CULLEN FROST BANKERS INC - 10-K Annual Report

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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D. C. 20549

FORM 10-K

[ ] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE
ACT OF 1934

FOR THE FISCAL YEAR ENDED DECEMBER 31, 1997

[X] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES
EXCHANGE ACT OF 1934

FOR THE TRANSITION PERIOD FROM ________ TO _________

COMMISSION FILE NUMBER 0-7275

CULLEN/FROST BANKERS, INC.
(Exact name of registrant as specified in its charter)

TEXAS 74-1751768
--------------------------- ----------------
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
100 W. HOUSTON STREET
SAN ANTONIO, TEXAS 78205
----------------------------------- ----------
(Address of principal executive
offices) (Zip Code)

REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE: (210) 220-4011

SECURITIES REGISTERED PURSUANT TO SECTION 12(B) OF THE ACT:
NONE.

SECURITIES REGISTERED PURSUANT TO SECTION 12(G) OF THE ACT:

COMMON STOCK, $5 PAR VALUE
(WITH ATTACHED RIGHTS)
---------------------------------
(Title of Class)

Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. YES X NO __

Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of the registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K. __

The aggregate market value of the voting stock held by non-affiliates of
the registrant was $1,251,133,604 based on the closing price of such stock as of
March 26, 1998.

Indicate the number of shares outstanding of each of the registrant's
classes of common stock, as of the latest practicable date.

Outstanding at
Class March 26, 1998
--------------------------------- ------------------
COMMON STOCK, $5 PAR VALUE 22,259,489

DOCUMENTS INCORPORATED BY REFERENCE

(1) Proxy Statement for Annual Meeting of Shareholders to be held May 27,
1998 (Part III)

TABLE OF CONTENTS
PAGE
----
PART I

ITEM 1. BUSINESS................... 3
ITEM 2. PROPERTIES................. 9
ITEM 3. LEGAL PROCEEDINGS.......... 10
ITEM 4. SUBMISSION OF MATTERS TO A
VOTE OF SECURITY HOLDERS... 10 *

PART II

ITEM 5. MARKET FOR REGISTRANT'S
COMMON STOCK AND RELATED
STOCKHOLDER MATTERS........ 10
ITEM 6. SELECTED FINANCIAL DATA.... 11
ITEM 7. MANAGEMENT'S DISCUSSION AND
ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF
OPERATIONS................. 13
ITEM 8. FINANCIAL STATEMENTS AND
SUPPLEMENTARY DATA......... 30
ITEM 9. CHANGES IN AND
DISAGREEMENTS WITH
ACCOUNTANTS ON ACCOUNTING
AND FINANCIAL DISCLOSURE... 60 *

PART III

ITEM 10. DIRECTORS AND EXECUTIVE
OFFICERS OF THE REGISTRANT. 60
ITEM 11. EXECUTIVE COMPENSATION..... 60
ITEM 12. SECURITY OWNERSHIP OF
CERTAIN BENEFICIAL OWNERS
AND MANAGEMENT............. 60
ITEM 13. CERTAIN RELATIONSHIPS AND
RELATED TRANSACTIONS....... 60
PART IV

ITEM 14. EXHIBITS, FINANCIAL
STATEMENT SCHEDULES, AND
REPORTS ON FORM 8-K........ 61

* Not Applicable
2

PART I

ITEM 1. BUSINESS

GENERAL

Cullen/Frost Bankers, Inc. ("Cullen/Frost" or "Company"), a Texas
business corporation incorporated in 1977 and headquartered in San Antonio,
Texas, is a bank holding company within the meaning of the Bank Holding Company
Act of 1956 ("the BHC Act") and as such is registered with the Board of
Governors of the Federal Reserve System ("Federal Reserve Board"). The New
Galveston Company, incorporated under the laws of Delaware, is a wholly owned
second tier bank holding company subsidiary which owns all banking and
non-banking subsidiaries with the exception of Cullen/Frost Capital Trust, a
Delaware statutory business trust and wholly-owned subsidiary of the
Corporation. At December 31, 1997, Cullen/Frost's principal assets consisted of
all of the capital stock of two national banks. Including the acquisition of
Harrisburg Bancshares, Inc., completed in the first quarter of 1998,
Cullen/Frost had 60 financial centers across Texas with 19 locations in the San
Antonio area, 20 in the Houston/Galveston area, five in Austin, ten in the
Corpus Christi area, three in San Marcos, two in McAllen and one in New
Braunfels. At December 31, 1997, Cullen/Frost had consolidated total assets of
$5,230,588,000 and total deposits of $4,483,911,000. Based on information from
the Federal Reserve Board, at September 30, 1997, Cullen/Frost was the largest
of the 93 unaffiliated bank holding companies headquartered in Texas.

Cullen/Frost provides policy direction to the Cullen/Frost subsidiary banks
in, among others, the following areas: (i) asset and liability management; (ii)
accounting, budgeting, planning and insurance; (iii) capitalization; and (iv)
regulatory compliance.

CULLEN/FROST SUBSIDIARY BANKS

Each of the Cullen/Frost subsidiary banks is a separate entity which
operates under the day-to-day management of its own board of directors and
officers. The largest of these banks is The Frost National Bank ("Frost
Bank"), the origin of which can be traced to a mercantile partnership organized
in 1868. Frost Bank was chartered as a national banking association in 1899. At
December 31, 1997, Frost Bank, which accounted for approximately 97 percent of
consolidated assets and 98 percent of loans and deposits of Cullen/Frost, was
the largest bank headquartered in San Antonio and South Texas. The Corporation's
other subsidiary bank is United States National Bank of Galveston which had $147
million in assets at December 31, 1997.

SERVICES OFFERED BY THE CULLEN/FROST SUBSIDIARY BANKS

COMMERCIAL BANKING

The subsidiary banks provide commercial services for corporations and other
business clients. Loans are made for a wide variety of purposes, including
interim construction financing on industrial and commercial properties and
financing on equipment, inventories, accounts receivable, leverage buyouts and
recapitalizations and turnaround situations. Frost Bank provides financial
services to business clients on both a national and international basis.

CONSUMER SERVICES

The subsidiary banks provide a full range of consumer banking services,
including checking accounts, savings programs, automated teller machines,
installment and real estate loans, home equity loans, drive-in and night deposit
services, safe deposit facilities, credit card services and discount brokerage
services.

INTERNATIONAL BANKING

Frost Bank provides international banking services to customers residing in
or dealing with businesses located in Mexico. Such services consist of accepting
deposits (in United States dollars only), making loans

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(in United States dollars only), issuing letters of credit, handling foreign
collections, transmitting funds and, to a limited extent, dealing in foreign
exchange. Reference is made to pages 20 and 26 of this document.

TRUST SERVICES

The subsidiary banks provide a wide range of trust, investment, agency and
custodial services for individual and corporate clients. These services include
the administration of estates and personal trusts and the management of
investment accounts for individuals, employee benefit plans and charitable
foundations. At December 31, 1997, trust assets with a market value of
approximately $9.1 billion were being administered by the subsidiary banks.
These assets were comprised of discretionary assets of $5.2 billion and
non-discretionary assets of $3.9 billion.

CORRESPONDENT BANKING

Frost Bank acts as correspondent for approximately 320 financial
institutions, primarily banks in Texas. These banks maintain deposits with Frost
Bank, which offers to the correspondents a full range of services including
check clearing, transfer of funds, loan participations, and securities custody
and clearance.

DISCOUNT BROKERAGE

Frost Brokerage Services was formed in March 1986 to provide discount
brokerage services and perform other transactions or operations related to the
sale and purchase of securities of all types. Frost Brokerage Services is a
subsidiary of Frost Bank.

SERVICES OFFERED BY THE CULLEN/FROST NON-BANKING SUBSIDIARIES

Main Plaza Corporation ("Main Plaza") is a wholly-owned non-banking
subsidiary. Main Plaza occasionally makes loans to qualified borrowers. Loans
are funded with borrowings against Cullen/Frost's current cash or borrowings
against credit lines.

Daltex General Agency, Inc. ("Daltex"), a wholly-owned non-banking
subsidiary, is a managing general insurance agency. Daltex provides vendor's
single interest insurance.

COMPETITION

The subsidiary banks encounter intense competition in their commercial
banking businesses, primarily from other banks located in their respective
service areas. The subsidiary banks also compete with insurance, finance and
mortgage companies, savings and loan institutions, credit unions, money market
funds and other financial institutions. In the case of some larger customers,
competition exists with institutions in other major metropolitan areas in Texas
and in the remainder of the United States, some of which are larger than the
Cullen/Frost subsidiary banks in terms of capital, resources and personnel.

SUPERVISION AND REGULATION

CULLEN/FROST

Cullen/Frost is a legal entity separate and distinct from its bank
subsidiaries and is a registered bank holding company under the BHC Act. The BHC
Act generally prohibits Cullen/Frost from engaging in any business activity
other than banking, managing and controlling banks, furnishing services to a
bank which it owns and controls or engaging in non-banking activities closely
related to banking.

As a bank holding company, Cullen/Frost is primarily regulated by the
Federal Reserve Board which has established guidelines with respect to the
maintenance of appropriate levels of capital and payment of dividends by bank
holding companies. Cullen/Frost is required to obtain prior approval of the
Federal Reserve Board for the acquisition of more than five percent of the
voting shares or certain assets of any company (including a bank) or to merge or
consolidate with another bank holding company.

4

The Federal Reserve Act and the Federal Deposit Insurance Act ("FDIA")
impose restrictions on loans by the subsidiary banks to Cullen/Frost and certain
of its subsidiaries, on investments in securities thereof and on the taking of
such securities as collateral for loans. Such restrictions generally prevent
Cullen/Frost from borrowing from the subsidiary banks unless the loans are
secured by marketable obligations. Further, such secured loans, other
transactions, and investments by each of such bank subsidiaries are limited in
amount as to Cullen/Frost or to certain other subsidiaries to ten percent of the
lending bank subsidiary's capital and surplus and as to Cullen/Frost and all
such subsidiaries to an aggregate of 20 percent of the lending bank subsidiary's
capital and surplus.

Under Federal Reserve Board policy, Cullen/Frost is expected to act as a
source of financial strength to its banks and to commit resources to support
such banks in circumstances where it might not do so absent such policy. In
addition, any loans by Cullen/Frost to its banks would be subordinate in right
of payment to deposits and to certain other indebtedness of its banks.

SUBSIDIARY BANKS

The two subsidiary national banks are organized as national banking
associations under the National Bank Act and are subject to regulation and
examination by the Office of the Comptroller of the Currency (the "Comptroller
of the Currency").

