the Corporation to grant
nonqualified stock options to outside directors. The options may be awarded to
outside directors in such number, and upon such terms, and at any time and from
time to time as determined by the Compensation and Benefits Committee
("Committee"). Each award is evidenced by an award agreement that specifies
the option price, the duration of the option, the number of shares to which the
option pertains, and such other provisions as the Committee determines. The
option price for each grant is at least equal to the fair market value of a
share on the date of grant. Options granted expire at such time as the Committee
determines at the date of grant and in no event does the exercise period exceed
a maximum of ten years.
The following is a summary of option transactions in each of the last three
years.
1983 Plan 1988 Plan 1992 Plan 1997 Plan
==================== ==================== =============================== ===============================
Weighted Weighted Shares Weighted Shares Weighted
Options Average Options Average Available Options Average Available Options Average
Outstanding Price Outstanding Price For Grant Outstanding Price For Grant Outstanding Price
==================================================================================================================================
Balance, Dec. 31, 1994 101,978 $ 4.92 269,250 $5.09 939,202 653,062 $17.08
Granted............... (204,000) 204,000 22.88
Exercised............. (43,936) 5.12 (34,652) 4.46 (23,742) 15.77
Canceled.............. (2,508) 5.46 (1,804) 5.46 5,254 (5,254) 16.05
-----------------------------------------------------------------------------------------------------------
Balance, Dec. 31, 1995 55,534 4.73 232,794 5.18 740,456 828,066 18.55
Granted............... (403,000) 403,000 30.14
Exercised............. (13,036) 4.14 (53,958) 5.14 (38,906) 17.73
Canceled.............. (5,868) 5.46 (788) 5.46 21,234 (21,234) 19.05
-----------------------------------------------------------------------------------------------------------
Balance, Dec. 31, 1996 36,630 4.83 178,048 5.20 358,690 1,170,926 22.56
Authorized............ 1,000,000 150,000
Granted............... (176,000) 176,000 48.19 (18,000) 18,000 $45.13
Exercised............. (10,248) 5.46 (35,715) 5.05 (95,838) 18.30
Canceled.............. 9,380 (9,380) 22.66
-----------------------------------------------------------------------------------------------------------
Balance, Dec. 31, 1997 26,382 $4.58 142,333 $5.24 1,192,070 1,241,708 $26.52 132,000 18,000 $45.13
===========================================================================================================
At Dec. 31, 1997
Per Share Price Range.... $3.41-$5.46 $3.01-$5.46 $12.73-$18.13* $45.13
$22.88-$30.25**
$48.19***
Weighted-Average Remaining
Contractual Life....... 2.2 Years 3.6 Years 6.2 Years* 9.6 Years
8.3 Years**
9.8 Years***
* Includes 493,488 options of which 328,179 are exercisable both with a weighted-average exercise price of $17.23.
** Includes 572,220 options of which 135,084 are exercisable both with a weighted-average exercise price of $27.87.
***Includes 176,000 options of which none are exercisable.
There were 649,978, 533,473 and 405,916 options exercisable for 1997, 1996,
and 1995 with a weighted-average exercise price of $16.66, $12.43 and $10.39,
respectively.
In accounting for the impact of issuing stock options, the Corporation has
elected not to follow the recognition requirements of SFAS 123, which requires
fair value accounting, but will rather continue to follow the requirements of
Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to
Employees" (APB 25) and Related Interpretation. SFAS 123 requires disclosure of
pro forma net income and earnings per share information assuming that stock
options granted in 1995, 1996 and 1997 have been accounted for in accordance
with the fair value requirements of SFAS 123.
The fair value for these options was estimated at the date of grant using a
Black-Scholes option pricing model. The Black-Scholes option valuation model was
developed for use in estimating the fair value of traded options which have
characteristics which are different from the Corporation's employee stock
options. In addition, option valuation models require the input of highly
subjective assumptions which can significantly impact the estimated fair value.
As such, in management's opinion, the existing models do not necessarily provide
a reliable single measure of the fair value of employee/outside director stock
options.
