2014.06.30 10Q
Table of Contents

United States
Securities and Exchange Commission
Washington, D.C. 20549
Form 10-Q
ý Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
For the quarterly period ended: June 30, 2014
Or
¨ Transition Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
For the transition period from                    to
Commission file number: 001-13221
Cullen/Frost Bankers, Inc.
(Exact name of registrant as specified in its charter)
Texas
74-1751768
(State or other jurisdiction of
incorporation or organization)
(I.R.S. Employer
Identification No.)
 
 
100 W. Houston Street, San Antonio, Texas
78205
(Address of principal executive offices)
(Zip code)
(210) 220-4011
(Registrant’s telephone number, including area code)
N/A
(Former name, former address and former fiscal year, if changed since last report)
Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.     Yes  ý    No  ¨
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes  ý    No  ¨
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, 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
ý
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  ý
As of July 23, 2014 there were 62,971,193 shares of the registrant’s Common Stock, $.01 par value, outstanding.

Table of Contents

Cullen/Frost Bankers, Inc.
Quarterly Report on Form 10-Q
June 30, 2014
Table of Contents
 
Page
Item 1.
 
 
 
 
 
 
 
Item 2.
Management's Discussion and Analysis of Financial Condition and Results of Operations
Item 3.
Item 4.
 
 
 
 
Item 1.
Item 1A.
Item 2.
Item 3.
Item 4.
Item 5.
Item 6.
 
 
 

2
Table of Contents

Part I. Financial Information
Item 1. Financial Statements (Unaudited)
Cullen/Frost Bankers, Inc.
Consolidated Balance Sheets
(Dollars in thousands, except per share amounts)
 
June 30,
2014
 
December 31,
2013
Assets:
 
 
 
Cash and due from banks
$
809,582

 
$
885,121

Interest-bearing deposits
4,193,255

 
3,646,756

Federal funds sold and resell agreements
17,773

 
24,248

Total cash and cash equivalents
5,020,610

 
4,556,125

Securities held to maturity, at amortized cost
3,065,867

 
3,139,748

Securities available for sale, at estimated fair value
6,322,943

 
5,895,436

Trading account securities
15,489

 
16,398

Loans, net of unearned discounts
10,679,377

 
9,515,700

Less: Allowance for loan losses
(98,286
)
 
(92,438
)
Net loans
10,581,091

 
9,423,262

Premises and equipment, net
369,158

 
313,331

Goodwill
649,020

 
536,649

Other intangible assets, net
15,700

 
6,345

Cash surrender value of life insurance policies
170,245

 
141,108

Accrued interest receivable and other assets
313,316

 
284,537

Total assets
$
26,523,439

 
$
24,312,939

 
 
 
 
Liabilities:
 
 
 
Deposits:
 
 
 
Non-interest-bearing demand deposits
$
9,507,581

 
$
8,311,149

Interest-bearing deposits
13,009,025

 
12,377,637

Total deposits
22,516,606

 
20,688,786

Federal funds purchased and repurchase agreements
612,991

 
668,253

Junior subordinated deferrable interest debentures
137,115

 
123,712

Other long-term borrowings
100,000

 
100,000

Accrued interest payable and other liabilities
386,053

 
218,027

Total liabilities
23,752,765

 
21,798,778

 
 
 
 
Shareholders’ Equity:
 
 
 
Preferred stock, par value $0.01 per share; 10,000,000 shares authorized; 6,000,000 Series A shares ($25 liquidation preference) issued at June 30, 2014 and December 31, 2013
144,486

 
144,486

Common stock, par value $0.01 per share; 210,000,000 shares authorized; 63,632,464 shares issued at June 30, 2014 and 61,632,464 shares issued at December 31, 2013
637

 
617

Additional paid-in capital
879,580

 
724,197

Retained earnings
1,630,799

 
1,575,282

Accumulated other comprehensive income, net of tax
160,468

 
140,434

Treasury stock, at cost; 681,246 shares at June 30, 2014 and 1,066,021 shares at December 31, 2013
(45,296
)
 
(70,855
)
Total shareholders’ equity
2,770,674

 
2,514,161

Total liabilities and shareholders’ equity
$
26,523,439

 
$
24,312,939

See Notes to Consolidated Financial Statements.


3
Table of Contents

Cullen/Frost Bankers, Inc.
Consolidated Statements of Income
(Dollars in thousands, except per share amounts)
 
Three Months Ended 
 June 30,
 
Six Months Ended 
 June 30,
 
2014
 
2013
 
2014
 
2013
Interest income:
 
 
 
 
 
 
 
Loans, including fees
$
110,268

 
$
103,316

 
$
214,583

 
$
205,372

Securities:
 
 
 
 
 
 
 
Taxable
22,114

 
25,485

 
43,517

 
52,862

Tax-exempt
37,969

 
28,690

 
73,533

 
56,644

Interest-bearing deposits
2,681

 
1,498

 
5,085

 
2,851

Federal funds sold and resell agreements
23

 
29

 
43

 
51

Total interest income
173,055

 
159,018

 
336,761

 
317,780

Interest expense:
 