Federal and state laws and regulations of general application to banks have
the effect, among others, of regulating the scope of the business of the
subsidiary banks, their investments, cash reserves, the purpose and nature of
loans, collateral for loans, the maximum interest rates chargeable on loans, the
amount of dividends that may be declared and required capitalization ratios.
Federal law imposes restrictions on extensions of credit to, and certain other
transactions with, Cullen/Frost and other subsidiaries, on investments in stock
or other securities thereof and on the taking of such securities as collateral
for loans to other borrowers.

Pursuant to the requirements of the Securities Exchange Act of 1934, as
amended, United States National Bank of Galveston ("U.S. National Bank") is
registered with the Comptroller of the Currency as transfer agent and is subject
to certain reporting requirements of and regulatory control by the Comptroller
of the Currency. The bond department of Frost Bank is subject to regulation
under the Texas Securities Act.

The Comptroller of the Currency with respect to Cullen/Frost's bank
subsidiaries has authority to prohibit a bank from engaging in what, in such
agency's opinion, constitutes an unsafe or unsound practice in conducting its
business. It is possible, depending upon the financial condition of the bank in
question and other factors, that such agency could claim that the payment of
dividends or other payments might, under some circumstances, be such an unsafe
or unsound practice.

The principal source of Cullen/Frost's cash revenues is dividends from its
bank subsidiaries, and there are certain limitations on the payment of dividends
to Cullen/Frost by such bank subsidiaries. The prior approval of the Comptroller
of the Currency is required if the total of all dividends declared by a national
bank in any calendar year would exceed the bank's net profits, as defined, for
that year combined with its retained net profits for the preceding two calendar
years less any required transfers to surplus. In addition, a national bank may
not pay dividends in an amount in excess of its undivided profits less certain
bad debts. Although not necessarily indicative of amounts available to be paid
in future periods, Cullen/Frost's subsidiary banks had approximately $31,062,000
available for the payment of dividends, without prior regulatory approval, at
December 31, 1997.

CAPITAL ADEQUACY

Bank regulators have adopted risk-based capital guidelines for bank holding
companies and banks. The minimum ratio of qualifying total capital to
risk-weighted assets (including certain off-balance sheet items) is eight
percent. At least half of the total capital is to be comprised of common stock,
retained earnings, perpetual preferred stocks, minority interests and for bank
holding companies, a limited amount of qualifying cumulative perpetual preferred
stock, less certain intangibles including goodwill ("Tier 1

5

capital"). The remainder ("Tier 2 capital") may consist of other preferred
stock, certain other instruments, and limited amounts of subordinated debt and
the allowance for loan and lease losses.

In addition, bank regulators have established minimum leverage ratio (Tier
1 capital to average total assets) guidelines for bank holding companies and
banks. These guidelines provide for a minimum leverage ratio of 3 percent for
bank holding companies and banks that meet certain specified criteria, including
that they have the highest regulatory rating. All other banking organizations
will be required to maintain a leverage ratio of 3 percent plus an additional
cushion of at least 100 to 200 basis points. The guidelines also provide that
banking organizations experiencing internal growth or making acquisitions will
be expected to maintain strong capital positions substantially above the minimum
supervisory levels, without significant reliance on intangible assets.
Furthermore, the guidelines indicate that the Federal Reserve Board will
continue to consider a "Tangible Tier 1 Leverage Ratio" in evaluating
proposals for expansion or new activities. The Tangible Tier 1 Leverage Ratio is
the ratio of Tier 1 capital, less intangibles not deducted from Tier 1 capital,
to average total assets. The bank regulators have not advised Cullen/Frost or
any bank subsidiary of any specific minimum leverage ratio applicable to it. For
information concerning Cullen/Frost's capital ratios, see the discussion under
the caption "Capital" on page 27 and Note L "Capital" on page 43.

FDICIA

The Federal Deposit Insurance Corporation Improvements Act of 1991
("FDICIA"), among other things, requires the Federal banking agencies to take
"prompt corrective action" in respect to depository institutions that do not
meet minimum capital requirements. FDICIA established five capital tiers: "well
capitalized," "adequately capitalized," "undercapitalized," "significantly
undercapitalized" and "critically undercapitalized". Under the final rules
adopted by the Federal banking regulators relating to these capital tiers, an
institution is deemed to be: well capitalized if the institution has a total
risk-based capital ratio of 10.0 percent or greater, a Tier 1 risk-based capital
ratio of 6.0 percent or greater, and a 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; adequately capitalized if the institution
has a total risk-based capital ratio of 8.0 percent or greater, a Tier 1
risk-based capital ratio of 4.0 percent or greater, and a leverage ratio of 4.0
percent or greater (or a leverage ratio of 3.0 percent for bank holding
companies which meet certain specified criteria, including having the highest
regulatory rating); undercapitalized if the institution has a total risk-based
capital ratio that is less than 8.0 percent, a Tier 1 risk-based capital ratio
less than 4.0 percent or a leverage ratio less than 4.0 percent (or a leverage
ratio less than 3.0 percent if the institution is rated composite 1 in its most
recent report of examination, subject to appropriate Federal banking agency
guidelines); significantly undercapitalized if the institution has a total
risk-based capital ratio less than 6.0 percent, a Tier 1 risk-based capital
ratio less than 3.0 percent, or a leverage ratio less than 3.0 percent; and
critically undercapitalized if the institution has a ratio of tangible equity to
total assets equal to or less than 2.0 percent.

At December 31, 1997, the two subsidiaries of Cullen/Frost that are insured
depository institutions -- Frost Bank and U.S. National Bank -- were considered
"well capitalized".

FDICIA generally prohibits a depository institution from making any capital
distributions (including payment of a dividend) or paying any management fee to
its holding company if the depository institution would thereafter be
undercapitalized. Undercapitalized institutions are subject to growth
limitations and are required to submit a capital restoration plan. The agencies
may not accept such a plan without determining, among other things, that the
plan is based on realistic assumptions and is likely to succeed in restoring the
depository institution's capital. In addition, for a capital restoration plan to
be acceptable, the depository institution's parent holding company must
guarantee that the institution will comply with such capital restoration plan.
The aggregate liability of the parent holding company is limited to the lesser
of (i) an amount equal to 5 percent of the depository institution's total assets
at the time it became undercapitalized and (ii) the amount which is necessary
(or would have been necessary) to bring the institution into compliance with all
capital standards applicable with respect to such institution as of the time it
fails to

6

comply with the plan. If a depository institution fails to submit an acceptable
plan, it is treated as if it is significantly undercapitalized.

"Significantly undercapitalized" depository institutions may be subject
to a number of requirements and restrictions, including orders to sell
sufficient voting stock to become "adequately capitalized," requirements to
reduce total assets, and cessation of receipt of deposits from correspondent
banks. "Critically undercapitalized" institutions are subject to the
appointment of a receiver or conservator.

FDICIA also contains a variety of other provisions that affect the
operations of Cullen/Frost, including reporting requirements, regulatory
standards for real estate lending, "truth in savings" provisions, and the
requirement that a depository institution give 90 days prior notice to customers
and regulatory authorities before closing any branch. The Federal regulatory
agencies have issued standards establishing loan-to-value limitations on real
estate lending. These standards have not had a significant effect on
Cullen/Frost and are not expected to have a significant effect in the future.

Any loans by a bank holding company to any of its subsidiary banks are
subordinate in right of payment to deposits and to certain other indebtedness of
such subsidiary banks. In the event of a bank holding company's bankruptcy, any
commitment by the bank holding company to a federal bank regulatory agency to
maintain the capital of a subsidiary bank will be assumed by the bankruptcy
trustee and be entitled to a priority of payment.

DEPOSIT INSURANCE

Cullen/Frost's subsidiary banks are subject to FDIC deposit insurance
assessments and to certain other statutory and regulatory provisions applicable
to FDIC-insured depository institutions. The risk-based assessment system
imposes insurance premiums based upon a matrix that takes into account a bank's
capital level and supervisory rating. See page 18 for a discussion of FDIC
premiums paid by Cullen/Frost.

A depository institution insured by the FDIC can be held liable for any
loss incurred by, or reasonably expected to be incurred by, the FDIC, in
connection with (i) the default of a commonly controlled FDIC-insured depository
institution or (ii) any assistance provided by the FDIC to a commonly
controlled, FDIC-insured depository institution in danger of default.
"Default" is defined generally as the appointment of a conservator or
receiver, and "in danger of default" is defined generally as the existence of
certain conditions indicating that a "default" is likely to occur in the
absence of regulatory assistance.

DEPOSITOR PREFERENCE

Deposits and certain claims for administrative expenses and employee
compensation against an insured depository institution are afforded priority
over other general unsecured claims against such an institution, including
federal funds and letters of credit, in the "liquidation or other resolution"
of such an institution by any receiver.

ACQUISITIONS

The BHC Act generally limits acquisitions by Cullen/Frost to commercial
banks and companies engaged in activities that the Federal Reserve Board has
determined to be so closely related to banking as to be a proper incident
thereto. Cullen/Frost's direct activities are generally limited to furnishing to
its subsidiaries services that qualify under the "closely related" and
"proper incident" tests. Prior Federal Reserve Board approval is required
under the BHC Act for new activities and acquisitions of most nonbanking
companies.

The BHC Act, the Federal Bank Merger Act, and the Texas Banking Code
regulate the acquisition of commercial banks. The BHC Act requires the prior
approval of the Federal Reserve Board for the direct or indirect acquisition of
more than five percent of the voting shares of a commercial bank or bank holding
company. With respect to Cullen/Frost's subsidiary banks, the approval of the
Comptroller of the Currency is required for branching, purchasing the assets of
other banks and bank mergers in which the continuing bank is a national bank.

7

In reviewing bank acquisition and merger applications, the bank regulatory
authorities will consider, among other things, the competitive effect and public
benefits of the transactions, the capital position of the combined organization,
and the applicant's record under the Community Reinvestment Act and fair housing
laws.

The Corporation regularly evaluates acquisition opportunities and conducts
due diligence activities in connection with possible acquisitions. As a result,
acquisition discussions and, in some cases negotiations, regularly take place
and future acquisitions could occur.

INTERSTATE BANKING AND BRANCHING LEGISLATION

The Riegle-Neal Interstate Branching Efficiency Act of 1994 ("IBBEA"),
authorizes interstate acquisitions of banks and bank holding companies without
geographic limitation beginning one year after enactment. In addition, as of
June 1, 1997, IBBEA authorized a bank to merge with a bank in another state as
long as neither of the states has opted out of interstate branching between the
date of enactment of IBBEA and May 31, 1997. IBBEA further provided that states
may enact laws permitting interstate bank merger transactions prior to June 1,
1997. A bank may establish a de novo branch in a state in which the bank does
not maintain a branch if the state expressly permits de novo branching. Once a
bank has established branches in a state through an interstate merger
transaction, the bank may establish and acquire additional branches at any
location in the state where any bank involved in the merger transaction could
have established or acquired branches under applicable federal or state law. A
bank that has established a branch in a state through de novo branching may
establish and acquire additional branches in such state in the same manner and
to the same extent as a bank having a branch in such state as a result of an
interstate merger. If a state opts out of interstate branching within the
specified time period, no bank in any other state may establish a branch in the
opting out state, whether through an acquisition or de novo. On August 28, 1995,
Texas enacted legislation opting out of interstate branching.