The following weighted-average assumptions were used for 1997, 1996 and
1995, respectively: risk-free interest rates of 5.37 percent, 6.50 percent and
6.33 percent; dividend yield of 2.00 percent for 1997 and 2.50 percent for 1996
and 1995; volatility factors of the expected market price of the Corporation's
common stock of 19 percent, 21 percent and 24 percent; and weighted-average
expected lives of the options of 8 years. The weighted-average grant-date fair
value of options granted during 1997, 1996 and 1995 was $13.18, $9.48 and $7.56,
respectively. For purposes of proforma disclosures, the estimated fair value of
the options is amortized to expense over the options' vesting period.
The Corporation's proforma information as if compensation expense had been
recognized in accordance with SFAS 123 is summarized below:
(in thousands except for earnings per
share information) 1997 1996 1995
- ----------------------------------------------------------------------
Proforma net income*................. $ 62,783 $ 54,692 $ 46,231
Proforma earnings per common share
Basic........................... $ 2.81 $ 2.44 $ 2.07
Diluted......................... 2.80 2.44 2.07
*Because SFAS 123 is applicable only to options granted subsequent to December
31, 1994, its proforma effect is not necessarily indicative of its impact on
future years.
In 1997, restricted stock grants of 58,500 were awarded under the 1992
Stock Plan. Restricted stock grants awarded under the 1992 Stock Plan totaled
3,000 and 52,900 shares for 1996 and 1995, respectively. The weighted-average
price for these awards equaled the market price at the date of grant and was
$48.19, $26.75 and $22.88 for 1997, 1996 and 1995, respectively. Deferred
compensation expense related to the restricted stock was $707,000 in 1997,
$472,000 in 1996, and $213,000 in 1995. Restricted shares are generally awarded
under a three year cliff vesting. The market value of restricted shares at the
date of grant is expensed over the restriction period.
The Corporation has change-in-control agreements with 19 of its executives.
Under seven of these agreements, as revised, each covered person could receive,
in the event of a change in control, one-half of his base compensation upon the
effectiveness of the change in control, and from one and one-half times up to
2.49 times (depending on the executive) of his average annual W-2 compensation
during the previous five years if such person is constructively terminated or
discharged for reasons other than cause within two years following the change in
control. Under the remaining 12 agreements, each covered person could receive
from two times up to 2.99 times (depending on the executive) of his average W-2
compensation during the previous five years if such person is constructively
terminated or discharged for reasons other than cause within two years following
the change in control. These agreements, other than certain instances of stock
appreciation and SERPS, limit payments to avoid being considered "parachute
payments" as defined by the Internal Revenue Code. The maximum contingent
liability under these agreements approximated $9,675,000 at December 31, 1997.
The Corporation has no material liability for post-retirement or
post-employment benefits other than pensions.
NOTE O -- INCOME TAXES
The following is an analysis of the Corporation's income taxes included in
the consolidated statements of operations for the years ended December 31, 1997,
1996, and 1995.