 
 
 
 
 
 
Deposits
2,567

 
3,882

 
5,128

 
7,890

Federal funds purchased and repurchase agreements
34

 
29

 
61

 
59

Junior subordinated deferrable interest debentures
601

 
1,690

 
1,162

 
3,363

Other long-term borrowings
224

 
236

 
446

 
474

Total interest expense
3,426

 
5,837

 
6,797

 
11,786

Net interest income
169,629

 
153,181

 
329,964

 
305,994

Provision for loan losses
4,924

 
3,575

 
11,524

 
9,575

Net interest income after provision for loan losses
164,705

 
149,606

 
318,440

 
296,419

Non-interest income:
 
 
 
 
 
 
 
Trust and investment management fees
26,748

 
22,561

 
52,159

 
44,446

Service charges on deposit accounts
20,462

 
20,044

 
40,436

 
40,088

Insurance commissions and fees
9,823

 
9,266

 
22,949

 
22,336

Interchange and debit card transaction fees
4,627

 
4,268

 
8,870

 
8,279

Other charges, commissions and fees
8,550

 
8,578

 
16,757

 
16,333

Net gain (loss) on securities transactions
2

 
6

 
2

 
11

Other
8,938

 
7,786

 
15,467

 
18,796

Total non-interest income
79,150

 
72,509

 
156,640

 
150,289

Non-interest expense:
 
 
 
 
 
 
 
Salaries and wages
70,473

 
66,502

 
140,690

 
132,967

Employee benefits
14,806

 
14,629

 
32,194

 
32,620

Net occupancy
13,733

 
12,645

 
26,686

 
24,624

Furniture and equipment
15,207

 
14,986

 
30,160

 
29,171

Deposit insurance
3,145

 
2,835

 
6,262

 
5,724

Intangible amortization
806

 
788

 
1,495

 
1,608

Other
45,800

 
37,373

 
84,424

 
78,858

Total non-interest expense
163,970

 
149,758

 
321,911

 
305,572

Income before income taxes
79,885

 
72,357

 
153,169

 
141,136

Income taxes
13,415

 
12,694

 
25,511

 
26,285

Net income
66,470

 
59,663

 
127,658

 
114,851

Preferred stock dividends
2,015

 
2,688

 
4,031

 
2,688

Net income available to common shareholders
$
64,455

 
$
56,975

 
$
123,627

 
$
112,163

 
 
 
 
 
 
 
 
Earnings per common share:
 
 
 
 
 
 
 
Basic
$
1.03

 
$
0.95

 
$
2.00

 
$
1.86

Diluted
1.02

 
0.94

 
1.99

 
1.85

See Notes to Consolidated Financial Statements.

4
Table of Contents

Cullen/Frost Bankers, Inc.
Consolidated Statements of Comprehensive Income
(Dollars in thousands)
 
Three Months Ended 
 June 30,
 
Six Months Ended 
 June 30,
 
2014
 
2013
 
2014
 
2013
Net income
$
66,470

 
$
59,663

 
$
127,658

 
$
114,851

Other comprehensive income (loss), before tax:
 
 
 
 
 
 
 
Securities available for sale and transferred securities:
 
 
 
 
 
 
 
Change in net unrealized gain/loss during the period
45,112

 
(74,025
)
 
66,543

 
(95,369
)
Change in net unrealized gain on securities transferred to held to maturity
(9,175
)
 
(9,745
)
 
(18,373
)
 
(18,204
)
Reclassification adjustment for net (gains) losses included in net income
(2
)
 
(6
)
 
(2
)
 
(11
)
Total securities available for sale and transferred securities
35,935

 
(83,776
)
 
48,168

 
(113,584
)
Defined-benefit post-retirement benefit plans:
 
 
 
 
 
 
 
Change in the net actuarial gain/loss
671

 
1,639

 
1,343

 
3,279

Derivatives:
 
 
 
 
 
 
 
Change in the accumulated gain/loss on effective cash flow hedge derivatives
—

 
(33
)
 
—

 
(33
)
Reclassification adjustments for (gains) losses included in net income:
 
 
 
 
 
 
 
Interest rate swaps on variable-rate loans
(9,345
)
 
(9,345
)
 
(18,690
)
 
(18,690
)
Interest rate swap on junior subordinated deferrable interest debentures
—

 
1,103

 
—

 
2,188

Total derivatives
(9,345
)
 
(8,275
)
 
(18,690
)
 
(16,535
)
Other comprehensive income (loss), before tax
27,261

 
(90,412
)
 
30,821

 
(126,840
)
Deferred tax expense (benefit) related to other comprehensive income
9,541

 
(31,644
)
 
10,787

 
(44,394
)
Other comprehensive income (loss), net of tax
17,720

 
(58,768
)
 
20,034

 
(82,446
)
Comprehensive income
$
84,190

 
$
895

 
$
147,692

 
$
32,405

See Notes to Consolidated Financial Statements.