REGULATORY ECONOMIC POLICIES

The earnings of the subsidiary banks are affected not only by general
economic conditions but also by the policies of various governmental regulatory
authorities. The Federal Reserve Board regulates the supply of credit in order
to influence general economic conditions, primarily through open market
operations in United States government obligations, varying the discount rate on
financial institution borrowings, varying reserve requirements against financial
institution deposits and restricting certain borrowings by such financial
institutions and their subsidiaries. The deregulation of interest rates has had
and is expected to continue to have an impact on the competitive environment in
which the subsidiary banks operate.

Governmental policies have had a significant effect on the operating
results of commercial banks in the past and are expected to continue to do so in
the future. However, Cullen/Frost cannot accurately predict the nature or extent
of any effect such policies may have on its future business and earnings.

EMPLOYEES

At December 31, 1997, Cullen/Frost employed 2,546 full-time equivalent
employees. Employees of Cullen/Frost enjoy a variety of employee benefit
programs, including a retirement plan, 401(k) stock purchase plans, various
comprehensive medical, accident and group life insurance plans and paid
vacations. Cullen/Frost considers its employee relations to be good.

8

EXECUTIVE OFFICERS OF THE REGISTRANT

The names, ages, recent business experience and positions or offices held
by each of the executive officers during 1997 of Cullen/Frost are as follows:

AGE AS OF
NAME AND POSITIONS OR OFFICES 12/31/97 RECENT BUSINESS EXPERIENCE
- ------------------------------------- --------- ------------------------------------------------------

T.C. Frost 70 Officer and Director of Frost Bank since 1950.
Senior Chairman of the Board Chairman of the Board of Cullen/Frost from 1973 to
and Director October 1995. Member of the Executive Committee of
Cullen/Frost 1973 to present. Chief Executive Officer
of Cullen/Frost from July 1977 to October 1997. Senior
Chairman of Cullen/Frost from October 1995 to present.

Richard W. Evans, Jr. 51 Officer of Frost Bank since 1973. Executive Vice
Chairman of the Board, President of Frost Bank from 1978 to April 1985.
Chief Executive Officer President of Frost Bank from April 1985 to August
and Director 1993. Chairman of the Board and Chief Executive
Officer of Frost Bank from August 1993 to present.
Director and Member of the Executive Committee of
Cullen/Frost from August 1993 to present. Chairman of
the Board and Chief Operating Officer of Cullen/Frost
from October 1995 to October 1997. Chairman of the
Board and Chief Executive Officer of Cullen/Frost from
October 1997 to present.

Patrick B. Frost 37 Officer of Frost Bank since 1985. President of Frost
President of Frost Bank Bank from August 1993 to present. Director of
and Director Cullen/Frost from May 1997 to present. Member of the
Executive Committee of Cullen/Frost from July 1997 to
present.

Phillip D. Green 43 Officer of Frost Bank since July 1980. Vice President
Executive Vice President and Controller of Frost Bank from January 1981 to
and Chief Financial Officer January 1983. Senior Vice President and Controller of
Frost Bank from January 1983 to July 1985. Senior Vice
President and Treasurer of Cullen/Frost from July 1985
to April 1989. Executive Vice President and Treasurer
of Cullen/Frost from May 1989 to October 1995.
Executive Vice President and Chief Financial Officer
of Cullen/Frost from January 1996 to present.

Diane Jack, age 49, has been an officer of Frost Bank since 1984 and Secretary
of Cullen/Frost from October 1993 to present.

There are no arrangements or understandings between any executive officer of
Cullen/Frost and any other person pursuant to which he was or is to be selected
as an officer.

ITEM 2. PROPERTIES

The executive offices of Cullen/Frost, as well as the principal banking
quarters of Frost Bank, are housed in both a 21-story office tower and a
nine-story office building located on approximately 3.5 acres of land in
downtown San Antonio. Cullen/Frost and Frost Bank lease approximately 50 percent
of the office tower. The nine-story office building was purchased in April 1994.
Frost Bank also leases space in a seven-story parking garage adjacent to the
banking quarters.

9

In June 1987, Frost Bank consummated the sale of its office tower and
leased back a portion of the premises under a 13-year primary lease term with
options allowing for occupancy up to 50 years. The Bank also sold its related
parking garage facility and leased back space in that structure under a 12-year
primary lease term with options allowing for occupancy up to 50 years.

The subsidiary bank located in Galveston is housed in facilities which,
together with tracts of adjacent land used for parking and drive-in facilities,
are either owned or leased by the subsidiary bank.

ITEM 3. LEGAL PROCEEDINGS

Certain subsidiaries of Cullen/Frost are defendants in various matters of
litigation which have arisen in the normal course of conducting a commercial
banking business. In the opinion of management, the judicial disposition of such
pending litigation will not have a material effect on Cullen/Frost's
consolidated financial position.

ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

None.

PART II

ITEM 5. MARKET FOR REGISTRANT'S COMMON STOCK AND RELATED STOCKHOLDER MATTERS

COMMON STOCK MARKET PRICES AND DIVIDENDS

The table below sets forth for each quarter the high and low sales prices
for Cullen/Frost's common stock and the dividends per share paid for each
quarter. The Company's common stock began trading on The New York Stock Exchange
("NYSE") on August 14, 1997 under the symbol: CFR. Therefore high and low
sales prices for the period August 14, 1997 through December 31, 1997 are as
reported by the NYSE. For the period 1996 through August 13, 1997 prices are as
reported through the NASDAQ National Market System. Prices quoted on the NASDAQ
National Market System reflect inter-dealer prices, without retail mark-up,
mark-down or commissions and represent actual transactions.

1997 1996
-------------------- --------------------
MARKET PRICE (per share) HIGH LOW High Low
- ----------------------------------------------------------------------------
First Quarter................... $ 38.63 $ 32.63 $ 26.38 $ 23.38
Second Quarter.................. 43.25 33.75 28.38 23.75
Third Quarter................... 48.00 40.38 30.88 25.50
Fourth Quarter.................. 62.75 47.44 36.50 29.25

The number of record holders of common stock at February 20, 1998 was 2,355.

CASH DIVIDENDS (per share) 1997 1996
- -----------------------------------------------------------
First Quarter........................ $ .21 $ .18
Second Quarter....................... .25 .21
Third Quarter........................ .25 .21
Fourth Quarter....................... .25 .21
--------------------
Total........................... $ .96 $ .81
--------------------

The Corporation's management is committed to the continuation of the
payment of regular cash dividends, however there is no assurance as to future
dividends because they are dependent on future earnings, capital requirements
and financial conditions. See "Capital" section on page 27 in Item 7 for
further discussion and Note K "Dividends" on page 43.

10

ITEM_6.__SELECTED FINANCIAL DATA

CONSOLIDATED STATEMENTS OF OPERATIONS
(dollars in thousands, except per share amounts)

Year Ended December 31
----------------------------------------------------------------
1997 1996 1995 1994 1993 1992
- -------------------------------------------------------------------------------------------------------
INTEREST INCOME:

Loans, including fees............ $ 217,432 $ 183,724 $ 150,497 $ 106,252 $ 90,756 $ 84,074
Securities....................... 95,444 99,562 98,862 95,109 91,145 99,188
Time deposits.................... 1 2 2 4 8
Federal funds sold and securities
purchased
under resale agreements........ 11,839 7,226 6,732 4,146 7,714 6,711
----------------------------------------------------------------
TOTAL INTEREST INCOME....... 324,715 290,513 256,093 205,509 189,619 189,981
INTEREST EXPENSE:
Deposits......................... 113,114 103,475 89,809 61,996 58,079 68,807
Federal funds purchased and
securities sold
under repurchase agreements.... 5,411 6,937 13,296 7,166 3,304 3,139
Guaranteed preferred beneficial
interests in the
Corporation's subordinated
debentures..................... 7,652
Long-term notes payable.......... 380 1,378
Other borrowings................. 1,294 1,019 733 30
----------------------------------------------------------------
TOTAL INTEREST EXPENSE...... 127,471 111,431 103,838 69,162 61,793 73,324
----------------------------------------------------------------
NET INTEREST INCOME......... 197,244 179,082 152,255 136,347 127,826 116,657
Provision (credit) for possible loan
losses............................. 7,900 7,300 6,272 (6,085) 5,498
----------------------------------------------------------------
NET INTEREST INCOME AFTER
PROVISION
(credit) for Possible Loan
Losses.................... 189,344 171,782 145,983 136,347 133,911 111,159
NON-INTEREST INCOME:
Trust fees....................... 39,971 34,031 31,762 29,529 26,278 21,861
Service charges on deposit
accounts....................... 43,727 38,294 30,382 28,182 27,303 23,663
Other service charges, collection
and
exchange charges, commissions
and fees....................... 10,148 8,764 11,055 9,366 7,972 6,183
Net gain (loss) on securities
transactions................... 494 (980) (1,396) (4,038) 1,433 (232)
Other............................ 14,992 14,426 15,940 13,776 13,243 10,338
----------------------------------------------------------------
TOTAL NON-INTEREST INCOME... 109,332 94,535 87,743 76,815 76,229 61,813
NON-INTEREST EXPENSE:
Salaries and wages............... 81,816 71,788 58,177 52,986 53,654 46,184
Pension and other employee
benefits....................... 16,849 15,351 10,905 9,910 12,052 9,746
Net occupancy of banking
premises....................... 19,496 18,782 17,992 15,777 20,749 16,963
Furniture and equipment.......... 12,463 11,789 11,259 10,937 10,155 8,295
Provision for real estate
losses......................... 43 610 1,445 12,963
Restructuring costs.............. 400 830 10,285
Intangible amortization.......... 11,920 11,306 8,124 7,627 6,877 700
Other............................ 57,369 51,564 54,982 57,495 56,861 52,299
----------------------------------------------------------------
TOTAL NON-INTEREST
EXPENSE................... 199,956 180,580 162,449 155,562 172,078 147,150
----------------------------------------------------------------
INCOME BEFORE INCOME TAXES
(CREDITS), EXTRAORDINARY
CREDIT AND CUMULATIVE
EFFECT OF ACCOUNTING
CHANGE.................... 98,720 85,737 71,277 57,600 38,062 25,822
Income taxes (credits)............... 35,235 30,759 24,998 20,177 (735) 8,197
----------------------------------------------------------------
Income before extraordinary credit
and
cumulative effect of accounting
change............................. 63,485 54,978 46,279 37,423 38,797 17,625
Extraordinary credit-income tax
benefit............................ 6,497
Cumulative effect of change in
accounting for income taxes........ 8,439
----------------------------------------------------------------
NET INCOME.................. $ 63,485 $ 54,978 $ 46,279 $ 37,423 $ 47,236 $ 24,122
----------------------------------------------------------------
Net income per common share:
Basic............................ $ 2.84 $ 2.45 $ 2.07 $ 1.69 $ 2.16 $ 1.34
Diluted.......................... 2.75 2.40 2.04 1.67 2.12 1.13
Return on Average Assets............. 1.28% 1.22% 1.17% 1.02% 1.34% .79%
Return on Average Equity............. 16.06 15.32 14.32 13.04 19.00 12.56