(in thousands) 1997 1996 1995
- ----------------------------------------------------------------------
Current income tax expense........... $ 41,617 $ 34,711 $ 26,148
Deferred income tax.................. (6,382) (3,952) (1,150)
-------------------------------
Income tax expense as reported....... $ 35,235 $ 30,759 $ 24,998
-------------------------------
The following is a reconciliation of the difference between income tax
expense as reported and the amount computed by applying the statutory income tax
rate to income before income taxes:
Year Ended December 31
-------------------------------
(in thousands) 1997 1996 1995
- ----------------------------------------------------------------------
Income before income taxes........... $ 98,720 $ 85,737 $ 71,277
Statutory rate....................... 35% 35% 35%
-------------------------------
Income tax expense at the statutory
rate............................... 34,552 30,008 24,947
Effect of tax-exempt interest........ (736) (677) (565)
Amortization of goodwill............. 1,027 778 437
Other................................ 392 650 179
-------------------------------
Income tax expense as reported....... $ 35,235 $ 30,759 $ 24,998
-------------------------------
Tax (expense) benefits related to
security transactions.............. $ (173) $ 343 $ 489
-------------------------------
The tax effects of temporary differences that give rise to significant
portions of deferred tax assets and liabilities at December 31, 1997, and 1996
are presented below:
(in thousands) 1997 1996
- -----------------------------------------------------------
Deferred tax assets:
Allowance for possible loan
losses......................... $ 14,733 $ 13,341
Building modification reserve... 1,592 1,592
Gain on sale of assets.......... 1,101 1,172
Net occupancy restructuring..... 211 801
Other........................... 1,615 1,458
--------------------
Total gross deferred tax
assets.................... 19,252 18,364
Deferred tax liabilities:
Prepaid expenses................ $ (598) $ (622)
Unrealized gain on securities
available for sale............. (4,667) (4,093)
Intangibles..................... (2,203) (1,659)
Other........................... (1,986) (1,342)
--------------------
Total gross deferred tax
liabilities............... (9,454) (7,716)
--------------------
Net deferred tax asset..... $ 9,798 $ 10,648
--------------------
At December 31, 1997 and 1996, no valuation allowance for deferred tax
assets was necessary because they were supported by recoverable taxes paid in
prior years.
NOTE P -- NON-INTEREST EXPENSE
Significant components of other non-interest expense for the years ended
December 31, 1997, 1996, and 1995 are presented below:
Year Ended December 31
-------------------------------
(in thousands) 1997 1996 1995
- ----------------------------------------------------------------------
Outside computer service............. $ 7,556 $ 7,546 $ 8,108
Other professional expenses.......... 4,786 3,760 2,729
Stationery, printing and supplies.... 4,585 4,103 3,394
FDIC insurance/FICO bonds............ 510 2 3,624
Other................................ 39,975 36,153 38,137
-------------------------------
Total........................... $ 57,412 $ 51,564 $ 55,992
-------------------------------
NOTE Q -- CASH FLOW DATA
For purposes of reporting cash flow, cash and cash equivalents include the
following:
December 31
----------------------------------
(in thousands) 1997 1996 1995
- ----------------------------------------------------------------------------
Cash and due from banks................. $ 604,227 $ 872,028 $ 533,333
Time deposits........................... 64
Federal funds sold...................... 190,000 52,850 100,550
----------------------------------
Total.............................. $ 794,227 $ 924,878 $ 633,947
----------------------------------
Generally, Federal funds are sold for one-day periods and securities
purchased under resale agreements are held for less than thirty-five days.
Supplemental cash flow information is as follows:
Year Ended December 31
----------------------------------
(in thousands) 1997 1996 1995
- ----------------------------------------------------------------------------
Cash paid:
Interest........................... $ 123,054 $ 110,555 $ 101,075
Income Taxes....................... 35,091 32,771 25,399
Non-cash items:
Loans originated to facilitate the
sale of foreclosed assets........ 90 848 2,059
Loan foreclosures.................. 3,740 2,883 1,883
NOTE R -- FAIR VALUES OF FINANCIAL INSTRUMENTS
Fair Values of Financial Instruments -- SFAS No. 107, "Disclosures about
Fair Value of Financial Instruments" requires disclosure of fair value
information about financial instruments, whether or not recognized in the
balance sheet, for which it is practicable to estimate that value. In cases
where quoted market prices are not available, fair values are based on estimates
using present value or other valuation techniques. Those techniques are
significantly affected by the assumptions used, including the discount rate and
estimates of future cash flows. SFAS No. 107 excludes certain financial
instruments and all non-financial instruments from its disclosure requirements.
This disclosure does not and is not intended to represent the fair value of the
Corporation.
The following methods and assumptions were used by the Corporation in
estimating its fair value disclosures for financial instruments:
CASH AND CASH EQUIVALENTS: The carrying amounts reported in the
consolidated balance sheet for cash and short-term investments approximate their
fair value.
SECURITIES: Estimated fair values are based on quoted market prices, if
available. If a quoted market price is not available, fair value is estimated
using quoted market prices for similar instruments.
