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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D. C. 20549
FORM 10-K
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE
ACT OF 1934
FOR THE FISCAL YEAR ENDED DECEMBER 31, 1998
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES
EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM ________ TO _________
COMMISSION FILE NUMBER 0-7275
CULLEN/FROST BANKERS, INC.
(Exact name of registrant as specified in its charter)
TEXAS 74-1751768
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
100 W. HOUSTON STREET
SAN ANTONIO, TEXAS 78205
(Address of principal executive offices) (Zip Code)
REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE: (210) 220-4011
SECURITIES REGISTERED PURSUANT TO SECTION 12(B) OF THE ACT:
COMMON STOCK, $.01 PAR VALUE
(WITH ATTACHED RIGHTS)
(Title of Class)
SECURITIES REGISTERED PURSUANT TO SECTION 12(G) OF THE ACT:
NONE
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. YES [X] NO [ ]
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of the registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K. [ ]
The aggregate market value of the voting stock held by non-affiliates of
the registrant was $1,250,969,589 based on the closing price of such stock as of
March 19, 1999.
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 19, 1999
--------------------------------- ------------------
COMMON STOCK, $.01 PAR VALUE 26,760,687
DOCUMENTS INCORPORATED BY REFERENCE
(1) Proxy Statement for Annual Meeting of Shareholders to be held May 26, 1999 (Part III)
TABLE OF CONTENTS
PAGE
----
PART I
ITEM 1. BUSINESS.................. 3
ITEM 2. PROPERTIES................ 10
ITEM 3. LEGAL PROCEEDINGS......... 10
ITEM 4. SUBMISSION OF MATTERS TO A
VOTE OF SECURITY HOLDERS... *
PART II
ITEM 5. MARKET FOR REGISTRANT'S
COMMON STOCK AND RELATED
STOCKHOLDER MATTERS....... 10
ITEM 6. SELECTED FINANCIAL DATA... 11
ITEM 7. MANAGEMENT'S DISCUSSION
AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF
OPERATIONS................ 13
ITEM 7A. QUANTITATIVE AND
QUALITATIVE DISCLOSURES
ABOUT MARKET RISK......... 32
ITEM 8. FINANCIAL STATEMENTS AND
SUPPLEMENTARY DATA........ 33
ITEM 9. CHANGES IN AND
DISAGREEMENTS WITH
ACCOUNTANTS ON ACCOUNTING
AND FINANCIAL
DISCLOSURE................ *
PART III
ITEM 10. DIRECTORS AND EXECUTIVE
OFFICERS OF THE REGISTRANT. 64
ITEM 11. EXECUTIVE COMPENSATION.... 64
ITEM 12. SECURITY OWNERSHIP OF
CERTAIN BENEFICIAL OWNERS
AND MANAGEMENT............ 64
ITEM 13. CERTAIN RELATIONSHIPS AND
RELATED TRANSACTIONS...... 64
PART IV
ITEM 14. EXHIBITS, FINANCIAL
STATEMENT SCHEDULES, AND
REPORTS ON FORM 8-K....... 65
* 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, 1998, Cullen/Frost's principal assets consisted of
all of the capital stock of two national banks. Including the acquisition of
Keller State Bank, completed in the first quarter of 1999, Cullen/Frost had 79
financial centers across Texas with 19 locations in the San Antonio area, 22 in
the Houston/Galveston area, 17 in the Fort Worth/Dallas 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, 1998, Cullen/Frost had consolidated total assets
of $6.9 billion and total deposits of $5.8 billion. Based on information from
the Federal Reserve Board, at September 30, 1998, Cullen/Frost was the largest
of the 106 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, 1998, Frost Bank, which accounted for approximately 98 percent of
consolidated assets, loans and deposits of Cullen/Frost, was the largest bank
headquartered in San Antonio and South Texas. The Corporation's other subsidiary
bank is United States National Bank of Galveston which had $151 million in
assets at December 31, 1998.
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 22 and 29 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, 1998, trust assets with a market value of
approximately $11.7 billion were being administered by the subsidiary banks.
These assets were comprised of discretionary assets of $5.4 billion and
non-discretionary assets of $6.3 billion.
CORRESPONDENT BANKING
Frost Bank acts as correspondent for approximately 333 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.
INSURANCE
Frost Insurance Agency, Inc., a wholly-owned subsidiary of The Frost
National Bank, will offer corporate and personal property and casualty insurance
as well as group health and life insurance products to individuals and
businesses. Frost Insurance Agency, Inc. generated no income during 1998.
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
4
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.
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.
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 $53.3
million available for the payment of dividends, without prior regulatory
approval, at December 31, 1998.
CAPITAL ADEQUACY
Bank regulators have adopted risk-based capital guidelines for bank holding
companies and banks. The minimum ratio of qualifying total capital to
risk-weighted assets (including certain off-balance sheet items) is eight
percent. At least half of the total capital is to be comprised of common stock,
retained earnings, perpetual preferred stocks, minority interests and for bank
holding companies, a limited amount of qualifying cumulative perpetual preferred
stock, less certain intangibles including goodwill ("Tier 1 capital"). The
remainder ("Tier 2 capital") may consist of other preferred stock, certain
other instruments, and limited amounts of subordinated debt and the allowance
for loan and lease losses.
5
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 at least 4 percent plus an
additional cushion where warranted. The guidelines also provide that banking
organizations experiencing internal growth or making acquisitions will be
expected to maintain strong capital positions substantially above the minimum
supervisory levels, without significant reliance on intangible assets.
Furthermore, the guidelines indicate that the Federal Reserve Board will
continue to consider a "Tangible Tier 1 Leverage Ratio" in evaluating
proposals for expansion or new activities. The Tangible Tier 1 Leverage Ratio is
the ratio of Tier 1 capital, less intangibles not deducted from Tier 1 capital,
to average total assets. The bank regulators have not advised Cullen/Frost or
any bank subsidiary of any specific minimum leverage ratio applicable to it. For
information concerning Cullen/Frost's capital ratios, see the discussion under
the caption "Capital" on page 30 and Note L "Capital" on page 46.
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, 1998, 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 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,"
6
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.
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.
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.
7
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; however in the
second quarter of 1998, the OCC approved a series of merger transactions
requested by a non-Texas based institution that ultimately resulted in the
merger of its Texas based bank into the non-Texas based institution. Although
challenged in the courts, the final legal ruling allowed the merger to proceed.
In addition, on May 13, 1998, the Texas Banking Commissioner began accepting
applications filed by state banks to engage in interstate mergers and branching.
REGULATORY ECONOMIC POLICIES
The earnings of the subsidiary banks are affected not only by general
economic conditions but also by the policies of various governmental regulatory
authorities. The Federal Reserve Board regulates the supply of credit in order
to influence general economic conditions, primarily through open market
operations in United States government obligations, varying the discount rate on
financial institution borrowings, varying reserve requirements against financial
institution deposits and restricting certain borrowings by such financial
institutions and their subsidiaries. The deregulation of interest rates has had
and is expected to continue to have an impact on the competitive environment in
which the subsidiary banks operate.
Governmental policies have had a significant effect on the operating
results of commercial banks in the past and are expected to continue to do so in
the future. However, Cullen/Frost cannot accurately predict the nature or extent
of any effect such policies may have on its future business and earnings.
EMPLOYEES
At December 31, 1998, Cullen/Frost employed 3,095 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 1998 of Cullen/Frost are as follows:
AGE AS OF
NAME AND POSITIONS OR OFFICES 12/31/98 RECENT BUSINESS EXPERIENCE
- ------------------------------------- --------- ------------------------------------------------------
T.C. Frost 71 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. 52 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 38 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 44 Officer of Frost Bank since July 1980. Vice President
Senior 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 October 1995 to July 1998. Senior
Executive Vice President and Chief Financial Officer
from July 1998 to present.