11

SELECTED FINANCIAL DATA
(dollars in thousands, except per share amounts)

Year Ended December 31
----------------------------------------------------------------------------------
1997 1996 1995 1994 1993 1992
----------------------------------------------------------------------------------

BALANCE SHEET DATA
Total assets..................... $ 5,230,588 $ 4,888,384 $ 4,200,211 $ 3,793,720 $ 3,639,047 $ 3,150,871
Guaranteed preferred beneficial
interest in the Corporation's
junior subordinated deferrable
interest debentures, net....... 98,403
Long-term notes payable.......... 13,400
Shareholders' equity............. 408,405 378,943 341,464 295,437 273,533 206,144
Average shareholders' equity to
average total assets........... 7.99% 7.98% 8.20% 7.85% 7.08% 6.29%
Tier 1 capital ratio............. 13.89 11.58 13.07 14.44 14.23 15.66
Total capital ratio.............. 15.14 12.83 14.32 15.69 15.49 17.52
PER COMMON SHARE DATA
Net income-basic................. $ 2.84 $ 2.45 $ 2.07 $ 1.69 $ 2.16* $ 1.34*
Net income-diluted............... 2.75 2.40 2.04 1.67 2.12* 1.13*
Cash dividends paid.............. .96 .81 .57 .34 .08
Shareholders' equity............. 18.34 16.86 15.24 13.28 12.43 9.90
LOAN PERFORMANCE INDICATORS
Non-performing assets............ $ 17,213 $ 12,371 $ 16,307 $ 19,975 $ 31,110 $ 51,303
Non-performing assets to:
Total loans plus foreclosed
assets.................... .65% .55% .90% 1.34% 2.47% 4.94%
Total assets................ .33 .25 .39 .53 .85 1.63
Allowance for possible loan
losses......................... $ 41,846 $ 37,626 $ 32,268 $ 26,002 $ 26,298 $ 31,897
Allowance for possible loan
losses to period-end loans..... 1.58% 1.67% 1.78% 1.75% 2.09% 3.10%
Net loan charge-offs
(recoveries)................... $ 5,785 $ 2,569 $ 436 $ (2,127) $ (486) $ 15,988
Net loan charge-offs (recoveries)
to average loans............... .23% .12% .03% (.16)% (.04)% 1.53%
COMMON STOCK DATA
Common shares outstanding at
period end..................... 22,265,270 22,482,113 22,398,900 22,246,124 22,018,396 20,824,368
Weighted average common shares... 22,368,744 22,443,915 22,308,718 22,118,794 22,843,770 18,500,832
Dilutive effect of stock
options........................ 696,508 461,827 366,930 327,028 457,806 3,447,828
Dividends as a percentage of net
income......................... 33.81% 32.87% 27.94% 20.12% 3.54%
NON-FINANCIAL DATA
Number of employees.............. 2,546 2,306 2,019 1,862 1,877 1,754
Shareholders of record........... 2,358 2,336 2,463 2,553 2,644 2,824

*1993 basic and diluted earnings per share before cumulative effect of an
accounting change was $1.78 and $1.74, respectively.

1992 basic and diluted earnings per share before extraordinary credit was $.95
and $.80, respectively.

12

ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS

FINANCIAL REVIEW

Discussed below are the operating results for Cullen/Frost Bankers, Inc.
and Subsidiaries ("Cullen/Frost" or the "Corporation") for the years 1995
through 1997. All balance sheet amounts presented in the following financial
review are averages unless otherwise indicated. Certain reclassifications have
been made to make prior periods comparable. Taxable-equivalent adjustments
assume a 35 percent federal tax rate. Dollar amounts in tables are stated in
thousands, except for per share amounts.

ACQUISITIONS

On March 7, 1997, the Corporation paid approximately $32.2 million to
acquire Corpus Christi Bancshares, Inc., including its subsidiary Citizens State
Bank, based in Corpus Christi, Texas. Total intangibles associated with the
acquisition were approximately $20.9 million. The Corporation acquired loans of
approximately $108 million and deposits of approximately $184 million. This
acquisition did not have a material impact on the Corporation's 1997 net income.

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. The Corporation acquired deposits of approximately
$112 million. Total intangibles associated with the acquisition were
approximately $11.0 million. On February 15, 1996, the Corporation paid
approximately $33.5 million to acquire Park National Bank in Houston, Texas. The
Corporation acquired deposits of approximately $225 million. Total intangibles
associated with the acquisition were $16.0 million. These acquisitions did not
have a material impact on the Corporation's 1996 net income.

On April 4, 1995, the Corporation entered the Rio Grande Valley area with
the acquisition of Valley Bancshares, Inc., including its subsidiary, Valley
National Bank in McAllen, Texas with approximately $49 million in deposits.
Total intangibles associated with the acquisition were approximately $5.0
million. On May 19, 1995, the acquisition of National Commerce Bank in Houston
with its three branch locations and approximately $101 million in deposits was
completed. Total intangibles associated with the acquisition were approximately
$15.6 million. On July 21, 1995, the Corporation acquired the two San Antonio
branches of Comerica Bank Texas with approximately $34 million in deposits.
These acquisitions did not have a material impact on the Corporation's 1995 net
income.

The acquisitions listed above were all accounted for as purchase
transactions and as such their results of operations are included from the date
of acquisition.

13

RESULTS OF OPERATIONS

For the year ended December 31, 1997, the Corporation reported net income
of $63.5 million or $2.75 per diluted common share, an all-time high in the
129-year history of Cullen/Frost. Net income for 1996 was $55.0 million or $2.40
per diluted common share, compared with $46.3 million or $2.04 per diluted
common share for 1995. The Corporation's return on average assets for 1997 was
1.28 percent compared with 1.22 percent in 1996 and 1.17 percent in 1995, while
return on average equity was 16.06 percent in 1997 compared with 15.32 percent
in 1996 and 14.32 percent in 1995.

1997 Change 1996 Change
EARNINGS SUMMARY 1997 From 1996 1996 From 1995 1995
- ------------------------------------------------------------------------------------------------------------

Taxable-equivalent net interest
income............................. $ 198,367 $18,288 $ 180,079 $ 26,943 $ 153,136
Taxable-equivalent adjustment........ 1,123 126 997 116 881
---------------------------------------------------------------------
Net interest income.................. 197,244 18,162 179,082 26,827 152,255
Provision for possible loan losses... 7,900 600 7,300 1,028 6,272
Non-interest income:
Net gain (loss) on securities
transactions.................. 494 1,474 (980) 416 (1,396)
Other........................... 108,838 13,323 95,515 6,376 89,139
---------------------------------------------------------------------
Total non-interest
income.................. 109,332 14,797 94,535 6,792 87,743
Non-interest expense:
Intangible amortization......... 11,920 614 11,306 3,182 8,124
Other operating expenses........ 188,036 18,762 169,274 14,949 154,325
---------------------------------------------------------------------
Total non-interest
expense................. 199,956 19,376 180,580 18,131 162,449
---------------------------------------------------------------------
Income before income taxes........... 98,720 12,983 85,737 14,460 71,277
Income taxes......................... 35,235 4,476 30,759 5,761 24,998
---------------------------------------------------------------------
Net income........................... $ 63,485 $ 8,507 $ 54,978 $ 8,699 $ 46,279
---------------------------------------------------------------------
Per common share:
Net income-basic................ $ 2.84 $ .39 $ 2.45 $ .38 $ 2.07
Net income-diluted.............. 2.75 .35 2.40 .36 2.04

Return on Average Assets............. 1.28% .06% 1.22% .05% 1.17%
Return on Average Equity............. 16.06 .74 15.32 1.00 14.32

NET INTEREST INCOME

Net interest income for 1997 was $197.2 million, an increase from $179.1
million recorded in 1996 and the $152.3 million recorded in 1995. The primary
reason for the yearly increase has been the consistent growth in loans. See
"Consolidated Average Balance Sheets" on pages 56 and 57 and "Rate Volume
Analysis" on page 58. The interest margin, was 4.74 percent for the year ended
December 31, 1997, compared to 4.76 percent and 4.56 percent for the years 1996
and 1995, respectively. The slight decrease in the net interest margin from a
year ago is reflective of higher deposit costs and interest expense related to
the $100 million Trust Preferred Capital Securities issued in early 1997, See
Note I "Borrowed Funds" on Page 41. The net interest margin increased in 1996
from 1995 due to higher loan volumes and lower deposit costs. Net interest
spread for 1997 decreased 7 basis points to 3.91 percent. This decrease is
largely the result of the $100 million Trust Preferred Capital Securities. Net
interest spread was 3.98 percent and 3.80 percent for 1996 and 1995,
respectively. The increase in net interest spread for 1996 is primarily due to
the Corporation's ability to maintain its earnings on funds with higher loan
volumes and the favorable impact of the acquisitions, while deposit costs
decreased.

The net interest spread as well as the net interest margin could be
impacted by future changes in short-and long-term interest rate levels.

14

INTEREST RATE SENSITIVITY

The Corporation's interest rate sensitivity and liquidity are monitored by
its Asset/Liability Management Committee on an ongoing basis. The Committee
seeks to avoid fluctuating net interest margins and to maintain consistent
growth of net interest income through periods of changing interest rates. As the
accompanying table indicates, the Corporation is liability-sensitive, on a
cumulative basis, at time periods of one year or less.

The Corporation continuously monitors and manages the balance between
interest rate-sensitive assets and liabilities. The Corporation's objective is
to manage the impact of fluctuating market rates on net interest income within
acceptable levels.