LOANS: For variable-rate loans that reprice frequently and with no
significant change in credit risk, fair values are based on carrying values. The
fair values for certain mortgage loans are based on quoted market prices of
similar loans sold, adjusted for differences in loan characteristics. The fair
value for other loans is estimated using discounted cash flow analyses, using
interest rates currently being offered for loans with similar terms to borrowers
of similar credit quality. The carrying amount of accrued interest approximated
its fair value.
DEPOSITS: SFAS No. 107 defines the fair value of demand deposits as the
amount payable on demand, and prohibits adjusting fair value for any deposit
base intangible. The deposit base intangible is not considered in the fair value
amounts. The carrying amounts for variable-rate money market accounts
approximate their fair value. The fair value of fixed-term certificates of
deposit are estimated using a discounted cash flow calculation that applies
interest rates currently being offered on certificates to a schedule of
aggregated expected monthly maturities.
SHORT-TERM BORROWINGS: The carrying amount reported in the consolidated
balance sheet approximates the estimated fair value.
LOAN COMMITMENTS, STANDBY AND COMMERCIAL LETTERS OF CREDIT: The
Corporation's lending commitments have variable interest rates and "escape"
clauses if the customer's credit quality deteriorates. Therefore the amounts
committed approximate fair value.
GUARANTEED PREFERRED BENEFICIAL INTEREST IN CORPORATION'S JUNIOR
SUBORDINATED DEFERRABLE INTEREST DEBENTURES: The fair value of the Trust
Preferred Capital Securities is estimated based on the quoted market prices of
the instruments.
INTEREST RATE SWAPS/FLOORS: The estimated fair value of the existing
agreements are based on quoted market prices.
The estimated fair values of the Corporation's financial instruments are as
follows:
December 31
----------------------------------------------------
1997 1996
----------------------------------------------------
ESTIMATED Estimated
CARRYING FAIR Carrying Fair
(in thousands) AMOUNT VALUE Amount Value
- --------------------------------------------------------------------------------------------
Financial assets:
Cash and cash equivalents....... $ 794,227 $ 794,227 $ 924,878 $ 924,878
Securities...................... 1,491,518 1,496,096 1,476,424 1,480,314
Loans........................... 2,643,522 2,664,064 2,253,468 2,256,628
Allowance for loan losses....... (41,846) (37,626)
----------------------------------------------------
Net loans.................. 2,601,676 2,664,064 2,215,842 2,256,628
Financial liabilities:
Deposits........................ 4,483,911 4,483,279 4,242,594 4,240,979
Short-term borrowings........... 162,112 162,112 203,189 203,189
Guaranteed preferred beneficial
in the Corporation's junior
subordinated deferrable
interest debentures........... 98,403 107,420
Off-balance sheet instruments:
Interest rate swaps............. (1,836) (1,061)
Interest rate floors............ 692
NOTE S -- DERIVATIVE FINANCIAL INSTRUMENTS
During 1997, the Corporation continued its strategy of entering into
off-balance sheet interest rate swaps to hedge its interest rate risk by
essentially converting fixed-rate loans into synthetic variable-rate
instruments. These swap transactions allow management to structure the interest
rate sensitivity of the asset side of the Corporation's balance sheet to more
closely match its view of the interest rate sensitivity of the Corporation's
funding sources. The Corporation had 42 interest rate swaps at December 31, 1997
with a notional amount of $267 million compared to 31 interest rate swaps at
December 31, 1996 with a notional amount of $251 million. Each swap was a hedge
against a specific commercial fixed-rate loan or against a specific pool of
consumer fixed-rate loans with lives ranging from two to ten years where the
Corporation pays a fixed rate and receives a floating rate. In each case, the
amortization of the interest rate swap generally matches the expected
amortization of the underlying loan or pool of loans. Each counterparty to a
swap transaction has a credit rating that is investment grade. Additionally in
1997, the Corporation entered into three interest rate floor agreements with a
notional amount totaling $500 million for three years. The interest rate floors
were intended to hedge floating interest rate exposure in commercial loan
accounts in an environment of falling interest rates. The net amount payable or
receivable under these interest rate swaps/floors contracts is accrued as an
adjustment to interest income and is not considered material in 1997 or 1996.
