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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, 2017
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, smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act.
Large accelerated filer
ý
Accelerated filer
¨
Non-accelerated filer
¨ (Do not check if a smaller reporting company)
Smaller reporting company
¨
 
 
Emerging growth company
¨
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act.    ¨
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 20, 2017 there were 64,229,805 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, 2017
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,
2017
 
December 31,
2016
Assets:
 
 
 
Cash and due from banks
$
542,475

 
$
561,838

Interest-bearing deposits
3,040,148

 
3,560,865

Federal funds sold and resell agreements
123,692

 
18,742

Total cash and cash equivalents
3,706,315

 
4,141,445

Securities held to maturity, at amortized cost
1,596,262

 
2,250,460

Securities available for sale, at estimated fair value
10,783,737

 
10,203,277

Trading account securities
27,600

 
16,703

Loans, net of unearned discounts
12,512,338

 
11,975,392

Less: Allowance for loan losses
(149,558
)
 
(153,045
)
Net loans
12,362,780

 
11,822,347

Premises and equipment, net
520,253

 
525,821

Goodwill
654,952

 
654,952

Other intangible assets, net
5,880

 
6,776

Cash surrender value of life insurance policies
178,987

 
177,884

Accrued interest receivable and other assets
369,548

 
396,654

Total assets
$
30,206,314

 
$
30,196,319

 
 
 
 
Liabilities:
 
 
 
Deposits:
 
 
 
Non-interest-bearing demand deposits
$
10,707,365

 
$
10,513,369

Interest-bearing deposits
14,906,208

 
15,298,206

Total deposits
25,613,573

 
25,811,575

Federal funds purchased and repurchase agreements
924,867

 
976,992

Junior subordinated deferrable interest debentures, net of unamortized issuance costs
136,155

 
136,127

Subordinated notes, net of unamortized issuance costs
98,473

 
99,990

Accrued interest payable and other liabilities
209,317

 
169,107

Total liabilities
26,982,385

 
27,193,791

 
 
 
 
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, 2017 and December 31, 2016
144,486

 
144,486

Common stock, par value $0.01 per share; 210,000,000 shares authorized; 64,225,827 shares issued at June 30, 2017 and 63,632,464 shares issued at December 31, 2016
642

 
637

Additional paid-in capital
948,593

 
906,732

Retained earnings
2,078,898

 
1,985,569

Accumulated other comprehensive income, net of tax
51,310

 
(24,623
)
Treasury stock, at cost; none at June 30, 2017 and 158,243 shares at December 31, 2016

 
(10,273
)
Total shareholders’ equity
3,223,929

 
3,002,528

Total liabilities and shareholders’ equity
$
30,206,314

 
$
30,196,319

See Notes to Consolidated Financial Statements.


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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,
 
2017
 
2016
 
2017
 
2016
Interest income:
 
 
 
 
 
 
 
Loans, including fees
$
131,073

 
$
113,349

 
$
253,673

 
$
225,935

Securities:
 
 
 
 
 
 
 
Taxable
23,527

 
25,531

 
48,829

 
51,505

Tax-exempt
55,435

 
50,910

 
112,382

 
101,243

Interest-bearing deposits
9,076

 
3,602

 
15,912

 
7,255

Federal funds sold and resell agreements
163

 
59

 
270

 
117

Total interest income
219,274

 
193,451

 
431,066

 
386,055

Interest expense:
 
 
 
 
 
 
 
Deposits
2,173

 
1,773

 
4,041

 
3,560

Federal funds purchased and repurchase agreements
187

 
52

 
326

 
108

Junior subordinated deferrable interest debentures
962

 
803

 
1,870

 
1,553

Other long-term borrowings
1,164

 
321

 
1,532

 
608

Total interest expense
4,486

 
2,949

 
7,769

 
5,829

Net interest income
214,788

 
190,502

 
423,297

 
380,226

Provision for loan losses
8,426

 
9,189

 
16,378

 
37,689

Net interest income after provision for loan losses
206,362

 
181,313

 
406,919

 
342,537

Non-interest income:
 
 
 
 
 
 
 
Trust and investment management fees
27,727

 
26,021

 
54,197

 
51,355

Service charges on deposit accounts
21,198

 
19,865

 
41,967

 
40,229

Insurance commissions and fees
9,728

 
9,360

 
23,549

 
24,783

Interchange and debit card transaction fees
5,692

 
5,381

 
11,266

 
10,403

Other charges, commissions and fees
9,898

 
10,069

 
19,490

 
19,122

Net gain (loss) on securities transactions
(50
)
 

 
(50
)
 
14,903

Other
6,887

 
7,321

 
14,361

 
13,365

Total non-interest income
81,080

 
78,017

 
164,780

 
174,160

Non-interest expense:
 
 
 
 
 
 
 
Salaries and wages
80,995

 
78,106

 
163,507

 
157,403

Employee benefits
18,198

 
17,712

 
39,823

 
38,017

Net occupancy
19,153

 
18,242

 
38,390

 
35,429

Furniture and equipment
18,250

 
17,978

 
36,240

 
35,495

Deposit insurance
5,570

 
4,197

 
10,485

 
7,854

Intangible amortization
438

 
619

 
896

 
1,283

Other
45,447

 
42,591

 
86,625

 
83,123

Total non-interest expense
188,051

 
179,445

 
375,966

 
358,604

Income before income taxes
99,391

 
79,885

 
195,733

 
158,093

Income taxes
13,838

 
8,378

 
25,239

 
17,770

Net income
85,553

 
71,507

 
170,494

 
140,323

Preferred stock dividends
2,015

 
2,015

 
4,031

 
4,031

Net income available to common shareholders
$
83,538

 
$
69,492

 
$
166,463

 
$
136,292

 
 
 
 
 
 
 
 
Earnings per common share:
 
 
 
 
 
 
 
Basic
$
1.30

 
$
1.12

 
$
2.59

 
$
2.19

Diluted
1.29

 
1.11

 
2.57

 
2.19

See Notes to Consolidated Financial Statements.

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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,
 
2017
 
2016
 
2017
 
2016
Net income
$
85,553

 
$
71,507

 
$
170,494

 
$
140,323

Other comprehensive income (loss), before tax:
 
 
 
 
 
 
 
Securities available for sale and transferred securities:
 
 
 
 
 
 
 
Change in net unrealized gain/loss during the period
90,390

 
165,288

 
124,201

 
287,506

Change in net unrealized gain on securities transferred to held to maturity
(3,860
)
 
(9,185
)
 
(10,146
)
 
(17,351
)
Reclassification adjustment for net (gains) losses included in net income
50

 

 
50

 
(14,903
)
Total securities available for sale and transferred securities
86,580

 
156,103

 
114,105

 
255,252

Defined-benefit post-retirement benefit plans:
 
 
 
 
 
 
 
Change in the net actuarial gain/loss

 
(862
)
 

 
(862
)
Reclassification adjustment for net amortization of actuarial gain/loss included in net income as a component of net periodic cost (benefit)
1,358

 
1,740

 
2,715

 
3,293

Total defined-benefit post-retirement benefit plans
1,358

 
878

 
2,715

 
2,431

Other comprehensive income (loss), before tax
87,938

 
156,981

 
116,820

 
257,683

Deferred tax expense (benefit) related to other comprehensive income
30,778

 
54,943

 
40,887

 
90,189

Other comprehensive income (loss), net of tax
57,160

 
102,038

 
75,933

 
167,494

Comprehensive income (loss)
$
142,713

 
$
173,545

 
$
246,427

 
$
307,817

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)
 
Six Months Ended 
 June 30,
 
2017
 
2016
Total shareholders’ equity at beginning of period
$
3,002,528

 
$
2,890,343

Net income
170,494

 
140,323

Other comprehensive income (loss)
75,933

 
167,494

Stock option exercises/stock unit conversions (752,075 shares in 2017 and 67,075 shares in 2016)
44,149

 
3,586

Stock compensation expense recognized in earnings
6,291

 
5,477

Purchase of treasury stock (469 shares in 2017)
(42
)
 

Cash dividends – preferred stock (approximately $0.67 per share in both 2017 and in 2016)
(4,031
)
 
(4,031
)
Cash dividends – common stock ($1.11 per share in 2017 and $1.07 per share in 2016)
(71,393
)
 
(66,524
)
Total shareholders’ equity at end of period
$
3,223,929

 
$
3,136,668

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)
 
Six Months Ended 
 June 30,
 
2017
 
2016
Operating Activities:
 
 
 
Net income
$
170,494

 
$
140,323

Adjustments to reconcile net income to net cash from operating activities:
 
 
 
Provision for loan losses
16,378

 
37,689

Deferred tax expense (benefit)
(4,173
)
 
(9,633
)
Accretion of loan discounts
(7,403
)
 
(8,185
)
Securities premium amortization (discount accretion), net
43,652

 
38,806

Net (gain) loss on securities transactions
50

 
(14,903
)
Depreciation and amortization
24,055

 
23,823

Net (gain) loss on sale/write-down of assets/foreclosed assets
(1,383
)
 
(596
)
Stock-based compensation
6,291

 
5,477

Net tax benefit from stock-based compensation
5,579

 
65

Earnings on life insurance policies
(1,565
)
 
(1,745
)
Net change in:
 
 
 
Trading account securities
(7,120
)
 
177

Accrued interest receivable and other assets
(20,116
)
 
(26,795
)
Accrued interest payable and other liabilities
(36,277
)
 
(4,664
)
Net cash from operating activities
188,462

 
179,839

 
 
 
 
Investing Activities:
 
 
 
Securities held to maturity:
 
 
 
Purchases

 

Sales

 
135,610

Maturities, calls and principal repayments
634,874

 
164,687

Securities available for sale:
 
 
 
Purchases
(8,825,545
)
 
(1,514,263
)
Sales
8,247,439

 
1,060,196

Maturities, calls and principal repayments
164,182

 
165,883

Proceeds from sale of loans

 
30,470

Net change in loans
(549,408
)
 
(144,192
)
Benefits received on life insurance policies
462

 
591

Proceeds from sales of premises and equipment
1,550

 
1,516

Purchases of premises and equipment
(14,481
)
 
(23,459
)
Proceeds from sales of repossessed properties
345

 
297

Net cash from investing activities
(340,582
)
 
(122,664
)
 
 
 
 
Financing Activities:
 
 
 
Net change in deposits
(198,002
)
 
(56,144
)
Net change in short-term borrowings
(52,125
)
 
(160,362
)
Proceeds from issuance of subordinated notes
98,434

 

Principal payments on subordinated notes
(100,000
)
 

Proceeds from stock option exercises
44,149

 
3,586

Purchase of treasury stock
(42
)
 

Cash dividends paid on preferred stock
(4,031
)
 
(4,031
)
Cash dividends paid on common stock
(71,393
)
 
(66,524
)
Net cash from financing activities
(283,010
)
 
(283,475
)
 
 
 
 
Net change in cash and cash equivalents
(435,130
)
 
(226,300
)
Cash and equivalents at beginning of period
4,141,445

 
3,591,523

Cash and equivalents at end of period
$
3,706,315

 
$
3,365,223


See Notes to Consolidated Financial Statements.

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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. The terms “Cullen/Frost,” “the Corporation,” “we,” “us” and “our” mean Cullen/Frost Bankers, Inc. and its subsidiaries, when appropriate. In addition to general commercial and consumer banking, other products and services offered include trust and investment management, insurance, brokerage, mutual funds, leasing, treasury management, capital markets advisory 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. All significant intercompany balances and transactions have been eliminated in consolidation. The accounting and financial reporting policies we follow 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 our 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 our consolidated financial statements, and notes thereto, for the year ended December 31, 2016, included in our Annual Report on Form 10-K filed with the SEC on February 3, 2017 (the “2016 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 and 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,
 
2017
 
2016
Cash paid for interest
$
6,666

 
$
5,770

Cash paid for income taxes
22,801

 
25,979

Significant non-cash transactions:
 
 
 
Unsettled purchases of securities
80,586

 
306,564

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

 
422

Accounting Changes, Reclassifications and Restatements. Certain items in prior financial statements have been reclassified to conform to the current presentation. As more fully described in our 2016 Form 10-K, during the third quarter of 2016, we elected to adopt the provisions of ASU 2016-09, “Compensation - Stock Compensation (Topic 718): Improvements to Employee Share-Based Payment Accounting,” in advance of the required application date of January 1, 2017. Our financial statements for the three and six months ended June 30, 2016 have been restated to reflect the adoption of ASU 2016-09 as of January 1, 2016. As a result, compared to previously reported amounts, our consolidated income statement reflects decreases in income tax expense of $28 thousand and $65 thousand for the three and six months ended June 30, 2016, respectively, and corresponding increases in net income of $28 thousand and $65 thousand for the three and six months ended June 30, 2016, respectively. The increase in net income during the six months ended June 30, 2016 resulted in a $0.01 increase in previously reported diluted earnings per share.

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Table of Contents

Note 2 - Securities
Securities. A summary of the amortized cost and estimated fair value of securities, excluding trading securities, is presented below.
 
June 30, 2017
 
December 31, 2016
 
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
$

 
$

 
$

 
$

 
$
249,889

 
$
1,762

 
$

 
$
251,651

Residential mortgage-backed securities
3,992

 
32

 
24

 
4,000

 
4,511

 
39

 

 
4,550

States and political subdivisions
1,590,920

 
37,288

 
2,891

 
1,625,317

 
1,994,710

 
16,821

 
6,335

 
2,005,196

Other
1,350

 

 
2

 
1,348

 
1,350

 

 

 
1,350

Total
$
1,596,262

 
$
37,320

 
$
2,917

 
$
1,630,665

 
$
2,250,460

 
$
18,622

 
$
6,335

 
$
2,262,747

Available for Sale
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
U.S. Treasury
$
4,203,901

 
$
27,541

 
$
7,188

 
$
4,224,254

 
$
4,003,692

 
$
24,984

 
$
8,945

 
$
4,019,731

Residential mortgage-backed securities
681,364

 
25,693

 
1,436

 
705,621

 
756,072

 
30,388

 
1,293

 
785,167

States and political subdivisions
5,734,600

 
122,028

 
45,286

 
5,811,342

 
5,403,918

 
50,101

 
98,134

 
5,355,885

Other
42,520

 

 

 
42,520

 
42,494

 

 

 
42,494

Total
$
10,662,385

 
$
175,262

 
$
53,910

 
$
10,783,737

 
$
10,206,176

 
$
105,473

 
$
108,372

 
$
10,203,277

All mortgage-backed securities included in the above table were issued by U.S. government agencies and corporations. At June 30, 2017, approximately 98.1% of the securities in our municipal bond portfolio were issued by political subdivisions or agencies within the State of Texas, of which approximately 67.3% are either guaranteed by the Texas Permanent School Fund, which has a “triple A” insurer financial strength rating, or are 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 table above. 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 $3.3 billion at June 30, 2017 and $3.9 billion at December 31, 2016.
During the fourth quarter of 2012, we 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 remaining transferred securities included in accumulated other comprehensive income in the accompanying balance sheet as of June 30, 2017 totaled $17.6 million ($11.4 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.
Unrealized Losses. As of June 30, 2017, 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
$
2,191

 
$
24

 
$

 
$

 
$
2,191

 
$
24

States and political subdivisions
20,127

 
83

 
118,937

 
2,808

 
139,064

 
2,891

Other
1,348

 
2

 

 

 
1,348

 
2

Total
$
23,666

 
$
109

 
$
118,937

 
$
2,808

 
$
142,603

 
$
2,917

Available for Sale
 
 
 
 
 
 
 
 
 
 
 
U.S. Treasury
$
1,587,812

 
$
7,188

 
$

 
$

 
$
1,587,812

 
$
7,188

Residential mortgage-backed securities
67,596

 
1,204

 
5,866

 
232

 
73,462

 
1,436

States and political subdivisions
1,450,982

 
38,138

 
142,507

 
7,148

 
1,593,489

 
45,286

Total
$
3,106,390

 
$
46,530

 
$
148,373

 
$
7,380

 
$
3,254,763

 
$
53,910


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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 our ability to retain our 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 we expect to receive full value for the securities. Furthermore, as of June 30, 2017, 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 we will not have to sell any such securities before a recovery of cost. Any unrealized losses are 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, 2017, management believes the impairments detailed in the table above are temporary and no impairment loss has been realized in our consolidated income statement.
Contractual Maturities. The amortized cost and estimated fair value of securities, excluding trading securities, at June 30, 2017 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
$
329,237

 
$
334,156

 
$
57,171

 
$
57,528

Due after one year through five years
170,170

 
177,977

 
4,818,303

 
4,845,635

Due after five years through ten years
349,324

 
357,485

 
362,030

 
375,143

Due after ten years
743,539

 
757,047

 
4,700,997

 
4,757,290

Residential mortgage-backed securities
3,992

 
4,000

 
681,364

 
705,621

Equity securities

 

 
42,520

 
42,520

Total
$
1,596,262

 
$
1,630,665

 
$
10,662,385

 
$
10,783,737

Sales of Securities. As more fully discussed in our 2016 Form 10-K, during 2016, we sold certain securities issued by municipalities that, based upon our internal credit analysis, had experienced significant deterioration in creditworthiness. Some of the securities we sold were classified as held to maturity prior to their sale. Despite their classification as held to maturity, we believe the sale of these securities was merited and permissible under the applicable accounting guidelines because of the significant deterioration in the creditworthiness of the issuers.
Sales of securities held to maturity were as follows:
 
Three Months Ended 
 June 30,
 
Six Months Ended 
 June 30,
 
2017
 
2016
 
2017
 
2016
Proceeds from sales
$

 
$

 
$

 
$
135,610

Amortized cost

 

 

 
131,840

Gross realized gains

 

 

 
3,770

Gross realized losses

 

 

 

Tax (expense) benefit of securities gains/losses

 

 

 
(1,319
)
Sales of securities available for sale were as follows:
 
Three Months Ended 
 June 30,
 
Six Months Ended 
 June 30,
 
2017
 
2016
 
2017
 
2016
Proceeds from sales
$
8,247,439

 
$

 
$
8,247,439

 
$
1,060,196

Gross realized gains

 

 

 
11,133

Gross realized losses
(50
)
 

 
(50
)
 

Tax (expense) benefit of securities gains/losses
18

 

 
18

 
(3,897
)

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Table of Contents

Premiums and Discounts. Premium amortization and discount accretion included in interest income on securities was as follows:
 
Three Months Ended 
 June 30,
 
Six Months Ended 
 June 30,
 
2017
 
2016
 
2017
 
2016
Premium amortization
$
(24,119
)
 
$
(22,219
)
 
$
(48,147
)
 
$
(44,559
)
Discount accretion
2,105

 
3,138

 
4,495

 
5,753

Net (premium amortization) discount accretion
$
(22,014
)
 
$
(19,081
)
 
$
(43,652
)
 
$
(38,806
)
Trading Account Securities. Trading account securities, at estimated fair value, were as follows:
 
June 30,
2017
 
December 31,
2016
U.S. Treasury
$
17,726

 
$
16,594

States and political subdivisions
9,874

 
109

Total
$
27,600

 
$
16,703

Net gains and losses on trading account securities were as follows:
 
Three Months Ended 
 June 30,
 
Six Months Ended 
 June 30,
 
2017
 
2016
 
2017
 
2016
Net gain on sales transactions
$
293

 
$
351

 
$
604

 
$
653

Net mark-to-market gains (losses)
(56
)
 
(2
)
 
(43
)
 
(1
)
Net gain (loss) on trading account securities
$
237

 
$
349

 
$
561

 
$
652

Note 3 - Loans
Loans were as follows:
 
June 30,
2017
 
Percentage
of Total
 
December 31,
2016
 
Percentage
of Total
Commercial and industrial
$
4,604,269

 
36.8
%
 
$
4,344,000

 
36.3
%
Energy:
 
 
 
 
 
 
 
Production
1,040,506

 
8.3

 
971,767

 
8.1

Service
183,543

 
1.5

 
221,213

 
1.8

Other
185,563

 
1.5

 
193,081

 
1.7

Total energy
1,409,612

 
11.3

 
1,386,061

 
11.6

Commercial real estate:
 
 
 
 
 
 
 
Commercial mortgages
3,620,885

 
28.9

 
3,481,157

 
29.1

Construction
1,050,837

 
8.4

 
1,043,261

 
8.7

Land
322,130

 
2.6

 
311,030

 
2.6

Total commercial real estate
4,993,852

 
39.9

 
4,835,448

 
40.4

Consumer real estate:
 
 
 
 
 
 
 
Home equity loans
355,744

 
2.8

 
345,130

 
2.9

Home equity lines of credit
283,344

 
2.3

 
264,862

 
2.2

Other
351,985

 
2.8

 
326,793

 
2.7

Total consumer real estate
991,073

 
7.9

 
936,785

 
7.8

Total real estate
5,984,925

 
47.8

 
5,772,233

 
48.2

Consumer and other
513,532

 
4.1

 
473,098

 
3.9

Total loans
$
12,512,338

 
100.0
%
 
$
11,975,392

 
100.0
%
Concentrations of Credit. Most of our 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 our loan portfolio consists of commercial and industrial and commercial real estate loans. As of June 30, 2017, there were no concentrations of loans related to any single industry in excess of 10% of total loans other than energy loans, which totaled 11.3% of total loans. Unfunded commitments to extend credit and standby letters of credit issued to customers in the energy industry totaled $1.1 billion and $42.9 million, respectively, as of June 30, 2017.

