Form 10-Q
Table of Contents

 

 

United States

Securities and Exchange Commission

Washington, D.C. 20549

Form 10-Q

 

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

For the quarterly period ended: September 30, 2011

Or

 

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

For the transition period from             to             

Commission file number: 001-13221

Cullen/Frost Bankers, Inc.

(Exact name of registrant as specified in its charter)

 

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

(210) 220-4011

(Registrant’s telephone number, including area code)

N/A

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

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

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

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

 

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

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

As of October 20, 2011, there were 61,245,244 shares of the registrant’s Common Stock, $.01 par value, outstanding.

 

 

 


Table of Contents

Cullen/Frost Bankers, Inc.

Quarterly Report on Form 10-Q

September 30, 2011

Table of Contents

 

     Page  

Part I - Financial Information

  
   Item 1.    Financial Statements (Unaudited)   
      Consolidated Statements of Income      3   
      Consolidated Balance Sheets      4   
      Consolidated Statements of Changes in Shareholders’ Equity      5   
      Consolidated Statements of Cash Flows      6   
      Notes to Consolidated Financial Statements      7   
   Item 2.    Management’s Discussion and Analysis of Financial Condition and Results of Operations      36   
   Item 3.    Quantitative and Qualitative Disclosures About Market Risk      61   
   Item 4.    Controls and Procedures      62   

Part II - Other Information

  
   Item 1.    Legal Proceedings      63   
   Item 1A.    Risk Factors      63   
   Item 2.    Unregistered Sales of Equity Securities and Use of Proceeds      63   
   Item 3.    Defaults Upon Senior Securities      63   
   Item 5.    Other Information      63   
   Item 6.    Exhibits      63   

Signatures

     64   

 

2


Table of Contents

Part I. Financial Information

Item 1. Financial Statements (Unaudited)

Cullen/Frost Bankers, Inc.

Consolidated Statements of Income

(Dollars in thousands, except per share amounts)

 

      Three Months Ended
September 30,
     Nine Months Ended
September 30,
 
     2011      2010      2011      2010  

Interest income:

           

Loans, including fees

   $ 99,737       $ 102,874       $ 298,036       $ 307,898   

Securities:

           

Taxable

     30,089         30,968         92,942         91,525   

Tax-exempt

     23,127         20,380         69,029         60,399   

Interest-bearing deposits

     1,811         1,438         4,454         3,282   

Federal funds sold and resell agreements

     15         28         44         59   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total interest income

     154,779         155,688         464,505         463,163   

Interest expense:

           

Deposits

     5,306         7,334         17,203         23,272   

Federal funds purchased and repurchase agreements

     63         116         277         290   

Junior subordinated deferrable interest debentures

     1,710         1,741         5,073         5,297   

Other long-term borrowings

     2,339         4,081         10,499         12,408   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total interest expense

     9,418         13,272         33,052         41,267   

Net interest income

     145,361         142,416         431,453         421,896   

Provision for loan losses

     9,010         10,100         27,445         32,321   
  

 

 

    

 

 

    

 

 

    

 

 

 

Net interest income after provision for loan losses

     136,351         132,316         404,008         389,575   

Non-interest income:

           

Trust fees

     18,405         17,029         55,601         51,029   

Service charges on deposit accounts

     24,306         24,980         71,293         74,714   

Insurance commissions and fees

     9,569         8,588         27,971         27,238   

Other charges, commissions and fees

     8,134         7,708         25,371         22,656   

Net gain (loss) on securities transactions

     6,409         —           6,414         6   

Other

     12,394         12,125         35,692         36,112   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total non-interest income

     79,217         70,430         222,342         211,755   

Non-interest expense:

           

Salaries and wages

     61,697         59,743         185,902         178,845   

Employee benefits

     12,004         12,698         40,365         39,894   

Net occupancy

     12,080         12,197         35,555         34,969   

Furniture and equipment

     13,106         12,165         38,015         35,316   

Deposit insurance

     2,583         4,661         9,941         15,533   

Intangible amortization

     1,108         1,276         3,335         3,908   

Other

     34,829         29,812         101,152         93,335   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total non-interest expense

     137,407         132,552         414,265         401,800   
  

 

 

    

 

 

    

 

 

    

 

 

 

Income before income taxes

     78,161         70,194         212,085         199,530   

Income taxes

     23,654         15,199         49,964         43,817   
  

 

 

    

 

 

    

 

 

    

 

 

 

Net income

   $ 54,507       $ 54,995       $ 162,121       $ 155,713   
  

 

 

    

 

 

    

 

 

    

 

 

 

Earnings per common share:

           

Basic

   $ 0.89       $ 0.90       $ 2.64       $ 2.57   

Diluted

     0.89         0.90         2.64         2.57   

See Notes to Consolidated Financial Statements.

 

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Table of Contents

Cullen/Frost Bankers, Inc.

Consolidated Balance Sheets

(Dollars in thousands, except per share amounts)

 

     September 30,     December 31,     September 30,  
     2011     2010     2010  

Assets:

      

Cash and due from banks

   $ 571,332      $ 587,847      $ 580,005   

Interest-bearing deposits

     3,885,202        2,171,828        2,264,241   

Federal funds sold and resell agreements

     30,827        61,302        8,638   
  

 

 

   

 

 

   

 

 

 

Total cash and cash equivalents

     4,487,361        2,820,977        2,852,884   

Securities held to maturity, at amortized cost

     366,267        283,629        256,724   

Securities available for sale, at estimated fair value

     5,339,812        5,157,470        5,255,006   

Trading account securities

     15,823        15,101        14,934   

Loans, net of unearned discounts

     8,089,577        8,117,020        8,052,948   

Less: Allowance for loan losses

     (115,433     (126,316     (126,157
  

 

 

   

 

 

   

 

 

 

Net loans

     7,974,144        7,990,704        7,926,791   

Premises and equipment, net

     321,517        316,909        315,259   

Goodwill

     528,072        527,684        527,684   

Other intangible assets, net

     11,656        14,335        15,552   

Cash surrender value of life insurance policies

     132,899        129,922        128,758   

Accrued interest receivable and other assets

     312,091        360,361        444,534   
  

 

 

   

 

 

   

 

 

 

Total assets

   $ 19,489,642      $ 17,617,092      $ 17,738,126   
  

 

 

   

 

 

   

 

 

 

Liabilities:

      

Deposits:

      

Non-interest-bearing demand deposits

   $ 6,541,239      $ 5,360,436      $ 5,294,993   

Interest-bearing deposits

     9,522,634        9,118,906        9,235,094   
  

 

 

   

 

 

   

 

 

 

Total deposits

     16,063,873        14,479,342        14,530,087   

Federal funds purchased and repurchase agreements

     658,246        475,673        430,737   

Junior subordinated deferrable interest debentures

     123,712        123,712        123,712   

Other long-term borrowings

     100,031        250,045        250,049   

Accrued interest payable and other liabilities

     296,904        226,640        287,404   
  

 

 

   

 

 

   

 

 

 

Total liabilities

     17,242,766        15,555,412        15,621,989   

Shareholders’ Equity:

      

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

     —          —          —     

Junior participating preferred stock, par value $0.01 per share; 250,000 shares authorized; none issued

     —          —          —     

Common stock, par value $0.01 per share; 210,000,000 shares authorized; 61,271,603 shares issued at September 30, 2011, 61,108,184 shares issued at December 31, 2010 and 60,836,307 shares issued at September 30, 2010

     613        611        608   

Additional paid-in capital

     676,079        657,335        640,398   

Retained earnings

     1,327,587        1,249,484        1,223,891   

Accumulated other comprehensive income, net of tax

     244,053        154,250        251,240   

Treasury stock, 26,359 shares at September 30, 2011, at cost

     (1,456     —          —     
  

 

 

   

 

 

   

 

 

 

Total shareholders’ equity

     2,246,876        2,061,680        2,116,137   
  

 

 

   

 

 

   

 

 

 

Total liabilities and shareholders’ equity

   $ 19,489,642      $ 17,617,092      $ 17,738,126   
  

 

 

   

 

 

   

 

 

 

See Notes to Consolidated Financial Statements.