Diane Jack, age 50, 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.
9
ITEM 2. PROPERTIES
The executive offices of Cullen/Frost, as well as the principal banking
quarters of Frost Bank, are housed in both a 21-story office tower and a
nine-story office building located on approximately 3.5 acres of land in
downtown San Antonio. Cullen/Frost and Frost Bank lease approximately 50 percent
of the office tower. The nine-story office building was purchased in April 1994.
Frost Bank also leases space in a seven-story parking garage adjacent to the
banking quarters. In June 1987, Frost Bank consummated the sale of its office
tower and leased back a portion of the premises under a 13-year primary lease
term with options allowing for occupancy up to 50 years. The Bank also sold its
related parking garage facility and leased back space in that structure under a
12-year primary lease term with options allowing for occupancy up to 50 years.
Both leases allow for purchase of the related asset under specific terms.
The subsidiary bank located in Galveston is housed in facilities which,
together with tracts of adjacent land used for parking and drive-in facilities,
are either owned or leased by the subsidiary bank.
ITEM 3. LEGAL PROCEEDINGS
Certain subsidiaries of Cullen/Frost are defendants in various matters of
litigation which have arisen in the normal course of conducting a commercial
banking business. In the opinion of management, the disposition of such pending
litigation will not have a material effect on Cullen/Frost's consolidated
financial position.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None.
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, 1998 are as
reported by the NYSE. For the period January 1, 1997 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.
1998 1997
-------------------- --------------------
MARKET PRICE (per share) HIGH LOW High Low
- ----------------------------------------------------------------------------
First Quarter................... $ 61.19 $ 50.75 $ 38.63 $ 32.63
Second Quarter.................. 60.69 49.50 43.25 33.75
Third Quarter................... 58.00 40.88 48.00 40.38
Fourth Quarter.................. 56.94 43.63 62.75 47.44
The number of record holders of common stock at February 19, 1999 was 2,647.
CASH DIVIDENDS (per share) 1998 1997
- -----------------------------------------------------------
First Quarter........................ $ .25 $ .21
Second Quarter....................... .30 .25
Third Quarter........................ .30 .25
Fourth Quarter....................... .30 .25
--------------------
Total........................... $ 1.15 $ .96
====================
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 30 in Item 7 for
further discussion and Note K "Dividends" on page 46.
10
ITEM 6. SELECTED FINANCIAL DATA
CONSOLIDATED STATEMENTS OF OPERATIONS
(dollars in thousands, except per share amounts)
Year Ended December 31
----------------------------------------------------------------
1998 1997 1996 1995 1994 1993
- -------------------------------------------------------------------------------------------------------
INTEREST INCOME:
Loans, including fees............ $ 300,721 $ 261,607 $ 219,279 $ 180,696 $ 125,571 $ 104,391
Securities....................... 120,259 110,070 112,921 109,593 104,986 103,600
Federal funds sold and securities
purchased
under resale agreements........ 7,111 12,423 7,506 7,154 4,337 8,157
----------------------------------------------------------------
TOTAL INTEREST INCOME....... 428,091 384,100 339,706 297,443 234,894 216,148
INTEREST EXPENSE:
Deposits......................... 138,283 131,140 117,179 100,785 69,154 64,457
Federal funds purchased and
securities sold
under repurchase agreements.... 11,606 8,739 9,773 15,347 8,336 5,284
Guaranteed preferred beneficial
interests in the
Corporation's junior
subordinated deferrable
interest debentures............ 8,475 7,652
Long-term notes payable.......... 380
Other borrowings................. 1,754 1,434 1,037 739 8 47
----------------------------------------------------------------
TOTAL INTEREST EXPENSE...... 160,118 148,965 127,989 116,871 77,498 70,168
----------------------------------------------------------------
NET INTEREST INCOME......... 267,973 235,135 211,717 180,572 157,396 145,980
Provision (credit) for possible loan
losses............................. 10,393 9,174 8,494 7,605 473 (5,851)
----------------------------------------------------------------
NET INTEREST INCOME AFTER
PROVISION (CREDIT) FOR
POSSIBLE LOAN LOSSES...... 257,580 225,961 203,223 172,967 156,923 151,831
NON-INTEREST INCOME:
Trust fees....................... 46,863 43,275 36,898 34,342 31,767 28,149
Service charges on deposit
accounts....................... 53,601 47,627 41,570 33,364 30,848 30,326
Other service charges, collection
and exchange charges, commissions
and fees....................... 15,482 11,349 9,199 11,456 9,668 7,972
Net gain (loss) on securities
transactions................... 359 498 (892) (1,382) (4,767) 1,503
Other............................ 22,361 18,953 17,403 18,241 15,628 14,273
----------------------------------------------------------------
TOTAL NON-INTEREST INCOME... 138,666 121,702 104,178 96,021 83,144 82,223
NON-INTEREST EXPENSE:
Salaries and wages............... 111,423 98,874 85,646 70,104 62,412 60,672
Pension and other employee
benefits....................... 21,295 19,874 18,224 13,313 11,720 13,417
Net occupancy of banking
premises....................... 25,486 22,812 21,486 20,238 17,779 22,109
Furniture and equipment.......... 18,921 16,147 14,697 13,276 12,631 11,467
Merger related charges........... 12,244
Restructuring costs.............. 400 830 10,285
Intangible amortization.......... 13,293 11,920 11,306 8,124 7,627 6,877
Other............................ 75,844 65,514 58,695 61,933 63,189 63,268
----------------------------------------------------------------
TOTAL NON-INTEREST
EXPENSE................... 278,506 235,141 210,054 187,388 176,188 188,095
----------------------------------------------------------------
INCOME BEFORE INCOME TAXES
AND
CUMULATIVE EFFECT OF
ACCOUNTING CHANGE......... 117,740 112,522 97,347 81,600 63,879 45,959
Income taxes......................... 42,095 39,555 34,409 28,213 22,100 1,788
----------------------------------------------------------------
Income before cumulative effect of
accounting change.................. 75,645 72,967 62,938 53,387 41,779 44,171
Cumulative effect of change in
accounting for income taxes........ 8,439
----------------------------------------------------------------
NET INCOME.................. $ 75,645 $ 72,967 $ 62,938 $ 53,387 $ 41,779 $ 52,610
================================================================
Net income per common share:
Basic............................ $ 2.85 $ 2.75 $ 2.37 $ 2.01 $ 1.58 $ 2.02
Diluted.......................... 2.77 2.67 2.31 1.98 1.56 1.98
Return on Average Assets............. 1.18% 1.28% 1.23% 1.20% 1.02% 1.33%
Return on Average Equity............. 15.44 16.38 15.63 14.84 13.17 19.16
Historical amounts have been restated to reflect the merger with Overton
Bancshares, Inc.