5
Table of Contents

Cullen/Frost Bankers, Inc.
Consolidated Statements of Changes in Shareholders’ Equity
(Dollars in thousands, except per share amounts)
 
Six Months Ended 
 June 30,
 
2014
 
2013
Total shareholders’ equity at beginning of period
$
2,514,161

 
$
2,417,482

Net income
127,658

 
114,851

Other comprehensive income (loss)
20,034

 
(82,446
)
Stock option exercises (384,775 shares in 2014 and 662,224 shares in 2013)
20,109

 
34,189

Stock compensation expense recognized in earnings
4,696

 
4,985

Tax benefits (deficiencies) related to stock compensation
1,664

 
(73
)
Common stock issued in acquisition of WNB Bancshares (2,000,000 shares)
149,043

 
—

Issuance of preferred stock (6,000,000 shares in 2013)
—

 
144,486

Purchase of treasury stock (1,905,077 shares in 2013)
—

 
(115,200
)
Accelerated share repurchase forward contract
—

 
(28,800
)
Cash dividends – preferred stock (approximately $0.67 per share in 2014 and $0.45 per share in 2013)
(4,031
)
 
(2,688
)
Cash dividends – common stock ($1.01 per share in 2014 and $0.98 per share in 2013)
(62,660
)
 
(58,948
)
Total shareholders’ equity at end of period
$
2,770,674

 
$
2,427,838

See Notes to Consolidated Financial Statements.


6
Table of Contents

Cullen/Frost Bankers, Inc.
Consolidated Statements of Cash Flows
(Dollars in thousands)
 
Six Months Ended 
 June 30,
 
2014
 
2013
Operating Activities:
 
 
 
Net income
$
127,658

 
$
114,851

Adjustments to reconcile net income to net cash from operating activities:
 
 
 
Provision for loan losses
11,524

 
9,575

Deferred tax expense (benefit)
(4,540
)
 
(1,739
)
Accretion of loan discounts
(7,033
)
 
(5,790
)
Securities premium amortization (discount accretion), net
28,359

 
18,124

Net (gain) loss on securities transactions
(2
)
 
(11
)
Depreciation and amortization
19,457

 
19,081

Net (gain) loss on sale/write-down of assets/foreclosed assets
939

 
3,023

Stock-based compensation
4,696

 
4,985

Net tax benefit (deficiency) from stock-based compensation
12

 
(448
)
Excess tax benefits from stock-based compensation
(1,652
)
 
(375
)
Earnings on life insurance policies
(1,414
)
 
(1,699
)
Net change in:
 
 
 
Trading account securities
909

 
13,297

Accrued interest receivable and other assets
(34,937
)
 
(42,461
)
Accrued interest payable and other liabilities
(43,764
)
 
(163,670
)
Net cash from operating activities
100,212

 
(33,257
)
 
 
 
 
Investing Activities:
 
 
 
Securities held to maturity:
 
 
 
Purchases
—

 
(221,107
)
Maturities, calls and principal repayments
43,271

 
9,723

Securities available for sale:
 
 
 
Purchases
(3,303,838
)
 
(8,910,706
)
Sales
2,028

 
8,495,587

Maturities, calls and principal repayments
3,270,776

 
517,698

Net change in loans
(490,836
)
 
(26,446
)
Net cash (paid) received in acquisitions
830,656

 
—

Proceeds from sales of premises and equipment
28

 
16,301

Purchases of premises and equipment
(44,618
)
 
(18,520
)
Proceeds from sales of repossessed properties
3,410

 
4,081

Net cash from investing activities
310,877

 
(133,389
)
 
 
 
 
Financing Activities:
 
 
 
Net change in deposits
203,777

 
(419,147
)
Net change in short-term borrowings
(105,451
)
 
(11,238
)
Principal payments on long-term borrowings
—

 
(7
)
Proceeds from stock option exercises
20,109

 
34,189

Excess tax benefits from stock-based compensation
1,652

 
375

Proceeds from issuance of preferred stock
—

 
144,486

Purchase of treasury stock
—

 
(115,200
)
Accelerated share repurchase forward contract
—

 
(28,800
)
Cash dividends paid on preferred stock
(4,031
)
 
(2,688
)
Cash dividends paid on common stock
(62,660
)
 
(58,948
)
Net cash from financing activities
53,396

 
(456,978
)
 
 
 
 
Net change in cash and cash equivalents
464,485

 
(623,624
)
Cash and equivalents at beginning of period
4,556,125

 
3,524,979

Cash and equivalents at end of period
$
5,020,610

 
$
2,901,355


See Notes to Consolidated Financial Statements.