 

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Table of Contents

Cullen/Frost Bankers, Inc.

Consolidated Statements of Changes in Shareholders’ Equity

(Dollars in thousands, except per share amounts)

 

     Nine Months Ended  
     September 30,  
     2011     2010  

Total shareholders’ equity at beginning of period

   $ 2,061,680      $ 1,894,424   

Comprehensive income:

    

Net income

     162,121        155,713   

Other comprehensive income

     89,803        97,035   
  

 

 

   

 

 

 

Total comprehensive income

     251,924        252,748   

Stock option exercises/deferred stock unit conversions (144,203 shares in 2011 and 611,253 shares in 2010)

     7,239        28,530   

Stock compensation expense recognized in earnings

     10,016        10,480   

Tax benefits related to stock compensation

     304        464   

Purchase of treasury stock (29,823 shares in 2011 and 3,406 shares in 2010)

     (1,657     (193

Treasury stock issued/sold to the 401(k) stock purchase plan (40,019 shares in 2010)

     —          2,069   

Common stock issued/sold to the 401(k) stock purchase plan (22,680 shares in 2011 and 150,165 shares in 2010)

     1,360        8,183   

Cash dividends ($1.37 per share in 2011 and $1.33 per share in 2010)

     (83,990     (80,568
  

 

 

   

 

 

 

Total shareholders’ equity at end of period

   $ 2,246,876      $ 2,116,137   
  

 

 

   

 

 

 

See Notes to Consolidated Financial Statements.

 

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Table of Contents

Cullen/Frost Bankers, Inc.

Consolidated Statements of Cash Flows

(Dollars in thousands)

 

     Nine Months Ended  
     September 30,  
     2011     2010  

Operating Activities:

    

Net income

   $ 162,121      $ 155,713   

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

    

Provision for loan losses

     27,445        32,321   

Deferred tax expense (benefit)

     (137     (878

Accretion of loan discounts

     (9,865     (7,889

Securities premium amortization (discount accretion), net

     7,590        5,974   

Net gain on securities transactions

     (6,414     (6

Depreciation and amortization

     28,082        27,929   

Net (gain) loss on sale of loans held for sale and other assets

     4,240        4,495   

Stock-based compensation

     10,016        10,480   

Net tax benefit (deficiency) from stock-based compensation

     (89     (149

Excess tax benefits from stock-based compensation

     (393     (613

Earnings on life insurance policies

     (2,977     (3,353

Net change in:

    

Trading account securities

     (722     1,192   

Student loans held for sale

     —          24,029   

Accrued interest receivable and other assets

     41,588        (2,464

Accrued interest payable and other liabilities

     (1,145     35,925   
  

 

 

   

 

 

 

Net cash from operating activities

     259,340        282,706   

Investing Activities:

    

Securities held to maturity:

    

Purchases

     (83,184     (250,981

Maturities, calls and principal repayments

     464        541   

Securities available for sale:

    

Purchases

     (6,195,375     (11,004,691

Sales

     5,587,391        9,997,994   

Maturities, calls and principal repayments

     587,650        743,257   

Net change in loans

     (17,748     255,555   

Net cash paid in acquisitions

     (1,044     —     

Proceeds from sales of premises and equipment

     1,256        905   

Purchases of premises and equipment

     (23,266     (9,366

Proceeds from sales of repossessed properties

     11,825        17,896   
  

 

 

   

 

 

 

Net cash from investing activities

     (132,031     (248,890

Financing Activities:

    

Net change in deposits

     1,584,531        1,216,777   

Net change in short-term borrowings

     182,573        (51,311

Principal payments on long-term borrowings

     (150,014     (18,885

Proceeds from stock option exercises

     7,239        28,530   

Excess tax benefits from stock-based compensation

     393        613   

Purchase of treasury stock

     (1,657     (193

Common stock/treasury stock sold to the 401(k) stock purchase plan

     —          2,626   

Cash dividends paid

     (83,990     (80,568
  

 

 

   

 

 

 

Net cash from financing activities

     1,539,075        1,097,589   
  

 

 

   

 

 

 

Net change in cash and cash equivalents

     1,666,384        1,131,405   

Cash and equivalents at beginning of period

     2,820,977        1,721,479   
  

 

 

   

 

 

 

Cash and equivalents at end of period

   $ 4,487,361      $ 2,852,884   
  

 

 

   

 

 

 

See Notes to Consolidated Financial Statements.

 

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Table of Contents

Cullen/Frost Bankers, Inc.

Notes to Consolidated Financial Statements

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

Note 1 - Significant Accounting Policies

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

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

The consolidated financial statements in this Quarterly Report on Form 10-Q have not been audited by an independent registered public accounting firm, but in the opinion of management, reflect all adjustments necessary for a fair presentation of the Corporation’s financial position and results of operations. All such adjustments were of a normal and recurring nature. The consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States for interim financial information and with the instructions to Form 10-Q adopted by the Securities and Exchange Commission (SEC). Accordingly, the financial statements do not include all of the information and footnotes required by accounting principles generally accepted in the United States for complete financial statements and should be read in conjunction with the Corporation’s consolidated financial statements, and notes thereto, for the year ended December 31, 2010, included in the Corporation’s Annual Report on Form 10-K filed with the SEC on February 3, 2011 (the “2010 Form 10-K”). Operating results for the interim periods disclosed herein are not necessarily indicative of the results that may be expected for a full year or any future period.

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

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

 

     Nine Months Ended
September 30,
 
     2011      2010  

Cash paid for interest

   $ 39,809       $ 47,976   

Cash paid for income tax

     35,612         47,351   

Significant non-cash transactions:

     

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

     16,803         12,707   

Loans to facilitate the sale of other real estate owned

     75         869   

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

     1,360         7,626   

Reclassifications. Certain items in prior financial statements have been reclassified to conform to the current presentation.

 

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Table of Contents

Note 2 - Securities

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

 

     September 30, 2011      December 31, 2010  
     Amortized
Cost
     Gross
Unrealized
Gains
     Gross
Unrealized
Losses
     Estimated
Fair Value
     Amortized
Cost
     Gross
Unrealized
Gains
     Gross
Unrealized
Losses
     Estimated
Fair Value
 

Held to Maturity

                    

U. S. Treasury

   $ 247,701       $ 31,049       $ —         $ 278,750       $ 247,421       $ 13,517       $ —         $ 260,938   

Residential mortgage-backed securities

     12,081         157         6         12,232         4,405         136         —           4,541   

States and political subdivisions

     105,485         5,738         —           111,223         30,803         —           1,054         29,749   

Other

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

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 366,267       $ 36,944       $ 6       $ 403,205       $ 283,629       $ 13,653       $ 1,054       $ 296,228   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Available for Sale:

                    

U. S. Treasury

   $ 773,362       $ 26,553       $ —         $ 799,915       $ 973,033       $ 13,998       $ —         $ 987,031   

Residential mortgage-backed securities

     2,244,650         149,689         1         2,394,338         1,989,299         103,018         987         2,091,330   

States and political subdivisions

     1,972,996         134,610         39         2,107,567         2,008,618         53,358         21,676         2,040,300   

Other

     37,992         —           —           37,992         38,809         —           —           38,809   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 5,029,000       $ 310,852       $ 40       $ 5,339,812       $ 5,009,759       $ 170,374       $ 22,663       $ 5,157,470   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

All mortgage-backed securities included in the above table were issued by U.S. government agencies and corporations. Securities with limited marketability, such as stock in the Federal Reserve Bank and the Federal Home Loan Bank, are carried at cost and are reported as other available for sale securities in the above table. The carrying value of securities pledged to secure public funds, trust deposits, repurchase agreements and for other purposes, as required or permitted by law was $2.2 billion and $2.3 billion at September 30, 2011 and December 31, 2010.