11
SELECTED FINANCIAL DATA
(dollars in thousands, except per share amounts)
Year Ended December 31
----------------------------------------------------------------------------
1998 1997 1996 1995 1994 1993
----------------------------------------------------------------------------
BALANCE SHEET DATA
Total assets..................... $ 6,869,605 $ 6,045,573 $ 5,599,248 $ 4,774,750 $ 4,260,076 $ 4,072,763
Guaranteed preferred beneficial
interest in the Corporation's
junior subordinated deferrable
interest debentures, net....... 98,458 98,403
Shareholders' equity............. 512,919 462,929 424,786 382,003 326,569 301,594
Average shareholders' equity to
average total assets........... 7.63% 7.83% 7.87% 8.10% 7.76% 6.96%
Tier 1 risk based capital
ratio.......................... 12.23 13.21 11.39 12.73 14.17 14.13
Total risk based capital ratio... 13.48 14.46 12.64 13.98 15.42 15.38
PER COMMON SHARE DATA
Net income-basic................. $ 2.85** $ 2.75 $ 2.37 $ 2.01 $ 1.58 $ 2.02*
Net income-diluted............... 2.77** 2.67 2.31 1.98 1.56 1.98*
Cash dividends paid-CFR.......... 1.15 .96 .81 .57 .34 .08
Shareholders' equity............. 19.20 17.49 15.92 14.35 12.34 11.50
LOAN PERFORMANCE INDICATORS
Non-performing assets............ $ 17,104 $ 18,088 $ 14,069 $ 18,681 $ 22,114 $ 33,834
Non-performing assets to:
Total loans plus foreclosed
assets.................... .47% .58% .53% .87% 1.27% 2.36%
Total assets................ .25 .30 .25 .39 .52 .83
Allowance for possible loan
losses......................... $ 53,616 $ 48,073 $ 42,821 $ 36,525 $ 29,017 $ 29,073
Allowance for possible loan
losses
to period-end loans............ 1.47% 1.54% 1.60% 1.71% 1.67% 2.04%
Net loan charge-offs
(recoveries)................... $ 6,100 $ 6,027 $ 2,825 $ 527 $ (1,894) $ (469)
Net loan charge-offs (recoveries)
to
average loans.................. .18% .21% .12% .03% (.12)% (.04)%
COMMON STOCK DATA
Common shares outstanding at
period end..................... 26,713 26,470 26,682 26,612 26,459 26,221
Weighted average common shares... 26,575 26,499 26,597 26,522 26,329 26,045
Dilutive effect of stock
options........................ 765 876 629 473 433 560
Dividends as a percentage of net
income***...................... 35.79% 30.50% 29.80% 24.47% 18.29% 3.35%
NON-FINANCIAL DATA
Number of employees.............. 3,095 3,045 2,743 2,399 2,198 2,137
Shareholders of record........... 2,624 2,358 2,336 2,463 2,553 2,644
*1993 basic and diluted earnings per share before cumulative effect of an
accounting change were $1.70 and $1.66, respectively.
**1998 basic and diluted earnings per share before the after-tax merger related
charge were $3.20 and $3.11, respectively.
***Includes dividends paid by Overton and excludes the after-tax impact of the
$12.2 million merger related charge in 1998.
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 1996
through 1998. During the second quarter of 1998, the Corporation completed the
merger with Overton Bancshares, Inc., as discussed below. The merger was
accounted for as a "pooling of interests" transaction and as such, historical
amounts have been restated to reflect the merger. In addition, as described
below, the Corporation completed acquisitions during the first quarter of 1998
and 1997 and two during the first quarter of 1996. These acquisitions were all
accounted for as purchase transactions and as such their results of operations
are included from the date of acquisition.
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.
MERGER AND ACQUISITIONS
On May 29, 1998, the Corporation completed the merger of Overton
Bancshares, Inc., ("Overton") in Fort Worth, Texas, and its wholly-owned
subsidiary Overton Bank & Trust, N.A. The merger was the Corporation's first
entry into the Fort Worth market. With the merger, the Corporation had twelve
locations in Fort Worth/Arlington and two in Dallas. The Corporation issued
approximately 4.38 million common shares as part of this transaction. As a
result of the transaction, the Corporation recorded a merger related charge of
$12.2 million primarily consisting of severance payments and other employee
benefits, and investment banking fees. In addition, shortly after the merger was
consummated the Corporation reclassified approximately $116 million of held to
maturity securities of Overton to available for sale securities.
On January 2, 1998, the Corporation paid approximately $55.3 million to
acquire Harrisburg Bancshares, Inc., including its subsidiary Harrisburg Bank in
Houston, Texas. The Corporation acquired loans of approximately $125 million and
deposits of approximately $222 million. Total intangibles associated with the
acquisition amounted to approximately $34.2 million. This acquisition did not
have a material impact on the Corporation's 1998 net income.
On March 7, 1997, the Corporation paid approximately $32.2 million to
acquire Corpus Christi Bancshares, Inc., including its subsidiary Citizens State
Bank, based in Corpus Christi, Texas. 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.
RESULTS OF OPERATIONS
For the year ended December 31, 1998, the Corporation reported net income
of $75.6 million or $2.77 per diluted common share, an all-time high. Operating
earnings for the year ended December 31, 1998 were $85.2 million or $3.11 per
diluted common share. Operating earnings exclude the after-tax impact of the
merger related charge of $12.2 million associated with the merger of Overton.
Net income for 1997 was $73.0 million or $2.67 per diluted common share,
compared with $62.9 million or $2.31 per diluted
13
common share for 1996. The Corporation's return on average assets for 1998 was
1.18 percent compared with 1.28 percent in 1997 and 1.23 percent in 1996, while
return on average equity was 15.44 percent in 1998 compared with 16.38 percent
in 1997 and 15.63 percent in 1996. Operating return on average assets and
average equity for 1998 were 1.33 percent and 17.38 percent, respectively.
1998 Change 1997 Change
EARNINGS SUMMARY 1998 From 1997 1997 From 1996 1996
- -----------------------------------------------------------------------------------------------------------
Taxable-equivalent net interest
income............................. $ 270,772 $33,687 $ 237,085 $ 24,096 $ 212,989
Taxable-equivalent adjustment........ 2,799 849 1,950 678 1,272
--------------------------------------------------------------------
Net interest income.................. 267,973 32,838 235,135 23,418 211,717
Provision for possible loan losses... 10,393 1,219 9,174 680 8,494
Non-interest income:
Net gain (loss) on securities
transactions.................. 359 (139) 498 1,390 (892)
Other........................... 138,307 17,103 121,204 16,134 105,070
--------------------------------------------------------------------
Total non-interest
income.................. 138,666 16,964 121,702 17,524 104,178
Non-interest expense:
Intangible amortization......... 13,293 1,373 11,920 614 11,306
Merger related charge........... 12,244 12,244
Other operating expenses........ 252,969 29,748 223,221 24,473 198,748
--------------------------------------------------------------------
Total non-interest
expense................. 278,506 43,365 235,141 25,087 210,054
--------------------------------------------------------------------
Income before income taxes........... 117,740 5,218 112,522 15,175 97,347
Income taxes......................... 42,095 2,540 39,555 5,146 34,409
--------------------------------------------------------------------
Net income........................... $ 75,645 $ 2,678 $ 72,967 $ 10,029 $ 62,938
====================================================================
Per common share:
Net income-basic................ $ 2.85* $ .10 $ 2.75 $ .38 $ 2.37
Net income-diluted.............. 2.77* .10 2.67 .36 2.31
Return on Average Assets............. 1.18%* (.10)% 1.28% .05% 1.23%
Return on Average Equity............. 15.44* (.94) 16.38 .75 15.63
* Operating basic and diluted earnings per share for 1998 were $3.20 and $3.11,
respectively. Operating ROA and ROE for 1998 were 1.33 percent and 17.38
percent, respectively.