7
Table of Contents

Notes to Consolidated Financial Statements
(Table amounts in thousands, except for share and per share amounts)
Note 1 - Significant Accounting Policies
Nature of Operations. Cullen/Frost Bankers, Inc. (Cullen/Frost) is a financial holding company and a bank holding company headquartered in San Antonio, Texas that provides, through its subsidiaries, a broad array of products and services throughout numerous Texas markets. In addition to general commercial and consumer banking, other products and services offered include trust and investment management, investment banking, insurance, brokerage, leasing, 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, 2013, included in the Corporation’s Annual Report on Form 10-K filed with the SEC on February 6, 2014 (the “2013 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:
 
Six Months Ended 
 June 30,
 
2014
 
2013
Cash paid for interest
$
6,461

 
$
12,039

Cash paid for income taxes
27,188

 
32,623

Significant non-cash transactions:
 
 
 
Loans foreclosed and transferred to other real estate owned and foreclosed assets
1,622

 
2,913

Loans to facilitate the sale of other real estate owned
102

 
—

Deferred gain on sale of building and parking garage
—

 
1,120


8
Table of Contents

Note 2 - Mergers and Acquisitions
On May 30, 2014, the Corporation acquired WNB Bancshares, Inc. ("WNB"), including its subsidiary Western National Bank ("Western"), a privately-held bank holding company and bank located in the Permian Basin region of Texas. The Corporation purchased all of the outstanding shares of WNB for approximately $198.1 million. The total purchase price included $149.0 million of the Corporation’s common stock (2 million shares) and $49.1 million in cash. Western was integrated into Frost Bank as of the close of business on June 20, 2014.
The acquisition of WNB was accounted for using the acquisition method with all cash consideration funded through internal sources. The operating results of WNB are included with the Corporation’s results of operations since the date of acquisition. The total purchase price paid for the acquisition of WNB was allocated based on the estimated fair values of the assets acquired and liabilities assumed as set forth below. The purchase price allocation is preliminary and is subject to final determination and valuation of the fair value of assets acquired and liabilities assumed.
Cash and cash equivalents
$
879,735

Securities available for sale
154,227

Loans
673,004

Premises and equipment
22,912

Core deposit intangible asset
10,850

Goodwill
112,371

Other assets
33,602

Deposits
(1,624,043
)
Other borrowings
(63,592
)
Other liabilities
(945
)
 
$
198,121

The loans acquired in this transaction were recorded at fair value with no carryover of any existing allowance for loan losses. Loans that were not deemed to be credit impaired at acquisition were subsequently considered as a part of the Corporation's determination of the adequacy of the allowance for loan losses. Purchased credit-impaired loans, meaning those loans with evidence of credit quality deterioration at acquisition, were not significant. The core deposit intangible asset acquired in this transaction will be amortized using an accelerated method over a period of 10 years. Pro forma condensed consolidated results of operations assuming WNB had been acquired at the beginning of the reported periods are not presented because the effect of this acquisition was not considered significant based on the SEC significance tests.
Expenditures related to the acquisition of WNB totaled $4.8 million and $6.0 million during the three and six months ended June 30, 2014, respectively, and are reported as a component of other non-interest expense in the accompanying consolidated income statements. During the third and fourth quarters of 2013, expenditures related to the acquisition of WNB totaled $1.4 million.


9
Table of Contents

Note 3 - Securities
A summary of the amortized cost and estimated fair value of securities, excluding trading securities, is presented below.
 
June 30, 2014
 
December 31, 2013
 
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
$
248,797

 
$
18,000

 
$
—

 
$
266,797

 
$
248,592

 
$
20,139

 
$
—

 
$
268,731

Residential mortgage-backed securities
9,330

 
91

 
—

 
9,421

 
9,674

 
89

 
143

 
9,620

States and political subdivisions
2,806,390

 
20,671

 
32,285

 
2,794,776

 
2,880,482

 
7,691

 
137,861

 
2,750,312

Other
1,350

 
—

 
—

 
1,350

 
1,000

 
—

 
—

 
1,000

Total
$
3,065,867

 
$
38,762

 
$
32,285

 
$
3,072,344

 
$
3,139,748

 
$
27,919

 
$
138,004

 
$
3,029,663

Available for Sale
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
U.S. Treasury
$
2,449,708