As of September 30, 2011, securities, with unrealized losses segregated by length of impairment, were as follows:

 

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

Held to Maturity

                 

Residential mortgage-backed securities

   $ 6,752       $ 6       $ —         $ —         $ 6,752       $ 6   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 6,752       $ 6       $ —         $ —         $ 6,752       $ 6   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Available for Sale

                 

Residential mortgage-backed securities

   $ 246       $ 1       $ —         $ —         $ 246       $ 1   

States and political subdivisions

     3,296         31         686         8         3,982         39   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 3,542       $ 32       $ 686       $ 8       $ 4,228       $ 40   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

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

Management has the ability and intent to hold the securities classified as held to maturity in the table above until they mature, at which time the Corporation will receive full value for the securities. Furthermore, as of September 30, 2011, management does not have the intent to sell any of the securities classified as available for sale in the table above and believes that it is more likely than not that the Corporation will not have to sell any such securities before a recovery of cost. Any unrealized losses are largely due to increases in market interest rates over the yields available at the time the underlying securities were purchased. The fair value is expected to recover as the bonds approach their maturity date or repricing date or if market yields for such investments decline. Management does not believe any of the securities are impaired due to reasons of credit quality. Accordingly, as of September 30, 2011, management believes the impairments detailed in the table above are temporary and no impairment loss has been realized in the Corporation’s consolidated income statement.

 

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The amortized cost and estimated fair value of securities, excluding trading securities, at September 30, 2011 are presented below by contractual maturity. Expected maturities may differ from contractual maturities because issuers may have the right to call or prepay obligations. Residential mortgage-backed securities and equity securities are shown separately since they are not due at a single maturity date.

 

     Held to Maturity      Available for Sale  
     Amortized
Cost
     Estimated
Fair Value
     Amortized
Cost
     Estimated
Fair Value
 

Due in one year or less

   $ —         $ —         $ 32,816       $ 33,229   

Due after one year through five years

     1,000         1,000         831,398         861,967   

Due after five years through ten years

     251,039         282,332         174,398         187,265   

Due after ten years

     102,147         107,641         1,707,746         1,825,021   

Residential mortgage-backed securities

     12,081         12,232         2,244,650         2,394,338   

Equity securities

     —           —           37,992         37,992   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 366,267       $ 403,205       $ 5,029,000       $ 5,339,812   
  

 

 

    

 

 

    

 

 

    

 

 

 

Sales of securities available for sale were as follows:

 

      Three Months  Ended
September 30,
     Nine Months Ended
September 30,
 
     2011      2010      2011      2010  

Proceeds from sales

   $ 39,005       $ —         $ 5,587,391       $ 9,997,994   

Gross realized gains

     6,409         —           6,418         8   

Gross realized losses

     —           —           4         2   

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

 

     September 30,      December 31,  
     2011      2010  

U.S. Treasury

   $ 14,035       $ 14,986   

States and political subdivisions

     1,788         115   
  

 

 

    

 

 

 

Total

   $ 15,823       $ 15,101   
  

 

 

    

 

 

 

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

 

     Three Months Ended
September 30,
     Nine Months Ended
September 30,
 
     2011      2010      2011      2010  

Net gain on sales transactions

   $ 303       $ 509       $ 772       $ 1,389   

Net mark-to-market gains

     4         20         11         143   
  

 

 

    

 

 

    

 

 

    

 

 

 

Net gain on trading account securities

   $ 307       $ 529       $ 783       $ 1,532   
  

 

 

    

 

 

    

 

 

    

 

 

 

 

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Note 3 - Loans

Loans were as follows:

 

     September 30,     Percentage     December 31,     Percentage     September 30,     Percentage  
     2011     of Total     2010     of Total     2010     of Total  

Commercial and industrial:

            

Commercial

   $ 3,571,807        44.2   $ 3,479,349        42.9   $ 3,415,306        42.4

Leases

     184,614        2.3        186,443        2.3        189,810        2.4   

Asset-based

     175,120        2.1        122,866        1.5        123,658        1.5   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total commercial and industrial

     3,931,541        48.6        3,788,658        46.7        3,728,774        46.3   

Commercial real estate:

            

Commercial mortgages

     2,370,871        29.3        2,374,542        29.3        2,359,169        29.3   

Construction

     508,182        6.3        593,273        7.3        586,073        7.3   

Land

     214,436        2.6        234,952        2.9        238,060        3.0   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total commercial real estate

     3,093,489        38.2        3,202,767        39.5        3,183,302        39.6   

Consumer real estate:

            

Home equity loans

     277,284        3.4        275,806        3.4        279,106        3.5   

Home equity lines of credit

     190,958        2.4        186,465        2.3        180,538        2.2   

1-4 family residential mortgages

     47,455        0.6        57,877        0.7        60,177        0.7   

Construction

     17,965        0.2        23,565        0.3        24,446        0.3   

Other

     233,053        2.9        254,551        3.1        266,558        3.3   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total consumer real estate

     766,715        9.5        798,264        9.8        810,825        10.0   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total real estate

     3,860,204        47.7        4,001,031        49.3        3,994,127        49.6   

Consumer and other:

            

Consumer installment

     299,417        3.7        319,384        3.9        322,239        4.0   

Other

     14,926        0.2        28,234        0.4        28,891        0.4   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total consumer and other

     314,343        3.9        347,618        4.3        351,130        4.4   

Unearned discounts

     (16,511     (0.2     (20,287     (0.3     (21,083     (0.3
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total loans

   $ 8,089,577        100.0   $ 8,117,020        100.0   $ 8,052,948        100.0
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

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

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

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

 

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projects unless other underwriting factors are present to help mitigate risk. The Corporation also utilizes third-party experts to provide insight and guidance about economic conditions and trends affecting market areas it serves. In addition, management tracks the level of owner-occupied commercial real estate loans versus non-owner occupied loans. At September 30, 2011, approximately 60% of the outstanding principal balance of the Corporation’s commercial real estate loans were secured by owner-occupied properties.

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

The Corporation originates consumer loans utilizing a computer-based credit scoring analysis to supplement the underwriting process. To monitor and manage consumer loan risk, policies and procedures are developed and modified, as needed, jointly by line and staff personnel. This activity, coupled with relatively small loan amounts that are spread across many individual borrowers, minimizes risk. Additionally, trend and outlook reports are reviewed by management on a regular basis. Underwriting standards for home equity loans are heavily influenced by statutory requirements, which include, but are not limited to, a maximum loan-to-value percentage of 80%, collection remedies, the number of such loans a borrower can have at one time and documentation requirements.

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

Concentrations of Credit. Most of the Corporation’s lending activity occurs within the State of Texas, including the four largest metropolitan areas of Austin, Dallas/Ft. Worth, Houston and San Antonio, as well as other markets. The majority of the Corporation’s loan portfolio consists of commercial and industrial and commercial real estate loans. Other than energy loans, as of September 30, 2011, there were no concentrations of loans related to any single industry in excess of 10% of total loans.

Student Loans Held for Sale. Prior to the second quarter of 2008, the Corporation originated student loans primarily for sale in the secondary market. These loans were generally sold on a non-recourse basis and were carried at the lower of cost or market on an aggregate basis. During the second quarter of 2008, the Corporation elected to discontinue the origination of student loans for resale, aside from previously outstanding commitments. All remaining student loans were sold during the second quarter of 2010.

Foreign Loans. The Corporation has U.S. dollar denominated loans and commitments to borrowers in Mexico. The outstanding balance of these loans and the unfunded amounts available under these commitments were not significant at September 30, 2011 or December 31, 2010.