RESULTS OF SEGMENT OPERATIONS
The Corporation's operations are managed along two major Operating
Segments: Banking and the Financial Management Group. A description of each
business and the methodologies used to measure financial performance are
described in Note V to the Consolidated Financial Statements on page 57. The
following table summarizes operating earnings and net income by Operating
Segment for each of the last three years:
YEAR ENDED DECEMBER 31
-------------------------------
(dollars in thousands) 1998 1997 1996
- ----------------------------------------------------------------------
Banking.............................. $ 78,826 $ 68,312 $ 57,801
Financial Management Group........... 14,497 12,878 9,244
Non-Banks............................ (8,167) (8,223) (4,107)
-------------------------------
Consolidated operating earnings...... $ 85,156* $ 72,967 62,938
Consolidated net income.............. $ 75,645 $ 72,967 $ 62,938
===============================
* Excludes the after-tax impact of the $12.2 million Overton merger related
charge. See discussion on page 13.
The increase in Banking net income in both 1998 and 1997 was due primarily
to loan growth and higher service charge income coupled with the impact of the
acquisitions of Corpus Christi Bancshares, Inc. and Harrisburg Bancshares, Inc.
14
The increase in the Financial Management Group net income in both years was
due mainly to the appreciation in market value of Trust assets, new accounts and
the acquisition of Corpus Christi Bancshares, Inc.
The increase in the operating loss in Non-Banks during 1997 reflects
partially increased funding costs due to the issuance of the Trust Preferred
Capital Securities.
NET INTEREST INCOME
Net interest income on a taxable equivalent basis for 1998 was $270.8
million, an increase from $237.1 million recorded in 1997 and the $213.0 million
recorded in 1996. The primary reason for the yearly increase has been the
consistent growth in loans generated both internally and through acquisitions.
See "Consolidated Average Balance Sheets" on pages 60 and 61 and "Rate Volume
Analysis" on page 62. The net interest margin, was 4.93 percent for the year
ended December 31, 1998, compared to 4.87 percent and 4.91 percent for the years
1997 and 1996, respectively. The increase in the net interest margin from a year
ago is due to higher loan volumes and lower deposit costs. The slight decrease
in the net interest margin in 1997 from 1996 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 44. Net
interest spread for 1998 increased five basis points to 4.04 percent. The
increase in net interest spread for 1998 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. Net
interest spread was 3.99 percent and 4.10 percent for 1997 and 1996,
respectively. The decrease in net interest spread for 1997 is largely the result
of the issuance of the $100 million Trust Preferred Capital Securities.
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.
MARKET RISK DISCLOSURE -- INTEREST RATE SENSITIVITY
Market risk is the potential loss arising from adverse changes in the fair
value of a financial instrument due to the changes in market rates and prices.
In the ordinary course of business, the Corporation's market risk is primarily
that of interest rate risk. The Corporation's interest rate sensitivity and
liquidity are monitored by its Asset/Liability Management Committee on an
ongoing basis. The Committee seeks to avoid fluctuating net interest margins and
to maintain consistent growth of net interest income through periods of changing
interest rates. A variety of measures are used to provide for a comprehensive
view of the magnitude of interest rate risk, the distribution of risk, level of
risk over time and exposure to changes in certain interest rate relationships.
The Corporation utilizes an earnings simulation model as the primary
quantitative tool in measuring the amount of interest rate risk associated with
changing market rates. The model quantifies the effects of various interest rate
scenarios on the projected net interest income and net income over the ensuing
12 month period. The model was used to measure the impact on net interest income
relative to a base case scenario, of rates increasing or decreasing ratably 200
basis points over the next 12 months. These simulations incorporate assumptions
regarding balance sheet growth and mix, pricing and the repricing and maturity
characteristics of the existing and projected balance sheet. All off-balance
sheet financial instruments such as derivatives are included in the model. Other
interest rate-related risks such as prepayment, basis and option risk are also
considered. The resulting model simulations show that a 200 basis point increase
in rates will result in a positive variance in net interest income of 0.7
percent relative to the base case over the next 12 months, while a decrease of
200 basis points will result in a negative variance in net interest income of
0.7 percent. This compares to last year when a 200 basis points increase in
rates resulted 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 resulted in a negative variance in net interest income of 1.7 percent.
The Corporation's trading portfolio is immaterial and as such separate
quantitative disclosure is not presented.
15
As the table below indicates, the Corporation is liability-sensitive, on a
cumulative basis, at time periods of one year or less (assuming non-maturity
deposits are immediately rate sensitive). This gap analysis is based on a point
in time and may not be meaningful because assets and liabilities must be
categorized according to contractual maturities and repricing periods rather
than estimating more realistic behaviors as is done in the sensitivity model
discussed above. Also, the gap analysis does not consider subsequent changes in
interest rate levels or spreads between asset and liability categories.
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. In order to meet this objective, the Corporation may lengthen
or shorten the duration of assets or liabilities or enter into derivative
contracts to mitigate potential market risk.
December 31, 1998
-------------------------------------------------------------------------------
Non-Rate
Immediately Sensitive
Rate Sensitive Rate Sensitive Within ----------
CUMULATIVE INTEREST RATE SENSITIVITY --------------- ---------------------------------- > Five
(PERIOD-END BALANCE) 0-30 Days 90 Days One Year Five Years Years Total
- -------------------------------------------------------------------------------------------------------------------------
Earning Assets:
Loans............................... $ 1,831,516 $2,030,435 $2,572,529 $3,358,681 $ 287,922 $ 3,646,603
Securities.......................... 184,938 406,592 933,595 1,550,298 541,405 2,091,703
Federal funds....................... 102,900 102,900 102,900 102,900 102,900
-------------------------------------------------------------------------------
Total earning assets........... $ 2,119,354 $2,539,927 $3,609,024 $5,011,879 $ 829,327 $ 5,841,206
===============================================================================
Interest-Bearing Liabilities:
Savings and Interest-on-Checking.... $ 961,597 $ 961,597 $ 961,597 $ 961,597 $ 961,597
Money market deposit accounts....... 1,493,778 1,493,778 1,493,778 1,493,778 1,493,778
Certificates of deposit and other
time accounts..................... 272,005 646,548 1,295,565 1,375,498 $171,115 1,546,613
Federal funds purchased and other
borrowings........................ 318,859 318,859 318,859 318,859 98,458 417,317
-------------------------------------------------------------------------------
Total interest-bearing
liabilities.................. $ 3,046,239 $3,420,782 $4,069,799 $4,149,732 $ 269,573 $ 4,419,305
===============================================================================
Interest sensitivity gap................ $ (926,885) $ (880,855) $ (460,775) $ 862,147 $ 559,754 $ 1,421,901
===============================================================================
Ratio of earning assets to
interest-bearing liabilities.......... .70 .74 .89 1.21
====================================================
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 $3,357,000. 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 further discussed on page
27.
LIQUIDITY
Asset liquidity is provided by cash and assets which are readily marketable
or pledgeable or which will mature in the near future. Liquid assets include
cash, short-term time deposits in banks, securities available for sale,
maturities and cash flow from securities held to maturity, and Federal funds
sold and securities purchased under resale agreements.
Liability liquidity is provided by access to funding sources which include
core depositors and correspondent banks in 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. The liquidity position of the
Corporation is continuously monitored and adjustments are made to the balance
between sources and uses of funds as deemed appropriate.
16
NON-INTEREST INCOME
Non-interest income of $138.7 million was reported for 1998, compared with
$121.7 million for 1997 and $104.2 million for 1996. Excluding securities
transactions, total non-interest income increased 14.1 percent from 1997. The
non-interest income growth in 1998 and 1997 was favorably impacted by the
acquisitions of Harrisburg Bancshares, Inc. and Corpus Christi Bancshares, Inc.
in the first quarter of 1998 and 1997, respectively.