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Foreign Loans. We have 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, 2017 or December 31, 2016.
Non-Accrual and Past Due Loans. Non-accrual loans, segregated by class of loans, were as follows:
 
June 30,
2017
 
December 31,
2016
Commercial and industrial
$
21,226

 
$
31,475

Energy
55,464

 
57,571

Commercial real estate:
 
 
 
Buildings, land and other
6,916

 
8,550

Construction

 

Consumer real estate
2,543

 
2,130

Consumer and other
264

 
425

Total
$
86,413

 
$
100,151

As of June 30, 2017, non-accrual loans reported in the table above included $11.4 million related to loans that were restructured as “troubled debt restructurings” during 2017. See the section captioned “Troubled Debt Restructurings” elsewhere in this note. Had non-accrual loans performed in accordance with their original contract terms, we would have recognized additional interest income, net of tax, of approximately $798 thousand and $1.6 million for the three and six months ended June 30, 2017, compared to $936 thousand and $1.8 million for three and six months ended June 30, 2016.
An age analysis of past due loans (including both accruing and non-accruing loans), segregated by class of loans, as of June 30, 2017 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
$
24,320

 
$
26,149

 
$
50,469

 
$
4,553,800

 
$
4,604,269

 
$
10,768

Energy
5,991

 
6,430

 
12,421

 
1,397,191

 
1,409,612

 
2,902

Commercial real estate:
 
 
 
 
 
 
 
 
 
 
 
Buildings, land and other
21,157

 
4,166

 
25,323

 
3,917,692

 
3,943,015

 
944

Construction

 

 

 
1,050,837

 
1,050,837

 

Consumer real estate
4,693

 
2,022

 
6,715

 
984,358

 
991,073

 
739

Consumer and other
3,508

 
740

 
4,248

 
509,284

 
513,532

 
650

Total
$
59,669

 
$
39,507

 
$
99,176

 
$
12,413,162

 
$
12,512,338

 
$
16,003

Impaired Loans. 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, 2017
 
 
 
 
 
 
 
 
 
Commercial and industrial
$
27,709

 
$
14,777

 
$
4,040

 
$
18,817

 
$
1,780

Energy
59,771

 
36,162

 
19,215

 
55,377

 
350

Commercial real estate:
 
 
 
 
 
 

 
 
Buildings, land and other
9,729

 
5,478

 

 
5,478

 

Construction

 

 

 

 

Consumer real estate
1,203

 
1,203

 

 
1,203

 

Consumer and other

 

 

 

 

Total
$
98,412

 
$
57,620

 
$
23,255

 
$
80,875

 
$
2,130


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Table of Contents

 
Unpaid Contractual
Principal
Balance
 
Recorded Investment
With No
Allowance
 
Recorded Investment
With
Allowance
 
Total
Recorded
Investment
 
Related
Allowance
December 31, 2016
 
 
 
 
 
 
 
 
 
Commercial and industrial
$
40,288

 
$
19,862

 
$
9,047

 
$
28,909

 
$
5,436

Energy
60,522

 
27,759

 
29,804

 
57,563

 
3,750

Commercial real estate:
 
 
 
 
 
 
 
 
 
Buildings, land and other
11,369

 
6,866

 

 
6,866

 

Construction

 

 

 

 

Consumer real estate
977

 
655

 

 
655

 

Consumer and other
32

 
30

 

 
30

 

Total
$
113,188

 
$
55,172

 
$
38,851

 
$
94,023

 
$
9,186

The average recorded investment in impaired loans was as follows:
 
Three Months Ended 
 June 30,
 
Six Months Ended 
 June 30,
 
2017
 
2016
 
2017

2016
Commercial and industrial
$
21,347

 
$
24,866

 
$
23,867

 
$
24,197

Energy
67,008

 
78,359

 
63,860

 
59,286

Commercial real estate:
 
 
 
 
 
 
 
Buildings, land and other
5,966

 
20,533

 
6,266

 
24,497

Construction

 
648

 

 
622

Consumer real estate
1,376

 
443

 
1,135

 
457

Consumer and other
12

 
27

 
18

 
18

Total
$
95,709

 
$
124,876

 
$
95,146

 
$
109,077

Troubled Debt Restructurings. Troubled debt restructurings during the six months ended June 30, 2017 and June 30, 2016 are set forth in the following table.
 
Six Months Ended 
 June 30, 2017
 
Six Months Ended 
 June 30, 2016
 
Balance at
Restructure
 
Balance at
Period-End
 
Balance at
Restructure
 
Balance at
Period-End
Commercial and industrial
$
784

 
$
643

 
$
510

 
$
505

Energy
12,959

 
12,458

 
62,546

 
20,795

Commercial real estate:
 
 
 
 
 
 
 
Buildings, land and other

 

 
1,456

 
1,456

Construction

 

 
243

 
224

 
$
13,743

 
$
13,101

 
$
64,755

 
$
22,980

Loan modifications are typically related to extending amortization periods, converting loans to interest only for a limited period of time, deferral of interest payments, waiver of certain covenants, consolidating notes and/or reducing collateral or interest rates. The modifications during the reported periods did not significantly impact our determination of the allowance for loan losses. As of June 30, 2017, there were no loans restructured during the last year that were in excess of 90 days past due. During the six months ended June 30, 2017, we recognized charge-offs totaling $10.0 million related to loans restructured during the third and fourth quarters of 2016. During the six months ended June 30, 2016, we recognized a charge-off of $9.5 million related to a loan restructured during the first quarter of 2016. The loan was subsequently sold with proceeds from the sale totaling $30.5 million.
Credit Quality Indicators. As part of the on-going monitoring of the credit quality of our 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.
We utilize a risk grading matrix to assign a risk grade to each of our commercial loans. Loans are graded on a scale of 1 to 14. A description of the general characteristics of the 14 risk grades is set forth in our 2016 Form 10-K. In monitoring credit quality trends in the context of assessing the appropriate level of the allowance for loan losses, we monitor portfolio credit quality by the weighted-average risk grade of each class of commercial loan. Individual relationship managers review updated financial

13

Table of Contents

information for all pass grade loans to reassess the risk grade on at least an annual basis. When a loan has a 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 risk grade of 10 or higher, a special assets officer monitors the loan on an on-going basis. The following tables present weighted-average risk grades for all commercial loans by class.
 
June 30, 2017
 
December 31, 2016
 
Weighted
Average
Risk Grade
 
Loans
 
Weighted
Average
Risk Grade
 
Loans
Commercial and industrial:
 
 
 
 
 
 
 
Risk grades 1-8
6.00

 
$
4,146,261

 
6.01

 
$
3,989,722

Risk grade 9
9.00

 
222,108

 
9.00

 
106,988

Risk grade 10
10.00

 
78,696

 
10.00

 
115,420

Risk grade 11
11.00

 
135,978

 
11.00

 
100,245

Risk grade 12
12.00

 
19,446

 
12.00

 
25,939

Risk grade 13
13.00

 
1,780

 
13.00

 
5,686

Total
6.39

 
$
4,604,269

 
6.35

 
$
4,344,000

Energy
 
 
 
 
 
 
 
Risk grades 1-8
6.32

 
$
1,024,927

 
6.34

 
$
854,688

Risk grade 9
9.00

 
43,415

 
9.00

 
78,524

Risk grade 10
10.00

 
115,913

 
10.00

 
150,872

Risk grade 11
11.00

 
169,893

 
11.00

 
244,406

Risk grade 12
12.00

 
55,114

 
12.00

 
53,821

Risk grade 13
13.00

 
350

 
13.00

 
3,750

Total
7.49

 
$
1,409,612

 
7.95

 
$
1,386,061

Commercial real estate:
 
 

 
 
 
 
Buildings, land and other
 
 
 
 
 
 
 
Risk grades 1-8
6.69

 
$
3,590,525

 
6.67

 
$
3,463,064

Risk grade 9
9.00

 
123,492

 
9.00

 
109,110

Risk grade 10
10.00

 
148,718

 
10.00

 
145,067

Risk grade 11
11.00

 
73,364

 
11.00

 
66,396

Risk grade 12
12.00

 
6,916

 
12.00

 
8,550

Risk grade 13
13.00

 

 
13.00

 

Total
6.97

 
$
3,943,015

 
6.95

 
$
3,792,187

Construction
 
 
 
 
 
 
 
Risk grades 1-8
7.03

 
$
1,019,355

 
6.97

 
$
1,023,194

Risk grade 9
9.00

 
22,632

 
9.00

 
15,829

Risk grade 10
10.00

 
5,116

 
10.00

 
2,889

Risk grade 11
11.00

 
3,734

 
11.00

 
1,349

Risk grade 12
12.00

 

 
12.00

 

Risk grade 13
13.00

 

 
13.00

 

Total
7.10

 
$
1,050,837

 
7.01

 
$
1,043,261

Net (charge-offs)/recoveries, segregated by class of loans, were as follows:
 
Three Months Ended 
 June 30,
 
Six Months Ended 
 June 30,
 
2017
 
2016
 
2017
 
2016
Commercial and industrial
$
(4,861
)
 
$
(3,966
)
 
$
(7,590
)
 
$
(5,098
)
Energy
(6,236
)
 
(16,747
)
 
(10,461
)
 
(17,758
)
Commercial real estate:
 
 
 
 
 
 
 
Buildings, land and other
460

 
481

 
502

 
542

Construction
3

 
2

 
6

 
9

Consumer real estate
111

 
74

 
207

 
173

Consumer and other
(1,401
)
 
(1,199
)
 
(2,529
)
 
(1,702
)
Total
$
(11,924
)
 
$
(21,355
)
 
$
(19,865
)
 
$
(23,834
)

14

Table of Contents

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, the components of which are more fully described in our 2016 Form 10-K, totaled 124.7 at May 31, 2017 (most recent date available) and 123.1 at December 31, 2016. 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 inherent 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. Our allowance for loan loss methodology, which is more fully described in our 2016 Form 10-K, 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. 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.
The following table presents details of the allowance for loan losses allocated to each portfolio segment as of June 30, 2017 and December 31, 2016 and detailed on the basis of the impairment evaluation methodology we used:
 
Commercial
and
Industrial
 
Energy
 
Commercial
Real Estate
 
Consumer
Real Estate
 
Consumer
and Other
 
Total
June 30, 2017
 
 
 
 
 
 
 
 
 
 
 
Historical valuation allowances
$
28,504

 
$
32,452

 
$
17,975

 
$
2,416

 
$
5,455

 
$
86,802

Specific valuation allowances
1,780

 
350

 

 

 

 
2,130

General valuation allowances
8,418

 
5,934

 
4,724

 
2,032

 
137

 
21,245

Macroeconomic valuation allowances
10,204

 
15,541

 
10,303

 
1,087

 
2,246

 
39,381

Total
$
48,906

 
$
54,277

 
$
33,002

 
$
5,535

 
$
7,838

 
$
149,558

Allocated to loans:
 
 
 
 
 
 
 
 
 
 
 
Individually evaluated
$
1,780

 
$
350

 
$

 
$

 
$

 
$
2,130

Collectively evaluated
47,126

 
53,927

 
33,002

 
5,535

 
7,838

 
147,428

Total
$
48,906

 
$
54,277

 
$
33,002

 
$
5,535

 
$
7,838

 
$
149,558

December 31, 2016
 
 
 
 
 
 
 
 
 
 
 
Historical valuation allowances
$
33,251

 
$
34,626

 
$
16,976

 
$
2,225

 
$
4,585

 
$
91,663

Specific valuation allowances
5,436

 
3,750

 

 

 

 
9,186

General valuation allowances
6,708

 
3,769

 
5,004

 
1,506

 
(144
)
 
16,843

Macroeconomic valuation allowances
7,520

 
18,508

 
8,233

 
507

 
585

 
35,353

Total
$
52,915

 
$
60,653

 
$
30,213

 
$
4,238

 
$
5,026

 
$
153,045

Allocated to loans:
 
 
 
 
 
 
 
 
 
 
 
Individually evaluated
$
5,436

 
$
3,750

 
$

 
$

 
$

 
$
9,186

Collectively evaluated
47,479

 
56,903

 
30,213

 
4,238

 
5,026

 
143,859

Total
$
52,915

 
$
60,653

 
$
30,213

 
$
4,238

 
$
5,026

 
$
153,045


15

Table of Contents

Our recorded investment in loans as of June 30, 2017 and December 31, 2016 related to each balance in the allowance for loan losses by portfolio segment and detailed on the basis of the impairment methodology we used was as follows:
 
Commercial
and
Industrial
 
Energy
 
Commercial
Real Estate
 
Consumer
Real Estate
 
Consumer
and Other
 
Total
June 30, 2017
 
 
 
 
 
 
 
 
 
 
 
Individually evaluated
$
18,817

 
$
55,377

 
$
5,478

 
$
1,203

 
$

 
$
80,875

Collectively evaluated
4,585,452

 
1,354,235

 
4,988,374

 
989,870

 
513,532

 
12,431,463

Total
$
4,604,269

 
$
1,409,612

 
$
4,993,852

 
$
991,073

 
$
513,532

 
$
12,512,338

December 31, 2016
 
 
 
 
 
 
 
 
 
 
 
Individually evaluated
$
28,909

 
$
57,563

 
$
6,866

 
$
655

 
$
30

 
$
94,023

Collectively evaluated
4,315,091

 
1,328,498

 
4,828,582

 
936,130

 
473,068

 
11,881,369

Total
$
4,344,000

 
$
1,386,061

 
$
4,835,448

 
$
936,785

 
$
473,098

 
$
11,975,392

The following table details activity in the allowance for loan losses by portfolio segment for the three and six months ended June 30, 2017 and 2016. 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
Industrial
 
Energy
 
Commercial
Real Estate
 
Consumer
Real Estate
 
Consumer
and Other
 
Total
Three months ended:
 
 
 
 
 
 
 
 
 
 
 
June 30, 2017
 
 
 
 
 
 
 
 
 
 
 
Beginning balance
$
45,583

 
$
61,793

 
$
34,009

 
$
4,823

 
$
6,848

 
$
153,056

Provision for loan losses
8,184

 
(1,280
)
 
(1,470
)
 
601

 
2,391

 
8,426

Charge-offs
(5,579
)
 
(6,317
)
 
(14
)
 
(2
)
 
(3,623
)
 
(15,535
)
Recoveries
718

 
81

 
477

 
113

 
2,222

 
3,611

Net charge-offs
(4,861
)
 
(6,236
)
 
463

 
111

 
(1,401
)
 
(11,924
)
Ending balance
$
48,906

 
$
54,277

 
$
33,002

 
$
5,535

 
$
7,838

 
$
149,558

June 30, 2016
 
 
 
 
 
 
 
 
 
 
 
Beginning balance
$
45,084

 
$
84,973

 
$
23,587

 
$
3,786

 
$
4,450

 
$
161,880

Provision for loan losses
6,460

 
(1,887
)
 
2,993

 
75

 
1,548

 
9,189

Charge-offs
(4,857
)
 
(16,749
)
 
(19
)
 
(23
)
 
(3,252
)
 
(24,900
)
Recoveries
891

 
2

 
502

 
97

 
2,053

 
3,545

Net charge-offs
(3,966
)
 
(16,747
)
 
483

 
74

 
(1,199
)
 
(21,355
)
Ending balance
$
47,578

 
$
66,339

 
$
27,063

 
$
3,935

 
$
4,799

 
$
149,714

 
 
 
 
 
 
 
 
 
 
 
 
Six months ended:
 
 
 
 
 
 
 
 
 
 
 
June 30, 2017
 
 
 
 
 
 
 
 
 
 
 
Beginning balance
$
52,915

 
$
60,653

 
$
30,213

 
$
4,238

 
$
5,026

 
$
153,045

Provision for loan losses
3,581

 
4,085

 
2,281

 
1,090

 
5,341

 
16,378

Charge-offs
(9,106
)
 
(10,595
)
 
(14
)
 
(13
)
 
(7,171
)
 
(26,899
)
Recoveries
1,516

 
134

 
522

 
220

 
4,642

 
7,034

Net charge-offs
(7,590
)
 
(10,461
)
 
508

 
207

 
(2,529
)
 
(19,865
)
Ending balance
$
48,906

 
$
54,277

 
$
33,002

 
$
5,535

 
$
7,838

 
$
149,558

June 30, 2016
 
 
 
 
 
 
 
 
 
 
 
Beginning balance
$
42,993

 
$
54,696

 
$
24,313

 
$
4,659

 
$
9,198

 
$
135,859

Provision for loan losses
9,683

 
29,401

 
2,199

 
(897
)
 
(2,697
)
 
37,689

Charge-offs
(6,718
)
 
(17,760
)
 
(47
)
 
(177
)
 
(5,976
)
 
(30,678
)
Recoveries
1,620

 
2

 
598

 
350

 
4,274

 
6,844

Net charge-offs
(5,098
)
 
(17,758
)
 
551

 
173

 
(1,702
)
 
(23,834
)
Ending balance
$
47,578

 
$
66,339

 
$
27,063

 
$
3,935

 
$
4,799

 
$
149,714


16

Table of Contents

Note 4 - Goodwill and Other Intangible Assets
Goodwill and other intangible assets are presented in the table below.
 