The Corporation's credit exposure on interest rate swaps/floors is limited
to the net favorable value of all swaps/floors to each counterparty. In such
cases collateral is required from the counterparties involved if the net value
of the swaps/floors exceeds a nominal amount considered to be immaterial. At
December 31, 1997, the Corporation's credit exposure relating to interest rate
swaps/floors was immaterial.
Activity in the notional amounts of end-user derivatives for each of the
three years ended December 31, 1997, 1996 and 1995, is summarized as follows:
Swaps Amortizing Interest Rate Total
(in millions) Receive Floating Floors Derivatives
- -------------------------------------------------------------------------------------------
Balance, December 31, 1994........... $ 34 $ 34
Additions....................... 115 115
Amortization and maturities..... 7 7
---------------------------------------------------
Balance, December 31, 1995........... 142 142
Additions....................... 168 168
Amortization and maturities..... 48 48
Terminations.................... 11 11
---------------------------------------------------
Balance, December 31, 1996........... 251 251
Additions....................... 125 $500 625
Amortization and maturities..... 89 89
Terminations.................... 20 20
---------------------------------------------------
Balance, December 31, 1997........... $ 267 $500 $767
---------------------------------------------------
NOTE T -- CONTINGENCIES
Certain subsidiaries of Cullen/Frost are defendants in various matters of
litigation which have arisen in the normal course of conducting a commercial
banking business. In the opinion of management, the disposition of such pending
litigation will not have a material effect on Cullen/Frost's consolidated
financial position.
NOTE U -- SUBSEQUENT EVENTS (UNAUDITED)
1998 ACQUISITIONS
HARRISBURG BANCSHARES, INC.,--HOUSTON
On January 2, 1998, the Corporation paid approximately $55.3 million to
acquire Harrisburg Bancshares, Inc., including its subsidiary Harrisburg Bank in
Houston, Texas. This transaction will be accounted for as a purchase with total
cash consideration being funded through currently available funds, including
funds provided by the issuance of the $100 million Trust Preferred Capital
Securities, see Note I "Borrowed Funds" on page 41. The purchase price will be
allocated to the underlying assets and liabilities based on estimated fair value
at the date of acquisition. Such estimates may be subsequently revised. The
Corporation acquired loans of approximately $125 million and deposits of
approximately $222 million. Total intangibles associated with the acquisition
amounted to approximately $34.2 million. This acquisition is not expected to
have a material impact on the Corporation's 1998 net income.
OVERTON BANCSHARES, INC.,--FORT WORTH
On May 29, 1998, the Corporation completed its previously announced merger
with Overton Bancshares, Inc., located in Fort Worth, Texas, which owned Overton
Bank and Trust N.A. The merger has been accounted for as a pooling-of-interests
transaction. The Corporation issued approximately 4.38 million common shares
to consummate the transaction. As of December 31, 1997, supplemental financial
information of the combined entities reflects total assets of $6.0 billion,
total loans of $3.1 billion, total liabilities of $5.6 billion, total deposits
of $5.2 billion, total shareholders' equity of $462 million, net interest income
of $235.1 million, net income of $73.0 million and diluted earnings per share
of $2.67. Diluted earnings per share on a supplemental combined basis for 1996
and 1995 are $2.31 and $1.98, respectively. A change in accounting methods
because of this transaction is not anticipated. These supplemental financial
amounts will become the historical financial amounts of the Corporation upon
issuance of financial statements for the period that includes the date of the
merger.