Year Ended December 31
----------------------------------------------------------------------
1998 1997 1996
-------------------- -------------------- --------------------
PERCENT Percent Percent
NON-INTEREST INCOME AMOUNT CHANGE Amount Change Amount Change
- -------------------------------------------------------------------------------------------------------------
Trust fees........................... $ 46,863 + 8.3% $ 43,275 + 17.3% $ 36,898 + 7.4%
Service charges on deposit
accounts........................... 53,601 + 12.5 47,627 + 14.6 41,570 + 24.6
Other service charges, collection and
exchange charges, commissions and
fees............................... 15,482 + 36.4 11,349 + 23.4 9,199 - 19.7
Net gain (loss) on securities
transactions....................... 359 - 27.9 498 N/M (892) + 35.5
Other................................ 22,361 + 18.0 18,953 + 8.9 17,403 - 4.6
-------- -------- --------
Total........................... $138,666 + 13.9 $121,702 + 16.8 $104,178 + 8.5
======== ======== ========
Trust income was up $3.6 million or 8.3 percent during 1998. Trust fees
increased during 1998 as the market value of trust assets continued to grow
impacted by the market and the addition of new accounts. The volatility of
general market conditions experienced throughout 1998 did have some impact on
the overall level of growth in trust fees; however, some of the growth
experienced in other service charges and other non-interest income is
attributable to fees collected through financial management services, such as
mutual fund fees, brokerage commissions and annuity income. The market value of
trust assets increased to $11.7 billion from $10.8 billion last year. The
December 31, 1998 trust assets were comprised of discretionary assets of $5.4
billion and non-discretionary assets of $6.3 billion compared to $5.5 billion
and $5.3 billion last year, respectively. The $6.4 million or 17.3 percent
increase in trust income from 1996 to 1997 is attributable to the increase in
the number of accounts held and trust asset growth resulting from improvement in
the stock and bond market.
Deposit service charges increased $6.0 million or 12.5 percent from 1997.
The increase occurred as the result of some fee increases and broad based
deposit growth that generated increases in overdraft charges, cash management
fees on commercial and individual deposits, as well as increases in ATM income.
Deposit service charges increased $6.1 million or 14.6 percent from 1996. The
increase was due mainly to higher service charges related to commercial
deposits, volumes processed for correspondent banks and overdraft charges. Other
service charges and fees increased $4.1 million or 36.4 percent when compared to
1997. This increase was primarily due to higher fees in accounts receivable
factoring and mutual fund fees collected through financial management services.
The $2.2 million or 23.4 percent increase in other service charges from 1996 to
1997 was primarily due to the same factors mentioned above for the growth in
1998 offset by lower bankcard discounts resulting from the Corporation's
outsourcing of its bankcard processing operation which was completed in May
1996.
During 1998 and 1997, the Corporation sold portions of its available for
sale investment portfolio resulting in net gains of $359,000 and $498,000,
respectively. This compares to an $892,000 loss in 1996 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.
Other non-interest income increased $3.4 million or 18.0 percent to $22.4
million in 1998 compared to an 8.9 percent increase in 1997. The increase in
1998 is primarily due to growth in VISA check card income, gains on the sale of
student and mortgage loans and gains on the disposition of foreclosed assets.
17
The increase in 1997 from 1996 was primarily due to gains recorded on the sale
of student loans, mineral interest income and VISA check card income. These
increases were offset by higher gains on the disposition of certain loans and
foreclosed assets recorded by the Corporation in 1996.
NON-INTEREST EXPENSE
Excluding the merger-related charge of $12.2 million during the second
quarter of 1998 which was associated with the merger of Overton, non-interest
expense was $266.3 million for 1998 compared with $235.1 million for 1997 and
$210.1 million for 1996. The acquisitions of Harrisburg Bancshares, Inc. and
Corpus Christi Bancshares, Inc. in the first quarter of 1998 and 1997,
respectively, impacted the growth in non-interest expense.
Year Ended December 31
--------------------------------------------------------------------
1998 1997 1996
-------------------- -------------------- --------------------
PERCENT Percent Percent
NON-INTEREST EXPENSE AMOUNT CHANGE Amount Change Amount Change
- ------------------------------------------------------------------------------------------------------------
Salaries and wages................... $111,423 +12.7% $ 98,874 +15.4% $ 85,646 +22.2%
Pension and other employee
benefits........................... 21,295 + 7.2 19,874 + 9.1 18,224 +36.9
Net occupancy of banking premises.... 25,486 +11.7 22,812 + 6.2 21,486 + 6.2
Furniture and equipment.............. 18,921 +17.2 16,147 + 9.9 14,697 +10.7
Intangible amortization.............. 13,293 +11.5 11,920 + 5.4 11,306 +39.2
Merger related charge................ 12,244
Other................................ 75,844 +15.8 65,514 +11.6 58,695 - 5.8
-------- -------- --------
Total........................... $278,506 +18.4 $235,141 +11.9 $210,054 +12.1
======== ======== ========
Salaries and wages increased by $12.5 million in 1998 and $13.2 million in
1997 or 12.7 percent and 15.4 percent, respectively. Salaries and wages in both
years have experienced increases related to acquisitions and merit increases.
Pension and other employee benefits increased by $1.4 million or 7.2 percent
during 1998 as a result of retirement plan expense and the impact of the
acquisition on payroll taxes and medical insurance. The $1.7 million or 9.1
percent increase in pension and other employee benefits from 1996 to 1997 was
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.
Net occupancy of banking premises increased $2.7 million or 11.7 percent
during 1998 primarily attributable to higher property taxes, depreciation and
lease expense as influenced by the acquisition and de novo branches opened late
in 1997 and 1998. The 6.2 percent increase in 1997 compared to 1996 was higher
building maintenance costs, property taxes and operating expenses, partially
offset by higher tenant income. Furniture and equipment costs increased $2.8
million or 17.2 percent in 1998 primarily due to the continued expansion of the
Corporation, as well as, technology initiatives and upgrades. Intangible
amortization increased by $1.4 million or 11.5 percent and by $614,000 or 5.4
percent in 1998 and 1997, respectively, due to the acquisitions.
Also included in 1998 was a $12.2 million merger related charge associated
with the merger of Overton. Of the $12.2 million charge, the majority was
related to severance payments and other employee benefits, and investment
banking fees.
Other non-interest expense increased $10.3 million or 15.8 percent during
1998 as a result of outside computer services related to the Year 2000
compliance program, see "Year 2000" on page 19, as well as, an increase in the
volume of VISA check cards issued after its initial introduction in late 1997.
Other non-interest expense was up 11.6 percent in 1997 mostly due to expenses
related to the Year 2000 compliance program and higher operating expenses, such
as, sales promotion, guard services, supplies, travel and telephone, which also
were impacted by the acquisitions.
18
YEAR 2000
The Corporation has an extensive program in place to address the internal
and external risks associated with the century date change to the Year 2000.
Currently, the Corporation estimates that the dollar amount to be spent on
incremental costs will be approximately $4.6 million over the three year period
beginning in 1997, funded out of its earnings, with approximately $3.6 million
spent through 1998. These costs are being expensed as incurred. Additionally,
the Corporation is spending about 30 percent of its annual technology budget to
facilitate progress on the Year 2000 program. The cost of compliance and
completion dates is based upon management's best estimates, which were derived
utilizing assumptions of future events, including the continued availability of
resources.
The Corporation has systematically inventoried and assessed the importance
of application software and system hardware and software during the now
completed awareness and assessment phase of its information technology. The
Corporation has also completed the renovation of mission critical systems and
has implemented 99 percent of the renovated mission critical systems. The
Corporation has completed the renovation, testing and installation of 99 percent
of technology systems in its owned facilities, including vault doors, elevators,
climate control systems, and security systems. In addition, the Corporation has
completed 98 percent of the testing of mission critical systems. The Corporation
expects to be completed with the non-mission critical applications by the second
quarter of 1999. The Corporation has commenced, and will continue into 1999,
integration testing to assure that logically related systems can interact and
process information correctly.