June 30,
2017
 
December 31,
2016
Goodwill
$
654,952

 
$
654,952

Other intangible assets:
 
 
 
Core deposits
$
4,636

 
$
5,298

Customer relationships
1,188

 
1,410

Non-compete agreements
56

 
68

 
$
5,880

 
$
6,776

The estimated aggregate future amortization expense for intangible assets remaining as of June 30, 2017 is as follows:
Remainder of 2017
$
807

2018
1,424

2019
1,167

2020
918

2021
697

Thereafter
867

 
$
5,880

Note 5 - Deposits
Deposits were as follows:
 
June 30,
2017
 
Percentage
of Total
 
December 31,
2016
 
Percentage
of Total
Non-interest-bearing demand deposits:
 
 
 
 
 
Commercial and individual
$
10,076,475

 
39.3
%
 
$
9,670,989

 
37.5
%
Correspondent banks
259,686

 
1.0

 
280,751

 
1.1

Public funds
371,204

 
1.5

 
561,629

 
2.2

Total non-interest-bearing demand deposits
10,707,365

 
41.8

 
10,513,369

 
40.8

Interest-bearing deposits:
 
 
 
 
 
 
 
Private accounts:
 
 
 
 
 
 
 
Savings and interest checking
6,349,462

 
24.8

 
6,436,065

 
24.9

Money market accounts
7,403,054

 
28.9

 
7,486,431

 
29.0

Time accounts of $100,000 or more
432,406

 
1.7

 
460,028

 
1.8

Time accounts under $100,000
327,228

 
1.3

 
338,714

 
1.3

Total private accounts
14,512,150

 
56.7

 
14,721,238

 
57.0

Public funds:
 
 
 
 
 
 
 
Savings and interest checking
299,505

 
1.2

 
446,872

 
1.7

Money market accounts
77,361

 
0.3

 
113,669

 
0.4

Time accounts of $100,000 or more
16,426

 

 
15,748

 
0.1

Time accounts under $100,000
766

 

 
679

 

Total public funds
394,058

 
1.5

 
576,968

 
2.2

Total interest-bearing deposits
14,906,208

 
58.2

 
15,298,206

 
59.2

Total deposits
$
25,613,573

 
100.0
%
 
$
25,811,575

 
100.0
%
The following table presents additional information about our deposits:
 
June 30,
2017
 
December 31,
2016
Deposits from foreign sources (primarily Mexico)
$
728,350

 
$
776,003

Deposits not covered by deposit insurance
12,708,257

 
12,889,047


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Table of Contents

Note 6 - Borrowed Funds
Subordinated Notes Payable. In March 2017, we issued $100 million of 4.50% subordinated notes that mature on March 17, 2027. The notes, which qualify as Tier 2 capital for Cullen/Frost, bear interest at the rate of 4.50% per annum, payable semi-annually on each March 17 and September 17. The notes are unsecured and subordinated in right of payment to the payment of our existing and future senior indebtedness and structurally subordinated to all existing and future indebtedness of our subsidiaries. Unamortized debt issuance costs related to these notes, totaled approximately $1.5 million at June 30, 2017. Proceeds from sale of the notes were used for general corporate purposes.
Our $100 million of 5.75% fixed-to-floating rate subordinated notes matured and were redeemed on February 15, 2017. See Note 8 - Borrowed Funds in our 2016 Form 10-K for additional information about these notes.
Note 7 - Commitments and Contingencies
Financial Instruments with Off-Balance-Sheet Risk. In the normal course of business, we enter into various transactions, which, in accordance with generally accepted accounting principles are not included in our consolidated balance sheets. We enter into these transactions to meet the financing needs of our customers. As more fully discussed in our 2016 Form 10-K, 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. We minimize our exposure to loss under these commitments by subjecting them to credit approval and monitoring procedures.
Financial instruments with off-balance-sheet risk were as follows:
 
June 30,
2017
 
December 31,
2016
Commitments to extend credit
$
7,616,002

 
$
7,476,420

Standby letters of credit
240,612

 
239,482

Deferred standby letter of credit fees
2,010

 
2,054

Lease Commitments. We lease certain office facilities and office equipment under operating leases. Rent expense for all operating leases totaled $7.5 million and $15.3 million during the three and six months ended June 30, 2017 and $7.3 million and $14.5 million during the three and six months ended June 30, 2016. There has been no significant change in our expected future minimum lease payments since December 31, 2016. See the 2016 Form 10-K for information regarding these commitments.
Litigation. We are 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 our financial statements.
Note 8 - Capital and Regulatory Matters
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.
Cullen/Frost’s and Frost Bank’s Common Equity Tier 1 capital includes common stock and related paid-in capital, net of treasury stock, and retained earnings. In connection with the adoption of the Basel III Capital Rules, we elected to opt-out of the requirement to include most components of accumulated other comprehensive income in Common Equity Tier 1. Common Equity Tier 1 for both Cullen/Frost and Frost Bank is reduced by, goodwill and other intangible assets, net of associated deferred tax liabilities, and subject to transition provisions. Frost Bank's Common Equity Tier 1 is also reduced by its equity investment in its financial subsidiary, Frost Insurance Agency (“FIA”).
Tier 1 capital includes Common Equity Tier 1 capital and additional Tier 1 capital. For Cullen/Frost, additional Tier 1 capital at June 30, 2017 and December 31, 2016 includes $144.5 million of 5.375% non-cumulative perpetual preferred stock. Frost Bank did not have any additional Tier 1 capital beyond Common Equity Tier 1 at June 30, 2017 or December 31, 2016.
Total capital includes Tier 1 capital and Tier 2 capital. Tier 2 capital for both Cullen/Frost and Frost Bank includes a permissible portion of the allowance for loan losses. Tier 2 capital for Cullen/Frost also includes $100.0 million of qualified subordinated debt at June 30, 2017 and $133.0 million of trust preferred securities at both June 30, 2017 and December 31, 2016.

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Table of Contents

The following table presents actual and required capital ratios for Cullen/Frost and Frost Bank under the Basel III Capital Rules. The minimum required capital amounts presented include the minimum required capital levels as of June 30, 2017 and December 31, 2016 based on the phase-in provisions of the Basel III Capital Rules and the minimum required capital levels as of January 1, 2019 when the Basel III Capital Rules have been fully phased-in. Capital levels required to be considered well capitalized are based upon prompt corrective action regulations, as amended to reflect the changes under the Basel III Capital Rules. See the 2016 Form 10-K for a more detailed discussion of the Basel III Capital Rules.
 
Actual
 
Minimum Capital Required - Basel III Phase-In Schedule
 
Minimum Capital Required - Basel III Fully Phased-In
 
Required to be
Considered Well
Capitalized
 
Capital
Amount
 
Ratio
 
Capital
Amount
 
Ratio
 
Capital
Amount
 
Ratio
 
Capital
Amount
 
Ratio
June 30, 2017
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Common Equity Tier 1 to Risk-Weighted Assets
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Cullen/Frost
$
2,385,585

 
12.81
%
 
$
1,070,444

 
5.75
%
 
$
1,303,367

 
7.00
%
 
$
1,210,067

 
6.50
%
Frost Bank
2,401,554

 
12.94

 
1,067,432

 
5.75

 
1,299,400

 
7.00

 
1,206,662

 
6.50

Tier 1 Capital to Risk-Weighted Assets
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Cullen/Frost
2,530,071

 
13.59

 
1,349,691

 
7.25

 
1,582,296

 
8.50

 
1,489,314

 
8.00

Frost Bank
2,401,554

 
12.94

 
1,345,892

 
7.25

 
1,577,843

 
8.50

 
1,485,123

 
8.00

Total Capital to Risk-Weighted Assets
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Cullen/Frost
2,912,629

 
15.65

 
1,722,019

 
9.25

 
1,954,601

 
10.50

 
1,861,642

 
10.00

Frost Bank
2,551,112

 
13.74

 
1,717,173

 
9.25

 
1,949,100

 
10.50

 
1,856,403

 
10.00

Leverage Ratio
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Cullen/Frost
2,530,071

 
8.61

 
1,174,957

 
4.00

 
1,174,910

 
4.00

 
1,468,696

 
5.00

Frost Bank
2,401,554

 
8.18

 
1,173,726

 
4.00

 
1,173,679

 
4.00

 
1,467,157

 
5.00

December 31, 2016
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Common Equity Tier 1 to Risk-Weighted Assets
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Cullen/Frost
$
2,239,186

 
12.52
%
 
$
916,360

 
5.125
%
 
$
1,251,425

 
7.00
%
 
$
1,162,213

 
6.50
%
Frost Bank
2,296,480

 
12.88

 
913,460

 
5.125

 
1,247,463

 
7.00

 
1,158,535

 
6.50

Tier 1 Capital to Risk-Weighted Assets
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Cullen/Frost
2,383,672

 
13.33

 
1,184,563

 
6.625

 
1,519,587

 
8.50

 
1,430,416

 
8.00

Frost Bank
2,296,480

 
12.88

 
1,180,814

 
6.625

 
1,514,776

 
8.50

 
1,425,889

 
8.00

Total Capital to Risk-Weighted Assets
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Cullen/Frost
2,669,717

 
14.93

 
1,542,168

 
8.625

 
1,877,137

 
10.50

 
1,788,020

 
10.00

Frost Bank
2,449,525

 
13.74

 
1,537,286

 
8.625

 
1,871,194

 
10.50

 
1,782,361

 
10.00

Leverage Ratio
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Cullen/Frost
2,383,672

 
8.14

 
1,171,682

 
4.00

 
1,171,573

 
4.00

 
1,464,602

 
5.00

Frost Bank
2,296,480

 
7.85

 
1,170,249

 
4.00

 
1,170,141

 
4.00

 
1,462,812

 
5.00

As of June 30, 2017, capital levels at Cullen/Frost and Frost Bank exceed all capital adequacy requirements under the Basel III Capital Rules on a fully phased-in basis. Based on the ratios presented above, capital levels as of June 30, 2017 at Cullen/Frost and Frost Bank exceed the minimum levels necessary to be considered “well capitalized.”
Cullen/Frost and Frost Bank are subject to the regulatory capital requirements administered by the Federal Reserve Board and, for Frost Bank, the Federal Deposit Insurance Corporation (“FDIC”). 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 our financial statements. Management believes, as of June 30, 2017, that Cullen/Frost and Frost Bank meet all capital adequacy requirements to which they are subject.
Stock Repurchase Plans. From time to time, our board of directors has authorized stock repurchase plans. In general, stock repurchase plans allow us to proactively manage our capital position and return excess capital to shareholders. Shares purchased under such plans also provide us with shares of common stock necessary to satisfy obligations related to stock compensation awards. On October 27, 2016, our board of directors authorized a $100.0 million stock repurchase program, allowing us to

19

Table of Contents

repurchase shares of our common stock over a two-year period from time to time at various prices in the open market or through private transactions. As of June 30, 2017, no shares have been repurchased under the plan.
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 June 30, 2017, Frost Bank could pay aggregate dividends of up to $420.6 million to Cullen/Frost without prior regulatory approval.
Under the terms of the junior subordinated deferrable interest debentures that Cullen/Frost has issued to Cullen/Frost Capital Trust II and WNB Capital Trust I, Cullen/Frost has the right at any time during the term of the debentures to defer the payment of interest at any time or from time to time for an extension period not exceeding 20 consecutive quarterly periods with respect to each extension period. In the event that we have elected to defer interest on the debentures, we may not, with certain exceptions, declare or pay any dividends or distributions on our capital stock or purchase or acquire any of our capital stock.
Under the terms of our Series A Preferred Stock, in the event that we do not declare and pay dividends on our Series A Preferred Stock for the most recent dividend period, we may not, with certain exceptions, declare or pay dividends on, or purchase, redeem or otherwise acquire, shares of our common stock or any of our securities that rank junior to our Series A Preferred Stock.
Note 9 - 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. We utilize interest rate swaps, caps and floors to mitigate exposure to interest rate risk and to facilitate the needs of our customers. Our objectives for utilizing these derivative instruments are described in our 2016 Form 10-K.
The notional amounts and estimated fair values of interest rate derivative contracts are presented in the following table. The fair values of interest rate derivative contracts are estimated utilizing internal valuation models with observable market data inputs.
 
June 30, 2017
 
December 31, 2016
 
Notional
Amount
 
Estimated
Fair Value
 
Notional
Amount
 
Estimated
Fair Value
Derivatives designated as hedges of fair value:
 
 
 
 
 
 
 
Financial institution counterparties:
 
 
 
 
 
 
 
Loan/lease interest rate swaps – assets
$
40,089

 
$
312

 
$
41,818

 
$
368

Loan/lease interest rate swaps – liabilities
14,921

 
(910
)
 
18,812

 
(1,278
)
Non-hedging interest rate derivatives:
 
 
 
 
 
 
 
Financial institution counterparties:
 
 
 
 
 
 
 
Loan/lease interest rate swaps – assets
211,908

 
2,357

 
206,745

 
2,649

Loan/lease interest rate swaps – liabilities
681,298

 
(23,602
)
 
694,965

 
(25,466
)
Loan/lease interest rate caps – assets
114,866

 
687

 
85,966

 
575

Customer counterparties:
 
 
 
 
 
 
 
Loan/lease interest rate swaps – assets
681,298

 
23,602

 
694,965

 
25,467

Loan/lease interest rate swaps – liabilities
211,908

 
(2,357
)
 
206,745

 
(2,649
)
Loan/lease interest rate caps – liabilities
114,866

 
(687
)
 
85,966

 
(575
)

20

Table of Contents

The weighted-average rates paid and received for interest rate swaps outstanding at June 30, 2017 were as follows:
 
Weighted-Average
 
Interest
Rate
Paid
 
Interest
Rate
Received
Interest rate swaps:
 
 
 
Fair value hedge loan/lease interest rate swaps
2.34
%
 
1.17
%
Non-hedging interest rate swaps – financial institution counterparties
3.99
%
 
2.77
%
Non-hedging interest rate swaps – customer counterparties
2.77
%
 
3.99
%
The weighted-average strike rate for outstanding interest rate caps was 3.07% at June 30, 2017.
Commodity Derivatives. We enter into commodity swaps and option contracts that are not designated as hedging instruments primarily to accommodate the business needs of our customers. Upon the origination of a commodity swap or option contract with a customer, we simultaneously enter into an offsetting contract with a third party financial institution to mitigate the exposure to fluctuations in commodity prices.
The notional amounts and estimated fair values of non-hedging commodity swap and option derivative positions outstanding are presented in the following table. We obtain dealer quotations and use internal valuation models with observable market data inputs to value our commodity derivative positions.
 
 
 
June 30, 2017
 
December 31, 2016
 
Notional
Units
 
Notional
Amount
 
Estimated
Fair Value
 
Notional
Amount
 
Estimated
Fair Value
Financial institution counterparties:
 
 
 
 
 
 
 
 
 
Oil – assets
Barrels
 
935

 
$
4,684

 
227

 
$
206

Oil – liabilities
Barrels
 
178

 
(153
)
 
944

 
(4,400
)
Natural gas – assets
MMBTUs
 
1,061

 
109

 

 

Natural gas – liabilities
MMBTUs
 
938

 
(85
)
 
1,299

 
(1,357
)
Customer counterparties:
 
 
 
 
 
 
 
 
 
Oil – assets
Barrels
 
178

 
163

 
944

 
4,580

Oil – liabilities
Barrels
 
935

 
(4,466
)
 
227

 
(206
)
Natural gas – assets
MMBTUs
 
938

 
87

 
1,299

 
1,393

Natural gas – liabilities
MMBTUs
 
1,061

 
(103
)
 

 

Foreign Currency Derivatives. We enter into foreign currency forward contracts that are not designated as hedging instruments primarily to accommodate the business needs of our customers. Upon the origination of a foreign currency denominated transaction with a customer, we simultaneously enter into an offsetting contract with a third party financial institution to negate the exposure to fluctuations in foreign currency exchange rates. We also utilize foreign currency forward contracts that are not designated as hedging instruments to mitigate the economic effect of fluctuations in foreign currency exchange rates on foreign currency holdings and certain short-term, non-U.S. dollar denominated loans. The notional amounts and fair values of open foreign currency forward contracts were as follows:
 
 
 
June 30, 2017
 
December 31, 2016
 
Notional
Currency
 
Notional
Amount
 
Estimated
Fair Value
 
Notional
Amount
 
Estimated
Fair Value
Financial institution counterparties:
 
 
 
 
 
 
 
 
 
Forward contracts – assets
EUR
 
497

 
$
9

 

 
$

Forward contracts – assets
GBP
 
217

 
5

 

 

Forward contracts – liabilities
EUR
 
1,194

 
(9
)
 
870

 
(9
)
Forward contracts – liabilities
CAD
 
538

 
(3
)
 
2,214

 
(21
)
Forward contracts – liabilities
GBP
 
2,434

 
(20
)
 
419

 
(3
)
Customer counterparties:
 
 
 
 
 
 
 
 
 
Forward contracts – assets
CAD
 
536

 
5

 
2,205

 
29

Forward contracts – liabilities
EUR
 
500

 
(6
)
 

 

Forward contracts – liabilities
GBP
 
219

 
(3
)
 

 


21

Table of Contents

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 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 
 June 30,
 
Six Months Ended 
 June 30,
 
2017
 
2016
 
2017
 
2016
Commercial loan/lease interest rate swaps:
 
 
 
 
 
 
 
Amount of gain (loss) included in interest income on loans
$
(198
)
 
$
(388
)
 
$
(443
)
 
$
(726
)
Amount of (gain) loss included in other non-interest expense
(2
)
 
(7
)
 
(3
)
 
(7
)
As stated above, we enter into non-hedge related derivative positions primarily to accommodate the business needs of our customers. Upon the origination of a derivative contract with a customer, we simultaneously enter into an offsetting derivative contract with a third party financial institution. We recognize immediate income based upon the difference in the bid/ask spread of the underlying transactions with our customers and the third party. Because we act only as an intermediary for our customer, subsequent changes in the fair value of the underlying derivative contracts for the most part offset each other and do not significantly impact our results of operations.
Amounts included in the consolidated statements of income related to non-hedging interest rate, commodity and foreign currency derivative instruments are presented in the table below.
 