 
$
19,080

 
$
20

 
$
2,468,768

 
$
2,522,159

 
$
18,395

 
$
—

 
$
2,540,554

U.S. Government agencies/corporations
—

 
—

 
—

 
—

 
54,024

 
—

 
44

 
53,980

Residential mortgage-backed securities
1,514,030

 
77,194

 
663

 
1,590,561

 
1,710,664

 
66,791

 
1,439

 
1,776,016

States and political subdivisions
2,153,351

 
67,502

 
251

 
2,220,602

 
1,476,316

 
20,090

 
7,492

 
1,488,914

Other
43,012

 
—

 
—

 
43,012

 
35,972

 
—

 
—

 
35,972

Total
$
6,160,101

 
$
163,776

 
$
934

 
$
6,322,943

 
$
5,799,135

 
$
105,276

 
$
8,975

 
$
5,895,436

All mortgage-backed securities included in the above table were issued by U.S. government agencies and corporations. At June 30, 2014, approximately 96.9% of the securities in the Corporation’s municipal bond portfolio were issued by political subdivisions or agencies within the State of Texas, of which approximately 69.7% are either guaranteed by the Texas Permanent School Fund, which has a “triple A” insurer financial strength rating, or secured by U.S. Treasury securities via defeasance of the debt by the issuers. 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 $2.6 billion at June 30, 2014 and $3.0 billion and December 31, 2013.
During the fourth quarter of 2012, the Corporation reclassified certain securities from available for sale to held to maturity. The securities had an aggregate fair value of $2.3 billion with an aggregate net unrealized gain of $165.7 million ($107.7 million, net of tax) on the date of the transfer. The net unamortized, unrealized gain on the transferred securities included in accumulated other comprehensive income in the accompanying balance sheet as of June 30, 2014 totaled $110.9 million ($72.1 million, net of tax). This amount will be amortized out of accumulated other comprehensive income over the remaining life of the underlying securities as an adjustment of the yield on those securities.
As of June 30, 2014, securities, with unrealized losses segregated by length of impairment, were as follows:
 
Less than 12 Months
 
More than 12 Months
 
Total
 
Estimated
Fair Value
 
Unrealized
Losses
 
Estimated
Fair Value
 
Unrealized
Losses
 
Estimated
Fair Value
 
Unrealized
Losses
Held to Maturity
 
 
 
 
 
 
 
 
 
 
 
Residential mortgage-backed securities
$
—

 
$
—

 
$
—

 
$
—

 
$
—

 
$
—

States and political subdivisions
200,820

 
828

 
1,410,468

 
31,457

 
1,611,288

 
32,285

Total
$
200,820

 
$
828

 
$
1,410,468

 
$
31,457

 
$
1,611,288

 
$
32,285

Available for Sale
 
 
 
 
 
 
 
 
 
 
 
U.S. Treasury
$
150,176

 
$
20

 
$
—

 
$
—

 
$
150,176

 
$
20

Residential mortgage-backed securities
5,384

 
12

 
17,509

 
651

 
22,893

 
663

States and political subdivisions
63,962

 
213

 
5,378

 
38

 
69,340

 
251

Total
$
219,522

 
$
245

 
$
22,887

 
$
689

 
$
242,409

 
$
934


10
Table of Contents

Declines in the fair value of held-to-maturity and available-for-sale securities below their cost that are deemed to be other than temporary are reflected in earnings as realized losses to the extent the impairment is related to credit losses. The amount of the impairment related to other factors is recognized in other comprehensive income. In estimating other-than-temporary impairment losses, management considers, among other things, (i) the length of time and the extent to which the fair value has been less than cost, (ii) the financial condition and near-term prospects of the issuer, and (iii) the intent and 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 June 30, 2014, 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 June 30, 2014, 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.
The amortized cost and estimated fair value of securities, excluding trading securities, at June 30, 2014 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
$
168,070

 
$
170,552

 
$
803,553

 
$
809,751

Due after one year through five years
463,083

 
489,871

 
1,537,991

 
1,551,000

Due after five years through ten years
155,173

 
153,605

 
1,266,080

 
1,291,383

Due after ten years
2,270,211

 
2,248,895

 
995,435

 
1,037,236

Residential mortgage-backed securities
9,330

 
9,421

 
1,514,030

 
1,590,561

Equity securities
—

 
—

 
43,012

 
43,012

Total
$
3,065,867

 
$
3,072,344

 
$
6,160,101

 
$
6,322,943

Sales of securities available for sale were as follows:
 
Three Months Ended 
 June 30,
 
Six Months Ended 
 June 30,
 
2014
 
2013
 
2014
 
2013
Proceeds from sales
$
2,028

 
$
3,997,485

 
$
2,028

 
$
8,495,587

Gross realized gains
3

 
6

 
3

 
11

Gross realized losses
(1
)
 
—

 
(1
)
 
—

Tax (expense) benefit of securities gains/losses
(1
)
 
(2
)
 
(1
)
 
(4
)
Trading account securities, at estimated fair value, were as follows:
 
June 30,
2014
 
December 31,
2013
U.S. Treasury
$
15,489

 
$
15,389

States and political subdivisions
—

 
1,009

Total
$
15,489

 
$
16,398

Net gains and losses on trading account securities were as follows:
 
Three Months Ended 
 June 30,
 
Six Months Ended 
 June 30,
 
2014
 
2013
 
2014
 
2013
Net gain on sales transactions
$
253

 
$
282

 
$
493

 
$
576

Net mark-to-market gains (losses)
—

 
(377
)
 
(3
)
 
(380
)
Net gain (loss) on trading account securities
$
253

 
$
(95
)
 
$
490

 
$
196


11
Table of Contents

Note 4 - Loans
Loans were as follows:
 
June 30,
2014
 
Percentage
of Total
 
December 31,
2013
 
Percentage
of Total
Commercial and industrial:
 
 
 
 
 
 
 
Commercial
$
5,322,752

 
49.9
 %
 
$
4,587,499

 
48.2
 %
Leases
302,081

 
2.8

 
319,577

 
3.4

Total commercial and industrial
5,624,833

 
52.7

 
4,907,076

 
51.6

Commercial real estate:
 
 
 
 
 
 
 