During 1998, the Corporation reviewed the Year 2000 preparedness of its
vendors and suppliers, and recently completed on-site due diligence visits with
key service providers. The great majority of these suppliers appear to be making
adequate progress. The Corporation will continue to monitor vendor and supplier
progress and develop contingency plans where necessary and feasible. The
Corporation is testing for key dates in the new century with critical third
party service providers, although it may be necessary to rely on proxy testing
in some cases. The majority of this work is expected to be done in the first
half of 1999. The Corporation will make available testing documentation, known
as proxy tests, to clients utilizing certain products and services. The
Corporation also relies on entities such as the Federal Reserve System,
Depository Trust Company, Participants Trust Company, Society for Worldwide
Interbank Financial Telecommunications (SWIFT), and the Clearing House Interbank
Payment Systems (CHIPS) in its securities processing and banking businesses, as
do other financial services providers in similar businesses. Testing of data
exchanges with organizations such as these is underway and is expected to be
completed during by the second quarter of 1999.
Although the Corporation is attempting to monitor and validate the efforts
of other parties, it cannot control the success of these efforts. The
Corporation is developing contingency plans where practical to provide
alternatives in situations where a third party furnishing a critical product or
service experiences significant Year 2000 issues. The Corporation is also
updating existing business continuity plans for the date change. This process is
well underway and will continue through the third quarter, 1999, as plans are
reviewed and validated.
As part of its credit analysis process, the Corporation has developed a
project plan for assessing the Year 2000 readiness of its significant credit
customers. An initial assessment of Year 2000 readiness has been completed for
the customers who have responded to the Corporation's inquiries about their
progress, which make up the majority of its credit customers and represent most
of its credit exposure. The Corporation will continue to monitor the progress of
these customers.
The Financial Management Group's (FMG) mission critical systems, such as
the trust and brokerage accounting and trading systems, are and have been
included in the Corporation's evaluation and testing of systems. FMG is also
updating current contingency plans to include possible Year 2000 circumstances.
In addition to the systems aspect, the FMG recognizes that there could be other
types of risks and is in the process of reviewing the managed assets comprising
the investment portfolios of FMG clients. The review process includes obtaining
public information provided by companies/issuers to regulatory bodies, such as
19
the Securities and Exchange Commission. Other public information that may be
relied upon for evaluating a company's/issuer's Year 2000 readiness are
analysts' reports and/or official statements from companies/issuers.
Although the FMG is attempting to review and monitor the efforts of other
parties, it cannot warrant the facts, circumstances, or the outcome of such
efforts. Where the Corporation does not serve in a fiduciary capacity for a
customer's assets it cannot provide any assurances on factors outside its
control such as the quality of assets, potential economic uncertainties and
other service providers. The Corporation also does not accept responsibility for
ensuring that its clients' own systems are Year 2000 compliant. In addition, the
Corporation does not guarantee that there will not be any disruptions on receipt
or disbursements of income. There may be disruptions that are beyond the control
of the Corporation. An example of this would be if an issuer/company or its
paying agent does not pay income as scheduled.
The Corporation's program is regularly reviewed by examiners from various
external agencies such as the Comptroller of the Currency and the Federal
Reserve Bank.
The Corporation expects to successfully complete its Year 2000 effort as
planned. However, it is subject to unique risks and uncertainties due to the
interdependencies in business and financial markets, and the numerous activities
and events outside of its control. Since the Corporation is still conducting
external testing and monitoring of third parties, it is unable to make
definitive assumptions as to the extent of Year 2000 failures that could result,
nor quantify the potential adverse effect that such failures could have on the
Corporation's operations, liquidity, and financial condition. Year 2000 risks
will be continually evaluated and contingency plans revised throughout 1999.
INCOME TAXES
The Corporation recognized income tax expense of $42.1 million in 1998,
compared to $39.6 million in 1997, and $34.4 million in 1996. The effective tax
rate in 1998 was 35.75 percent compared to 35.15 percent in 1997 and 35.35
percent in 1996. For a detailed analysis of the Corporation's income taxes see
Note O "Income Taxes" on page 52.
20
CASH EARNINGS
Historically, excluding the merger with Overton, the Corporation's
acquisitions have been accounted for using the purchase method of accounting
which results in the creation of intangible assets. These intangible assets are
deducted from capital in the determination of regulatory capital. Thus, "cash"
or "tangible" earnings represents the regulatory capital generated during the
year and can be viewed as net income excluding intangible amortization, net of
tax. While the definition of "cash" or "tangible" earnings may vary by
company, we believe this definition is appropriate as it measures the per share
growth of regulatory capital, which impacts the amount available for dividends
and acquisitions. The following table reconciles reported earnings to net income
excluding intangible amortization ("cash" earnings) for each of the three most
recent year periods:
Year Ended December 31
-----------------------------------------------------------------------------------
1998 1997
-------------------------------------- -----------------------------------------
REPORTED INTANGIBLE "CASH" Reported Intangible "Cash"
EARNINGS AMORTIZATION EARNINGS Earnings Amortization Earnings
- --------------------------------------------------------------------------------------------------------------------------
Income before income taxes........... $117,740 $ 13,293 $131,033 $112,522 $ 11,920 $124,442
Income taxes......................... 42,095 3,242 45,337 39,555 3,145 42,700
-----------------------------------------------------------------------------------
Net income........................... $ 75,645 $ 10,051 $ 85,696 $ 72,967 $ 8,775 $ 81,742
===================================================================================
Net income per diluted common
share(1)............................ $ 2.77 $ .36 $ 3.13 $ 2.67 $ .32 $ 2.99
Return on assets(1).................. 1.18 % 1.34 %* 1.28 % 1.44 %*
Return on equity(1).................. 15.44 17.49 ** 16.38 18.35 **
Year Ended December 31
----------------------------------
1996
----------------------------------
Reported Intangible "Cash"
Earnings Amortization Earnings
- ------------------------------------- -----------------------------------
Income before income taxes........... $97,347 $ 11,306 $108,653
Income taxes......................... 34,409 3,267 37,676
----------------------------------
Net income........................... $62,938 $ 8,039 $ 70,977
==================================
Net income per diluted common
share(1)............................ $ 2.31 $ .30 $ 2.61
Return on assets(1).................. 1.23% 1.39 %*
Return on equity(1).................. 15.63 17.63 **
(1) 1998 diluted operating earnings per share and diluted operating cash
earnings per share were $3.11 and $3.48, respectively. Operating cash ROA
and cash ROE for 1998 were 1.48 percent and 19.43 percent, respectively.
Operating earnings exclude the after-tax impact of the $12.2 million
merger related charge associated with the merger with Overton.
* CALCULATED AS A/B
** CALCULATED AS A/C
- -------------------
1998 1997 1996
--------- --------- ---------
(A) Net income before intangible
amortization (including goodwill
and core deposit intangibles, net
of tax).......................... $ 85,696 $ 81,742 $ 70,977
(B) Total average assets............. 6,417,569 5,687,577 5,113,495
(C) Average shareholders' equity..... 489,958 445,450 402,687
SOURCES AND USES OF FUNDS
Average assets for 1998 of $6.4 billion increased by 12.8 percent from 1997
levels and increased 11.2 percent between 1996 and 1997. Funding sources in 1998
reflected an increase in demand deposits and Federal funds purchased. The
Corporation's uses of funds continued a trend which started in 1995 of replacing
securities with loans as the largest component of earning assets. This reflects
the increases in loan volumes from a year ago.