Three Months Ended 
 June 30,
 
Six Months Ended 
 June 30,
 
2017
 
2016
 
2017
 
2016
Non-hedging interest rate derivatives:
 
 
 
 
 
 
 
Other non-interest income
$
607

 
$
979

 
$
977

 
$
1,414

Other non-interest expense
2

 

 
1

 

Non-hedging commodity derivatives:
 
 
 
 
 
 
 
Other non-interest income
104

 
13

 
156

 
145

Non-hedging foreign currency derivatives:
 
 
 
 
 
 
 
Other non-interest income
9

 
8

 
18

 
14

Counterparty Credit Risk. Our credit exposure relating to interest rate swaps, commodity swaps/options and foreign currency forward contracts with bank customers was approximately $23.5 million at June 30, 2017. This credit exposure is partly mitigated as transactions with customers are generally secured by the collateral, if any, securing the underlying transaction being hedged. Our credit exposure, net of collateral pledged, relating to interest rate swaps, commodity swaps/options and foreign currency forward contracts with upstream financial institution counterparties was approximately $8.9 million at June 30, 2017. This amount was primarily related to excess collateral we posted to counterparties. Collateral levels for upstream financial institution counterparties are monitored and adjusted as necessary. See Note 10 – Balance Sheet Offsetting and Repurchase Agreements for additional information regarding our credit exposure with upstream financial institution counterparties.
The aggregate fair value of securities we posted as collateral related to derivative contracts totaled $13.1 million at June 30, 2017. At such date, we also had $14.2 million in cash collateral on deposit with other financial institution counterparties.

22

Table of Contents

Note 10 - Balance Sheet Offsetting and Repurchase Agreements
Balance Sheet Offsetting. Certain financial instruments, including resell and repurchase agreements and derivatives, may be eligible for offset in the consolidated balance sheet and/or subject to master netting arrangements or similar agreements. Our derivative transactions with upstream financial institution counterparties are generally executed under International Swaps and Derivative Association (“ISDA”) master agreements which include “right of set-off” provisions. In such cases there is generally a legally enforceable right to offset recognized amounts and there may be an intention to settle such amounts on a net basis. Nonetheless, we do not generally offset such financial instruments for financial reporting purposes.
Information about financial instruments that are eligible for offset in the consolidated balance sheet as of June 30, 2017 is presented in the following tables.
 
Gross Amount
Recognized
 
Gross Amount
Offset
 
Net Amount
Recognized
June 30, 2017
 
 
 
 
 
Financial assets:
 
 
 
 
 
Derivatives:
 
 
 
 
 
Loan/lease interest rate swaps and caps
$
3,356

 
$

 
$
3,356

Commodity swaps and options
4,793

 

 
4,793

Foreign currency forward contracts
14

 

 
14

Total derivatives
8,163

 

 
8,163

Resell agreements
9,642

 

 
9,642

Total
$
17,805

 
$

 
$
17,805

Financial liabilities:
 
 
 
 
 
Derivatives:
 
 
 
 
 
Loan/lease interest rate swaps
$
24,512

 
$

 
$
24,512

Commodity swaps and options
238

 

 
238

Foreign currency forward contracts
32

 

 
32

Total derivatives
24,782

 

 
24,782

Repurchase agreements
919,017

 

 
919,017

Total
$
943,799

 
$

 
$
943,799

 
 
 
Gross Amounts Not Offset
 
 
 
Net Amount
Recognized
 
Financial
Instruments
 
Collateral
 
Net
Amount
June 30, 2017
 
 
 
 
 
 
 
Financial assets:
 
 
 
 
 
 
 
Derivatives:
 
 
 
 
 
 
 
Counterparty A
$
413

 
$
(413
)
 
$

 
$

Counterparty B
1,896

 
(1,896
)
 

 

Counterparty C
979

 
(979
)
 

 

Counterparty D
1,610

 
(1,610
)
 

 

Other counterparties
3,265

 
(848
)
 
(2,028
)
 
389

Total derivatives
8,163

 
(5,746
)
 
(2,028
)
 
389

Resell agreements
9,642

 

 
(9,642
)
 

Total
$
17,805

 
$
(5,746
)
 
$
(11,670
)
 
$
389

Financial liabilities:
 
 
 
 
 
 
 
Derivatives:
 
 
 
 
 
 
 
Counterparty A
$
9,644

 
$
(413
)
 
$
(9,231
)
 
$

Counterparty B
3,737

 
(1,896
)
 
(1,841
)
 

Counterparty C
1,260

 
(979
)
 
(9
)
 
272

Counterparty D
8,004

 
(1,610
)
 
(6,394
)
 

Other counterparties
2,137

 
(848
)
 
(1,278
)
 
11

Total derivatives
24,782

 
(5,746
)
 
(18,753
)
 
283

Repurchase agreements
919,017

 

 
(919,017
)
 

Total
$
943,799

 
$
(5,746
)
 
$
(937,770
)
 
$
283


23

Table of Contents

Information about financial instruments that are eligible for offset in the consolidated balance sheet as of December 31, 2016 is presented in the following tables.
 
Gross Amount
Recognized
 
Gross Amount
Offset
 
Net Amount
Recognized
December 31, 2016
 
 
 
 
 
Financial assets:
 
 
 
 
 
Derivatives:
 
 
 
 
 
Loan/lease interest rate swaps and caps
$
3,592

 
$

 
$
3,592

Commodity swaps and options
206

 

 
206

Foreign currency forward contracts

 

 

Total derivatives
3,798

 

 
3,798

Resell agreements
9,642

 

 
9,642

Total
$
13,440

 
$

 
$
13,440

Financial liabilities:
 
 
 
 
 
Derivatives:
 
 
 
 
 
Loan/lease interest rate swaps
$
26,744

 
$

 
$
26,744

Commodity swaps and options
5,757

 

 
5,757

Foreign currency forward contracts
33

 

 
33

Total derivatives
32,534

 

 
32,534

Repurchase agreements
963,317

 

 
963,317

Total
$
995,851

 
$

 
$
995,851

 
 
 
Gross Amounts Not Offset
 
 
 
Net Amount
Recognized
 
Financial
Instruments
 
Collateral
 
Net
Amount
December 31, 2016
 
 
 
 
 
 
 
Financial assets:
 
 
 
 
 
 
 
Derivatives:
 
 
 
 
 
 
 
Counterparty A
$
687

 
$
(687
)
 
$

 
$

Counterparty B
223

 
(223
)
 

 

Counterparty C
158

 
(158
)
 

 

Counterparty D
1,820

 
(1,820
)
 

 

Other counterparties
910

 
(677
)
 
(64
)
 
169

Total derivatives
3,798

 
(3,565
)
 
(64
)
 
169

Resell agreements
9,642

 

 
(9,642
)
 

Total
$
13,440

 
$
(3,565
)
 
$
(9,706
)
 
$
169

Financial liabilities:
 
 
 
 
 
 
 
Derivatives:
 
 
 
 
 
 
 
Counterparty A
$
11,233

 
$
(687
)
 
$
(10,026
)
 
$
520

Counterparty B
6,867

 
(223
)
 
(6,344
)
 
300

Counterparty C
4,578

 
(158
)
 
(4,415
)
 
5

Counterparty D
7,706

 
(1,820
)
 
(5,886
)
 

Other counterparties
2,150

 
(677
)
 
(676
)
 
797

Total derivatives
32,534

 
(3,565
)
 
(27,347
)
 
1,622

Repurchase agreements
963,317

 

 
(963,317
)
 

Total
$
995,851

 
$
(3,565
)
 
$
(990,664
)
 
$
1,622


24

Table of Contents

Repurchase Agreements. We utilize securities sold under agreements to repurchase to facilitate the needs of our customers and to facilitate secured short-term funding needs. Securities sold under agreements to repurchase are stated at the amount of cash received in connection with the transaction. We monitor collateral levels on a continuous basis. We may be required to provide additional collateral based on the fair value of the underlying securities. Securities pledged as collateral under repurchase agreements are maintained with our safekeeping agents.
The remaining contractual maturity of repurchase agreements in the consolidated balance sheets as of June 30, 2017 and December 31, 2016 is presented in the following tables.
 
Remaining Contractual Maturity of the Agreements
 
Overnight and Continuous
 
Up to 30 Days
 
30-90 Days
 
Greater than 90 Days
 
Total
June 30, 2017
 
 
 
 
 
 
 
 
 
Repurchase agreements:
 
 
 
 
 
 
 
 
 
U.S. Treasury
$
842,269

 
$

 
$

 
$

 
$
842,269

Residential mortgage-backed securities
76,748

 

 

 

 
76,748

Total borrowings
$
919,017

 
$

 
$

 
$

 
$
919,017

Gross amount of recognized liabilities for repurchase agreements
 
$
919,017

Amounts related to agreements not included in offsetting disclosures above
 
$

 
 
 
 
 
 
 
 
 
 
December 31, 2016
 
 
 
 
 
 
 
 
 
Repurchase agreements:
 
 
 
 
 
 
 
 
 
U.S. Treasury
$
841,475

 
$

 
$

 
$

 
$
841,475

Residential mortgage-backed securities
121,842

 

 

 

 
121,842

Total borrowings
$
963,317

 
$

 
$

 
$

 
$
963,317

Gross amount of recognized liabilities for repurchase agreements
 
$
963,317

Amounts related to agreements not included in offsetting disclosures above
 
$

Note 11 - Stock-Based Compensation
A combined summary of activity in our active stock plans is presented in the table. Performance stock units outstanding are presented assuming attainment of the maximum payout rate as set forth by the performance criteria. The target award level for performance stock units granted in 2016 was 29,240. As of June 30, 2017, there were 1,480,137 shares remaining available for grant for future stock-based compensation awards.
 
 
Director Deferred
Stock Units
Outstanding
 
Non-Vested Stock
Awards/Stock Units
Outstanding
 
Performance Stock Units Outstanding
 
Stock Options
Outstanding
 
 
Number of Units
 
Weighted-
Average
Fair Value
at Grant
 
Number
of Shares/Units
 
Weighted-
Average
Fair Value
at Grant
 
Number of Units
 
Weighted-
Average
Fair Value
at Grant
 
Number
of Shares
 
Weighted-
Average
Exercise
Price
Balance, January 1, 2017
 
53,659

 
$
61.48

 
256,850

 
$
73.43

 
43,860

 
$
69.70

 
4,089,028

 
$
62.67

Authorized
 

 

 

 

 

 

 

 

Granted
 
5,447

 
95.37

 

 

 

 

 

 

Exercised/vested
 
(6,098
)
 
62.29

 
(1,730
)
 
76.07

 

 

 
(744,247
)
 
59.32

Forfeited/expired
 

 

 
(870
)
 
76.07

 

 

 
(33,492
)
 
69.35

Balance, June 30, 2017
 
53,008

 
$
64.87

 
254,250

 
$
73.40

 
43,860

 
$
69.70

 
3,311,289

 
$
63.36


25

Table of Contents

Shares issued in connection with stock compensation awards are issued from available treasury shares. If no treasury shares are available, new shares are issued from available authorized shares. Shares issued in connection with stock compensation awards along with other related information were as follows:
 
Three Months Ended 
 June 30,
 
Six Months Ended 
 June 30,
 
2017
 
2016
 
2017
 
2016
New shares issued from available authorized shares
310,021

 

 
593,363

 

Issued from available treasury stock

 
65,200

 
158,712

 
67,075

Total
310,021

 
65,200

 
752,075

 
67,075

 
 
 
 
 
 
 
 
Proceeds from stock option exercises
$
19,402

 
$
3,490

 
$
44,149

 
$
3,586

Stock-based compensation expense is recognized ratably over the requisite service period for all awards. For most stock option awards, the service period generally matches the vesting period. For stock options granted to certain executive officers and for non-vested stock units granted to all participants, the service period does not extend past the date the participant reaches 65 years of age. Deferred stock units granted to non-employee directors generally have immediate vesting and the related expense is fully recognized on the date of grant. For performance stock units, the service period generally matches the three-year performance period specified by the award, however, the service period does not extend past the date the participant reaches 65 years of age. Expense recognized each period is dependent upon our estimate of the number of shares that will ultimately be issued.
Stock-based compensation expense and the related income tax benefit is presented in the following table.
 
Three Months Ended 
 June 30,
 
Six Months Ended 
 June 30,
 
2017
 
2016
 
2017
 
2016
Stock options
$
1,573

 
$
2,117

 
$
3,360

 
$
4,242

Non-vested stock awards/stock units
901

 
358

 
1,934

 
715

Director deferred stock units
519

 
520

 
519

 
520

Performance stock units
195

 

 
478

 

Total
$
3,188

 
$
2,995

 
$
6,291

 
$
5,477

Income tax benefit
$
1,116

 
$
1,048

 
$
2,202

 
$
1,917

Unrecognized stock-based compensation expense at June 30, 2017 is presented in the table below. Unrecognized stock-based compensation expense related to performance stock units is presented assuming attainment of the maximum payout rate as set forth by the performance criteria.
Stock options
$
8,694

Non-vested stock awards/stock units
8,413

Performance stock units
2,579

Total
$
19,686


26

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Note 12 - Earnings Per Common Share
Earnings per common share is computed using the two-class method as more fully described in our 2016 Form 10-K. The following table presents a reconciliation of net income available to common shareholders, net earnings allocated to common stock and the number of shares used in the calculation of basic and diluted earnings per common share.
 
Three Months Ended 
 June 30,
 
Six Months Ended 
 June 30,
 
2017
 
2016
 
2017
 
2016
Net income
$
85,553

 
$
71,507

 
$
170,494

 
$
140,323

Less: Preferred stock dividends
2,015

 
2,015

 
4,031

 
4,031

Net income available to common shareholders
83,538

 
69,492

 
166,463

 
136,292

Less: Earnings allocated to participating securities
436

 
252

 
871

 
487

Net earnings allocated to common stock
$
83,102

 
$
69,240

 
$
165,592

 
$
135,805

 
 
 
 
 
 
 
 
Distributed earnings allocated to common stock
$
36,545

 
$
33,463

 
$
71,020

 
$
66,285

Undistributed earnings allocated to common stock
46,557

 
35,777

 
94,572

 
69,520

Net earnings allocated to common stock
$
83,102

 
$
69,240

 
$
165,592

 
$
135,805

 
 
 
 
 
 
 
 
Weighted-average shares outstanding for basic earnings per common share
64,061,264

 
61,959,411

 
63,900,620

 
61,944,438

Dilutive effect of stock compensation
974,067

 
497,532

 
988,198

 
267,632

Weighted-average shares outstanding for diluted earnings per common share
65,035,331

 
62,456,943

 
64,888,818

 
62,212,070

Note 13 - Defined Benefit Plans
The components of the combined net periodic expense (benefit) for our defined benefit pension plans are presented in the table below.
 
Three Months Ended 
 June 30,
 
Six Months Ended 
 June 30,
 
2017
 
2016
 
2017
 
2016
Expected return on plan assets, net of expenses
$
(2,780
)
 
$
(2,889
)
 
$
(5,559
)
 
$
(5,779
)
Interest cost on projected benefit obligation
1,548

 
1,749

 
3,095

 
3,498

Net amortization and deferral
1,358

 
1,553

 
2,715

 
3,106

SERP settlement costs

 
187

 

 
187

Net periodic expense (benefit)
$
126

 
$
600

 
$
251

 
$
1,012

Our non-qualified defined benefit pension plan is not funded. No contributions to the qualified defined benefit pension plan were made during the six months ended June 30, 2017. We do not expect to make any contributions to the qualified defined benefit plan during the remainder of 2017.
Note 14 - Income Taxes
Income tax expense was as follows:
 
Three Months Ended 
 June 30,
 
Six Months Ended 
 June 30,
 
2017
 
2016
 
2017
 
2016
Current income tax expense
$
13,710

 
$
13,616

 
$
29,412

 
$
27,403

Deferred income tax expense (benefit)
128

 
(5,238
)
 
(4,173
)
 
(9,633
)
Income tax expense, as reported
$
13,838

 
$
8,378

 
$
25,239

 
$
17,770

 
 
 
 
 
 
 
 
Effective tax rate
13.9
%
 
10.5
%
 
12.9
%
 
11.2
%
Net deferred tax assets totaled $27.0 million at June 30, 2017 and $63.7 million at December 31, 2016. No valuation allowance for deferred tax assets was recorded at June 30, 2017 as management believes it is more likely than not that all of the deferred tax assets will be realized because they were supported by recoverable taxes paid in prior years. The effective income tax rates differed from the U.S. statutory rate of 35% during the comparable periods primarily due to the effect of tax-exempt income from loans, securities and life insurance policies and the income tax effects associated with stock-based compensation. There were no

27

Table of Contents

unrecognized tax benefits during any of the reported periods. Interest and/or penalties related to income taxes are reported as a component of income tax expense. Such amounts were not significant during the reported periods.
We file income tax returns in the U.S. federal jurisdiction. We are no longer subject to U.S. federal income tax examinations by tax authorities for years before 2013.
Note 15 - Other Comprehensive Income (Loss)
The before and after tax amounts allocated to each component of other comprehensive income (loss) are presented in the following table. Reclassification adjustments related to securities available for sale are included in net gain (loss) on securities transactions in the accompanying consolidated statements of income. Reclassification adjustments related to defined-benefit post-retirement benefit plans are included in the computation of net periodic pension expense (see Note 13 – Defined Benefit Plans).
 