Commercial mortgages
2,985,184

 
28.0

 
2,800,760

 
29.4

Construction
577,446

 
5.4

 
426,639

 
4.5

Land
272,959

 
2.5

 
239,937

 
2.5

Total commercial real estate
3,835,589

 
35.9

 
3,467,336

 
36.4

Consumer real estate:
 
 
 
 
 
 
 
Home equity loans
336,890

 
3.2

 
329,853

 
3.5

Home equity lines of credit
213,109

 
2.0

 
195,132

 
2.1

1-4 family residential mortgages
35,625

 
0.3

 
32,447

 
0.3

Construction
21,506

 
0.2

 
13,123

 
0.1

Other
256,085

 
2.4

 
237,649

 
2.5

Total consumer real estate
863,215

 
8.1

 
808,204

 
8.5

Total real estate
4,698,804

 
44.0

 
4,275,540

 
44.9

Consumer and other:
 
 
 
 
 
 
 
Consumer installment
371,648

 
3.4

 
350,827

 
3.7

Other
6,581

 
0.1

 
7,289

 
0.1

Total consumer and other
378,229

 
3.5

 
358,116

 
3.8

Unearned discounts
(22,489
)
 
(0.2
)
 
(25,032
)
 
(0.3
)
Total loans
$
10,679,377

 
100.0
 %
 
$
9,515,700

 
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 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

12
Table of Contents

real estate loans versus non-owner occupied loans. At June 30, 2014, approximately 57% 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 completed 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. As of June 30, 2014, there were no concentrations of loans related to any single industry in excess of 10% of total loans other than energy loans, which totaled 14.3% of total loans.
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 June 30, 2014 or December 31, 2013.
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.

13
Table of Contents

Non-accrual loans, segregated by class of loans, were as follows:
 
June 30,
2014
 
December 31,
2013
Commercial and industrial:
 
 
 
Energy
$
525

 
$
590

Other commercial
34,139

 
26,143

Commercial real estate:
 
 
 
Buildings, land and other
21,833

 
27,035

Construction
301

 
—

Consumer real estate
2,179

 
2,207

Consumer and other
654

 
745

Total
$
59,631

 
$
56,720

As of June 30, 2014, non-accrual loans reported in the table above included $6.7 million related to loans that were restructured as “troubled debt restructurings” during 2014. 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 $355 thousand and $713 thousand for the three and six months ended June 30, 2014, compared to $591 thousand and $1.2 million for the same period in 2013.
An age analysis of past due loans (including both accruing and non-accruing loans), segregated by class of loans, as of June 30, 2014 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
$
1,808

 
$
525

 
$
2,333

 
$
1,528,313

 
$
1,530,646

 
$
—

Other commercial
17,242

 
8,951

 
26,193

 
4,067,994

 
4,094,187

 
4,048

Commercial real estate:
 
 
 
 
 
 
 
 
 
 
 
Buildings, land and other
14,201

 
11,936

 
26,137

 
3,232,006

 
3,258,143

 
1,039

Construction
301

 
—

 
301

 
577,145

 
577,446

 
—

Consumer real estate
4,305

 
2,512

 
6,817

 
856,398

 
863,215

 
2,204

Consumer and other
3,053

 
777

 
3,830

 
374,399

 
378,229

 
585

Unearned discounts
—

 
—

 
—

 
(22,489
)
 
(22,489
)
 
—

Total
$
40,910

 
$
24,701

 
$
65,611

 
$
10,613,766

 
$
10,679,377

 
$
7,876

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 collectibility 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.

14
Table of Contents

Impaired loans are set forth in the following table. No interest income was recognized on impaired loans subsequent to their classification as impaired.
 
Unpaid Contractual
Principal
Balance
 
Recorded Investment
With No
Allowance
 
Recorded Investment
With
Allowance
 
Total
Recorded
Investment
 
Related
Allowance
June 30, 2014
 
 
 
 
 
 
 
 
 
Commercial and industrial:
 
 
 
 
 
 
 
 
 
Energy
$
545

 
$
525

 
$
—

 
$
525

 
$
—

Other commercial
40,764

 
29,322

 
1,805

 
31,127

 
613

Commercial real estate:
 
 
 
 
 
 
 
 
 
Buildings, land and other
25,390

 
18,894

 
998

 
19,892

 
776

Construction
478

 
301

 
—

 
301

 
—

Consumer real estate
881

 
689

 
—

 
689

 
—

Consumer and other
299

 
252

 
—

 
252

 
—

Total
$
68,357

 
$
49,983

 
$
2,803

 
$
52,786

 
$
1,389

December 31, 2013
 
 
 
 
 
 
 
 
 
Commercial and industrial:
 
 
 
 
 
 
 
 
 
Energy
$
545

 
$
531

 
$
—

 
$
531

 
$
—

Other commercial
31,429

 
15,337

 
7,004

 
22,341

 
4,140

Commercial real estate:
 
 
 
 
 
 
 
 
 