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

 

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

 

     September 30,      December 31,      September 30,  
     2011      2010      2010  

Commercial and industrial:

        

Energy

   $ —         $ —         $ —     

Other commercial

     58,208         60,408         66,128   

Commercial real estate:

        

Buildings, land and other

     45,333         64,213         64,813   

Construction

     1,821         9,299         10,345   

Consumer real estate

     4,060         2,758         2,541   

Consumer and other

     756         462         1,073   
  

 

 

    

 

 

    

 

 

 

Total

   $ 110,178       $ 137,140       $ 144,900   
  

 

 

    

 

 

    

 

 

 

As of September 30, 2011, non-accrual loans reported in the table above included $8.7 million ($191 thousand in other commercial loans, $7.1 million in buildings, land and other loans, $960 thousand in consumer real estate and $469 thousand in consumer loans) related to loans that were restructured as “troubled debt restructurings” during 2011. See the section captioned “Troubled Debt Restructurings” elsewhere in this note.

Had non-accrual loans performed in accordance with their original contract terms, the Corporation would have recognized additional interest income, net of tax, of approximately $823 thousand and $2.6 million for the three and nine months ended September 30, 2011, compared to $944 thousand and $2.9 million for the three and nine months ended September 30, 2010.

An age analysis of past due loans (including both accruing and non-accruing loans), segregated by class of loans, as of September 30, 2011 was as follows:

 

     Loans
30-89  Days
Past Due
     Loans
90 or  More
Days
Past Due
     Total
Past Due
Loans
     Current
Loans
    Total
Loans
    Accruing
Loans 90  or
More Days
Past Due
 

Commercial and industrial:

               

Energy

   $ 450       $ 65       $ 515       $ 913,632      $ 914,147      $ 65   

Other commercial

     35,163         19,355         54,518         2,962,876        3,017,394        6,695   

Commercial real estate:

               

Buildings, land and other

     23,905         26,969         50,874         2,534,433        2,585,307        6,910   

Construction

     4,544         958         5,502         502,680        508,182        910   

Consumer real estate

     5,929         4,712         10,641         756,074        766,715        2,962   

Consumer and other

     2,204         140         2,344         311,999        314,343        140   

Unearned discounts

     —           —           —           (16,511     (16,511     —     
  

 

 

    

 

 

    

 

 

    

 

 

   

 

 

   

 

 

 

Total

   $ 72,195       $ 52,199       $ 124,394       $ 7,965,183      $ 8,089,577      $ 17,682   
  

 

 

    

 

 

    

 

 

    

 

 

   

 

 

   

 

 

 

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

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

 

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

 

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

September 30, 2011

                    

Commercial and industrial:

                    

Energy

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

Other commercial

     79,327         42,583         10,387         52,970         6,883         60,696         57,455   

Commercial real estate:

                    

Buildings, land and other

     52,193         34,267         7,848         42,115         1,283         44,453         50,562   

Construction

     2,162         1,773         —           1,773         —           2,265         5,104   

Consumer real estate

     2,510         2,498         —           2,498         —           2,227         1,689   

Consumer and other

     568         568         —           568         —           335         193   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 136,760       $ 81,689       $ 18,235       $ 99,924       $ 8,166       $ 109,976       $ 115,003   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

December 31, 2010

                    

Commercial and industrial:

                    

Energy

   $ —         $ —         $ —         $ —         $ —         $ —         $ 1,012   

Other commercial

     73,518         40,901         14,541         55,442         9,137         57,563         61,076   

Commercial real estate:

                    

Buildings, land and other

     72,099         50,551         11,254         61,805         4,076         62,231         59,179   

Construction

     9,834         8,553         747         9,300         300         9,715         8,132   

Consumer real estate

     517         517         —           517         —           654         960   

Consumer and other

     —           —           —           —           —           79         393   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 155,968       $ 100,522       $ 26,542       $ 127,064       $ 13,513       $ 130,242       $ 130,752   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

September 30, 2010

                    

Commercial and industrial:

                    

Energy

   $ —         $ —         $ —         $ —         $ —         $ 715       $ 1,265   

Other commercial

     71,485         26,288         33,396         59,684         16,555         56,073         62,485   

Commercial real estate:

                    

Buildings, land and other

     75,002         50,410         12,246         62,656         3,827         62,296         58,523   

Construction

     10,576         9,383         747         10,130         150         8,905         7,840   

Consumer real estate

     792         792         —           792         —           885         1,071   

Consumer and other

     157         157         —           157         —           214         492   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 158,012       $ 87,030       $ 46,389       $ 133,419       $ 20,532       $ 129,088       $ 131,676   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Troubled Debt Restructurings. The restructuring of a loan is considered a “troubled debt restructuring” if both (i) the borrower is experiencing financial difficulties and (ii) the creditor has granted a concession. Concessions may include interest rate reductions or below market interest rates, principal forgiveness, restructuring amortization schedules and other actions intended to minimize potential losses. Effective July 1, 2011, the Corporation adopted the provisions of Accounting Standards Update (“ASU”) No. 2011-02, “Receivables (Topic 310) - A Creditor’s Determination of Whether a Restructuring Is a Troubled Debt Restructuring.” As such, the Corporation reassessed all loan modifications occurring since January 1, 2011 for identification as troubled debt restructurings.

Troubled debt restructurings are set forth in the following table. There were no troubled debt restructurings during 2010.

 

     Three      Nine  
     Months Ended      Months Ended  
     September 30,      September 30,  
     2011      2011  

Commercial and industrial:

     

Other commercial

   $ 191       $ 191   

Commercial real estate:

     

Buildings, land and other

     3,325         7,519   

Consumer real estate

     969         969   

Consumer

     469         469   
  

 

 

    

 

 

 
   $ 4,954       $ 9,148   
  

 

 

    

 

 

 

 

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All of the loans identified as troubled debt restructurings by the Corporation were previously on non-accrual status and reported as impaired loans prior to restructuring. The modifications primarily related to extending the amortization periods of the loans. The Corporation did not grant interest-rate concessions on any restructured loan. All loans restructured during the nine months ended September 30, 2011 are on non-accrual status as of September 30, 2011. See the section captioned “Non-accrual Loans” elsewhere in this note. Because the loans were classified and on non-accrual status both before and after restructuring, the modifications did not impact the Corporation’s determination of the allowance for loan losses. As of September 30, 2011, there have been no defaults on any loans that were modified as troubled debt restructurings during the preceding twelve months.

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

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

 

   

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

 

   

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

 

   

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

 

   

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

 

   

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

 

   

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

 

   

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

 

   

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

 

   

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

 

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

 

     September 30, 2011      December 31, 2010      September 30, 2010  
      Weighted             Weighted             Weighted         
     Average             Average             Average         
     Risk Grade      Loans      Risk Grade      Loans      Risk Grade      Loans  

Commercial and industrial:

                 

Energy

                 

Risk grades 1-8

     5.18       $ 912,728         5.27       $ 786,664         5.13       $ 752,410   

Risk grade 9

     9.00         1,419         9.00         20,224         9.00         54,864   

Risk grade 10

     10.00         —           10.00         —           10.00         —     

Risk grade 11

     11.00         —           11.00         —           11.00         —     

Risk grade 12

     12.00         —           12.00         —           12.00         —     

Risk grade 13

     13.00         —           13.00         —           13.00         —     
     

 

 

       

 

 

       

 

 

 

Total energy

     5.19       $ 914,147         5.36       $ 806,888         5.39       $ 807,274   
     

 

 

       

 

 

       

 

 

 

Other commercial

                 

Risk grades 1-8

     6.20       $ 2,687,564         6.16       $ 2,572,011         6.26       $ 2,459,477   

Risk grade 9

     9.00         94,687         9.00         95,278         9.00         90,981   

Risk grade 10

     10.00         52,753         10.00         116,158         10.00         141,907   

Risk grade 11

     11.00         124,603         11.00         137,923         11.00         161,478   

Risk grade 12

     12.00         47,875         12.00         48,216         12.00         44,012   

Risk grade 13

     13.00         9,912         13.00         12,184         13.00         23,645   
     

 

 

       

 

 

       

 

 

 

Total other commercial

     6.67       $ 3,017,394         6.75       $ 2,981,770         6.93       $ 2,921,500   
     

 

 

       

 

 

       

 

 

 