Percentage of Total Average
-------------------------------
SOURCES AND USES OF FUNDS 1998 1997 1996
- ----------------------------------------------------------------------
Sources of Funds:
Deposits:
Demand..................... 25.4% 24.3% 24.0%
Time....................... 59.7 61.4 62.2
Federal funds purchased......... 3.9 3.3 4.0
Equity capital.................. 7.6 7.8 7.9
Borrowed funds.................. 2.0 2.0 0.4
Other liabilities............... 1.4 1.2 1.5
-------------------------------
Total...................... 100.0% 100.0% 100.0%
===============================
Uses of Funds:
Loans........................... 53.5% 51.3% 47.8%
Securities...................... 30.1 30.4 34.5
Federal funds sold.............. 2.0 4.0 2.8
Non-earning assets.............. 14.4 14.3 14.9
-------------------------------
Total...................... 100.0% 100.0% 100.0%
===============================
21
LOANS
Average loans for 1998 were $3.4 billion, an increase of 17.8 percent from
1997. This increase was driven by continued improved economic conditions in the
Texas markets the Corporation serves and the 1998 acquisition.
December 31
------------------------------------------------------------------------------------
1998
---------------------------
LOAN PORTFOLIO ANALYSIS PERCENTAGE OF
(PERIOD-END BALANCES) AMOUNT TOTAL LOANS 1997 1996 1995 1994
- ---------------------------------------------------------------------------------------------------------------------------
Real estate:
Construction.................... $ 292,789 8.0% $ 179,201 $ 125,054 $ 89,704 $ 65,742
Land............................ 75,397 2.1 60,339 53,742 40,005 39,383
Permanent Mortgages:
Commercial.................... 346,479 9.5 259,320 230,205 203,659 181,898
Residential................... 655,484 18.0 516,345 472,878 375,365 305,220
Other........................... 349,255 9.6 355,475 355,712 282,467 246,922
------------------------------------------------------------------------------------
Total real estate............... 1,719,404 47.2 1,370,680 1,237,591 991,200 839,165
Commercial and
industrial......................... 1,211,180 33.2 989,355 831,841 637,714 477,082
Consumer............................. 625,018 17.1 645,988 526,778 431,223 354,907
Financial institutions............... 7,416 .2 3,767 12,749 10,409 7,173
Foreign.............................. 45,187 1.2 72,911 45,562 43,847 45,290
Other................................ 41,755 1.2 37,388 20,891 22,380 17,906
Unearned discount.................... (3,357) (.1) (3,194) (2,098) (2,063) (3,958)
------------------------------------------------------------------------------------
Total........................... $ 3,646,603 100.0% $ 3,116,895 $ 2,673,314 $ 2,134,710 $ 1,737,565
====================================================================================
Percent change from previous year.... +17.0% +16.6% +25.2% +22.9% +20.9%
Period-end loans increased to $3.6 billion at year-end 1998, up 17.0
percent from the previous year-end. Most of the increase in period-end loans is
attributable to commercial and industrial loans and residential real estate
loans which increased $222 million and $139 million, respectively. Home equity
loans accounted for approximately 59 percent of the increase in residential real
estate loans. The increase in period-end loans was offset by a $21 million
decrease in consumer loans primarily related to a reduction in indirect lending.
Approximately 76 percent of the increase in loans from a year ago resulted from
internally generated growth.
Total real estate loans at December 31, 1998 were $1.7 billion, up 25.4
percent from year-end 1997. Amortizing permanent mortgages represented 58.3
percent of the total real estate loan portfolio at year end. Residential
mortgages increased $139 million or 26.9 percent. Real estate loans categorized
as "other" are primarily amortizing commercial and industrial loans with
maturities of less than five years. Approximately 58 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 25 for
further discussion for the loan portfolio and "Loan Maturity and Sensitivity"
on page 62.
MEXICAN LOANS
At December 31, 1998, the Corporation's cross-border outstandings to
Mexico, excluding $19.8 million in loans secured by liquid U.S. assets, totaled
$25.4 million, down from $48.6 million last year. The decrease from a year ago
represents normal fluctuations in lines of credit used by Mexican banks to
finance trade. Of the trade-related credits, approximately 65 percent are
related to companies exporting from Mexico. In addition, loans insured by the
Export Import Bank were made to Mexican businesses to
22
purchase goods of the United States. At December 31, 1998, 1997 and 1996, none
of the Mexican-related loans were on non-performing status.
December 31
---------------------------------------------------------------------
1998 1997
---------------------------------------------------------------------
PERCENTAGE PERCENTAGE Percentage Percentage
OF TOTAL OF TOTAL of Total of Total
MEXICAN LOANS AMOUNT LOANS ASSETS Amount Loans Assets
- ------------------------------------------------------------------------------------------------------------
Financial institutions............... $21,346 .6% .3% $35,563 1.2% .6%
Commercial and industrial............ 4,016 .1 .1 13,034 .4 .2
---------------------------------------------------------------------
Total................................ $25,362 .7% .4% $48,597 1.6% .8%
=====================================================================
December 31
---------------------------------
1996
---------------------------------
Percentage Percentage
of Total of Total
MEXICAN LOANS Amount Loans Assets
- ------------------------------------- ---------------------------------
Financial institutions............... $24,932 .9% .4%
Commercial and industrial............ 5,000 .2 .1
----------------------------------
Total................................ $29,932 1.1% .5%
==================================
The above table excludes $19,825,000, $24,314,000 and $15,630,000 in loans
secured by liquid assets held in the United States in 1998, 1997 and 1996,
respectively.
NON-PERFORMING ASSETS
Non-performing assets were $17.1 million at December 31, 1998, compared
with $18.1 million at December 31, 1997 and $14.1 million at December 31, 1996.
Non-performing assets as a percentage of total loans and foreclosed assets were
.47 percent at December 31, 1998, down from .58 percent one year ago.
December 31
-----------------------------------------------------
NON-PERFORMING ASSETS 1998 1997 1996 1995 1994
- --------------------------------------------------------------------------------------------
Non-accrual.......................... $ 12,997 $ 13,077 $ 10,733 $ 15,372 $ 17,316
Foreclosed assets.................... 4,107 5,011 3,336 3,309 4,798
-----------------------------------------------------
Total............................ $ 17,104 $ 18,088 $ 14,069 $ 18,681 $ 22,114
=====================================================
As a percentage of total assets...... .25% .30% .25% .39% .52%
As a percentage of total loans plus
foreclosed assets.................. .47 .58 .53 .87 1.27
After-tax impact of lost interest per
common share....................... $ .04 $ .04 $ .04 $ .05 $ .06
Accruing loans 90 days past due:
Consumer........................... $ 1,347 $ 3,410 $ 1,841 $ 1,294 $ 574
All other.......................... 9,434 3,412 4,108 4,378 3,070
-----------------------------------------------------
Total............................ $ 10,781 $ 6,822 $ 5,949 $ 5,672 $ 3,644
=====================================================
The Corporation did not have any restructured loans for the years ended December
31, 1998-1994.
Interest income that would have been recorded in 1998 on non-performing assets,
had such assets performed in accordance with their original contract terms, was
$1,262,000 on non-accrual loans and $392,000 on foreclosed assets. During 1998,
the amount of interest income actually recorded on non-accrual loans was
$742,000.
There were no foreign loans 90 days past due as of December 31, 1998.
Loans to a customer whose financial condition has deteriorated are
considered for non-accrual status whether or not the loan is 90 days or more
past due. All non-consumer loans 90 days or more past due are classified as
non-accrual unless the loan is well secured and in the process of collection.