December 31, 1997
-------------------------------------------------------------------------------
Immediately Non-Rate
Rate Sensitive Rate Sensitive Within Sensitive
CUMULATIVE INTEREST RATE SENSITIVITY --------------- ---------------------------------- ----------
(PERIOD-END BALANCE) 0-30 Days 90 Days One Year Five Years >Five Years Total
- -------------------------------------------------------------------------------------------------------------------------

Earning Assets:
Loans............................... $1,462,302 $1,585,971 $1,881,332 $2,324,959 $318,563 $ 2,643,522
Securities.......................... 212,388 362,244 1,008,874 1,402,880 88,638 1,491,518
Federal funds sold and other short-
term investments.................. 190,000 190,000 190,000 190,000 190,000

-------------------------------------------------------------------------------
Total earning assets........... $1,864,690 $2,138,215 $3,080,206 $3,917,839 $407,201 $ 4,325,040
-------------------------------------------------------------------------------
Interest-Bearing Liabilities:
Savings and Interest-on-Checking.... $ 766,416 $ 766,416 $ 766,416 $ 766,416 $ 766,416
Money market deposit accounts....... 996,110 996,110 996,110 996,110 996,110
Certificates of deposit and other
time accounts..................... 368,895 697,062 1,206,709 1,289,155 $ 93,407 1,382,562
Federal funds purchased and other
borrowings........................ 132,112 132,112 132,112 132,112 98,403 230,515
-------------------------------------------------------------------------------
Total interest-bearing
liabilities.................. $2,263,533 $2,591,700 $3,101,347 $3,183,793 $191,810 $ 3,375,603
-------------------------------------------------------------------------------
Interest sensitivity gap................ $(398,843) $(453,485) $ (21,141) $ 734,046 $215,391 $ 949,437
-------------------------------------------------------------------------------
Ratio of earning assets to
interest-bearing liabilities.......... .82 .83 .99 1.23
----------------------------------------------------

In developing the classifications used for this analysis, it was necessary to
make certain assumptions and approximations in assigning assets and liabilities
to different maturity categories. For example, savings and Interest-on-Checking
are subject to immediate withdrawal and as such are presented as repricing
within the earliest period presented even though their balances have
historically not shown significant sensitivity to changes in interest rates.

Loans are included net of unearned discount of $2,318,000. Consumer loans are
distributed in the immediately rate-sensitive category for those tied to market
rates or to other categories according to the repayment schedule.

The above table does not reflect interest rate swaps/floors further discussed on
page 25.

The Corporation utilizes an interest rate sensitivity model as the primary
quantitative tool in measuring the amount of interest rate risk that is present
at the end of each month. The model quantifies the effects of various interest
rate scenarios on the projected net interest income and net income over the
ensuing 12 month period. The model was used to measure the impact on net
interest income relative to a base case scenario, of rates increasing or
decreasing ratably 200 basis points over the next 12 months. These simulations
incorporate assumptions regarding balance sheet growth and mix, pricing and the
repricing and maturity characteristics of the existing and projected balance
sheet. Other interest rate-related risks such as prepayment, basis and option
risk are also considered. The resulting model simulations show that a 200 basis
point increase in rates will result in a positive variance in net interest
income of 1.3 percent relative to the base case over the next 12 months; while a
decrease of 200 basis points will result in a negative variance in net interest
income of 1.7 percent.
15

LIQUIDITY

Asset liquidity is provided by cash and assets which are readily marketable
or pledgeable or which will mature in the near future. Liquid assets include
cash, short-term investments in time deposits in banks, Federal funds sold and
securities available for sale.

Liquidity is also provided by access to funding sources which include core
depositors and correspondent banks in the Corporation's natural trade area which
maintain accounts with and sell Federal funds to subsidiary banks of the
Corporation, as well as Federal funds purchased and securities sold under
repurchase agreements from upstream banks.

NON-INTEREST INCOME

Non-interest income of $109,332,000 was reported for 1997, compared with
$94,535,000 for 1996 and $87,743,000 for 1995. Excluding securities
transactions, total non-interest income increased 13.9 percent from 1996. The
non-interest income growth in 1997 was favorably impacted by the acquisition of
Corpus Christi Bancshares, Inc., in the first quarter of 1997. The non-interest
income growth in 1996 was favorably impacted by the acquisitions of S.B.T.
Bancshares, Inc. and Park National Bank, in the first quarter of 1996.

Year Ended December 31
--------------------------------------------------------------------
1997 1996 1995
-------------------- ------------------- -------------------
PERCENT Percent Percent
NON-INTEREST INCOME AMOUNT CHANGE Amount Change Amount Change
- ------------------------------------------------------------------------------------------------------------

Trust fees........................... $ 39,971 + 17.5% $34,031 + 7.1% $31,762 + 7.6%
Service charges on deposit
accounts........................... 43,727 + 14.2 38,294 +26.0 30,382 + 7.8
Other service charges, collection and
exchange charges, commissions and
fees............................... 10,148 + 15.8 8,764 - 20.7 11,055 +18.0
Net gain (loss) on securities
transactions....................... 494 +150.4 (980) +29.8 (1,396) +65.4
Other................................ 14,992 + 3.9 14,426 - 9.5 15,940 +15.7
-------- ------- -------
Total........................... $109,332 + 15.7 $94,535 + 7.7 $87,743 +14.2
-------- ------- -------

Trust income was up $5.9 million or 17.5 percent during 1997 as the market
value of trust assets increased to $9.1 billion from $8.1 billion last year
primarily due to the increase in the number of accounts held and trust asset
growth resulting from the continued improvement in the stock and bond market.
The December 31, 1997 trust assets were comprised of discretionary assets of
$5.2 billion and non-discretionary assets of $3.9 billion compared to $4.2
billion and $3.9 billion last year, respectively. The $2.3 million or 7.1
percent increase in trust income from 1995 to 1996 is attributable to the
increase in the number of accounts held and trust asset growth resulting from
improvement in the stock and bond market. This increase was offset by lower
corporate trust income resulting from the sale of the Corporation's corporate
trust business in 1995.

Deposit service charges increased $5.4 million or 14.2 percent from 1996.
The increase is due mainly to higher service charges related to commercial
deposits, volumes processed for correspondent banks and overdraft charges.
Deposit service charges increased $7.9 million or 26.0 percent from 1995. The
increase was due mainly to higher volumes, primarily processing for
correspondent banks, and service charges on corporate and retail deposits. Other
service charges and fees increased $1.4 million or 15.8 percent when compared to
1996. This increase was primarily due to higher fees from accounts receivable
factoring, asset based lending and mutual fund fees offset by lower bankcard
discounts resulting from the Corporation's outsourcing of its bankcard
processing operations which was completed in May 1996. The outsourcing of
bankcard processing also accounted for the decrease of 20.7 percent in other
service charges from 1995 to 1996.

16

During the fourth quarter of 1997, the Corporation sold a portion of its
available for sale investment portfolio resulting in a gain of $476,000. This
compares to a $980,000 and $1.4 million loss in 1996 and 1995, respectively,
which resulted primarily from the Corporation restructuring a portion of its
available for sale investment portfolio by replacing lower-yielding securities
with higher-yielding securities during the second quarter of 1996 and the fourth
quarter of 1995.

Other non-interest income increased $566,000 or 3.9 percent to $14,992,000
in 1997 compared to a 9.5 percent decrease in 1996. The increase in 1997 is
primarily due to gains recorded on the sale of student loans, mineral interest
income and Visa check card fees. These increases were offset by higher gains on
the disposition of certain loans and foreclosed assets recorded by the
Corporation in 1996. The decrease in 1996 from 1995 was primarily due to the
gain recognized on the sale of the Corporation's corporate trust business in
1995.

NON-INTEREST EXPENSE

Non-interest expense was $199,956,000 for 1997 compared with $180,580,000
for 1996 and $162,449,000 for 1995. The acquisition of Corpus Christi Bancshares
in the first quarter of 1997 impacted the growth in expenses and contributed to
the variances from 1996 discussed below. The acquisition of S.B.T. Bancshares,
Inc. and Park National Bank in the first quarter of 1996 impacted the growth in
expenses and contributed to the variances from 1995 discussed below.

Year Ended December 31
----------------------------------------------------------------------
1997 1996 1995
-------------------- -------------------- --------------------
PERCENT Percent Percent
NON-INTEREST EXPENSE AMOUNT CHANGE Amount Change Amount Change
- --------------------------------------------------------------------------------------------------------------

Salaries and wages................... $ 81,816 +14.0% $ 71,788 +23.4% $ 58,177 + 9.8%
Pension and other employee benefits.. 16,849 + 9.8 15,351 +40.8 10,905 +10.0
Net occupancy of banking premises.... 19,496 + 3.8 18,782 + 4.4 17,992 +14.0
Furniture and equipment.............. 12,463 + 5.7 11,789 + 4.7 11,259 + 2.9
Intangible amortization.............. 11,920 + 5.4 11,306 +39.2 8,124 + 6.5
Other................................ 57,412 +11.3 51,564 - 7.9 55,992 - 4.0
-------- -------- --------
Total........................... $199,956 +10.7 $180,580 +11.2 $162,449 + 4.4
-------- -------- --------

Salaries and wages increased by $10.0 million or 14.0 percent during 1997
primarily because of the impact of the acquisition and normal merit increases.
Salaries and wages increased by $13.6 million or 23.4 percent during 1996
primarily because of the acquisitions. Pension and other employee benefits
increased by $1.5 million or 9.8 percent during 1997 primarily due to the impact
of the 1997 acquisition on payroll taxes and medical insurance expense offset by
lower contributions to fund the employer match on the employee related stock
plans due to the use of forfeited shares. The 40.8 percent increase in pension
and other employee benefits from 1995 to 1996 was primarily due to higher
retirement plan expense, payroll taxes, and medical insurance expense related to
the 1996 acquisitions and the impact of an early retirement charge.

Net occupancy of banking premises increased $714,000 or 3.8 percent during
1997 primarily due to higher building maintenance costs, property taxes and
operating expenses, partially offset by higher tenant income. The 4.4 percent
increase in 1996 compared to 1995 was primarily due to higher lease, building
maintenance, and property tax expense related to the 1996 acquisitions.
Furniture and equipment costs increased $674,000 or 5.7 percent in 1997
primarily due to higher equipment rental and software related expenses. The
$530,000 increase in 1996 is mostly due to higher depreciation expense
associated with the acquisitions. Intangible amortization increased by $614,000
or 5.4 percent and by $3.2 million or 39.2 percent in 1997 and 1996,
respectively, due to the acquisitions.