Commercial real estate:

                 

Buildings, land and other

                 

Risk grades 1-8

     6.65       $ 2,259,305         6.71       $ 2,189,602         6.73       $ 2,188,518   

Risk grade 9

     9.00         91,035         9.00         137,314         9.00         92,320   

Risk grade 10

     10.00         72,975         10.00         91,962         10.00         126,589   

Risk grade 11

     11.00         116,659         11.00         126,403         11.00         123,276   

Risk grade 12

     12.00         42,391         12.00         54,366         12.00         58,247   

Risk grade 13

     13.00         2,942         13.00         9,847         13.00         8,279   
     

 

 

       

 

 

       

 

 

 

Total commercial real estate

     7.12       $ 2,585,307         7.29       $ 2,609,494         7.31       $ 2,597,229   
     

 

 

       

 

 

       

 

 

 

Construction

                 

Risk grades 1-8

     6.98       $ 439,502         7.10       $ 485,455         7.19       $ 489,289   

Risk grade 9

     9.00         30,358         9.00         52,817         9.00         30,985   

Risk grade 10

     10.00         28,255         10.00         32,055         10.00         32,616   

Risk grade 11

     11.00         8,246         11.00         13,646         11.00         22,839   

Risk grade 12

     12.00         1,821         12.00         9,300         12.00         10,130   

Risk grade 13

     13.00         —           13.00         —           13.00         214   
     

 

 

       

 

 

       

 

 

 

Total construction

     7.35       $ 508,182         7.59       $ 593,273         7.68       $ 586,073   
     

 

 

       

 

 

       

 

 

 

The Corporation has established maximum loan to value standards to be applied during the origination process of commercial and consumer real estate loans. The Corporation does not subsequently monitor loan-to-value ratios (either individually or on a weighted-average basis) for loans that are subsequently considered to be of a pass grade (grades 9 or better) and/or current with respect to principal and interest payments. As stated above, when an individual commercial real estate loan has a calculated risk grade of 10 or higher, a special assets officer analyzes the loan to determine whether the loan is impaired. At that time, the Corporation reassesses the loan to value position in the loan. If the loan is determined to be collateral dependent, specific allocations of the allowance for loan losses are made for the amount of any collateral deficiency. If a collateral deficiency is ultimately deemed to be uncollectible, the amount is charged-off. These loans and related assessments of collateral position are monitored on an individual, case-by-case basis. The Corporation does not monitor loan-to-value ratios on a weighted-average basis for commercial real estate loans having a calculated risk grade of 10 or higher. Nonetheless, there were four commercial real estate loans having a calculated risk grade of 10 or higher in excess of $5 million as of September 30, 2011. Three of the loans totaled $29.7 million and had a weighted-average loan-to-value ratio of 62.4%. The fourth loan, totaling $7.3 million, is structured as a borrowing base facility secured by numerous rotating

 

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lots and single family residences that generally have a loan-to-value of 80% or less. When an individual consumer real estate loan becomes past due by more than 10 days, the assigned relationship manager will begin collection efforts. The Corporation only reassesses the loan to value position in a consumer real estate loan if, during the course of the collections process, it is determined that the loan has become collateral dependent, and any collateral deficiency is recognized as a charge-off to the allowance for loan losses. Accordingly, the Corporation does not monitor loan-to-value ratios on a weighted-average basis for collateral dependent consumer real estate loans.

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

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

 

     Three Months Ended
September 30,
    Nine Months Ended
September 30,
 
     2011     2010     2011     2010  

Commercial and industrial:

        

Energy

   $ 1      $ 1      $ 5      $ 7   

Other commercial

     (13,602     (5,789     (25,154     (20,034

Commercial real estate:

        

Buildings, land and other

     (1,162     (1,522     (8,689     (5,414

Construction

     (121     (91     (473     (633

Consumer real estate

     (750     (429     (1,642     (1,375

Consumer and other

     (684     (1,555     (2,375     (4,024
  

 

 

   

 

 

   

 

 

   

 

 

 

Total

   $ (16,318   $ (9,385   $ (38,328   $ (31,473
  

 

 

   

 

 

   

 

 

   

 

 

 

In assessing the general economic conditions in the State of Texas, management monitors and tracks the Texas Leading Index (“TLI”), which is produced by the Federal Reserve Bank of Dallas. The TLI is a single summary statistic that is designed to signal the likelihood of the Texas economy’s transition from expansion to recession and vice versa. Management believes this index provides a reliable indication of the direction of overall credit quality. The TLI is a composite of the following eight leading indicators: (i) Texas Value of the Dollar, (ii) U.S. Leading Index, (iii) real oil prices (iv) well permits, (v) initial claims for unemployment insurance, (vi) Texas Stock Index, (vii) Help-Wanted Index and (viii) average weekly hours worked in manufacturing. The TLI totaled 119.6 at August 31, 2011 (most recent date available), 118.2 at December 31, 2010 and 115.2 at September 30, 2010. A higher TLI value implies more favorable economic conditions.

Allowance for Loan Losses. The allowance for loan losses is a reserve established through a provision for loan losses charged to expense, which represents management’s best estimate of probable losses that have been incurred within the existing portfolio of loans. The allowance, in the judgment of management, is necessary to reserve for estimated loan losses and risks inherent in the loan portfolio. The Corporation’s allowance for loan loss methodology follows the accounting guidance set forth in U.S. generally accepted accounting principles and the Interagency Policy Statement on the Allowance for Loan and Lease Losses, which was jointly issued by the Corporation’s regulatory agencies. In that regard, the Corporation’s allowance for loan losses includes allowance allocations calculated in accordance with ASC Topic 310, “Receivables” and allowance allocations calculated in accordance with ASC Topic 450, “Contingencies.” Accordingly, the methodology is based on historical loss experience by type of credit and internal risk grade, specific homogeneous risk pools and specific loss allocations, with adjustments for current events and conditions. The Corporation’s process for determining the appropriate level of the allowance for loan losses is designed to account for credit deterioration as it occurs. The provision for loan losses reflects loan quality trends, including the levels of and trends related to non-accrual loans, past due loans, potential problem loans, criticized loans and net charge-offs or recoveries, among other factors. The provision for loan losses also reflects the totality of actions taken on all loans for a particular period. In other words, the amount of the provision reflects not only the necessary increases in the allowance for loan losses related to newly identified criticized loans, but it also reflects actions taken related to other loans including, among other things, any necessary increases or decreases in required allowances for specific loans or loan pools.

 

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

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

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

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

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

The environmental adjustment factor is based upon a more qualitative analysis of risk and is calculated through a survey of senior officers who are involved in credit making decisions at a corporate-wide and/or regional level. On a quarterly basis, survey participants rate the degree of various risks utilizing a numeric scale that translates to varying grades of high, moderate or low levels of risk. The results are then input into a risk-weighting matrix to determine an appropriate environmental risk adjustment factor. The various risks that may be considered in the determination of the environmental adjustment factor include, among other things, (i) the experience, ability and effectiveness of the bank’s lending management and staff; (ii) the effectiveness of the Corporation’s loan policies, procedures and internal controls; (iii) changes in asset quality; (iv) the impact of legislative and governmental influences affecting industry sectors; (v) the effectiveness of the internal loan review function; (vi) the impact of competition on loan structuring and pricing; and (vii) the impact of rising interest rates on portfolio risk. In periods where the surveyed risks are perceived to be higher, the risk-weighting matrix will generally result in a higher environmental adjustment factor, which, in turn will result in higher levels of general valuation allowance allocations. The opposite holds true in periods where the surveyed risks are perceived to be lower. The environmental adjustment factor resulted in additional general valuation allowance allocations to the various loan portfolio segments totaling $13.6 million at September 30, 2011, $9.5 million at December 31, 2010 and $10.1 million at September 30, 2010.