When a loan is placed on non-accrual status, interest income is not recognized
until collected, and any previously accrued but uncollected interest is
reversed. A loan is considered to be restructured if it has been modified as to
original terms, resulting in a reduction or deferral of principal and/or
interest as a concession to the debtor. Classification of an asset in the
non-performing category does not preclude ultimate collection of loan principal
or interest.
At December 31, 1998, the Corporation had $5,597,000 in loans to borrowers
experiencing financial difficulties which had not been included in either of the
non-accrual or 90 days past due loan categories. Management monitors such loans
closely and reviews their performance on a regular basis.
ALLOWANCE FOR POSSIBLE LOAN LOSSES
The allowance for possible loan losses was $53.6 million or 1.47 percent of
period-end loans at December 31, 1998, compared to $48.1 million or 1.54 percent
of period-end loans at year-end 1997. The
23
allowance for possible loan losses as a percentage of non-accrual loans was
412.5 percent at December 31, 1998, compared with 367.6 percent at December 31,
1997.
The Corporation recorded a $10.4 million provision for possible loan losses
during 1998, compared to $9.2 million and $8.5 million recorded during 1997 and
1996, respectively. The provision is reflective of the continued growth in the
loan portfolio. The provision is also influenced by prior loan portfolio losses;
the current condition of the loan portfolio both as to specific and in the
aggregate; the present business/economic environment within which the bank
operates; and changes in other conditions which influence credit risk. These
other conditions include but are not limited to; the bank's lending policies and
procedures dealing with underwriting standards; the experience, ability, and
depth of lending management and staff; the existence of any concentrations of
credit and changes in the level of such concentrations; the effect of external
factors such as competition and legal and regulatory requirements; and changes
in the quality of the bank's loan review system and the degree of oversight by
the bank's board of directors.
The Corporation recorded net charge-offs of $6.1 million for the year ended
December 31, 1998, compared to net charge-offs of $6.0 million and $2.8 million
in 1997 and 1996, respectively. The Corporation's gross charge-offs in 1998
consisted primarily of consumer loans which increased $871,000 to $8.1 million
and commercial and industrial loans which increased $2.0 million to $4.0
million. The Corporation's gross charge-offs in 1997 consisted primarily of
consumer loans which increased $3.4 million to $7.2 million and commercial and
industrial loans which decreased $4.5 million to $2.0 million. The Corporation's
gross charge-offs in 1996 consisted primarily of commercial and industrial loans
which increased to $6.5 million from $739,000 in 1995 and consumer loans which
decreased slightly from 1995.
Year Ended December 31
--------------------------------------------------------------------
ALLOWANCE FOR POSSIBLE LOAN LOSSES 1998 1997 1996 1995 1994
- -----------------------------------------------------------------------------------------------------------
Average loans outstanding during
year, net of unearned discount..... $ 3,437,510 $ 2,917,371 $ 2,445,759 $ 1,971,663 $ 1,552,189
====================================================================
Balance of allowance for possible
loan losses at beginning of year... $ 48,073 $ 42,821 $ 36,525 $ 29,017 $ 29,073
Provision for possible loan losses... 10,393 9,174 8,494 7,605 473
Loan loss reserve of acquired
(disposed) institutions............ 1,250 2,105 627 430 (2,423)
Charge-offs:
Real estate........................ (397) (650) (351) (288) (1,366)
Commercial and industrial.......... (3,980) (2,028) (6,485) (739) (561)
Consumer........................... (8,081) (7,209) (3,776) (3,856) (2,401)
Other, including foreign........... (90) (40) (9) (2)
--------------------------------------------------------------------
Total charge-offs............... (12,548) (9,927) (10,621) (4,885) (4,328)
--------------------------------------------------------------------
Recoveries:
Real estate........................ 1,674 956 2,476 1,277 1,976
Commercial and industrial.......... 2,176 965 3,747 1,796 2,495
Consumer........................... 2,528 1,853 1,445 1,231 1,698
Other, including foreign........... 70 126 128 54 53
--------------------------------------------------------------------
Total recoveries................ 6,448 3,900 7,796 4,358 6,222
--------------------------------------------------------------------
Net (charge-offs) recoveries......... (6,100) (6,027) (2,825) (527) 1,894
Balance of allowance for possible
loan losses at end of year......... $ 53,616 $ 48,073 $ 42,821 $ 36,525 $ 29,017
====================================================================
Net (charge-offs) recoveries as a
percentage of average loans
outstanding during year, net of
unearned discount.................. (.18)% (.21)% (.12)% (.03)% .12%
Allowance for possible loan losses as
a percentage of year-end loans, net
of unearned discount............... 1.47 1.54 1.60 1.71 1.67
There were no foreign charge-offs in 1998-1994.
24
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 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, 1998, 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, 1998, 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 41 percent of the consumer loan portfolio,
direct non-real estate consumer loans, which represent 29 percent of the
portfolio and direct real estate consumer loans, which represent 30 percent. The
indirect segment is composed almost exclusively of new and used automobile
financing. Non-real estate direct loans include automobile loans, unsecured
revolving credit products, personal loans secured by cash and cash equivalents,
and other similar types of credit facilities. The direct real estate loans are
primarily Home Equity, home improvement and residential lot loans. Effective
January 1, 1998, in accordance with a constitutional amendment allowing for the
existence of Home Equity loans in the State of Texas, 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. As of December 31, 1998, Home Equity loans aggregated
approximately $82 million, and were originated for a general variety of purposes
including: education, business start-ups, debt consolidation and automobile
financing. It is anticipated this product will continue to grow and eventually
represent the largest distinct segment of the
25
consumer portfolio. To date the primary growth of this product has been from
existing customers. Underwriting standards for this product are heavily
influenced by the statute requirements, which include but are not limited to;
maximum loan-to-value percentage, collection remedies, the number of such loans
a borrower can have at one time and documentation requirements.
A computer based credit scoring analysis is used to supplement the consumer
loan underwriting process. To monitor and manage consumer loan risk, policies
and procedures are developed and modified, as needed, jointly by line and staff
personnel. This activity, coupled with relatively small loan amounts that are
spread across many individual borrowers, minimizes the risk. Additionally, trend
and outlook reports are provided to senior management on a frequent basis to aid
in planning.
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 potential loan
losses inherent in the loan portfolio. 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
------------------------------------------------------------------------------
1998 1997 1996
----------------------- ------------------------ ------------------------
ALLOWANCE Allowance Allowance
FOR AS A for As a for As a
POSSIBLE PERCENTAGE Possible Percentage Possible Percentage
ALLOCATION OF ALLOWANCE FOR POSSIBLE LOAN OF TOTAL Loan of Total Loan of Total
LOAN LOSSES LOSSES LOANS Losses Loans Losses Loans
- ---------------------------------------------------------------------------------------------------------------------
Commercial and industrial............ $15,604 .43% $ 14,346 .46% $ 9,648 .36%
Real estate.......................... 9,594 .26 9,460 .31 9,853 .37
Consumer............................. 17,913 .49 17,486 .56 13,903 .52
Purchasing or carrying securities.... 85 88 6
Financial institutions............... 45 60 44
Other, including foreign............. 172 .01 371 .01 213 .01
Not allocated........................ 10,203 .28 6,262 .20 9,154 .34
------------------------------------------------------------------------------
TOTAL............................. $53,616 1.47% $ 48,073 1.54% $ 42,821 1.60%
==============================================================================
December 31
------------------------------------------------------
1995 1994
------------------------------------------------------
Allowance Allowance
for As a for As a
Possible Percentage Possible Percentage
ALLOCATION OF ALLOWANCE FOR POSSIBLE Loan of Total Loan of Total
LOAN LOSSES Losses Loans Losses Loans
- ------------------------------------------------------------------------------------------