Three Months Ended 
 June 30, 2017
 
Three Months Ended 
 June 30, 2016
 
Before Tax
Amount
 
Tax  Expense,
(Benefit)
 
Net of  Tax
Amount
 
Before Tax
Amount
 
Tax  Expense,
(Benefit)
 
Net of  Tax
Amount
Securities available for sale and transferred securities:
 
 
 
 
 
 
 
 
 
 
 
Change in net unrealized gain/loss during the period
$
90,390

 
$
31,636

 
$
58,754

 
$
165,288

 
$
57,851

 
$
107,437

Change in net unrealized gain on securities transferred to held to maturity
(3,860
)
 
(1,351
)
 
(2,509
)
 
(9,185
)
 
(3,215
)
 
(5,970
)
Reclassification adjustment for net (gains) losses included in net income
50

 
18

 
32

 

 

 

Total securities available for sale and transferred securities
86,580

 
30,303

 
56,277

 
156,103

 
54,636

 
101,467

Defined-benefit post-retirement benefit plans:
 
 
 
 
 
 
 
 
 
 
 
Change in the net actuarial gain/loss

 

 

 
(862
)
 
(302
)
 
(560
)
Reclassification adjustment for net amortization of actuarial gain/loss included in net income as a component of net periodic cost (benefit)
1,358

 
475

 
883

 
1,740

 
609

 
1,131

Total defined-benefit post-retirement benefit plans
1,358

 
475

 
883

 
878

 
307

 
571

Total other comprehensive income (loss)
$
87,938

 
$
30,778

 
$
57,160

 
$
156,981

 
$
54,943

 
$
102,038

 
 
Six Months Ended 
 June 30, 2017
 
Six Months Ended 
 June 30, 2016
 
Before Tax
Amount
 
Tax  Expense,
(Benefit)
 
Net of  Tax
Amount
 
Before Tax
Amount
 
Tax  Expense,
(Benefit)
 
Net of  Tax
Amount
Securities available for sale and transferred securities:
 
 
 
 
 
 
 
 
 
 
 
Change in net unrealized gain/loss during the period
$
124,201

 
$
43,470

 
$
80,731

 
$
287,506

 
$
100,627

 
$
186,879

Change in net unrealized gain on securities transferred to held to maturity
(10,146
)
 
(3,551
)
 
(6,595
)
 
(17,351
)
 
(6,073
)
 
(11,278
)
Reclassification adjustment for net (gains) losses included in net income
50

 
18

 
32

 
(14,903
)
 
(5,216
)
 
(9,687
)
Total securities available for sale and transferred securities
114,105

 
39,937

 
74,168

 
255,252

 
89,338

 
165,914

Defined-benefit post-retirement benefit plans:
 
 
 
 
 
 
 
 
 
 
 
Change in the net actuarial gain/loss

 

 

 
(862
)
 
(302
)
 
(560
)
Reclassification adjustment for net amortization of actuarial gain/loss included in net income as a component of net periodic cost (benefit)
2,715

 
950

 
1,765

 
3,293

 
1,153

 
2,140

Total defined-benefit post-retirement benefit plans
2,715

 
950

 
1,765

 
2,431

 
851

 
1,580

Total other comprehensive income (loss)
$
116,820

 
$
40,887

 
$
75,933

 
$
257,683

 
$
90,189

 
$
167,494


28

Table of Contents

Activity in accumulated other comprehensive income (loss), net of tax, was as follows:
 
Securities
Available
For Sale
 
Defined
Benefit
Plans
 
Accumulated
Other
Comprehensive
Income
Balance January 1, 2017
$
16,153

 
$
(40,776
)
 
$
(24,623
)
Other comprehensive income (loss) before reclassifications
74,136

 

 
74,136

Amounts reclassified from accumulated other comprehensive income (loss)
32

 
1,765

 
1,797

Net other comprehensive income (loss) during period
74,168

 
1,765

 
75,933

Balance at June 30, 2017
$
90,321

 
$
(39,011
)
 
$
51,310

 
 
 
 
 
 
Balance January 1, 2016
$
160,611

 
$
(46,748
)
 
$
113,863

Other comprehensive income (loss) before reclassifications
175,601

 
(560
)
 
175,041

Amounts reclassified from accumulated other comprehensive income (loss)
(9,687
)
 
2,140

 
(7,547
)
Net other comprehensive income (loss) during period
165,914

 
1,580

 
167,494

Balance at June 30, 2016
$
326,525

 
$
(45,168
)
 
$
281,357

Note 16 – Operating Segments
We are managed under a matrix organizational structure whereby our two primary operating segments, Banking and Frost Wealth Advisors, overlap a regional reporting structure. See our 2016 Form 10-K for additional information regarding our operating segments. Summarized operating results by segment were as follows:
 
Banking
 
Frost  Wealth
Advisors
 
Non-Banks
 
Consolidated
Revenues from (expenses to) external customers:
 
 
 
 
 
 
 
Three months ended:
 
 
 
 
 
 
 
June 30, 2017
$
261,250

 
$
36,712

 
$
(2,094
)
 
$
295,868

June 30, 2016
237,444

 
32,225

 
(1,150
)
 
268,519

Six months ended:
 
 
 
 
 
 
 
June 30, 2017
$
520,161

 
$
71,300

 
$
(3,384
)
 
$
588,077

June 30, 2016
492,717

 
63,948

 
(2,279
)
 
554,386

Net income (loss):
 
 
 
 
 
 
 
Three months ended:
 
 
 
 
 
 
 
June 30, 2017
$
81,529

 
$
6,279

 
$
(2,255
)
 
$
85,553

June 30, 2016
68,223

 
4,860

 
(1,576
)
 
71,507

Six months ended:
 
 
 
 
 
 
 
June 30, 2017
$
162,398

 
$
11,573

 
$
(3,477
)
 
$
170,494

June 30, 2016
134,190

 
9,012

 
(2,879
)
 
140,323


29

Table of Contents

Note 17 – Fair Value Measurements
The fair value of an asset or liability is the price that would be received to sell that asset or paid to transfer that liability in an orderly transaction occurring in the principal market (or most advantageous market in the absence of a principal market) for such asset or liability. In estimating fair value, we utilize valuation techniques that are consistent with the market approach, the income approach and/or the cost approach. Such valuation techniques are consistently applied. Inputs to valuation techniques include the assumptions that market participants would use in pricing an asset or liability. ASC Topic 820 establishes a three-level fair value hierarchy for valuation inputs that gives the highest priority to quoted prices in active markets for identical assets or liabilities and the lowest priority to unobservable inputs. See our 2016 Form 10-K for additional information regarding the fair value hierarchy and a description of our valuation techniques.
Financial Assets and Financial Liabilities. The table below summarizes financial assets and financial liabilities measured at fair value on a recurring basis as of June 30, 2017 and December 31, 2016, segregated by the level of the valuation inputs within the fair value hierarchy of ASC Topic 820 utilized to measure fair value.
 
Level 1
Inputs
 
Level 2
Inputs
 
Level 3
Inputs
 
Total Fair
Value
June 30, 2017
 
 
 
 
 
 
 
Securities available for sale:
 
 
 
 
 
 
 
U.S. Treasury
$
4,224,254

 
$

 
$

 
$
4,224,254

Residential mortgage-backed securities

 
705,621

 

 
705,621

States and political subdivisions

 
5,811,342

 

 
5,811,342

Other

 
42,520

 

 
42,520

Trading account securities:
 
 
 
 
 
 
 
U.S. Treasury
17,726

 

 

 
17,726

States and political subdivisions

 
9,874

 

 
9,874

Derivative assets:
 
 
 
 
 
 
 
Interest rate swaps, caps and floors

 
26,958

 

 
26,958

Commodity swaps and options

 
5,043

 

 
5,043

Foreign currency forward contracts
19

 

 

 
19

Derivative liabilities:
 
 
 
 
 
 
 
Interest rate swaps, caps and floors

 
27,556

 

 
27,556

Commodity swaps and options

 
4,807

 

 
4,807

Foreign currency forward contracts
41

 

 

 
41

December 31, 2016
 
 
 
 
 
 
 
Securities available for sale:
 
 
 
 
 
 
 
U.S. Treasury
$
4,019,731

 
$

 
$

 
$
4,019,731

Residential mortgage-backed securities

 
785,167

 

 
785,167

States and political subdivisions

 
5,355,885

 

 
5,355,885

Other

 
42,494

 

 
42,494

Trading account securities:
 
 
 
 
 
 
 
U.S. Treasury
16,594

 

 

 
16,594

States and political subdivisions

 
109

 

 
109

Derivative assets:
 
 
 
 
 
 
 
Interest rate swaps, caps and floors

 
29,059

 

 
29,059

Commodity swaps and options

 
6,179

 

 
6,179

Foreign currency forward contracts
29

 

 

 
29

Derivative liabilities:
 
 
 
 
 
 
 
Interest rate swaps, caps and floors

 
29,968

 

 
29,968

Commodity swaps and options

 
5,963

 

 
5,963

Foreign currency forward contracts
33

 

 

 
33


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Certain financial assets and financial liabilities are measured at fair value on a nonrecurring basis; that is, the instruments are not measured at fair value on an ongoing basis but are subject to fair value adjustments in certain circumstances (for example, when there is evidence of impairment). Financial assets measured at fair value on a non-recurring basis during the reported periods include certain impaired loans reported at the fair value of the underlying collateral if repayment is expected solely from the collateral. The following table presents impaired loans that were remeasured and reported at fair value through a specific valuation allowance allocation of the allowance for loan losses based upon the fair value of the underlying collateral during the reported periods.
 
Six Months Ended 
 June 30, 2017
 
Six Months Ended 
 June 30, 2016
 
Level 2
 
Level 3
 
Level 2
 
Level 3
Carrying value of impaired loans before allocations
$

 
$
21,686

 
$

 
$
11,183

Specific valuation allowance (allocations) reversals of prior allocations

 
(561
)
 

 
(2,944
)
Fair value
$

 
$
21,125

 
$

 
$
8,239

Non-Financial Assets and Non-Financial Liabilities. We do not have any non-financial assets or non-financial liabilities measured at fair value on a recurring basis. Non-financial assets measured at fair value on a non-recurring basis during the reported periods include certain foreclosed assets which, upon initial recognition, were remeasured and reported at fair value through a charge-off to the allowance for loan losses and certain foreclosed assets which, subsequent to their initial recognition, were remeasured at fair value through a write-down included in other non-interest expense. The following table presents foreclosed assets that were remeasured and reported at fair value during the reported periods:
 
Six Months Ended 
 June 30, 2017
 
2017
 
2016
Foreclosed assets remeasured at initial recognition:
 
 
 
Carrying value of foreclosed assets prior to remeasurement
$

 
$
425

Charge-offs recognized in the allowance for loan losses

 
(3
)
Fair value
$

 
$
422

Foreclosed assets remeasured subsequent to initial recognition:
 
 
 
Carrying value of foreclosed assets prior to remeasurement
$
89

 
$

Write-downs included in other non-interest expense
(16
)
 

Fair value
$
73

 
$

Financial Instruments Reported at Amortized Cost. The estimated fair values of financial instruments that are reported at amortized cost in our consolidated balance sheets, segregated by the level of the valuation inputs within the fair value hierarchy utilized to measure fair value, were as follows:
 
June 30, 2017
 
December 31, 2016
 
Carrying
Amount
 
Estimated
Fair Value
 
Carrying
Amount
 
Estimated
Fair Value
Financial assets:
 
 
 
 
 
 
 
Level 2 inputs:
 
 
 
 
 
 
 
Cash and cash equivalents
$
3,706,315

 
$
3,706,315

 
$
4,141,445

 
$
4,141,445

Securities held to maturity
1,596,262

 
1,630,665

 
2,250,460

 
2,262,747

Cash surrender value of life insurance policies
178,987

 
178,987

 
177,884

 
177,884

Accrued interest receivable
157,151

 
157,151

 
156,714

 
156,714

Level 3 inputs:
 
 
 
 
 
 
 
Loans, net
12,362,780

 
12,384,234

 
11,822,347

 
11,903,956

Financial liabilities:
 
 
 
 
 
 
 
Level 2 inputs:
 
 
 
 
 
 
 
Deposits
25,613,573

 
25,608,770

 
25,811,575

 
25,812,039

Federal funds purchased and repurchase agreements
924,867

 
924,867

 
976,992

 
976,992

Junior subordinated deferrable interest debentures
136,155

 
137,115

 
136,127

 
137,115

Subordinated notes payable and other borrowings
98,473

 
102,280

 
99,990

 
100,000

Accrued interest payable
2,307

 
2,307

 
1,204

 
1,204


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Note 18 - Accounting Standards Updates
Information about certain recently issued accounting standards updates is presented below. Also refer to Note 21 - Accounting Standards Updates in our 2016 Form 10-K for additional information related to previously issued accounting standards updates.
Accounting Standards Update (“ASU”) 2014-09, “Revenue from Contracts with Customers (Topic 606).” ASU 2014-09 implements a common revenue standard that clarifies the principles for recognizing revenue. The core principle of ASU 2014-09 is that an entity should recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. To achieve that core principle, an entity should apply the following steps: (i) identify the contract(s) with a customer, (ii) identify the performance obligations in the contract, (iii) determine the transaction price, (iv) allocate the transaction price to the performance obligations in the contract and (v) recognize revenue when (or as) the entity satisfies a performance obligation. ASU 2014-09 was originally going to be effective for us on January 1, 2017; however, the FASB recently issued ASU 2015-14, “Revenue from Contracts with Customers (Topic 606) – Deferral of the Effective Date" which deferred the effective date of ASU 2014-09 by one year to January 1, 2018. Our revenue is comprised of net interest income on financial assets and financial liabilities, which is explicitly excluded from the scope of ASU 2014-09, and non-interest income. We expect that ASU 2014-09 will require us to change how we recognize certain recurring revenue streams within trust and investment management fees, insurance commissions and fees and other categories of non-interest income; however, we do not expect these changes to have a significant impact on our financial statements. We expect to adopt the standard in the first quarter of 2018 with a cumulative effect adjustment to opening retained earnings, if such adjustment is deemed to be significant.
ASU 2017-04, “Intangibles - Goodwill and Other (Topic 350) - Simplifying the Test for Goodwill Impairment.” ASU 2017-04 eliminates Step 2 from the goodwill impairment test which required entities to compute the implied fair value of goodwill. Under ASU 2017-04, an entity should perform its annual, or interim, goodwill impairment test by comparing the fair value of a reporting unit with its carrying amount. An entity should recognize an impairment charge for the amount by which the carrying amount exceeds the reporting unit’s fair value; however, the loss recognized should not exceed the total amount of goodwill allocated to that reporting unit. ASU 2017-04 will be effective for us on January 1, 2020, with early adoption permitted for interim or annual impairment tests beginning in 2017. ASU 2017-04 is not expected to have a significant impact on our financial statements.
ASU 2017-05, “Other Income - Gains and Losses from the Derecognition of Nonfinancial Assets (Subtopic 610-20) - Clarifying the Scope of Asset Derecognition Guidance and Accounting for Partial Sales of Nonfinancial Assets.” ASU 2017-05 clarifies the scope of Subtopic 610-20 and adds guidance for partial sales of nonfinancial assets, including partial sales of real estate. Historically, U.S. GAAP contained several different accounting models to evaluate whether the transfer of certain assets qualified for sale treatment. ASU 2017-05 reduces the number of potential accounting models that might apply and clarifies which model does apply in various circumstances. ASU 2017-05 will be effective for us on January 1, 2018 and is not expected to have a significant impact on our financial statements.
ASU 2017-08 ,“Receivables - Nonrefundable Fees and Other Costs (Subtopic 310-20) - Premium Amortization on Purchased Callable Debt Securities.” ASU 2017-08 shortens the amortization period for certain callable debt securities held at a premium to require such premiums to be amortized to the earliest call date unless applicable guidance related to certain pools of securities is applied to consider estimated prepayments. Under prior guidance, entities were generally required to amortize premiums on individual, non-pooled callable debt securities as a yield adjustment over the contractual life of the security. ASU 2017-08 does not change the accounting for callable debt securities held at a discount. ASU 2017-08 will be effective for us on January 1, 2019, with early adoption permitted. We are currently evaluating the potential impact of ASU 2017-08 on our financial statements.
ASU 2017-09, “Compensation-Stock Compensation (Topic 718)- Scope of Modification Accounting.” ASU 2017-09 clarifies when changes to the terms or conditions of a share-based payment award must be accounted for as modifications. Under ASU 2017-09, an entity will not apply modification accounting to a share-based payment award if all of the following are the same immediately before and after the change: (i) the award's fair value, (ii) the award's vesting conditions and (iii) the award's classification as an equity or liability instrument. ASU 2017-09 will be effective for us on January 1, 2018 and is not expected to have a significant impact on our financial statements.


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Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
Financial Review
Cullen/Frost Bankers, Inc.
The following discussion should be read in conjunction with our consolidated financial statements, and notes thereto, for the year ended December 31, 2016, and the other information included in the 2016 Form 10-K. Operating results for the three and six months ended June 30, 2017 are not necessarily indicative of the results for the year ending December 31, 2017 or any future period.
Dollar amounts in tables are stated in thousands, except for per share amounts.
Forward-Looking Statements and Factors that Could Affect Future Results
Certain statements contained in this Quarterly Report on Form 10-Q that are not statements of historical fact constitute forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995 (the “Act”), notwithstanding that such statements are not specifically identified as such. In addition, certain statements may be contained in our future filings with the SEC, in press releases, and in oral and written statements made by us or with our approval that are not statements of historical fact and constitute forward-looking statements within the meaning of the Act. Examples of forward-looking statements include, but are not limited to: (i) projections of revenues, expenses, income or loss, earnings or loss per share, the payment or nonpayment of dividends, capital structure and other financial items; (ii) statements of plans, objectives and expectations of Cullen/Frost or its management or Board of Directors, including those relating to products or services; (iii) statements of future economic performance; and (iv) statements of assumptions underlying such statements. Words such as “believes”, “anticipates”, “expects”, “intends”, “targeted”, “continue”, “remain”, “will”, “should”, “may” and other similar expressions are intended to identify forward-looking statements but are not the exclusive means of identifying such statements.
Forward-looking statements involve risks and uncertainties that may cause actual results to differ materially from those in such statements. Factors that could cause actual results to differ from those discussed in the forward-looking statements include, but are not limited to:
Local, regional, national and international economic conditions and the impact they may have on us and our customers and our assessment of that impact.
Volatility and disruption in national and international financial and commodity markets.
Government intervention in the U.S. financial system.
Changes in the mix of loan geographies, sectors and types or the level of non-performing assets and charge-offs.
Changes in estimates of future reserve requirements based upon the periodic review thereof under relevant regulatory and accounting requirements.
The effects of and changes in trade and monetary and fiscal policies and laws, including the interest rate policies of the Federal Reserve Board.
Inflation, interest rate, securities market and monetary fluctuations.
The effect of changes in laws and regulations (including laws and regulations concerning taxes, banking, securities and insurance) with which we and our subsidiaries must comply.
The soundness of other financial institutions.
Political instability.
Impairment of our goodwill or other intangible assets.
Acts of God or of war or terrorism.
The timely development and acceptance of new products and services and perceived overall value of these products and services by users.
Changes in consumer spending, borrowings and savings habits.
Changes in the financial performance and/or condition of our borrowers.
Technological changes.
Acquisitions and integration of acquired businesses.
Our ability to increase market share and control expenses.
Our ability to attract and retain qualified employees.
Changes in the competitive environment in our markets and among banking organizations and other financial service providers.
The effect of changes in accounting policies and practices, as may be adopted by the regulatory agencies, as well as the Public Company Accounting Oversight Board, the Financial Accounting Standards Board and other accounting standard setters.
Changes in the reliability of our vendors, internal control systems or information systems.
Changes in our liquidity position.

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Table of Contents

Changes in our organization, compensation and benefit plans.
The costs and effects of legal and regulatory developments, the resolution of legal proceedings or regulatory or other governmental inquiries, the results of regulatory examinations or reviews and the ability to obtain required regulatory approvals.
Greater than expected costs or difficulties related to the integration of new products and lines of business.
Our success at managing the risks involved in the foregoing items.
Forward-looking statements speak only as of the date on which such statements are made. We do not undertake any obligation to update any forward-looking statement to reflect events or circumstances after the date on which such statement is made, or to reflect the occurrence of unanticipated events.
Application of Critical Accounting Policies and Accounting Estimates
We follow accounting and reporting policies that conform, in all material respects, to accounting principles generally accepted in the United States and to general practices within the financial services industry. 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 amounts reported in the financial statements and accompanying notes. While we base estimates on historical experience, current information and other factors deemed to be relevant, actual results could differ from those estimates.
We consider accounting estimates to be critical to reported financial results if (i) the accounting estimate requires management to make assumptions about matters that are highly uncertain and (ii) different estimates that management reasonably could have used for the accounting estimate in the current period, or changes in the accounting estimate that are reasonably likely to occur from period to period, could have a material impact on our financial statements. Accounting policies related to the allowance for loan losses are considered to be critical as these policies involve considerable subjective judgment and estimation by management.
For additional information regarding critical accounting policies, refer to Note 1 - Summary of Significant Accounting Policies and Note 3 - Loans in the notes to consolidated financial statements and the sections captioned “Application of Critical Accounting Policies and Accounting Estimates” and “Allowance for Loan Losses” in Management’s Discussion and Analysis of Financial Condition and Results of Operations included in the 2016 Form 10-K. There have been no significant changes in our application of critical accounting policies related to the allowance for loan losses since December 31, 2016.
Overview
A discussion of our results of operations is presented below. Certain reclassifications have been made to make prior periods comparable. Taxable-equivalent adjustments are the result of increasing income from tax-free loans and investments by an amount equal to the taxes that would be paid if the income were fully taxable based on a 35% federal tax rate, thus making tax-exempt yields comparable to taxable asset yields.