Certain general valuation allowances are not allocated to specific loan portfolio segments and are reported as the unallocated portion of the allowance for loan losses. Included in these general valuation allowances are allocations for groups of similar loans with risk characteristics that exceed certain concentration limits established by management. Concentration risk limits have been established, among other things, for certain industry concentrations, large balance and highly leveraged credit relationships that exceed specified risk grades, and loans originated with policy, credit and/or collateral exceptions that exceed specified risk grades. In addition, during the first quarter of 2011, the Corporation further refined its methodology for the determination of general valuation allowances to also (i) provide additional allocations for loans that did not undergo a

 

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separate, independent concurrence review during the underwriting process (generally those loans under $1.0 million at origination), (ii) reduce the minimum balance/commitment threshold for which allocations are made for highly leveraged credit relationships that exceed specified risk grades, (iii) lower the maximum risk grade thresholds for highly leveraged credit relationships, and (iv) include a reduction factor for recoveries of prior charge-offs to compensate for the fact that historical loss allocations are based upon gross charge-offs rather than net. The net effect of these changes to the Corporation’s methodology for the determination of general valuation allowances did not significantly impact the provision for loan losses recorded during the nine months ended September 30, 2011.

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

 

     September 30,     December 31,      September 30,  
     2011     2010      2010  

Excessive industry concentrations

   $ 1,961      $ 1,720       $ 2,024   

Large relationship concentrations

     2,185        2,127         1,878   

Highly-leveraged credit relationships

     3,763        —           —     

Policy exceptions

     1,950        2,414         2,422   

Credit and collateral exceptions

     1,985        557         616   

Loans not reviewed by concurrence

     9,039        —           —     

Adjustment for recoveries

     (11,948     —           —     

General macroeconomic risk

     22,548        17,978         4,099   
  

 

 

   

 

 

    

 

 

 
   $ 31,483      $ 24,796       $ 11,039   
  

 

 

   

 

 

    

 

 

 

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

The following tables detail activity in the allowance for loan losses by portfolio segment for the three and nine months ended September 30, 2011 and 2010. Allocation of a portion of the allowance to one category of loans does not preclude its availability to absorb losses in other categories.

 

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

Three months ended:

             

September 30, 2011

             

Beginning balance

   $ 56,566      $ 20,901      $ 3,683      $ 12,611      $ 28,980       $ 122,741   

Provision for loan losses

     3,920        1,194        513        880        2,503         9,010   

Charge-offs

     (15,084     (1,689     (834     (2,359     —           (19,966

Recoveries

     1,483        406        84        1,675        —           3,648   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

    

 

 

 

Net charge-offs

     (13,601     (1,283     (750     (684     —           (16,318
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

    

 

 

 

Ending balance

   $ 46,885      $ 20,812      $ 3,446      $ 12,807      $ 31,483       $ 115,433   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

    

 

 

 

September 30, 2010

             

Beginning balance

   $ 65,293      $ 31,229      $ 2,467      $ 18,763      $ 7,690       $ 125,442   

Provision for loan losses

     4,693        1,379        342        337        3,349         10,100   

Charge-offs

     (6,739     (1,911     (673     (3,155     —           (12,478

Recoveries

     951        298        244        1,600        —           3,093   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

    

 

 

 

Net charge-offs

     (5,788     (1,613     (429     (1,555     —           (9,385
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

    

 

 

 

Ending balance

   $ 64,198      $ 30,995      $ 2,380      $ 17,545      $ 11,039       $ 126,157   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

    

 

 

 

 

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Table of Contents
     Commercial
and
Industrial
    Commercial
Real Estate
    Consumer
Real  Estate
    Consumer
and Other
    Unallocated     Total  
            
            

Nine months ended:

            

September 30, 2011

            

Beginning balance

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

Provision for loan losses

     14,245        1,440        1,865        3,208        6,687        27,445   

Charge-offs

     (28,258     (10,261     (2,113     (7,058     —          (47,690

Recoveries

     3,109        1,099        471        4,683        —          9,362   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net charge-offs

     (25,149     (9,162     (1,642     (2,375     —          (38,328
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Ending balance

   $ 46,885      $ 20,812      $ 3,446      $ 12,807      $ 31,483      $ 115,433   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

September 30, 2010

            

Beginning balance

   $ 57,394      $ 28,514      $ 2,560      $ 16,929      $ 19,912      $ 125,309   

Provision for loan losses

     26,831        8,528        1,195        4,640        (8,873     32,321   

Charge-offs

     (22,241     (6,982     (1,734     (8,748     —          (39,705

Recoveries

     2,214        935        359        4,724        —          8,232   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net charge-offs

     (20,027     (6,047     (1,375     (4,024     —          (31,473
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Ending balance

   $ 64,198      $ 30,995      $ 2,380      $ 17,545      $ 11,039      $ 126,157   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

The following table details the amount of the allowance for loan losses allocated to each portfolio segment as of September 30, 2011 and 2010, disaggregated on the basis of the Corporation’s impairment methodology.

 

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

September 30, 2011

                 

Loans individually evaluated for impairment

   $ 23,263       $ 4,075       $ —         $ —         $ —         $ 27,338   

Loans collectively evaluated for impairment

     23,622         16,737         3,446         12,807         31,483         88,095   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Balance at September 30, 2011

   $ 46,885       $ 20,812       $ 3,446       $ 12,807       $ 31,483       $ 115,433   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

September 30, 2010

                 

Loans individually evaluated for impairment

   $ 44,329       $ 10,372       $ —         $ —         $ —         $ 54,701   

Loans collectively evaluated for impairment

     19,869         20,623         2,380         17,545         11,039         71,456   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Balance at September 30, 2010

   $ 64,198       $ 30,995       $ 2,380       $ 17,545       $ 11,039       $ 126,157   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

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The Corporation’s recorded investment in loans as of September 30, 2011, December 31, 2010 and September 30, 2010 related to each balance in the allowance for loan losses by portfolio segment and disaggregated on the basis of the Corporation’s impairment methodology was as follows:

 

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

September 30, 2011

                

Loans individually evaluated for impairment

   $ 235,143       $ 273,289       $ —         $ —         $ —        $ 508,432   

Loans collectively evaluated for impairment

     3,696,398         2,820,200         766,715         314,343         (16,511     7,581,145   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

   

 

 

 

Ending balance

   $ 3,931,541       $ 3,093,489       $ 766,715       $ 314,343       $ (16,511   $ 8,089,577   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

   

 

 

 

December 31, 2010

                

Loans individually evaluated for impairment

   $ 314,482       $ 337,578       $ —         $ —         $ —        $ 652,060   

Loans collectively evaluated for impairment

     3,474,176         2,865,189         798,264         347,618         (20,287     7,464,960   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

   

 

 

 

Ending balance

   $ 3,788,658       $ 3,202,767       $ 798,264       $ 347,618       $ (20,287   $ 8,117,020   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

   

 

 

 

September 30, 2010

                

Loans individually evaluated for impairment

   $ 365,509       $ 372,032       $ —         $ —         $ —        $ 737,541   

Loans collectively evaluated for impairment

     3,363,265         2,811,270         810,825         351,130         (21,083     7,315,407   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

   

 

 

 

Ending balance

   $ 3,728,774       $ 3,183,302       $ 810,825       $ 351,130       $ (21,083   $ 8,052,948   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

   

 

 

 

Note 4 - Goodwill and Other Intangible Assets

Goodwill and other intangible assets are presented in the table below. The increases in goodwill and certain other intangible assets were related to the acquisition of Clark Benefit Group, an independent San Antonio based insurance agency that specialized in providing employee benefits to small and mid-size businesses, on May 1, 2011. The purchase of Clark Benefit Group did not significantly impact the Corporation’s financial Statements.