Buildings, land and other
27,792

 
15,697

 
8,870

 
24,567

 
2,786

Construction
—

 
—

 
—

 
—

 
—

Consumer real estate
907

 
745

 
—

 
745

 
—

Consumer and other
334

 
278

 
—

 
278

 
—

Total
$
61,007

 
$
32,588

 
$
15,874

 
$
48,462

 
$
6,926

The average recorded investment in impaired loans was as follows:
 
Three Months Ended 
 June 30,
 
Six Months Ended 
 June 30,
 
2014
 
2013
 
2014

2013
Commercial and industrial:
 
 
 
 
 
 
 
Energy
$
526

 
$
—

 
$
527

 
$
356

Other commercial
25,259

 
40,331

 
24,286

 
40,489

Commercial real estate:
 
 
 
 
 
 
 
Buildings, land and other
20,460

 
37,473

 
21,829

 
37,035

Construction
307

 
1,035

 
204

 
1,057

Consumer real estate
704

 
818

 
717

 
833

Consumer and other
258

 
375

 
265

 
383

Total
$
47,514

 
$
80,032

 
$
47,828

 
$
80,153


15
Table of Contents

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, reductions in collateral and other actions intended to minimize potential losses.
Troubled debt restructurings during the six months ended June 30, 2014 and June 30, 2013 are set forth in the following table.
 
Six Months Ended 
 June 30, 2014
 
Six Months Ended 
 June 30, 2013
 
Balance at
Restructure
 
Balance at
Period-End
 
Balance at
Restructure
 
Balance at
Period-End
Commercial and industrial:
 
 
 
 
 
 
 
Other commercial
$
3,752

 
$
3,672

 
$
2,138

 
$
1,343

Commercial real estate:

 

 

 

Buildings, land and other
3,122

 
3,069

 
4,165

 
3,726

 
$
6,874

 
$
6,741

 
$
6,303

 
$
5,069

The modifications during the reported periods primarily related to extending amortization periods, converting the loans to interest only for a limited period of time, consolidating notes and/or reducing collateral or interest rates. The modifications did not significantly impact the Corporation’s determination of the allowance for loan losses. Approximately $2.9 million of commercial and industrial loans and $3.1 million of the commercial real estate loans restructured during the six months ended June 30, 2014 were related to a single loan relationship that was previously restructured during the third quarter of 2013. As of June 30, 2014, $725 thousand of loans restructured during 2013 were in excess of 90 days past due. During the six months ended June 30, 2014, the Corporation charged-off $427 thousand of commercial and industrial loans that were restructured during 2013. During the six months ended June 30, 2014, the Corporation also foreclosed upon certain commercial real estate loans that were restructured during 2013. The Corporation recognized $500 thousand of other real estate owned and no charge-offs in connection with these foreclosures. The aforementioned charge-offs, foreclosures and past due loans did not significantly impact the Corporation’s determination of the allowance for loan losses.
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.

16
Table of Contents

•
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.

17
Table of Contents

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.
 
June 30, 2014
 
December 31, 2013
 
Weighted
Average
Risk Grade
 
Loans
 
Weighted
Average
Risk Grade
 
Loans
Commercial and industrial:
 
 
 
 
 
 
 
Energy
 
 
 
 
 
 
 
Risk grades 1-8
5.18

 
$
1,498,846

 
5.37

 
$
1,106,348

Risk grade 9
9.00

 
23,819

 
9.00

 
7,726

Risk grade 10
10.00

 
1,138

 
10.00

 
245

Risk grade 11
11.00

 
6,318

 
11.00

 
500

Risk grade 12
12.00

 
525

 
12.00

 
590

Risk grade 13
13.00

 
—

 
13.00

 
—

Total energy
5.27

 
$
1,530,646

 
5.40

 
$
1,115,409

Other commercial
 
 
 
 
 
 
 
Risk grades 1-8
5.91

 
$
3,828,593

 
5.95

 
$
3,507,963

Risk grade 9
9.00

 
68,090

 
9.00

 
74,766

Risk grade 10
10.00

 
88,123

 
10.00

 
89,878

Risk grade 11
11.00

 
75,242

 
11.00

 
92,917

Risk grade 12
12.00

 
32,854

 
12.00

 
21,389

Risk grade 13
13.00

 
1,285

 
13.00

 
4,754

Total other commercial
6.19

 
$
4,094,187

 
6.27

 
$
3,791,667

Commercial real estate:
 
 
 
 
 
 
 
Buildings, land and other
 
 
 
 
 
 
 
Risk grades 1-8
6.50

 
$
3,041,659

 
6.59

 
$
2,844,665

Risk grade 9
9.00

 
116,775

 
9.00

 
65,770

Risk grade 10
10.00

 
35,763

 
10.00

 
49,881

Risk grade 11
11.00

 
42,112

 
11.00

 
53,208

Risk grade 12
12.00

 
21,058

 
12.00

 
24,387

Risk grade 13
13.00

 
776

 
13.00

 
2,786

Total commercial real estate
6.72

 
$
3,258,143

 
6.83

 
$
3,040,697

Construction
 
 
 
 
 
 
 