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Table of Contents

Results of Operations
Net income available to common shareholders totaled $83.5 million, or $1.29 per diluted common share and $166.5 million, or $2.57 per diluted common share, for the three and six months ended June 30, 2017 compared to $69.5 million, or $1.11 per diluted common share, and $136.3 million, or $2.19 per diluted common share, for the three and six months ended June 30, 2016.
Selected data for the comparable periods was as follows:
 
Three Months Ended 
 June 30,
 
Six Months Ended 
 June 30,
 
2017
 
2016
 
2017
 
2016
Taxable-equivalent net interest income
$
258,020

 
$
230,158

 
$
510,413

 
$
459,331

Taxable-equivalent adjustment
43,232

 
39,656

 
87,116

 
79,105

Net interest income
214,788

 
190,502

 
423,297

 
380,226

Provision for loan losses
8,426

 
9,189

 
16,378

 
37,689

Net interest income after provision for loan losses
206,362

 
181,313

 
406,919

 
342,537

Non-interest income
81,080

 
78,017

 
164,780

 
174,160

Non-interest expense
188,051

 
179,445

 
375,966

 
358,604

Income before income taxes
99,391

 
79,885

 
195,733

 
158,093

Income taxes
13,838

 
8,378

 
25,239

 
17,770

Net income
85,553

 
71,507

 
170,494

 
140,323

Preferred stock dividends
2,015

 
2,015

 
4,031

 
4,031

Net income available to common shareholders
$
83,538

 
$
69,492

 
$
166,463

 
$
136,292

Earnings per common share – basic
$
1.30

 
$
1.12

 
$
2.59

 
$
2.19

Earnings per common share – diluted
1.29

 
1.11

 
2.57

 
2.19

Dividends per common share
0.57

 
0.54

 
1.11

 
1.07

Return on average assets
1.11
%
 
0.99
%
 
1.11
%
 
0.97
%
Return on average common equity
11.07

 
9.70

 
11.31

 
9.63

Average shareholders’ equity to average assets
10.53

 
10.71

 
10.33

 
10.62

Net income available to common shareholders increased $14.0 million, or 20.2% for the three months ended June 30, 2017 and increased $30.2 million, or 22.1% for the six months ended June 30, 2017 compared to the same periods in 2016. The increase during the three months ended June 30, 2017 was primarily the result of a $24.3 million increase in net interest income and a $3.1 million increase in non-interest income partly offset by an $8.6 million increase in non-interest expense and a $5.5 million increase in income tax expense. The increase during the six months ended June 30, 2017 was primarily the result of a $43.1 million increase in net interest income and a $21.3 million decrease in the provision for loan losses partly offset by a $17.4 million increase in non-interest expense, a $9.4 million decrease in non-interest income and a $7.5 million increase in income tax expense.
Details of the changes in the various components of net income are further discussed below.
Net Interest Income
Net interest income is the difference between interest income on earning assets, such as loans and securities, and interest expense on liabilities, such as deposits and borrowings, which are used to fund those assets. Net interest income is our largest source of revenue, representing 72.0% of total revenue during the first six months of 2017. Net interest margin is the ratio of taxable-equivalent net interest income to average earning assets for the period. The level of interest rates and the volume and mix of earning assets and interest-bearing liabilities impact net interest income and net interest margin.
The Federal Reserve influences the general market rates of interest, including the deposit and loan rates offered by many financial institutions. Our loan portfolio is significantly affected by changes in the prime interest rate. The prime interest rate, which is the rate offered on loans to borrowers with strong credit, remained at 3.50% during most of 2016. In December 2016, the prime rate increased 25 basis points to 3.75% and remained at that level until March 2017, when the prime rated increased another 25 basis points to 4.00%. In June 2017, the prime rate increased an additional 25 basis points to 4.25%. Our loan portfolio is also impacted by changes in the London Interbank Offered Rate (LIBOR). At June 30, 2017, the one-month and three-month U.S. dollar LIBOR interest rates were 1.22% and 1.30%, respectively, while at June 30, 2016, the one-month and three-month U.S. dollar LIBOR interest rates were 0.46% and 0.65%, respectively. The effective federal funds rate, which is the cost of immediately available overnight funds, remained at 0.50% during most of 2016. In December 2016, the effective federal funds rate increased 25 basis points to 0.75% and remained at that level until March 2017, when the effective federal funds rate increased another 25 basis points to 1.00%. In June 2017, the effective federal funds rate was increased an additional 25 basis points to 1.25%.

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Table of Contents

We are primarily funded by core deposits, with non-interest-bearing demand deposits historically being a significant source of funds. This lower-cost funding base is expected to have a positive impact on our net interest income and net interest margin in a rising interest rate environment. The Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act”) repealed the federal prohibitions on the payment of interest on demand deposits, thereby permitting depository institutions to pay interest on business transaction and other accounts beginning July 21, 2011. To date, we have not experienced any significant additional interest costs as a result of the repeal; however, we may begin to incur interest costs associated with certain demand deposits in the future as market conditions warrant. See Item 3. Quantitative and Qualitative Disclosures About Market Risk elsewhere in this report for information about the expected impact of this legislation on our sensitivity to interest rates. Further analysis of the components of our net interest margin is presented below.
The following tables present the changes in taxable-equivalent net interest income and identifies the changes due to differences in the average volume of earning assets and interest-bearing liabilities and the changes due to changes in the average interest rate on those assets and liabilities. The changes in net interest income due to changes in both average volume and average interest rate have been allocated to the average volume change or the average interest rate change in proportion to the absolute amounts of the change in each. The comparison between the periods includes an additional change factor that shows the effect of the difference in the number of days in each period for assets and liabilities that accrue interest based upon the actual number of days in the period, as further discussed below.
 
Three Months Ended
 
June 30, 2017 vs. June 30, 2016
 
Increase (Decrease) Due to Change in
 
 
 
Rate
 
Volume
 
Number of Days
 
Total
Interest-bearing deposits
$
4,688

 
$
786

 
$

 
$
5,474

Federal funds sold and resell agreements
80

 
24

 

 
104

Securities:
 
 
 
 
 
 
 
Taxable
(1,520
)
 
(484
)
 

 
(2,004
)
Tax-exempt
(4,283
)
 
12,444

 

 
8,161

Loans, net of unearned discounts
9,818

 
7,846

 

 
17,664

Total earning assets
8,783

 
20,616

 

 
29,399

Savings and interest checking

 
13

 

 
13

Money market deposit accounts
98

 
(3
)
 

 
95

Time accounts
52

 
(14
)
 

 
38

Public funds
256

 
(2
)
 

 
254

Federal funds purchased and repurchase agreements
116

 
19

 

 
135

Junior subordinated deferrable interest debentures
159

 

 

 
159

Subordinated notes payable and other notes
848

 
(5
)
 

 
843

Total interest-bearing liabilities
1,529

 
8

 

 
1,537

Net change
$
7,254

 
$
20,608

 
$

 
$
27,862


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Table of Contents

 
Six Months Ended
 
June 30, 2017 vs. June 30, 2016
 
Increase (Decrease) Due to Change in
 
 
 
Rate
 
Volume
 
Number of Days
 
Total
Interest-bearing deposits
$
7,254

 
$
1,443

 
$
(40
)
 
$
8,657

Federal funds sold and resell agreements
111

 
43

 
(1
)
 
153

Securities:
 
 
 
 
 
 
 
Taxable
(3,354
)
 
879

 
(201
)
 
(2,676
)
Tax-exempt
(6,540
)
 
25,847

 

 
19,307

Loans, net of unearned discounts
15,005

 
13,832

 
(1,256
)
 
27,581

Total earning assets
12,476

 
42,044

 
(1,498
)
 
53,022

Savings and interest checking

 
34

 
(3
)
 
31

Money market deposit accounts
54

 

 
(13
)
 
41

Time accounts
80

 
(24
)
 
(3
)
 
53

Public funds
359

 
(2
)
 
(1
)
 
356

Federal funds purchased and repurchase agreements
179

 
40

 
(1
)
 
218

Junior subordinated deferrable interest debentures
316

 
1

 

 
317

Subordinated notes payable and other notes
1,056

 
(132
)
 

 
924

Total interest-bearing liabilities
2,044

 
(83
)
 
(21
)
 
1,940

Net change
$
10,432

 
$
42,127

 
$
(1,477
)
 
$
51,082

Taxable-equivalent net interest income for the three months ended June 30, 2017 increased $27.9 million, or 12.1%, while taxable-equivalent net interest income for the six months ended June 30, 2017 increased $51.1 million, or 11.1%, compared to the same periods in 2016. Taxable-equivalent net interest income for the six months ended June 30, 2017 included 181 days compared to 182 days for the same period in 2016 as a result of the leap year. The additional day added approximately $1.5 million to taxable-equivalent net interest income during the six months ended June 30, 2016. Excluding the impact of the additional day results in an effective increase in taxable-equivalent net interest income of approximately $52.6 million during the six months ended June 30, 2017. The increases in taxable-equivalent net interest income during the three and six months ended June 30, 2017, excluding the impact of the aforementioned additional day during the six months ended June 30, 2016, were primarily related to the impact of increases in the average volume of tax-exempt securities and loans as well as increases in the average yields on loans and interest-bearing deposits partly offset by the impact of decreases in the average yields on tax-exempt and taxable securities. The average volume of interest-earning assets for the three months ended June 30, 2017 increased $1.9 billion, while the average volume of interest-earning assets during the six months ended June 30, 2017 increased $2.0 billion compared to the same periods in 2016. The increase in average earning assets during the three months ended June 30, 2017, included a $775.4 million increase in average tax-exempt securities, a $737.6 million increase in average loans and a $536.1 million increase in average interest-bearing deposits partly offset by a $179.3 million decrease in average taxable securities. The increase in average earning assets during the six months ended June 30, 2017, included a $786.2 million increase in average tax-exempt securities, a $665.3 million increase in average loans, a $497.9 million increase in average interest-bearing deposits and a $12.2 million increase in average taxable securities.
The net interest margin increased 13 basis points from 3.57% during the three months ended June 30, 2016 to 3.70% during the three months ended June 30, 2017 and increased 9 basis points from 3.58% during the six months ended June 30, 2016 to 3.67% during the six months ended June 30, 2017. The increases in the net interest margin during the three and six months ended June 30, 2017 were primarily due to increases in the average yield on interest earning assets. The average yield on interest-earning assets increased 14 basis points from 3.62% during the three months ended June 30, 2016 to 3.76% during the three months ended June 30, 2017 and increased 10 basis points from 3.62% during the six months ended June 30, 2016 to 3.72% during the six months ended June 30, 2017. The increases in the average yield on interest earning assets during the three and six months ended June 30, 2017 were mostly due to increases in the average yields on interest-bearing deposits and loans. The average yield on interest-earning assets is primarily impacted by changes in market interest rates as well as changes in the volume and relative mix of interest-earning assets.
The average yield on loans increased 25 basis points from 3.99% during the first six months of 2016 to 4.24% during the first six months of 2017. The average yield on loans was positively impacted by increases in market interest rates compared to the same period in 2016, as discussed above. The average volume of loans during the first six months of 2017 increased $665.3 million, or 5.8%, compared to the same period in 2016. Loans made up approximately 43.5% of average interest-earning assets during the first six months of 2017 compared to 44.2% during the same period in 2016.

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The average yield on securities was 3.96% during the first six months of 2017, decreasing 7 basis points from 4.03% during the first six months of 2016. Despite the fact that the average yield on taxable securities decreased 14 basis points from 2.05% during the first six months of 2016 to 1.91% during the first six months of 2017 and the average yield on tax-exempt securities decreased 20 basis point from 5.61% during the first six months of 2016 to 5.41% during the first six months of 2017, the overall average yield on securities only decreased 7 basis points because of a higher proportion of average securities invested in higher yielding tax-exempt securities during the first six months of 2017 compared to the same period in 2016. Tax exempt securities made up approximately 58.4% of total average securities during the first six months of 2017, compared to 55.7% during the same period in 2016. The average volume of total securities during the first six months of 2017 increased $798.4 million, or 6.8%, compared to the same period in 2016. Securities made up approximately 44.5% of average interest-earning assets during the first six months of 2017 compared to 44.8% during the same period in 2016.
Average federal funds sold, resell agreements and interest-bearing deposits during the first six months of 2017 increased $509.3 million compared to the same period in 2016.The increase in average federal funds sold, resell agreements and interest-bearing deposits was primarily related to growth in average deposits. Federal funds sold, resell agreements and interest-bearing deposits made up approximately 12.1% of average interest-earning assets during the first six months of 2017 compared to 11.0% during the same period in 2016. The combined average yield on federal funds sold, resell agreements and interest-bearing deposits was 0.96% during the first six months of 2017 compared to 0.52% during the same period in 2016. As discussed above, the effective federal funds rate increased from 0.50% to 0.75% in December 2016, increased from 0.75% to 1.00% in March 2017 and increased from 1.00% to 1.25% in June 2017.
The average rate paid on interest-bearing liabilities was 0.10% during the first six months of 2017, increasing 2 basis points from 0.08% during the same period in 2016. Average deposits increased $1.8 billion during the first six months of 2017 compared to the same period in 2016. Average non-interest-bearing deposits for the first six months of 2017 increased $871.8 million compared to the same period in 2016, while average interest-bearing deposits for the first six months of 2017 increased $879.6 million compared to the same period in 2016. The ratio of average interest-bearing deposits to total average deposits was 58.4% during the first six months of 2017 compared to 59.0% during the same period in 2016. The average cost of deposits is primarily impacted by changes in market interest rates as well as changes in the volume and relative mix of interest-bearing deposits. The average cost of interest-bearing deposits and total deposits was 0.05% and 0.03%, respectively, during the first six months of both 2017 and 2016. The average cost of interest-bearing deposits remained flat over the comparable periods as increases in the average cost of time accounts and public funds were offset by the impact of decreases in the relative proportions of these account types as well as the relative proportion of money market accounts to total interest-bearing deposits while the relative proportion of lower cost savings and interest checking accounts increased.
Our net interest spread, which represents the difference between the average rate earned on earning assets and the average rate paid on interest-bearing liabilities, was 3.62% during the first six months of 2017 compared to 3.54% during the same period in 2016. The net interest spread, as well as the net interest margin, will be impacted by future changes in short-term and long-term interest rate levels, as well as the impact from the competitive environment. A discussion of the effects of changing interest rates on net interest income is set forth in Item 3. Quantitative and Qualitative Disclosures About Market Risk included elsewhere in this report.
Our hedging policies permit the use of various derivative financial instruments, including interest rate swaps, swaptions, caps and floors, to manage exposure to changes in interest rates. Details of our derivatives and hedging activities are set forth in Note 9 - Derivative Financial Instruments in the accompanying notes to consolidated financial statements included elsewhere in this report. Information regarding the impact of fluctuations in interest rates on our derivative financial instruments is set forth in Item 3. Quantitative and Qualitative Disclosures About Market Risk included elsewhere in this report.
Provision for Loan Losses
The provision for loan losses is determined by management as the amount to be added to the allowance for loan losses after net charge-offs have been deducted to bring the allowance to a level which, in management’s best estimate, is necessary to absorb inherent losses within the existing loan portfolio. The provision for loan losses totaled $8.4 million and $16.4 million for the three and six months ended June 30, 2017 compared to $9.2 million and $37.7 million for the three and six months ended June 30, 2016. See the section captioned “Allowance for Loan Losses” elsewhere in this discussion for further analysis of the provision for loan losses.

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Non-Interest Income
The components of non-interest income were as follows:
 
Three Months Ended 
 June 30,
 
Six Months Ended 
 June 30,
 
2017
 
2016
 
2017
 
2016
Trust and investment management fees
$
27,727

 
$
26,021

 
$
54,197

 
$
51,355

Service charges on deposit accounts
21,198

 
19,865

 
41,967

 
40,229

Insurance commissions and fees
9,728

 
9,360

 
23,549

 
24,783

Interchange and debit card transaction fees
5,692

 
5,381

 
11,266

 
10,403

Other charges, commissions and fees
9,898

 
10,069

 
19,490

 
19,122

Net gain (loss) on securities transactions
(50
)
 

 
(50
)
 
14,903

Other
6,887

 
7,321

 
14,361

 
13,365

Total
$
81,080

 
$
78,017

 
$
164,780

 
$
174,160

Total non-interest income for the three and six months ended June 30, 2017 increased $3.1 million, or 3.9% and decreased $9.4 million, or 5.4%, compared to the same periods in 2016, respectively. Excluding the impact of the net gain (loss) on securities transactions, total non-interest income effectively increased $5.6 million, or 3.5% for the six months ended June 30, 2017 compared to the same period in 2016. Changes in the various components of non-interest income are discussed in more detail below.
Trust and Investment Management Fees. Trust and investment management fees for the three and six months ended June 30, 2017 increased $1.7 million, or 6.6%, and increased $2.8 million, or 5.5%, compared to the same periods in 2016, respectively. Investment fees are the most significant component of trust and investment management fees, making up approximately 82.7% and 81.2% of total trust and investment management fees for the first six months of 2017 and 2016, respectively. Investment and other custodial account fees are generally based on the market value of assets within a trust account. Volatility in the equity and bond markets impacts the market value of trust assets and the related investment fees.
The increase in trust and investment management fees during the three and six months ended June 30, 2017 compared to the same period in 2016 was primarily the result of increases in trust investment fees (up $1.6 million and $3.1 million, respectively). The increase in trust investment fees during 2017 was due to higher average equity valuations and an increase in the number of accounts.
At June 30, 2017, trust assets, including both managed assets and custody assets, were primarily composed of equity securities (48.8% of assets), fixed income securities (39.4% of assets) and cash equivalents (7.3% of assets). The estimated fair value of these assets was $30.5 billion (including managed assets of $13.6 billion and custody assets of $16.9 billion) at June 30, 2017, compared to $29.3 billion (including managed assets of $13.4 billion and custody assets of $15.9 billion) at December 31, 2016 and $29.6 billion (including managed assets of $13.2 billion and custody assets of $16.5 billion) at June 30, 2016.
Service Charges on Deposit Accounts. Service charges on deposit accounts for the three months ended June 30, 2017 increased $1.3 million, or 6.7%, compared to the same period in 2016. The increase was primarily due to increases in overdraft/insufficient funds charges on consumer and commercial accounts (up $690 thousand and $169 thousand, respectively), consumer service charges (up $262 thousand) and commercial service charges (up $218 thousand). Service charges on deposit accounts for the six months ended June 30, 2017 increased $1.7 million, or 4.3%, compared to the same period in 2016. The increase was primarily due to increases in overdraft/insufficient funds charges on consumer and commercial accounts (up $1.3 million and $299 thousand, respectively) and commercial service charges (up $147 thousand). Overdraft/insufficient funds charges totaled $8.6 million ($6.6 million consumer and $2.0 million commercial) during the three months ended June 30, 2017 compared to $7.7 million ($5.9 million consumer and $1.8 million commercial) during the same period in 2016. Overdraft/insufficient funds charges totaled $17.1 million ($13.2 million consumer and $3.9 million commercial) during the six months ended June 30, 2017 compared to $15.5 million ($11.9 million consumer and $3.6 million commercial) during the same period in 2016.
Insurance Commissions and Fees. Insurance commissions and fees for the three months ended June 30, 2017 increased $368 thousand, or 3.9%, compared to the same period in 2016. The increase was related to increases in commission income (up $209 thousand) and contingent commission (up $159 thousand). Insurance commissions and fees for the six months ended June 30, 2017 decreased $1.2 million, or 5.0%, compared to the same period in 2016. The decrease was related to a decrease in contingent income (down $2.5 million) partly offset by an increase in commission income (up $1.2 million). Insurance commissions and fees include contingent commissions totaling $692 thousand and $3.0 million during the three and six months ended June 30, 2017, respectively, and $533 thousand and $5.5 million during the same periods in 2016. Contingent income primarily consists of amounts received from various property and casualty insurance carriers related to the loss performance of insurance policies previously placed. These performance related contingent payments are seasonal in nature and are mostly received during the first quarter of