 

     September 30,      December 31,  
     2011      2010  

Goodwill

   $ 528,072       $ 527,684   
  

 

 

    

 

 

 

Other intangible assets:

     

Core deposits

   $ 9,089       $ 11,819   

Customer relationship

     2,271         2,253   

Non-compete agreements

     296         263   
  

 

 

    

 

 

 
   $ 11,656       $ 14,335   
  

 

 

    

 

 

 

The estimated aggregate future amortization expense for intangible assets remaining as of September 30, 2011 is as follows:

 

Remainder of 2011

   $ 1,051   

2012

     3,638   

2013

     2,858   

2014

     2,029   

2015

     1,264   

Thereafter

     816   
  

 

 

 
   $ 11,656   
  

 

 

 

 

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Note 5 - Deposits

Deposits were as follows:

 

     September 30,      Percentage     December 31,      Percentage     September 30,      Percentage  
     2011      of Total     2010      of Total     2010      of Total  

Non-interest-bearing demand deposits:

            

Commercial and individual

   $ 5,759,723         35.8   $ 4,791,149         33.1   $ 4,774,943         32.9

Correspondent banks

     350,082         2.2        361,100         2.5        312,372         2.1   

Public funds

     431,434         2.7        208,187         1.4        207,678         1.4   
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 

Total non-interest-bearing demand deposits

     6,541,239         40.7        5,360,436         37.0        5,294,993         36.4   

Interest-bearing deposits:

            

Private accounts:

            

Savings and interest checking

     2,579,745         16.1        2,505,143         17.3        2,302,753         15.9   

Money market accounts

     5,469,492         34.0        4,949,764         34.2        5,357,511         36.9   

Time accounts of $100,000 or more

     581,192         3.6        611,836         4.2        604,477         4.2   

Time accounts under $100,000

     546,583         3.4        571,447         4.0        586,158         4.0   
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 

Total private accounts

     9,177,012         57.1        8,638,190         59.7        8,850,899         61.0   

Public funds:

            

Savings and interest checking

     164,183         1.0        255,605         1.8        184,429         1.2   

Money market accounts

     46,099         0.3        84,093         0.6        97,225         0.7   

Time accounts of $100,000 or more

     132,657         0.9        137,506         0.9        99,751         0.7   

Time accounts under $100,000

     2,683         —          3,512         —          2,790         —     
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 

Total public funds

     345,622         2.2        480,716         3.3        384,195         2.6   
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 

Total interest-bearing deposits

     9,522,634         59.3        9,118,906         63.0        9,235,094         63.6   
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 

Total deposits

   $ 16,063,873         100.0   $ 14,479,342         100.0   $ 14,530,087         100.0
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 

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

 

     September 30,      December 31,      September 30,  
     2011      2010      2010  

Money market deposits obtained through brokers

   $ 28,246       $ 24,700       $ 324,106   

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

     60,979         60,972         61,819   

Deposits from foreign sources (primarily Mexico)

     729,933         748,255         776,448   

Note 6 - Commitments and Contingencies

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

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

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

 

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

 

     September 30,      December 31,  
     2011      2010  

Commitments to extend credit

   $ 4,787,910       $ 4,528,196   

Standby letters of credit

     235,300         294,116   

Deferred standby letter of credit fees

     1,413         1,707   

Lease Commitments. The Corporation leases certain office facilities and office equipment under operating leases. Rent expense for all operating leases totaled $5.3 million and $16.1 million for the three and nine months ended September 30, 2011 and $5.4 million and $16.1 million for the three and nine months ended September 30, 2010. There has been no significant change in the future minimum lease payments payable by the Corporation since December 31, 2010. See the 2010 Form 10-K for information regarding these commitments.

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

Note 7 - Regulatory Matters

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

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

Cullen/Frost’s and Frost Bank’s Tier 1 capital consists of shareholders’ equity excluding unrealized gains and losses on securities available for sale, the accumulated gain or loss on effective cash flow hedging derivatives, the net actuarial gain/loss on the Corporation’s defined benefit post-retirement benefit plans, goodwill and other intangible assets. Tier 1 capital for Cullen/Frost also includes $120 million of trust preferred securities issued by an unconsolidated subsidiary trust. Cullen/Frost’s and Frost Bank’s total capital is comprised of Tier 1 capital for each entity plus a permissible portion of the allowance for loan losses. The Corporation’s aggregate $100 million of 5.75% fixed-to-floating rate subordinated notes are not included in Tier 1 capital but are included in total capital of Cullen/Frost.

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

 

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

 

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

September 30, 2011

               

Total Capital to Risk-Weighted Assets

               

Cullen/Frost

   $ 1,806,869         16.57   $ 872,423         8.00   $ 1,090,529         10.00

Frost Bank

     1,622,983         14.89        871,896         8.00        1,089,870         10.00   

Tier 1 Capital to Risk-Weighted Assets

               

Cullen/Frost

     1,591,436         14.59        436,212         4.00        654,317         6.00   

Frost Bank

     1,507,550         13.83        435,948         4.00        653,922         6.00   

Leverage Ratio

               

Cullen/Frost

     1,591,436         8.82        721,670         4.00        902,088         5.00   

Frost Bank

     1,507,550         8.36        721,150         4.00        901,438         5.00   

December 31, 2010

               

Total Capital to Risk-Weighted Assets

               

Cullen/Frost

   $ 1,720,691         15.91   $ 865,081         8.00   $ 1,081,351         10.00

Frost Bank

     1,558,977         14.43        864,318         8.00        1,080,397         10.00   

Tier 1 Capital to Risk-Weighted Assets

               

Cullen/Frost

     1,494,375         13.82        432,540         4.00        648,811         6.00   

Frost Bank

     1,432,661         13.26        432,159         4.00        648,238         6.00   

Leverage Ratio

               

Cullen/Frost

     1,494,375         8.68        688,880         4.00        861,100         5.00   

Frost Bank

     1,432,661         8.33        688,196         4.00        860,246         5.00   

Management believes that, as of September 30, 2011, Cullen/Frost and its bank subsidiary, Frost Bank, were “well capitalized” based on the ratios presented above.

Cullen/Frost is subject to the regulatory capital requirements administered by the Federal Reserve, while Frost Bank is subject to the regulatory capital requirements administered by the Office of the Comptroller of the Currency and the Federal Deposit Insurance Corporation. Regulatory authorities can initiate certain mandatory actions if Cullen/Frost or Frost Bank fail to meet the minimum capital requirements, which could have a direct material effect on the Corporation’s financial statements. Management believes, as of September 30, 2011, that Cullen/Frost and Frost Bank meet all capital adequacy requirements to which they are subject.

Dividend Restrictions. In the ordinary course of business, Cullen/Frost is dependent upon dividends from Frost Bank to provide funds for the payment of dividends to shareholders and to provide for other cash requirements. Banking regulations may limit the amount of dividends that may be paid. Approval by regulatory authorities is required if the effect of dividends declared would cause the regulatory capital of Frost Bank to fall below specified minimum levels. Approval is also required if dividends declared exceed the net profits for that year combined with the retained net profits for the preceding two years. Under the foregoing dividend restrictions and while maintaining its “well capitalized” status, at September 30, 2011, Frost Bank could pay aggregate dividends of up to $276.4 million to Cullen/Frost without prior regulatory approval.

Trust Preferred Securities. In accordance with the applicable accounting standard related to variable interest entities, the accounts of the Corporation’s wholly owned subsidiary trust, Cullen/Frost Capital Trust II, have not been included in the Corporation’s consolidated financial statements. However, the $120.0 million in trust preferred securities issued by this subsidiary trust have been included in the Tier 1 capital of Cullen/Frost for regulatory capital purposes pursuant to guidance from the Federal Reserve. On July 21, 2010, financial regulatory reform legislation entitled the “Dodd-Frank Wall Street Reform and Consumer Protection Act” (the “Dodd-Frank Act”) was signed into law. Certain provisions of the Dodd-Frank Act will require the Corporation to deduct, over three years beginning on January 1, 2013, all trust preferred securities from the Corporation’s Tier 1 capital. Nonetheless, excluding trust preferred securities from Tier 1 capital at September 30, 2011 would not affect the Corporation’s ability to meet all capital adequacy requirements to which it is subject.