Other non-interest expense increased $5.8 million or 11.3 percent during
1997 primarily due to expenses related to the Year 2000 compliance program, see
"Year 2000" on page 18, and higher operating

17

expenses, such as, sales promotion, guard services, supplies, travel and
telephone, which were impacted by the acquisitions. Other non-interest expense
was down 7.9 percent in 1996 mostly due to lower FDIC insurance, franchise
taxes, and federal reserve service charges. The Corporation paid $510,000 in
FDIC insurance premiums in 1997 primarily relating to the premium imposed on all
banks to service the Financing Corporation (FICO) bonds compared to a minimal
amount in 1996 and $3.6 million in 1995. For 1996, the FDIC Board reduced the
insurance premiums to zero for banks in the lowest risk category. However,
legislation enacted in 1996 provided for assessments on banks (based on deposit
levels) to pay interest on FICO bonds, the proceeds of which were used in the
bailout of the Savings and Loan industry in the 1980's. For each of the three
years beginning in 1997, the assessment on banks will be approximately 1.3 cents
for each $100 of qualified deposits. For the second half of 1995, the FDIC
assessment rate imposed on banks ranged from 4 cents for each $100 of domestic
deposits (for well capitalized banks in the highest of three supervisory rating
categories) to 31 cents (for inadequately capitalized banks in the lowest of the
three supervisory rating categories). This was a decrease from the previous
assessment range of 23 cents to 31 cents for those respective categories, for
each $100 of domestic deposits.

The Corporation's efficiency ratio of 65.1 percent for 1997 improved from
65.5 percent for 1996 and 66.8 percent for 1995. Excluding intangible
amortization, the efficiency ratio was 62.2 percent for 1997, an improvement
from the 62.6 percent for 1996 and 64.5 percent for 1995. The efficiency ratio
measures what percentage of bank revenue is absorbed by non-interest expense.

YEAR 2000

The Corporation's Year 2000 compliance program includes modifying or
replacing appropriate hardware and software utilized by the Corporation.
Currently, the Corporation estimates that the dollar amount to be spent on
incremental outside costs to remediate its Year 2000 issues will be
approximately $3 million over a three year period beginning in 1997, funded out
of its earnings. These costs are being expensed as incurred and were
approximately $900,000 for the year 1997. The cost of compliance and expected
completion dates are based upon management's best estimates which were derived
utilizing assumptions of future events including the continued availability of
certain resources, third party vendor remediation plans and other factors.
Management expects all mission critical systems to be installed and certified by
November 1998 and believes that its program is producing the appropriate level
of preparedness.

Regardless of the Year 2000 compliance of the Corporation's systems, there
is no complete assurance that the Corporation will not be adversely affected to
the extent other entities not affiliated with the Corporation are unsuccessful
in properly addressing this issue. In an effort to minimize this possibility,
active communication has been on-going between the Corporation and its external
service providers and intermediaries. In addition, a risk reduction program was
initiated in 1997 that addresses potential Year 2000 exposure in the loan
portfolio. Public awareness sessions have been hosted by the Corporation for
customers and suppliers in our marketplace during 1997, and such communication
is planned to continue throughout 1998.

INCOME TAXES

The Corporation recognized income tax expense of $35,235,000 in 1997,
compared to $30,759,000 in 1996, and $24,998,000 in 1995. The effective tax rate
in 1997 was 35.69 percent compared to 35.88 percent in 1996 and 35.07 percent in
1995. For a detailed analysis of the Corporation's income taxes see Note O
"Income Taxes" on page 49.

18

CASH EARNINGS

Historically, the Corporation's acquisitions have been accounted for using
the purchase method of accounting which results in the creation of intangible
assets. These intangible assets are deducted from capital in the determination
of regulatory capital. Thus, "cash" or "tangible" earnings represents the
regulatory capital generated during the year and can be viewed as net income
excluding intangible amortization, net of tax. While the definition of "cash"
or "tangible" earnings may vary by company, we believe this definition is
appropriate as it measures the per share growth of regulatory capital, which
impacts the amount available for dividends and acquisitions. The following table
reconciles reported earnings to net income excluding intangible amortization
("cash" earnings) for the three year period ending in 1997:

Year Ended December 31
---------------------------------------------------------------------------------------------
1997 1996 1995
-------------------------------------- -------------------------------------- ---------
REPORTED INTANGIBLE "CASH" Reported Intangible "Cash" Reported
EARNING AMORTIZATION EARNINGS Earnings Amortization Earnings Earnings
- ------------------------------------------------------------------------------------------------------------------------------------

Income before income taxes........... $98,720 $ 11,920 $110,640 $85,737 $ 11,306 $97,043 $71,277
Income taxes......................... 35,235 3,144 38,379 30,759 3,267 34,026 24,998
---------------------------------------------------------------------------------------------
Net income........................... $63,485 $ 8,776 $ 72,261 $54,978 $ 8,039 $63,017 $46,279
---------------------------------------------------------------------------------------------
Net income per diluted common
share............................... $ 2.75 $ .38 $ 3.13 $ 2.40 $ .35 $ 2.75 $ 2.04
Return on assets..................... 1.28% 1.46 %* 1.22% 1.40%* 1.17%
Return on equity..................... 16.06 18.28 ** 15.32 17.56** 14.32

Intangible "Cash"
Amortization Earnings
- -------------------------------------
Income before income taxes........... $8,124 $79,401
Income taxes......................... 2,495 27,493

Net income........................... $5,629 $51,908

Net income per diluted common
share............................... $ .25 $ 2.29
Return on assets..................... 1.32%*
Return on equity..................... 16.06**

* CALCULATED AS A/B

** CALCULATED AS A/C
- -------------------

1997 1996 1995
--------- --------- ---------
(A) Net income before intangible
amortization (including goodwill
and core deposit intangibles, net
of tax).......................... $ 72,261 $ 63,017 $ 51,908
(B) Total average assets............. 4,945,658 4,496,495 3,944,026
(C) Average shareholders' equity..... 395,304 358,837 323,288

SOURCES AND USES OF FUNDS

Average assets for 1997 of $4,945,658,000 increased by 10.0 percent from
1996 levels and increased 14.0 percent between 1995 and 1996. Funding sources in
1997 reflected an increase in borrowed funds as a result of the issuance of the
$100 million Trust Preferred Capital Securities discussed in Note I "Borrowed
Funds" on page 41, while time deposits and Federal funds purchased were
reduced. The Corporation's uses of funds continued a trend which started in 1995
of replacing securities with loans as the largest component of earning assets.
This reflects the increases in loan volumes from a year ago.

Percentage of Total Average
Assets
-------------------------------
SOURCES AND USES OF FUNDS 1997 1996 1995
- ----------------------------------------------------------------------
Sources of Funds:
Deposits:
Demand..................... 24.3% 23.9% 21.9%
Time....................... 61.7 62.8 61.6
Federal funds purchased............ 2.4 3.3 6.4
Equity capital..................... 8.0 8.0 8.2
Borrowed funds..................... 2.3 .4 .3
Other liabilities.................. 1.3 1.6 1.6

-------------------------------
Total........................... 100.0% 100.0% 100.0%
-------------------------------
Uses of Funds:
Loans.............................. 50.0% 46.4% 42.7%
Securities......................... 30.2 34.6 39.5
Federal funds sold................. 4.4 3.1 3.0
Non-earning assets................. 15.4 15.9 14.8
-------------------------------
Total...................... 100.0% 100.0% 100.0%
-------------------------------
19

LOANS

Average loans for 1997 were $2,470,841,000, an increase of 18.4 percent
from 1996. This increase was driven by continued improved economic conditions in
the Texas markets the Corporation serves and the 1997 acquisition.

December 31,
------------------------------------------------------------------------------------
1997
---------------------------
LOAN PORTFOLIO ANALYSIS PERCENTAGE OF
(PERIOD-END BALANCES) AMOUNT TOTAL LOANS 1996 1995 1994 1993
- ---------------------------------------------------------------------------------------------------------------------------

Real estate:
Construction.................... $ 116,100 4.4% $ 84,146 $ 54,168 $ 44,502 $ 32,297
Land............................ 54,142 2.0 50,208 37,695 36,805 32,317
Permanent Mortgages:
Commercial.................... 254,716 9.6 225,845 198,276 177,223 144,122
Residential................... 461,635 17.5 422,985 339,650 277,786 276,165
Other........................... 247,824 9.4 261,207 208,633 178,460 150,499
------------------------------------------------------------------------------------
Total real estate............... 1,134,417 42.9 1,044,391 838,422 714,776 635,400
Commercial and industrial............ 804,257 30.4 650,114 509,150 375,085 311,436
Consumer............................. 602,415 22.8 491,086 402,183 331,042 268,331
Financial institutions............... 3,767 .2 12,749 10,409 5,578 284
Foreign.............................. 72,911 2.8 45,562 43,847 45,290 31,763
Purchasing or carrying securities.... 788 1,812 1,711 1,884 1,204
Other................................ 27,285 1.0 8,908 13,068 13,386 17,797
Unearned discount.................... (2,318) (.1) (1,154) (1,337) (3,487) (8,456)
------------------------------------------------------------------------------------
Total........................... $ 2,643,522 100.0% $ 2,253,468 $ 1,817,453 $ 1,483,554 $ 1,257,759
------------------------------------------------------------------------------------
Percent change from previous year.... +17.3% +24.0% +22.5% +18.0% +22.1%

Period-end loans increased to $2,643,522,000 at year-end 1997, up 17.3
percent from the previous year end. Most of the increase in period-end loans is
attributable to commercial and consumer loans which increased $154 million and
$111 million, respectively. Approximately 72 percent of the increase in loans
from a year ago resulted from internally generated growth.

Total real estate loans at December 31, 1997 were $1,134,417,000, up 8.6
percent from year-end 1996. Amortizing permanent mortgages represented 63.1
percent of the total real estate loan portfolio at year end. Residential
mortgages increased $38,650,000 or 9.1 percent. Real estate loans categorized as
"other" are primarily amortizing commercial and industrial loans with
maturities of less than five years. Approximately 62 percent of all commercial
real estate loans are owner occupied or have a major tenant (National or
Regional company), which historically has resulted in a lower risk, provides
financial stability and is less susceptible to economic swings. See page 23 for
further discussion for the loan portfolio and "Loan Maturity and Sensitivity"
on page 58.

MEXICAN LOANS

At December 31, 1997, the Corporation's cross-border outstandings to
Mexico, excluding $24,314,000 in loans secured by liquid U.S. assets, totaled
$48,597,000, up from $29,932,000 last year. The increase from a year ago
represents the additional usage of lines of credit extended to Mexican banks to
support trade-related transactions. Of the trade-related credits, approximately
89 percent are related to companies exporting from Mexico. In addition, loans
insured by the Export Import Bank were made to Mexican

20

businesses to purchase goods of the United States. At December 31, 1997, 1996
and 1995, none of the Mexican-related loans were on non-performing status.