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each year. These commissions totaled $2.0 million and $4.4 million during the six months ended June 30, 2017 and 2016, respectively. The decrease in performance related contingent income during 2017 was primarily related to a lack of growth within the portfolio and a deterioration in the loss performance of insurance policies previously placed. Contingent income also includes amounts received from various benefit plan insurance companies related to the volume of business generated and/or the subsequent retention of such business. These benefit plan related contingent commissions totaled $398 thousand and $1.0 million during the three and six months ended June 30, 2017 and $461 thousand and $1.1 million during the three and six months ended June 30, 2016. The increases in commission income during the three and six months ended June 30, 2016 were primarily related to increases in benefit plan commissions due to increased business volumes.
Interchange and Debit Card Transaction Fees. Interchange fees, or “swipe” fees, are charges that merchants pay to us and other card-issuing banks for processing electronic payment transactions. Interchange and debit card transaction fees consist of income from check card usage, point of sale income from PIN-based debit card transactions and ATM service fees. Interchange and debit card transaction fees for the three and six months ended June 30, 2017 increased $311 thousand, or 5.8%, and $863 thousand, or 8.3%, compared to the three and six months ended June 30, 2016. The increases were primarily due to increases in income from debit card transactions (up $264 thousand and $663 thousand for the three and six months ended June 30, 2017, respectively) and ATM service fees (up $48 thousand and $200 thousand for the three and six months ended June 30, 2017, respectively). The increases were primarily related to increased transaction volumes.
Federal Reserve rules applicable to financial institutions that have assets of $10 billion or more provide that the maximum permissible interchange fee for an electronic debit transaction is the sum of 21 cents per transaction and 5 basis points multiplied by the value of the transaction. An upward adjustment of no more than 1 cent to an issuer's debit card interchange fee is allowed if the card issuer develops and implements policies and procedures reasonably designed to achieve certain fraud-prevention standards. The Federal Reserve also has rules governing routing and exclusivity that require issuers to offer two unaffiliated networks for routing transactions on each debit or prepaid product.
Other Charges, Commissions and Fees. Other charges, commissions and fees for the three months ended June 30, 2017 decreased $171 thousand, or 1.7%, compared to the same period in 2016. The decrease was primarily due to decreases in income from corporate finance and capital market advisory services (down $258 thousand), loan processing fees (down $256 thousand) and other service charges (down $209 thousand), among other things. These decreases were partly offset by increases in income related to the sale of mutual funds (up $325 thousand) and income from the sale of annuities (up $318 thousand), among other things. Fluctuations in the aforementioned items were due to fluctuations in business volumes. Other charges, commissions and fees for the six months ended June 30, 2017 increased $368 thousand, or 1.9%, compared to the same period in 2016. The increase included increases in income related to the sale of mutual funds (up $784 thousand), wire transfer fees (up $185 thousand) and loan processing fees (up $140 thousand), among other things. These increases were partly offset by decreases in income from corporate finance and capital market advisory services (down $367 thousand) and human resources consulting fee income (down $326 thousand), among other things. Human resources consulting fee income decreased as we no longer provide these services. Changes in the other aforementioned categories of other charges, commissions and fees were due to fluctuations in business volumes.
Net Gain/Loss on Securities Transactions. During the six months ended June 30, 2017, we sold U.S Treasury securities with an amortized cost totaling $8.2 billion and realized a net loss of $50 thousand on those sales. The sales were primarily related to securities purchased during 2017 and subsequently sold in connection with our tax planning strategies related to the Texas franchise tax. The gross proceeds from the sales of these securities outside of Texas are included in total revenues/receipts from all sources reported for Texas franchise tax purposes, which results in a reduction in the overall percentage of revenues/receipts apportioned to Texas and subjected to taxation under the Texas franchise tax.
During the six months ended June 30, 2016, we sold available-for-sale U.S. Treasury securities with an amortized cost totaling $749.5 million and realized a gain of $2.8 million on those sales. The securities sold were due to mature during 2016. Most of the proceeds from the sale of these securities were reinvested into U.S. Treasury securities having comparable yields, but longer-terms. As more fully discussed in Note 2 - Securities in our 2016 Form 10-K, during the first six months of 2016, we also sold certain municipal securities that were classified as both available for sale and held to maturity due to a significant deterioration in the creditworthiness of the issuers. These securities had a total amortized cost of $431.4 million and we realized a gain of $12.1 million on those sales.
Other Non-Interest Income. Other non-interest income for the three months ended June 30, 2017 decreased $434 thousand, or 5.9%, compared to the same period in 2016. The decrease was primarily related to decreases in public finance underwriting fees (down $474 thousand), income from customer derivative and trading activities (down $392 thousand) and sundry and other miscellaneous income (down $356 thousand) partly offset by increases in gains on the sale of foreclosed and other assets (up $652 thousand) and income from customer foreign currency transactions (up $123 thousand). The fluctuations in public finance underwriting fees, income from customer derivative and trading activities and income from customer foreign currency transactions

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were primarily related to changes in business volumes. During the second quarter of 2017, gains on the sale of foreclosed and other assets included $700 thousand related to amortization of the deferred gain on our headquarters building, which we sold in December 2016.
Other non-interest income for the six months ended June 30, 2017 increased $1.0 million, or 7.5%, compared to the same period in 2016. The increase was primarily related to increases in gains on the sale of foreclosed and other assets (up $769 thousand), sundry and other miscellaneous income (up $379 thousand) and income from customer foreign currency transactions (up $248 thousand) partly offset by decreases in income from customer derivative and trading activities (down $514 thousand) and lease rental income (down $254 thousand). Sundry income during 2017 included $758 thousand related to the settlement of a non-solicitation agreement, among other things. The fluctuations in income from customer foreign currency transactions and income from customer derivative and trading activities were primarily related to changes in business volumes. During the first six months of 2017, gains on the sale of foreclosed and other assets included $1.5 million related to amortization of the aforementioned deferred gain on our headquarters building.
Non-Interest Expense
The components of non-interest expense were as follows:
 
Three Months Ended 
 June 30,
 
Six Months Ended 
 June 30,
 
2017
 
2016
 
2017
 
2016
Salaries and wages
$
80,995

 
$
78,106

 
$
163,507

 
$
157,403

Employee benefits
18,198

 
17,712

 
39,823

 
38,017

Net occupancy
19,153

 
18,242

 
38,390

 
35,429

Furniture and equipment
18,250

 
17,978

 
36,240

 
35,495

Deposit insurance
5,570

 
4,197

 
10,485

 
7,854

Intangible amortization
438

 
619

 
896

 
1,283

Other
45,447

 
42,591

 
86,625

 
83,123

Total
$
188,051

 
$
179,445

 
$
375,966

 
$
358,604

Total non-interest expense for the three and six months ended June 30, 2017 increased $8.6 million, or 4.8% and $17.4 million, or 4.8%, compared to the same periods in 2016. Changes in the various components of non-interest expense are discussed below.
Salaries and Wages. Salaries and wages for the three and six months ended June 30, 2017 increased $2.9 million, or 3.7%, and $6.1 million, or 3.9%, compared to the same periods in 2016. The increase was primarily related to an increase in salaries, due to an increase in the number of employees and normal annual merit and market increases, as well as increases in stock compensation and incentive compensation.
Employee Benefits. Employee benefits expense for the three months ended June 30, 2017 increased $486 thousand, or 2.7%, compared to the same period in 2016. The increase was primarily due to increases in medical insurance expense (up $423 thousand), payroll taxes (up $303 thousand) and expenses related to our 401(k) and profit sharing plans (up $112 thousand) partly offset by a decrease in expenses related to our defined benefit retirement plans (down $474 thousand). Employee benefits expense for the six months ended June 30, 2017 increased $1.8 million, or 4.8%, compared to the same period in 2016. The increase was primarily due to increases in payroll taxes (up $1.2 million), expenses related to our 401(k) and profit sharing plans (up $705 thousand) and medical insurance expense (up $683 thousand) partly offset by a decrease in expenses related to our defined benefit retirement plans (down $761 thousand).
During the three and six months ended June 30, 2017, we recognized a combined net periodic pension expense of $126 thousand and $251 thousand, respectively, related to our defined benefit retirement plans compared to a combined net periodic pension expense of $600 thousand and $1.0 million during the same periods in 2016. Net periodic pension expense during the second quarter of 2016 included $187 thousand in supplemental executive retirement plan (“SERP”) settlement costs related to the retirement of a former executive officer. Our defined benefit retirement and restoration plans were frozen effective as of December 31, 2001 and were replaced by a profit sharing plan. Management believes these actions helped to reduce the volatility in retirement plan expense. However, we still have funding obligations related to the defined benefit and restoration plans and could recognize retirement expense related to these plans in future years, which would be dependent on the return earned on plan assets, the level of interest rates and employee turnover.
Net Occupancy. Net occupancy expense for the three and six months ended June 30, 2017 increased $911 thousand, or 5.0%, and $3.0 million, or 8.4%, compared to the same periods in 2016. The increase during the three months ended June 30, 2017 was primarily related to increases in lease expense (up $743 thousand), property taxes (up $338 thousand) and depreciation on leasehold

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improvements (up $187 thousand) partly offset by a decrease in building depreciation (down $347 thousand). The increase during the six months ended June 30, 2017 was primarily related to increases in lease expense (up $1.8 million), property taxes (up $675 thousand), depreciation on leasehold improvements (up $480 thousand), repairs and maintenance/service contracts expense (up $461 thousand) and utilities expense (up $196 thousand) partly offset by a decrease in building depreciation (down $737 thousand). The increases in lease expense and the decreases in building depreciation during the reported periods were related to the sale and lease back of our headquarters building in December 2016, as more fully discussed in our 2016 Form 10-K, as well as new locations.
Furniture and Equipment. Furniture and equipment expense for the three and six months ended June 30, 2017 increased $272 thousand, or 1.5%, and $745 thousand, or 2.1%, compared to the same periods in 2016. The increases were primarily related to increases in software maintenance (up $656 thousand and $1.3 million for the three and six months ended June 30, 2017, respectively) and depreciation on furniture and equipment (up $467 thousand and $1.2 million for the three and six months ended June 30, 2017, respectively) partly offset by decreases in equipment rental expense (down $464 thousand and $1.1 million for the three and six months ended June 30, 2017, respectively), service contracts (down $374 thousand and $555 thousand for the three and six months ended June 30, 2017, respectively) and software amortization (down $110 thousand and $339 thousand for the three and six months ended June 30, 2017, respectively), among other things.
Deposit Insurance. Deposit insurance expense totaled $5.6 million and $10.5 million for the three and six months ended June 30, 2017 compared to $4.2 million and $7.9 million for the three and six months ended June 30, 2016. The increase was related to an increase in the overall assessment rate and an increase in assets. The increase in the assessment rate was partly related to a new surcharge that became applicable during the third quarter of 2016. In August 2016, the Federal Deposit Insurance Corporation (“FDIC”) announced that the Deposit Insurance Fund (“DIF”) reserve ratio had surpassed 1.15% as of June 30, 2016. As a result, beginning in the third quarter of 2016, the range of initial assessment rates for all institutions was adjusted downward and institutions with $10 billion or more in assets were assessed a quarterly surcharge. The quarterly surcharge will continue to be assessed until such time as the reserve ratio reaches the statutory minimum of 1.35% required by the Dodd-Frank Wall Street Reform and Consumer Protection Act.
Intangible Amortization. Intangible amortization is primarily related to core deposit intangibles and, to a lesser extent, intangibles related to customer relationships and non-compete agreements. Intangible amortization for the three and six months ended June 30, 2017 decreased $181 thousand, or 29.2%, and $387 thousand, or 30.2%, respectively, compared to the same periods in 2016. The decrease in amortization was primarily related to the completion of amortization of certain previously recognized intangible assets as well as a reduction in the annual amortization rate of certain previously recognized intangible assets as we use an accelerated amortization approach which results in higher amortization rates during the earlier years of the useful lives of intangible assets.
Other Non-Interest Expense. Other non-interest expense for the three months ended June 30, 2017 increased $2.9 million, or 6.7%, compared to the same period in 2016. The increase included increases in fraud losses, primarily check card related, (up $1.7 million), advertising/promotions expense (up $577 thousand), outside computer services expense (up $535 thousand) and travel/meals and entertainment expense (up $427 thousand), among other things. These items were partly offset by decreases in check card expense (down $640 thousand), losses on the sale/write-down of foreclosed and other assets (down $199 thousand) and professional services expense (down $166 thousand), among other things. Other non-interest expense for the six months ended June 30, 2017 increased $3.5 million, or 4.2%, compared to the same period in 2016. The increase included increases in fraud losses (up $892 thousand), advertising/promotions expense (up $708 thousand), outside computer services expense (up $672 thousand), travel/meals and entertainment expense (up $634 thousand), guard service expense (up $503 thousand) and sundry and other miscellaneous expense (up $458 thousand), among other things. These items were partly offset by a decrease in check card expense (down $659 thousand), among other things.


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Results of Segment Operations
Our operations are managed along two primary operating segments: Banking and Frost Wealth Advisors. A description of each business and the methodologies used to measure financial performance is described in Note 16 - Operating Segments in the accompanying notes to consolidated financial statements included elsewhere in this report. Net income (loss) by operating segment is presented below:
 
Three Months Ended 
 June 30,
 
Six Months Ended 
 June 30,
 
2017
 
2016
 
2017
 
2016
Banking
$
81,529

 
$
68,223

 
$
162,398

 
$
134,190

Frost Wealth Advisors
6,279

 
4,860

 
11,573

 
9,012

Non-Banks
(2,255
)
 
(1,576
)
 
(3,477
)
 
(2,879
)
Consolidated net income
$
85,553

 
$
71,507

 
$
170,494

 
$
140,323

Banking
Net income for the three and six months ended June 30, 2017 increased $13.3 million, or 19.5%, and $28.2 million, or 21.0%, compared to the same periods in 2016. The increase during the three months ended June 30, 2017 was primarily the result of a $23.4 million increase in net interest income, a $763 thousand decrease in the provision for loan losses and a $373 thousand increase in non-interest income partly offset by a $6.3 million increase in non-interest expense and a $5.0 million increase in income tax expense. The increase during the six months ended June 30, 2017 was primarily the result of a $41.0 million increase in net interest income and a $21.3 million decrease in the provision for loan losses partly offset by a $14.1 million increase in non-interest expense, a $13.6 million decrease in non-interest income, and a $6.4 million increase in income tax expense.
Net interest income for the three and six months ended June 30, 2017 increased $23.4 million, or 12.4%, and $41.0 million, or 10.9%, compared to the same periods in 2016. Taxable-equivalent net interest income for the first six months of 2017 included 181 days compared to 182 days for the same period in 2016 as a result of the leap year. The additional day added approximately $1.5 million to taxable-equivalent net interest income during the first six months of 2016. Despite the effect of this additional day during 2016, net interest income during the three and six months ended June 30, 2017 increased as a result of increases in the average volume of tax-exempt securities and loans as well as increases in the average yields on loans and interest-bearing deposits partly offset by the impact of decreases in the average yields on tax-exempt and taxable securities. See the analysis of net interest income included in the section captioned “Net Interest Income” included elsewhere in this discussion.
The provision for loan losses for the three and six months ended June 30, 2017 totaled $8.4 million and $16.4 million compared to $9.2 million and $37.7 million for the same period in 2016. See the analysis of the provision for loan losses included in the section captioned “Allowance for Loan Losses” included elsewhere in this discussion.
Non-interest income for the three months ended June 30, 2017 increased $373 thousand, or 0.8%, while non-interest income for the six months ended June 30, 2017 decreased $13.6 million, or 11.8%, compared to the same periods in 2016. The increase during the three months ended June 30, 2017 was primarily related to increases in service charges on deposit accounts, insurance commissions and fees and interchange and debit card transaction fees partly offset by decreases in other charges, commissions and fees and other non-interest income. The decrease during the six months ended June 30, 2017 was primarily related to a decrease in the net gain on securities transactions and, to a lesser extent, a decrease in insurance commissions and fees partly offset by increases in service charges on deposit accounts, interchange and debit card transaction fees and other non-interest income. During 2016, the net gain on securities transactions totaled $14.9 million, which resulted from the sale of certain municipal securities as a result of significant deterioration in the creditworthiness of the issuers and the sale of certain U.S. Treasury Securities. The increases in service charges on deposit accounts for the three and six months ended June 30, 2017 were primarily due to increases in overdraft/insufficient funds charges on consumer and commercial accounts, consumer service charges and commercial service charges. The increase in insurance commissions and fees during the three months ended June 30, 2017 was related to increases in commission income and contingent commissions. The decrease in insurance commissions and fees for the six months ended June 30, 2017 was related to a decrease in contingent income, primarily related to a lack of growth within the portfolio and a deterioration in the loss performance of insurance policies previously placed, partly offset by an increase in commission income. The increases in interchange and debit card transaction fees during the three and six months ended June 30, 2017 were primarily due to increases in income from debit card transactions and ATM service fees resulting from increased transaction volumes. The decreases in other charges, commissions and fees during the three and six months ended June 30, 2017 included decreases in income from corporate finance and capital market advisory services, human resources consulting fees and other service charges, among other things. These decreases were primarily due to fluctuations in business volumes. The decrease in other non-interest income for the three months ended June 30, 2017 was primarily related to decreases in public finance underwriting fees, income from customer derivative and trading activities and sundry and other miscellaneous income partly offset by increases in gains on