 

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Table of Contents

Note 8 - Derivative Financial Instruments

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

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

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

During 2007, the Corporation entered into three interest rate swap contracts on variable-rate loans with a total notional amount of $1.2 billion. The interest rate swap contracts were designated as hedging instruments in cash flow hedges with the objective of protecting the overall cash flows from the Corporation’s monthly interest receipts on a rolling portfolio of $1.2 billion of variable-rate loans outstanding throughout the 84-month period beginning in October 2007 and ending in October 2014 from the risk of variability of those cash flows such that the yield on the underlying loans would remain constant. As further discussed below, the Corporation terminated portions of the hedges and settled portions of the interest rate swap contracts during November 2009 and terminated the remaining portions of the hedges and settled the remaining portions of the interest rate swap contracts during November 2010. Under the initial hedge relationship, the desired constant yield was 7.559% in the case of the first contract (underlying loan pool totaling $650.0 million carrying an interest rate equal to Prime), 8.059% in the case of the second contract (underlying loan pool totaling $230.0 million carrying an interest rate equal to Prime plus a margin of 50 basis points) and 8.559% in the case of the third contract (underlying loan pool totaling $320.0 million carrying an interest rate equal to Prime plus a margin of 100 basis points). Under the swaps, the Corporation received a fixed interest rate of 7.559% and paid a variable interest rate equal to the daily Federal Reserve Statistical Release H-15 Prime Rate (Prime), with monthly settlements.

As stated above, during November 2009, the Corporation settled portions of two of the interest rate swap contracts having a total notional amount of $400.0 million and concurrently terminated the hedges related to the interest cash flows on a rolling portfolio of $400.0 million of variable rate loans. The terminated hedges had underlying loan pools totaling $300.0 million carrying an interest rate equal to Prime and $100.0 million carrying an interest rate equal to Prime plus a margin of 50 basis points. In November 2010, the Corporation settled the remaining interest rate swap contracts having a total notional amount of $800.0 million and concurrently terminated the hedges related to the interest cash flows on a rolling portfolio of $800.0 million of variable rate loans. The terminated hedges had underlying loan pools totaling $350.0 million carrying an interest rate equal to Prime, $130.0 million carrying an interest rate equal to Prime plus a margin of 50 basis points and $320.0 million carrying an interest rate equal to Prime plus a margin of 100 basis points. The deferred accumulated after-tax gain applicable to the settled interest rate contracts included in accumulated other comprehensive income totaled $74.6 million at September 30, 2011. The deferred gain will be reclassified into earnings through October 2014 when the formerly hedged transactions impact future earnings.

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

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

 

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Table of Contents

The notional amounts and estimated fair values of interest rate derivative contracts outstanding at September 30, 2011 and December 31, 2010 are presented in the following table. The Corporation obtains dealer quotations to value its interest rate derivative contracts designated as hedges of cash flows, while the fair values of other interest rate derivative contracts are estimated utilizing internal valuation models with observable market data inputs.

 

     September 30, 2011     December 31, 2010  
     Notional
Amount
     Estimated
Fair Value
    Notional
Amount
     Estimated
Fair Value
 

Interest rate derivatives designated as hedges of fair value:

          

Commercial loan/lease interest rate swaps

   $ 81,989       $ (8,805   $ 104,088       $ (8,350

Interest rate derivatives designated as hedges of cash flows:

          

Interest rate swap on junior subordinated deferrable interest debentures

     120,000         (9,137     120,000         (9,895

Non-hedging interest rate derivatives:

          

Commercial loan/lease interest rate swaps

     579,750         61,127        593,792         44,335   

Commercial loan/lease interest rate swaps

     579,750         (61,410     593,792         (44,666

Commercial loan/lease interest rate caps

     20,000         66        20,000         388   

Commercial loan/lease interest rate caps

     20,000         (66     20,000         (388

The weighted-average rates paid and received for interest rate swaps outstanding at September 30, 2011 were as follows:

 

     Weighted-Average  
     Interest
Rate
Paid
    Interest
Rate
Received
 

Interest rate swaps:

    

Fair value hedge commercial loan/lease interest rate swaps

     4.46     0.23

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

     5.47        1.88   

Non-hedging interest rate swaps

     1.85        5.08   

Non-hedging interest rate swaps

     5.08        1.85   

The weighted-average strike rate for outstanding interest rate caps was 3.10% at September 30, 2011.

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

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

 

       September 30, 2011     December 31, 2010  
      Notional
Units
     Notional
Amount
     Estimated
Fair Value
    Notional
Amount
     Estimated
Fair Value
 

Non-hedging commodity swaps:

             

Oil

     Barrels         525       $ 6,947        321       $ 2,502   

Oil

     Barrels         525         (6,829     321         (2,428

Natural gas

     MMBTUs         3,105         2,816        510         195   

Natural gas

     MMBTUs         3,105         (2,724     510         (174

Non-hedging commodity options:

             

Oil

     Barrels         2,639         21,605        1,288         7,706   

Oil

     Barrels         2,639         (21,605     1,288         (7,706

Natural gas

     MMBTUs         1,440         1,549        3,820         3,774   

Natural gas

     MMBTUs         1,440         (1,549     3,820         (3,774

 

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Table of Contents

Foreign Currency Derivatives. The Corporation enters into foreign currency forward contracts that are not designated as hedging instruments primarily to accommodate the business needs of its customers. Upon the origination of a foreign currency denominated transaction with a customer, the Corporation simultaneously enters into an offsetting contract with a third party to negate the exposure to fluctuations in foreign currency exchange rates. The Corporation also utilizes foreign currency forward contracts that are not designated as hedging instruments to mitigate the economic effect of fluctuations in foreign currency exchange rates on certain short-term, non-U.S. dollar denominated loans. The notional amounts and fair values of open foreign currency forward contracts were not significant at September 30, 2011 and December 31, 2010.

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

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

 

      Three Months Ended
September 30,
    Nine Months Ended
September 30,
 
     2011     2010     2011     2010  

Commercial loan/lease interest rate swaps:

        

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

   $ (874   $ (1,241   $ (2,848   $ (3,975

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

     (7     (21     (10     (112

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

 

     Three Months Ended
September 30,
    Nine Months Ended
September 30,
 
     2011     2010     2011     2010  

Interest rate swaps/caps/floors on variable-rate loans:

        

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

   $ 9,345      $ 11,129      $ 28,035      $ 33,099   

Amount of gain (loss) recognized in other comprehensive income

     —          20,944        —          71,675   

Interest rate swaps on junior subordinated deferrable interest debentures:

        

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

     1,117        1,061        3,304        3,256   

Amount of gain (loss) recognized in other comprehensive income

     (908     (2,612     (2,560     (8,178

No ineffectiveness related to interest rate derivatives designated as hedges of cash flows was recognized in the consolidated statements of income during the reported periods. The accumulated net after-tax gain related to effective cash flow hedges included in accumulated other comprehensive income totaled $68.9 million at September 30, 2011 and $86.6 million at December 31, 2010. The Corporation currently expects approximately $5.4 million of the net after-tax gain related to effective cash flow hedges included in accumulated other comprehensive income at September 30, 2011 will be reclassified into earnings during the remainder of 2011. This amount represents management’s best estimate given current expectations about market interest rates and volumes related to loan pools underlying the terminated cash flow hedges. Because actual market interest rates and volumes related to loan pools underlying the terminated cash flow hedges may differ from management’s expectations, there can be no assurance as to the ultimate amount that will be reclassified into earnings during 2011.

 

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Table of Contents

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

Amounts included in the consolidated statements of income related to non-hedging interest rate and commodity derivative instruments are presented in the table below.

 

      Three Months Ended
September 30,
     Nine Months Ended
September 30,
 
     2011      2010      2011     2010  

Non-hedging interest rate derivatives:

          

Other non-interest income

   $ 90       $ 410       $ 826      $ 2,004   

Other non-interest expense

     79         34         (49     112   

Non-hedging commodity derivatives:

          

Other non-interest income

     82         80         544        126   </