December 31
--------------------------------------------------------------------------------------------
1997 1996 1995

--------------------------------------------------------------------------------------------
PERCENTAGE PERCENTAGE Percentage Percentage Percentage
OF TOTAL OF TOTAL of Total of Total of Total
MEXICAN LOANS AMOUNT LOANS ASSETS Amount Loans Assets Amount Loans
- -----------------------------------------------------------------------------------------------------------------------------------

Financial institutions............... $35,563 1.3% .7% $24,932 1.1% .5% $30,560 1.7%
Commercial and industrial............ 13,034 .5 .2 5,000 .2 .1 26
--------------------------------------------------------------------------------------------
Total.............................. $48,597 1.8% .9% $29,932 1.3% .6% $30,586 1.7%
--------------------------------------------------------------------------------------------

Percentage
of Total
MEXICAN LOANS Assets
- -------------------------------------
Financial institutions............... .7%
Commercial and industrial............

Total.............................. .7%

The above table excludes $24,314,000, $15,630,000 and $13,261,000 in loans
secured by liquid assets held in the United States in 1997, 1996 and 1995,
respectively.

NON-PERFORMING ASSETS

Non-performing assets were $17,213,000 at December 31, 1997, compared with
$12,371,000 at December 31, 1996 and $16,307,000 at December 31, 1995.
Non-performing assets as a percentage of total loans and foreclosed assets were
.65 percent at December 31, 1997, up from .55 percent one year ago.

December 31
-----------------------------------------------------
NON-PERFORMING ASSETS 1997 1996 1995 1994 1993
- --------------------------------------------------------------------------------------------

Non-accrual and restructured loans... $ 12,702 $ 10,129 $ 14,798 $ 16,664 $ 27,677
Foreclosed assets.................... 4,511 2,242 1,509 3,311 3,433
-----------------------------------------------------
Total............................ $ 17,213 $ 12,371 $ 16,307 $ 19,975 $ 31,110
-----------------------------------------------------
As a percentage of total assets...... .33% .25% .39% .53% .85%
As a percentage of total loans plus
foreclosed assets.................. .65 .55 .90 1.34 2.47
After-tax impact of lost interest per
common share....................... $ .04 $ .04 $ .05 $ .07 $ .10
Accruing loans 90 days past due:
Consumer........................... $ 3,378 $ 1,829 $ 1,276 $ 574 $ 765
All other.......................... 3,273 4,082 3,912 3,070 3,827
-----------------------------------------------------
Total............................ $ 6,651 $ 5,911 $ 5,188 $ 3,644 $ 4,592
-----------------------------------------------------

Interest income that would have been recorded in 1997 on non-performing assets,
had such assets performed in accordance with their original contract terms, was
$1,131,000 on non-accrual and restructured loans and $218,000 on foreclosed
assets. During 1997, the amount of interest income actually recorded on
non-accrual and restructured loans was $564,000.

Loans 90 days past due include $50,000 in foreign loans.

Loans to a customer whose financial condition has deteriorated are
considered for non-accrual status whether or not the loan is 90 days or more
past due. All non-consumer loans 90 days or more past due are classified as
non-accrual unless the loan is well secured and in the process of collection.
When a loan is placed on non-accrual status, interest income is not recognized
until collected, and any previously accrued but uncollected interest is
reversed. Restructured loans have been modified as to original terms, resulting
in a reduction or deferral of principal and/or interest as a concession to the
debtor. Classification of an asset in the non-performing category does not
preclude ultimate collection of loan principal or interest.

At December 31, 1997, the Corporation had $3,351,000 in loans to borrowers
experiencing financial difficulties which had not been included in either of the
non-accrual, restructured or 90 days past due loan categories. Management
monitors such loans closely and reviews their performance on a regular basis.

ALLOWANCE FOR POSSIBLE LOAN LOSSES

The allowance for possible loan losses was $41,846,000 or 1.58 percent of
period-end loans at December 31, 1997, compared to $37,626,000 or 1.67 percent
of period-end loans at year-end 1996. The allowance for possible loan losses as
a percentage of non-accrual and restructured loans was 329.4 percent at December
31, 1997, compared with 371.5 percent at December 31, 1996.

21

The Corporation recorded a $7,900,000 provision for possible loan losses
during 1997, compared to $7,300,000 and $6,272,000 recorded during 1996 and
1995, respectively. The provision is reflective of the continued growth in the
loan portfolio.

The Corporation recorded net charge-offs of $5,785,000 for the year ended
December 31, 1997, compared to net charge-offs of $2,569,000 and $436,000 in
1996 and 1995, respectively. The Corporation's gross charge-offs in 1997
consisted primarily of consumer loans which increased $3.5 million to $7.2
million and commercial and industrial which decreased $4.4 million to $1.7
million. The Corporation's charge-offs in 1996 consisted primarily of commercial
and industrial loans which increased to $6.2 million from $654,000 in 1995 and
consumer loans which decreased slightly from 1995. The Corporation's charge-offs
in 1995 consisted primarily of consumer loan charge-offs, which increased to
$3.8 million in 1995 from $2.4 million the previous year primarily as a result
of the increased loan volumes.

Year Ended December 31
--------------------------------------------------------------------
ALLOWANCE FOR POSSIBLE LOAN LOSSES 1997 1996 1995 1994 1993
- -----------------------------------------------------------------------------------------------------------

Average loans outstanding during
year, net of unearned discount..... $ 2,470,841 $ 2,086,816 $ 1,682,541 $ 1,339,656 $ 1,171,825
--------------------------------------------------------------------
Balance of allowance for possible
loan losses at beginning of year... $ 37,626 $ 32,268 $ 26,002 $ 26,298 $ 31,897
Provision (credit) for possible loan
losses............................. 7,900 7,300 6,272 (6,085)
Loan loss reserve of acquired
(disposed) institutions............ 2,105 627 430 (2,423)
Charge-offs:
Real estate........................ (644) (351) (228) (1,349) (3,481)
Commercial and industrial.......... (1,743) (6,176) (654) (316) (1,287)
Consumer........................... (7,163) (3,709) (3,797) (2,357) (3,369)
Other, including foreign........... (40) (9) (2) (63)
--------------------------------------------------------------------
Total charge-offs............... (9,590) (10,245) (4,681) (4,022) (8,200)
--------------------------------------------------------------------
Recoveries:
Real estate........................ 943 2,467 1,258 1,970 2,412
Commercial and industrial.......... 896 3,665 1,722 2,434 3,577
Consumer........................... 1,840 1,416 1,211 1,692 2,237
Other, including foreign........... 126 128 54 53 460
--------------------------------------------------------------------
Total recoveries................ 3,805 7,676 4,245 6,149 8,686
--------------------------------------------------------------------
Net (charge-offs) recoveries......... (5,785) (2,569) (436) 2,127 486
--------------------------------------------------------------------
Balance of allowance for possible
loan losses at end of year......... $ 41,846 $ 37,626 $ 32,268 $ 26,002 $ 26,298
--------------------------------------------------------------------
Net (charge-offs) recoveries as a
percentage of average loans
outstanding during year, net of
unearned discount.................. (.23)% (.12)% (.03)% .16% .04%
Allowance for possible loan losses as
a percentage of year-end loans, net
of unearned discount............... 1.58 1.67 1.78 1.75 2.09

There were no foreign charge-offs in 1997-1993.

The Corporation has certain lending policies and procedures in place which
are designed to maximize loan income within an acceptable level of risk. These
policies and procedures, some of which are described below, are reviewed
regularly by senior management. A reporting system supplements this review
process

22

by providing management and the board of directors with frequent reports related
to loan production, loan quality, concentrations of credit, loan delinquencies
and non-performing and potential problem loans.

Commercial and industrial loans are a diverse group of loans to small,
medium and large businesses. The purpose of these loans vary from supporting
seasonal working capital needs to term financing of equipment. These loans are
underwritten focusing on evaluating and understanding management's ability to
operate profitably and prudently expand their business. Once it is determined
management possess sound ethics and solid business acumen, current and projected
cash flows are examined to determine the ability to repay their obligations as
agreed upon. In addition, collateral must be of good quality and single purpose
projects are avoided. Underwriting standards are designed to promote
relationship banking rather than transactional banking. While some short-term
loans may be made on an unsecured basis, most are secured by the assets being
financed with appropriate collateral margins.

Diversification in the loan portfolio is a means of managing risk
associated with fluctuations in economic conditions. At December 31, 1997, the
Corporation had no concentration of commercial and industrial loans in any
single industry that exceeded 10 percent of total loans.

The diversity of the commercial real estate portfolio allows the
Corporation to reduce the impact of a decline in a single market or industry. In
addition to monitoring and evaluating commercial real estate loans based on
collateral, geography and risk grade criteria, management closely tracks its
level of owner-occupied commercial real estate loans versus non-owner occupied
loans. Additionally, the Corporation utilizes the knowledge of third party
experts to provide insight and guidance about the economic conditions and
dynamics of the markets served by the Corporation. Within the commercial real
estate loan category, the Corporation's primary focus has been the growth of
loans secured by owner-occupied properties. At December 31, 1997, a majority of
the Corporation's commercial real estate loans were secured by owner-occupied
properties. These loans are viewed primarily as cash flow loans and secondarily
as loans secured by real estate. Consequently, these loans must withstand the
analysis of a commercial loan and the underwriting process of a commercial real
estate loan.

Loans secured by non-owner occupied commercial real estate are made to
developers and builders who have a relationship with the Corporation and who
have a proven record of success. These loans are underwritten through the use of
feasibility studies, independent appraisal reviews, sensitivity analysis of
absorption and lease rates and financial analysis of the developers and property
owners. Sources of repayment for these types of loans may be pre-committed
permanent loans from approved long-term lenders, sales of developed property or
an interim loan commitment from the Corporation. These loans are closely
monitored by on-site inspections and are considered to have higher risks than
the other real estate loans due to their ultimate repayment being sensitive to
interest rate changes, general economic conditions and the availability of
long-term financing.

The consumer loan portfolio has three distinct segments -- indirect
consumer loans, which represent 59 percent of the consumer loan portfolio,
direct non-real estate consumer loans, which represent 26 percent of the
portfolio and direct real estate consumer loans, which represent 15 percent. The
indirect segment is composed almost exclusively of new and used automobile
financing. Non-real estate direct loans include automobile loans, unsecured
revolving credit products, personal loans secured by cash and cash equivalents,
and other similar types of credit facilities. The direct real estate loans are
primarily extended for home improvement purposes and residential lot financing
for future homesteads. In addition, on November 4, 1997, Texas voters approved a
constitutional amendment allowing for the existence of home equity loans in the
State of Texas. Effective January 1, 1998, the Corporation began offering home
equity loans up to 80 percent of the estimated value of the personal residence
of the borrower less the balances on existing mortgage and home improvement
loans. Home equity loans will be offered for a variety of purposes including:
education, business start-ups, debt consolidation and automobile financing. It
is anticipated this product will become another distinct segment of the consumer
portfolio before the end of the year. Primary growth of this product is expected
to be from existing customers. Underwriting standards for this product are
heavily influenced by the statute requirements, which include but are not
limited to; maximum loan-to-

23

value percentage, collection remedies, the number of such loans a borrower can
have at one time and documentation requirements.