Note V - Condensed Parent Corporation Financial Statements
Condensed financial information of the parent Corporation as of December
31, 1997 and 1996 and for each of the three years in the period ended December
31,1997 follows:
Year Ended December 31
================================
Statement of Operations (in thousands) 1997 1996 1995
===================================================================================================
Income:
Dividends from second tier bank holding company subsidiary........ $21,996 $65,173 $56,631
Interest and other................................................ 5,075 713 1,101
-------------------------------
Total Income................................................... 27,071 65,886 57,732
Expenses:
Salaries and employee benefits.................................... 2,896 4,096 1,051
Interest expense.................................................. 7,887
Other............................................................. 1,096 1,005 1,375
-------------------------------
Total Expenses................................................. 11,879 5,101 2,426
-------------------------------
Income Before Income Tax Credits and Equity in
Undistributed Net Income of Subsidiaries..................... 15,192 60,785 55,306
Income tax credits................................................. 2,038 1,216 375
Equity in undistributed net income of subsidiaries................. 46,255 (7,023) (9,402)
-------------------------------
Net Income..................................................... $63,485 $54,978 $46,279
===============================
December 31
========================
Balance Sheets (in thousands) 1997 1996
================================================================================================
Assets
Cash and time deposits................................................ $ 241 $ 454
Securities purchased under resale agreements.......................... 43,990 47,020
Loans to non-bank subsidiaries........................................ 52 212
Investments in second tier bank holding company subsidiary............ 474,683 337,504
Other................................................................. 2,267 1,947
------------------------
Total Assets....................................................... $521,233 $387,137
========================
Liabilities
Other................................................................. $ 11,332 $ 8,194
Guaranteed preferred beneficial interest in the Corporation's
junior subordinated deferrable interest debentures.................. 101,496
------------------------
Total Liabilities.................................................. 112,828 8,194
Shareholders' Equity.................................................. 408,405 378,943
------------------------
Total Liabilities and Shareholders' Equity......................... $521,233 $387,137
========================
Year Ended December 31
================================
Statements of Cash Flows (in thousands) 1997 1996 1995
===================================================================================================
Operating Activities
Net income....................................................... $ 63,485 $ 54,978 $ 46,279
Adjustments to reconcile net income to net cash
provided by operating activities:...............................
Net income of subsidiaries.................................... (68,251) (58,150) (47,229)
Dividends from subsidiaries................................... 21,996 65,173 56,631
Net change in other liabilities and assets.................... 3,420 971 1,578
-------------------------------
Net cash provided by operating activities.................. 20,650 62,972 57,259
Investing Activities
Capital contributions to subsidiaries............................ (88,211) (53,386) (9,470)
Net decrease in loans............................................ 160 986 242
-------------------------------
Net cash used by investing activities...................... (88,051) (52,400) (9,228)
Financing Activities
Proceeds from issuance of guaranteed preferred
beneficial interest in the Corporation's
subordinated debentures......................................... 101,446
Purchase of treasury stock....................................... (17,814)
Proceeds from employee stock purchase plans and options.......... 1,989 325 691
Cash dividends................................................... (21,463) (18,073) (12,723)
-------------------------------
Net cash provided (used) by financing activities........... 64,158 (17,748) (12,032)
-------------------------------
Increase (decrease) in cash and cash equivalents........... (3,243) (7,176) 35,999
Cash and cash equivalents at beginning of year................... 47,474 54,650 18,651
-------------------------------
Cash and cash equivalents at end of year................... $ 44,231 $ 47,474 $ 54,650
===============================
Report Of Ernst & Young LLP
Independent Auditors
SHAREHOLDERS AND BOARD OF DIRECTORS
CULLEN/FROST BANKERS, INC.
We have audited the accompanying consolidated balance sheets of
Cullen/Frost Bankers, Inc. and Subsidiaries as of December 31, 1997 and 1996,
and the related consolidated statements of operations, changes in shareholders'
equity, and cash flows for each of the three years in the period ended December
31, 1997. These financial statements are the responsibility of the Corporation's
management. Our responsibility is to express an opinion on these financial
statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly,
in all material respects, the consolidated financial position of Cullen/Frost
Bankers, Inc. and Subsidiaries at December 31, 1997 and 1996, and the
consolidated results of their operations and their cash flows for each of the
three years in the period ended December 31, 1997, in conformity with generally
accepted accounting principles.
ERNST & YOUNG LLP
San Antonio, Texas
February 15, 1998