Risk grades 1-8
6.84

 
$
572,960

 
7.05

 
$
418,999

Risk grade 9
9.00

 
2,629

 
9.00

 
1,301

Risk grade 10
10.00

 
1,343

 
10.00

 
5,931

Risk grade 11
11.00

 
213

 
11.00

 
408

Risk grade 12
12.00

 
301

 
12.00

 
—

Risk grade 13
13.00

 
—

 
13.00

 
—

Total construction
6.86

 
$
577,446

 
7.10

 
$
426,639

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 two commercial real estate loans having

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a calculated risk grade of 10 or higher in excess of $5 million as of June 30, 2014, which totaled $14.8 million and had a weighted-average loan-to-value ratio of approximately 73.2%. 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 time frames. Such delinquency time frames 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 
 June 30,
 
Six Months Ended 
 June 30,
 
2014
 
2013
 
2014
 
2013
Commercial and industrial:
 
 
 
 
 
 
 
Energy
$
460

 
$
—

 
$
447

 
$
(900
)
Other commercial
(1,594
)
 
(2,883
)
 
(3,277
)
 
(18,510
)
Commercial real estate:
 
 
 
 
 
 
 
Buildings, land and other
(400
)
 
(244
)
 
(2,018
)
 
(29
)
Construction
275

 
116

 
315

 
230

Consumer real estate
(27
)
 
15

 
(4
)
 
(261
)
Consumer and other
(508
)
 
(768
)
 
(1,139
)
 
(1,158
)
Total
$
(1,794
)
 
$
(3,764
)
 
$
(5,676
)
 
$
(20,628
)
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 131.4 at May 31, 2014 (most recent date available) and 129.1 at December 31, 2013. 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 U.S. bank 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

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Table of Contents

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.
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 (no less than annually) 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 as a result of applying an environmental risk adjustment factor to the base historical loss allocation, (ii) the additional reserves allocated for loans to borrowers in distressed industries and (iii) the additional reserves allocated 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.
General valuation allowances also include amounts allocated for loans to borrowers in distressed industries. To determine the amount of the allocation for each loan portfolio segment, management calculates the weighted-average risk grade for all loans to borrowers in distressed industries by loan portfolio segment. A multiple is then applied to the amount by which the weighted-average risk grade for loans to borrowers in distressed industries exceeds the weighted-average risk grade for all pass-grade loans

20
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within the loan portfolio segment to derive an allocation factor for loans to borrowers in distressed industries. The amount of the allocation for each loan portfolio segment is the product of this allocation factor and the outstanding balance of pass-grade loans within the identified distressed industries that have a risk grade of 6 or higher. Management identifies potential distressed industries by analyzing industry trends related to delinquencies, classifications and charge-offs. At June 30, 2014 and December 31, 2013, certain segments of contractors were considered to be a distressed industry based on elevated levels of delinquencies, classifications and charge-offs relative to other industries within the Corporation’s loan portfolio. Furthermore, the Corporation determined, through a review of borrower financial information that, as a whole, contractors have experienced, among other things, decreased revenues, reduced backlog of work, compressed margins and little, if any, net income.
General valuation allowances also include allocations for groups of loans with similar risk characteristics that exceed certain concentration limits established by management and/or the Corporation’s board of directors. 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. Additionally, general valuation allowances are provided for loans that did not undergo a separate, independent concurrence review during the underwriting process (generally those loans under $1.0 million at origination). The Corporation’s allowance methodology for general valuation allowances also includes 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 adjustment for recoveries is based on the lower of annualized, year-to-date gross recoveries or the total gross recoveries for the preceding four quarters, adjusted, when necessary, for expected future trends in recoveries.
The following table presents details of the allowance for loan losses, segregated by loan portfolio segment.
 
Commercial
and
Industrial
 
Commercial
Real Estate
 
Consumer
Real Estate
 
Consumer
and Other
 
Unallocated
 
Total
June 30, 2014
 
 
 
 
 
 
 
 
 
 
 
Historical valuation allowances
$
37,103

 
$
14,226

 
$
2,081

 
$
10,054

 
$
—

 
$
63,464

Specific valuation allowances
613

 
776

 
—

 
—

 
—

 
1,389

General valuation allowances:
 
 
 
 
 
 
 
 
 
 
 
Environmental risk adjustment
7,363

 
3,409

 
470

 
2,497

 
—

 
13,739

Distressed industries
4,006

 
17

 
—

 
—

 
—

 
4,023

Excessive industry concentrations
1,482

 
201

 
—

 
—

 
—

 
1,683

Large relationship concentrations
1,833

 
1,247

 
—

 
—

 
—

 
3,080

Highly-leveraged credit relationships
5,752

 
1,212

 
—

 
—

 
—

 
6,964

Policy exceptions
—

 
—

 
—

 
—

 
2,829

 
2,829

Credit and collateral exceptions
—

 
—

 
—

 
—

 
2,162

 
2,162

Loans not reviewed by concurrence
2,189

 
2,303

 
2,324

 
1,170

 
—

 
7,986

Adjustment for recoveries
(4,669
)
 
(1,345
)
 
(216