A computer based credit scoring analysis is used to supplement the consumer
loan underwriting process. To monitor and manage consumer loan risk, policies
and procedures are developed and modified, as needed, jointly by line and staff
personnel. This activity, coupled with relatively small loan amounts that are
spread across many individual borrowers, minimizes the risk. Additionally, trend
and outlook reports are provided to senior management on a frequent basis to aid
in planning.

The Corporation has an independent Loan Review Division that reviews and
validates the credit risk program on a periodic basis. Results of these reviews
are presented to senior management and the board of directors. Loan Review's
function complements and reinforces the risk identification and assessment
decisions made by lenders and credit personnel as well as the Corporation's
policies and procedures.

Loans identified as losses by management, internal loan review and/or bank
examiners are charged-off. Furthermore, consumer loan accounts are charged-off
automatically based on regulatory requirements.

An allowance for possible loan losses is maintained in an amount which, in
management's judgment, provides an adequate reserve to absorb possible loan
losses. Industry concentrations, specific credit risks, loan loss experience,
current loan portfolio quality, the impact of rising interest rates, experience
level and effectiveness of employees, economic, competitive, political and
regulatory conditions and other pertinent factors are all considered in
determining the adequacy of the allowance.

An audit committee of non-management directors reviews the adequacy of the
allowance for possible loan losses quarterly.

December 31
------------------------------------------------------------------------------------------
1997 1996 1995 1994
----------------------- ------------------------ ------------------------ ----------
ALLOWANCE Allowance Allowance Allowance
FOR AS A for As a for As a for
POSSIBLE PERCENTAGE Possible Percentage Possible Percentage Possible
ALLOCATION OF ALLOWANCE LOAN OF TOTAL Loan of Total Loan of Total Loan
FOR POSSIBLE LOAN LOSSES LOSSES LOANS Losses Loans Losses Loans Losses
- ---------------------------------------------------------------------------------------------------------------------------------

Commercial and industrial............ $10,868 .41% $ 6,897 .31% $ 8,151 .45% $ 4,291
Real estate.......................... 6,933 .26 7,564 .34 9,593 .53 8,842
Consumer............................. 17,391 .66 13,819 .61 12,124 .67 10,387
Purchasing or carrying securities.... 88 6 6 7
Financial institutions............... 60 44 32 28
Other, including foreign............. 371 .01 213 .01 167 .01 160
Not allocated........................ 6,135 .24 9,083 .40 2,195 .12 2,287
------------------------------------------------------------------------------------------

Total............................. $41,846 1.58% $ 37,626 1.67% $ 32,268 1.78% $ 26,002
------------------------------------------------------------------------------------------

1993
------------------------
Allowance
As a for As a
Percentage Possible Percentage
ALLOCATION OF ALLOWANCE of Total Loan of Total
FOR POSSIBLE LOAN LOSSES Loans Losses Loans
- -------------------------------------
Commercial and industrial............ .29% $ 3,453 .27%
Real estate.......................... .60 10,432 .83
Consumer............................. .70 6,756 .54
Purchasing or carrying securities.... 3
Financial institutions............... 8
Other, including foreign............. .01 332 .03
Not allocated........................ .15 5,314 .42

Total............................. 1.75% $ 26,298 2.09%

Allocation of a portion of the allowance does not preclude its availability
to absorb losses in other categories. The unallocated portion of the allowance
represents an additional amount beyond that specifically reserved for specific
risks available to absorb unidentified losses in the current loan portfolio.

SECURITIES

Total securities, including securities available for sale, were
$1,491,518,000 at year-end 1997 compared to $1,476,424,000 a year ago.
Securities available for sale totaled $1,342,759,000 at December 31, 1997,
compared to $1,299,285,000 at year-end 1996. These securities consist primarily
of U.S. Treasury securities and obligations of U.S. Government agencies. The
remaining securities, consisting primarily of U.S. Government agency
obligations, are classified as securities held to maturity and are carried at
amortized cost.

Debt securities are classified as held to maturity when the Corporation has
the positive intent and ability to hold the securities to maturity. Available
for sale securities are stated at fair value, with unrealized gains and losses,
net of tax, reported as a separate component of shareholders' equity.

24

The average yield of the securities portfolio for the year ended December
31, 1997 was 6.40 percent compared with 6.42 percent for 1996. See page 59
"Maturity Distribution and Securities Portfolio Yields."

December 31
--------------------------------------------------------------------------------
1997 1996 1995
------------------------ ------------------------ ------------------------
PERIOD-END PERCENTAGE Period-end Percentage Period-end Percentage
SECURITIES BALANCE OF TOTAL Balance of Total Balance of Total
- ------------------------------------------------------------------------------------------------------------------------

U.S. Treasury........................ $ 310,380 20.8% $ 231,351 15.7% $ 223,457 14.5%
U.S. Government agencies
and corporations................... 1,168,691 78.4 1,233,238 83.5 1,301,731 84.7
States and political subdivisions.... 5,093 .3 5,449 .4 5,527 .4
Other................................ 7,354 .5 6,386 .4 5,852 .4
--------------------------------------------------------------------------------
Total........................... $1,491,518 100.0% $1,476,424 100.0% $1,536,567 100.0%
--------------------------------------------------------------------------------
Average yield earned during the year
(taxable-equivalent basis)......... 6.40% 6.42% 6.36%

INTEREST RATE SWAPS/FLOORS

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 their view of the interest rate sensitivity of the Corporation's
funding sources. The Corporation had 42 interest rate swaps at December 31, 1997
compared to 31 interest rate swaps at December 31, 1996. Each swap was a hedge
against a specific commercial fixed-rate loan or against a specific pool of
consumer fixed-rate loans, with a notional amount of $267 million and $251
million, respectively. In each case, the amortization of the interest rate swap
generally matches the expected amortization of the underlying loan or pool of
loans and was a hedge against either a specific commercial loan or a specific
pool of consumer loans with lives ranging from two to ten years. Each
counterparty to a swap transaction has a credit rating that is investment grade.
The net amount payable or receivable under these interest rate swap contracts is
accrued as an adjustment to interest income and was not considered material in
1997 and 1996.

During 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.

DEPOSITS

Total average demand deposits increased 11.8 percent from 1996. This can be
attributed to an increase in commercial and individual and correspondent bank
deposit levels of $103.4 million and $24.9 million, respectively. The increase
in commercial and individual is partially related to the 1997 acquisition. The
Corporation has made a strategic effort in growing its correspondent bank
relationships in the markets it serves. Reflective of this effort and continued
growth, the Corporation ranks 29th in the United States for correspondent bank
balances as of June 30, 1997.

1997 1996 1995
--------------------- --------------------- --------------------
AVERAGE PERCENT Average Percent Average Percent
DEMAND DEPOSITS BALANCE CHANGE Balance Change Balance Change
- --------------------------------------------------------------------------------------------------------------

Commercial and individual............ $ 935,779 +12.4% $ 832,356 +19.5% $ 696,499 +3.4%
Correspondent banks.................. 223,621 +12.5 198,750 +51.4 131,295 +5.5
Public funds......................... 43,177 - 3.9 44,923 +22.2 36,772 - 4.6
---------- ---------- ----------
Total........................... $1,202,577 +11.8 $1,076,029 +24.5 $ 864,566 +3.3
---------- ---------- ----------

25

Total average time deposits increased 8.1 percent from 1996 with the
largest increase coming from money market deposit accounts partially related to
the 1997 acquisition. Public funds in 1996 increased 94.7 percent from 1995
levels to $245.3 million primarily due to the conversion of a repurchase
agreement into a time deposit in 1996 as well as an increase in deposits by a
taxing authority.

1997 1996 1995
---------------------------- ----------------------------- --------------------
AVERAGE PERCENT Average Percent Average Percent
TIME DEPOSITS BALANCE CHANGE COST Balance Change Cost Balance Change
- ----------------------------------------------------------------------------------------------------------------------------

Savings and Interest-on-Checking..... $ 736,174 + 1.9% 1.22% $ 722,518 + .3% 1.36 % $ 720,489 - 9.5%
Money market deposit accounts........ 974,341 +20.2 4.00 810,616 +31.4 3.93 616,931 +12.7
Time accounts of $100,000 or more.... 517,027 +12.3 5.12 460,196 + 2.0 4.95 450,959 +23.6
Time accounts under $100,000......... 568,001 - 3.2 4.76 586,675 +14.1 4.84 513,999 + 5.0
Public funds......................... 257,189 + 4.9 4.51 245,266 +94.7 4.36 125,971 +46.3
--------- --------- ---------
Total............................ $3,052,732 + 8.1 3.71 $2,825,271 +16.3 3.66 $2,428,349 + 6.3
--------- --------- ---------

TIME DEPOSITS Cost
- -------------------------------------
Savings and Interest-on-Checking..... 1.76%
Money market deposit accounts........ 3.84
Time accounts of $100,000 or more.... 5.09
Time accounts under $100,000......... 4.87
Public funds......................... 4.33
Total............................ 3.70

The following table summarizes the certificates of deposits in amounts of
$100,000 or more as of December 31, 1997 by time remaining until maturity.

December 31
-------------------------
1997
REMAINING MATURITY OF PRIVATE -------------------------
CERTIFICATES OF DEPOSIT PERCENTAGE
OF $100,000 OR MORE AMOUNT OF TOTAL
- ----------------------------------------------------------------
Three months or less................. $ 63,431 11.6%
After three, within six months....... 117,141 21.4
After six, within twelve months...... 179,753 32.9
After twelve months.................. 186,255 34.1
-------------------------
Total........................... $ 546,580 100.0%
-------------------------
Percentage of total private time
deposits 19.1%

Other time deposits of $100,000 or more were $185,527,000 at December 31, 1997.
Of this amount 74.6 percent matures within three months, 6.5 percent matures
between three and six months and the remainder matures between six months and
one year.

Mexico is a part of the natural trade territory of the banking offices of
Cullen/Frost. Thus, dollar-denominated foreign deposits from Mexican sources
have traditionally been a significant source of funding. The Corporation's
average foreign deposits increased 5.9 percent from 1996. The Mexican economic
recovery and growth in manufacturing which began in 1996 continued to improve in
1997.

FOREIGN DEPOSITS 1997 1996 1995
- -------------------------------------------------------------------------
Average balance...................... $ 607,642 $ 573,583 $ 562,191
Percentage of total average
deposits........................... 14.3% 14.7% 17.1%

26

SHORT-TERM BORROWINGS
The Corporation's primary source of short-ter