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the sale of foreclosed and other assets and income from customer foreign currency transactions. The increase in other non-interest income for the six months ended June 30, 2017 was primarily related to increases in gains on the sale of foreclosed and other assets, sundry and other miscellaneous income and income from customer foreign currency transactions partly offset by decreases in income from customer derivative and trading activities and lease rental income. The fluctuations in public finance underwriting fees, income from customer derivative and trading activities and income from customer foreign currency transactions were primarily related to changes in business volumes. Gains on the sale of foreclosed and other assets during 2017 included the amortization of the deferred gain on our headquarters building, which we sold in December 2016. See the analysis of these categories of non-interest income included in the section captioned “Non-Interest Income” included elsewhere in this discussion.
Non-interest expense for the three and six months ended June 30, 2017 increased $6.3 million, or 4.1%, and $14.1 million, or 4.6%, compared to the same periods in 2016. The increase during the three and six months ended June 30, 2017 was primarily related to increases in salaries and wages, other non-interest expense, deposit insurance expense and employee benefits. The increases in salaries were primarily due to increases in the number of employees and normal annual merit and market increases, as well as increases in stock compensation and incentive compensation. The increases in other non-interest expense were primarily related to increases in fraud losses, primarily check card related, advertising/promotions expense, outside computer services expense, travel/meals and entertainment expense and sundry and other miscellaneous expense, among other things, partly offset by decreases in check card expense, among other things. The increases in deposit insurance expense were related to an increase in the assessment rate due to a new quarterly surcharge and increases in assets. The increases in employee benefits expense were primarily due to increases in payroll taxes, expenses related to our 401(k) and profit sharing plans and medical insurance expense partly offset by decreases in expenses related to our defined benefit retirement plans. See the analysis of these categories of non-interest expense included in the section captioned “Non-Interest Expense” included elsewhere in this discussion.
Frost Insurance Agency, which is included in the Banking operating segment, had gross commission revenues of $9.7 million and $23.7 million during the three and six months ended June 30, 2017 and $9.4 million and $24.9 million during the three and six months ended June 30, 2016. The decreases were primarily related to decreases in contingent commissions, partly offset by increases in benefit plan commissions. See the analysis of insurance commissions and fees included in the section captioned “Non-Interest Income” included elsewhere in this discussion.
Frost Wealth Advisors
Net income for the three and six months ended June 30, 2017 increased $1.4 million, or 29.2% and $2.6 million, or 28.4%, compared to the same periods in 2016. The increase during the three months ended June 30, 2017 was primarily due to a $2.6 million increase in non-interest income and $1.9 million increase in net interest income partly offset by a $2.3 million increase in non-interest expense and a $764 thousand increase in income tax expense. The increase during the six months ended June 30, 2017 was primarily due to a $4.0 million increase in non-interest income and a $3.3 million increase in net interest income partly offset by a $3.4 million increase in non-interest expense and a $1.4 million increase in income tax expense.
Net interest income for the three and six months ended June 30, 2017 increased $1.9 million, or 74.1%, and $3.3 million, or 69.1%, compared to the same periods in 2016. The increases were primarily due to an increase in the funds transfer price received for funds provided related to Frost Wealth Advisors' repurchase agreements and increases in the average volume of funds provided.
Non-interest income for the three and six months ended June 30, 2017 increased $2.6 million, or 8.9%, and $4.0 million, or 6.8%, compared to the same periods in 2016. The increases in non-interest income during the three and six months ended June 30, 2017 were primarily related to increases in trust and investment management fees and other charges, commissions and fees. Trust and investment management fee income is the most significant income component for Frost Wealth Advisors. Investment fees are the most significant component of trust and investment management fees, making up approximately 82.7% of total trust and investment management fees for the first six months of 2017. Investment and other custodial account fees are generally based on the market value of assets within a trust account. Volatility in the equity and bond markets impacts the market value of trust assets and the related investment fees. The increases in trust and investment management fees during the three and six months ended June 30, 2017 compared to the same periods in 2016 were primarily the result of increases in trust investment fees. The increase in trust investment fees during 2017 was due to higher average equity valuations and an increase in the number of accounts. The increase in other charges, commissions and fees during the three and six months ended June 30, 2017 was primarily due to increases in income related to the sale of mutual funds and annuities. See the analysis of trust and investment management fees and other charges, commissions and fees included in the section captioned “Non-Interest Income” included elsewhere in this discussion.
Non-interest expense for the three and six months ended June 30, 2017 increased $2.3 million, or 9.3%, and $3.4 million, or 6.8%, compared to the same period in 2016. The increases during the three and six months ended June 30, 2017 were primarily related to increases in net occupancy expense, salaries and wages and employee benefits. The increase in non-interest expense for the six months ended June 30, 2017 was partly offset by a decrease in other non-interest expense. The increase in net occupancy expense and decrease in other non-interest expense were related to a change in the way we allocate occupancy expenses among

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our operating segments. Beginning in 2017, operating segments receive a direct charge for occupancy expense based upon cost centers within the segment. Such amounts are now reported as occupancy expense. Previously, these costs were included within the allocated overhead and reported as a component of other non-interest expense. The increases in salaries and wages during the three and six months ended June 30, 2017 were primarily related to an increases in the number of employees and normal annual merit and market increases and increases in stock compensation. The increases in employee benefits expense during the three and six months ended June 30, 2017 were primarily related to increases in payroll taxes, expenses related to our defined benefit retirement plans and medical insurance expense.
Non-Banks
The Non-Banks operating segment had a net loss of $2.3 million and $3.5 million for the three and six months ended June 30, 2017, respectively, compared to a net loss of $1.6 million and $2.9 million for the same periods in 2016. The increases in net loss during the three and six months ended June 30, 2017 were primarily due to increases in net interest expense primarily related to an increase in the interest rates paid on our long-term borrowings partly offset by increases in income tax benefit.
Income Taxes
We recognized income tax expense of $13.8 million and $25.2 million, for an effective tax rate of 13.9% and 12.9% for the three and six months ended June 30, 2017 compared to $8.4 million and $17.8 million, for an effective tax rate of 10.5% and 11.2% for the three and six months ended June 30, 2016. The effective income tax rates differed from the U.S. statutory rate of 35% during the comparable periods primarily due to the effect of tax-exempt income from loans, securities and life insurance policies and the income tax effects associated with stock-based compensation. The increases in income tax expense and the effective tax rates during 2017 were primarily related to increases in total income with a higher proportion of taxable income relative to tax-exempt income.
Average Balance Sheet
Average assets totaled $30.1 billion for the six months ended June 30, 2017 representing an increase of $2.0 billion, or 7.0%, compared to average assets for the same period in 2016. The growth in average assets was primarily funded by deposit growth, an increase in average federal funds purchased and repurchase agreements and earnings retention. The increase was primarily reflected in earning assets, which increased $2.0 billion, or 7.6%, during the first six months of 2017 compared to the same period of 2016. The increase in earning assets included a $786.2 million increase in average tax-exempt securities, a $665.3 million increase in average loans and a $497.9 million increase in average interest-bearing deposits. Average deposit growth included an $879.6 million increase in interest-bearing deposit accounts and an $871.8 million increase in non-interest bearing deposits. Average non-interest bearing deposits made up 41.6% and 41.0% of average total deposits during the first six months of 2017 and 2016, respectively.

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Loans
Loans were as follows as of the dates indicated:
 
June 30,
2017
 
Percentage
of Total
 
December 31,
2016
 
Percentage
of Total
Commercial and industrial
$
4,604,269

 
36.8
%
 
$
4,344,000

 
36.3
%
Energy:
 
 
 
 
 
 
 
Production
1,040,506

 
8.3

 
971,767

 
8.1

Service
183,543

 
1.5

 
221,213

 
1.8

Other
185,563

 
1.5

 
193,081

 
1.7

Total energy
1,409,612

 
11.3

 
1,386,061

 
11.6

Commercial real estate:
 
 
 
 
 
 
 
Commercial mortgages
3,620,885

 
28.9

 
3,481,157

 
29.1

Construction
1,050,837

 
8.4

 
1,043,261

 
8.7

Land
322,130

 
2.6

 
311,030

 
2.6

Total commercial real estate
4,993,852

 
39.9

 
4,835,448

 
40.4

Consumer real estate:
 
 
 
 
 
 
 
Home equity loans
355,744

 
2.8

 
345,130

 
2.9

Home equity lines of credit
283,344

 
2.3

 
264,862

 
2.2

Other
351,985

 
2.8

 
326,793

 
2.7

Total consumer real estate
991,073

 
7.9

 
936,785

 
7.8

Total real estate
5,984,925

 
47.8

 
5,772,233

 
48.2

Consumer and other
513,532

 
4.1

 
473,098

 
3.9

Total loans
$
12,512,338

 
100.0
%
 
$
11,975,392

 
100.0
%
Loans increased $536.9 million, or 4.5%, compared to December 31, 2016. The majority of our loan portfolio is comprised of commercial and industrial loans, energy loans and real estate loans. Commercial and industrial loans made up 36.8% and 36.3% of total loans at June 30, 2017 and December 31, 2016, respectively, while energy loans made up 11.3% and 11.6% of total loans, respectively, and real estate loans made up 47.8% and 48.2% of total loans, respectively, at those dates. Real estate loans include both commercial and consumer balances. Selected details related to our loan portfolio segments are presented below. Refer to our 2016 Form 10-K for a more detailed discussion of our loan origination and risk management processes.
Commercial and industrial. Commercial and industrial loans increased $260.3 million, or 6.0%, during the first six months of 2017. Our commercial and industrial loans are a diverse group of loans to small, medium and large businesses. The purpose of these loans varies from supporting seasonal working capital needs to term financing of equipment. While some short-term loans may be made on an unsecured basis, most are secured by the assets being financed with collateral margins that are consistent with our loan policy guidelines. The commercial and industrial loan portfolio also includes commercial leases and purchased shared national credits ("SNC"s).
Energy. Energy loans include loans to entities and individuals that are engaged in various energy-related activities including (i) the development and production of oil or natural gas, (ii) providing oil and gas field servicing, (iii) providing energy-related transportation services (iv) providing equipment to support oil and gas drilling (v) refining petrochemicals, or (vi) trading oil, gas and related commodities. Energy loans increased $23.6 million, or 1.7%, during the first six months of 2017 compared to December 31, 2016. The increase was primarily related to production loans. The average loan size, the significance of the portfolio and the specialized nature of the energy industry requires a highly prescriptive underwriting policy. Exceptions to this policy are rarely granted. Due to the large borrowing requirements of this customer base, the energy loan portfolio includes participations and purchased shared national credits.
Purchased Shared National Credits. Purchased shared national credits are participations purchased from upstream financial organizations and tend to be larger in size than our originated portfolio. Our purchased SNC portfolio totaled $825.7 million at June 30, 2017, increasing $53.6 million, or 6.9%, from $772.2 million at December 31, 2016. At June 30, 2017, 53.4% of outstanding purchased SNCs were related to the energy industry and 13.4% of outstanding purchased SNCs were related to the construction industry. The remaining purchased SNCs were diversified throughout various other industries, with no other single industry exceeding 10% of the total purchased SNC portfolio. Additionally, almost all of the outstanding balance of purchased SNCs was included in the energy and commercial and industrial portfolio, with the remainder included in the real estate categories. SNC participations are originated in the normal course of business to meet the needs of our customers. As a matter of policy, we generally only participate in SNCs for companies headquartered in or which have significant operations within our market areas. In addition, we must have direct access to the company’s management, an existing banking relationship or the expectation of

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broadening the relationship with other banking products and services within the following 12 to 24 months. SNCs are reviewed at least quarterly for credit quality and business development successes.
Commercial Real Estate. Commercial real estate loans totaled $5.0 billion at June 30, 2017, increasing $158.4 million compared to $4.8 billion at December 31, 2016. At such dates, commercial real estate loans represented 83.4% and 83.8% of total real estate loans, respectively. The majority of this portfolio consists of commercial real estate mortgages, which includes both permanent and intermediate term loans. These loans are viewed primarily as cash flow loans and secondarily as loans secured by real estate. Consequently, these loans must undergo the analysis and underwriting process of a commercial and industrial loan, as well as that of a real estate loan. At June 30, 2017, approximately 51% of the outstanding principal balance of our commercial real estate loans were secured by owner-occupied properties.
Consumer Real Estate and Other Consumer Loans. The consumer loan portfolio, including all consumer real estate and consumer installment loans, totaled $1.5 billion at June 30, 2017 and $1.4 billion at December 31, 2016. Consumer real estate loans, increased $54.3 million, or 5.8%, from December 31, 2016. Combined, home equity loans and lines of credit made up 64.5% and 65.1% of the consumer real estate loan total at June 30, 2017 and December 31, 2016, respectively. We offer home equity loans up to 80% of the estimated value of the personal residence of the borrower, less the value of existing mortgages and home improvement loans. In general, we do not originate 1-4 family mortgage loans; however, from time to time, we may invest in such loans to meet the needs of our customers or for other regulatory compliance purposes. Consumer and other loans, increased $40.4 million, or 8.5%, from December 31, 2016. The consumer and other loan portfolio primarily consists of automobile loans, overdrafts, unsecured revolving credit products, personal loans secured by cash and cash equivalents and other similar types of credit facilities.
Non-Performing Assets
Non-performing assets and accruing past due loans are presented in the table below. Troubled debt restructurings on non-accrual status are reported as non-accrual loans. Troubled debt restructurings on accrual status are reported separately.
 
June 30,
2017
 
December 31,
2016
Non-accrual loans:
 
 
 
Commercial and industrial
$
21,226

 
$
31,475

Energy
55,464

 
57,571

Commercial real estate:
 
 
 
Buildings, land and other
6,916

 
8,550

Construction

 

Consumer real estate
2,543

 
2,130

Consumer and other
264

 
425

Total non-accrual loans
86,413

 
100,151

Restructured loans
1,696

 

Foreclosed assets:
 
 
 
Real estate
2,041

 
2,440

Other

 

Total foreclosed assets
2,041

 
2,440

Total non-performing assets
$
90,150

 
$
102,591

 
 
 
 
Ratio of non-performing assets to:
 
 
 
Total loans and foreclosed assets
0.72
%
 
0.86
%
Total assets
0.30

 
0.34

Accruing past due loans:
 
 
 
30 to 89 days past due
$
56,056

 
$
55,456

90 or more days past due
16,003

 
24,864

Total accruing past due loans
$
72,059

 
$
80,320

Ratio of accruing past due loans to total loans:
 
 
 
30 to 89 days past due
0.45
%
 
0.46
%
90 or more days past due
0.13

 
0.21

Total accruing past due loans
0.58
%
 
0.67
%

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Non-performing assets include non-accrual loans, troubled debt restructurings and foreclosed assets. Non-performing assets at June 30, 2017 decreased $12.4 million from December 31, 2016 primarily due to a decrease in non-accrual commercial and industrial loans. Non-accrual energy loans included three credit relationships in excess of $5 million totaling $44.8 million at June 30, 2017 and four such credit relationships totaling $52.1 million at December 31, 2016. Non-accrual commercial and industrial loans included one credit relationship in excess of $5 million at both June 30, 2017 and December 31, 2016. This credit relationship totaled $9.7 million at June 30, 2017 and $9.8 million at December 31, 2016. Non-accrual real estate loans primarily consist of land development, 1-4 family residential construction credit relationships and loans secured by office buildings and religious facilities.
Generally, loans are placed on non-accrual status if principal or interest payments become 90 days past due and/or management deems the collectibility of the principal and/or interest to be in question, as well as when required by regulatory requirements. Once interest accruals are discontinued, accrued but uncollected interest is charged to current year operations. Subsequent receipts on non-accrual loans are recorded as a reduction of principal, and interest income is recorded only after principal recovery is reasonably assured. Classification of a loan as non-accrual does not preclude the ultimate collection of loan principal or interest.
Foreclosed assets represent property acquired as the result of borrower defaults on loans. Foreclosed assets are recorded at estimated fair value, less estimated selling costs, at the time of foreclosure. Write-downs occurring at foreclosure are charged against the allowance for loan losses. Regulatory guidelines require us to reevaluate the fair value of foreclosed assets on at least an annual basis. Our policy is to comply with the regulatory guidelines. Write-downs are provided for subsequent declines in value and are included in other non-interest expense along with other expenses related to maintaining the properties. Write-downs of foreclosed assets were not significant during the six months ended June 30, 2017 or 2016.
Potential problem loans consist of loans that are performing in accordance with contractual terms but for which management has concerns about the ability of an obligor to continue to comply with repayment terms because of the obligor’s potential operating or financial difficulties. Management monitors these loans closely and reviews their performance on a regular basis. At June 30, 2017 and December 31, 2016, we had $131.0 million and $62.7 million in loans of this type which are not included in any one of the non-accrual, restructured or 90 days past due loan categories. At June 30, 2017, potential problem loans consisted of eight credit relationships. Of the total outstanding balance at June 30, 2017, 55.9% was related to the energy industry and 17.5% was related to the manufacturing industry. Weakness in these organizations’ operating performance and financial condition, loan agreement breaches and borrowing base deficits for certain energy credits, among other factors, have caused us to heighten the attention given to these credits.
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 inherent 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. Our allowance for loan loss methodology, which is more fully described in our 2016 Form 10-K, 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. 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.
The table below provides, as of the dates indicated, an allocation of the allowance for loan losses by loan type; however, allocation of a portion of the allowance to one category of loans does not preclude its availability to absorb losses in other categories:
 
June 30,
2017
 
December 31,
2016
Commercial and industrial
$
48,906

 
$
52,915

Energy
54,277

 
60,653

Commercial real estate
33,002

 
30,213

Consumer real estate
5,535

 
4,238

Consumer and other
7,838

 
5,026

Total
$
149,558

 
$
153,045

The reserve allocated to commercial and industrial loans at June 30, 2017 decreased $4.0 million compared to December 31, 2016. The decrease was due to decreases in historical and specific valuation allowances partly offset by increases in macroeconomic valuation allowances and general valuation allowances. Historical valuation allowances decreased $4.7 million from $33.3 million

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at December 31, 2016 to $28.5 million at June 30, 2017. The decrease was primarily related to decreases in the historical loss allocation factors for non-classified loans graded as “watch” (risk grade 9) and “special mention” (risk grade 10) and classified commercial and industrial loans partly offset by increases in the volume of certain categories of both non-classified and classified loans. Classified loans consist of loans having a risk grade of 11, 12 or 13. Classified commercial and industrial loans totaled $157.2 million at June 30, 2017 compared to $131.9 million at December 31, 2016. The weighted-average risk grade of commercial and industrial loans was 6.39 at June 30, 2017 compared to 6.35 at December 31, 2016. Commercial loan net charge-offs totaled $7.6 million during the first six months of 2017 compared to $5.1 million during the first six months of 2016. Specific valuation allowances decreased $3.7 million from $5.4 million at December 31, 2016 to $1.8 million at June 30, 2017. Charge-offs in 2017 included $3.6 million related to two credit relationships that, as of December 31, 2016, had associated specific valuation allowances totaling $3.5 million. Charge-offs in 2017 also included $2.7 million related to a single credit relationship for which we had no specific allocation as of December 31, 2016, or at the time of charge-off. Macroeconomic valuation allowances for commercial and industrial loans increased $2.7 million from $7.5 million at December 31, 2016 to $10.2 million at June 30, 2017. The increase was primarily related to an increase in the general macroeconomic allocation partly offset by a decrease in the environmental risk adjustment. General valuation allowances for commercial and industrial loans increased $1.7 million from $6.7 million at December 31, 2016 to $8.4 million at June 30, 2017. The increase was primarily related to a decrease in the adjustment for recoveries and increases in the allocations for highly leveraged credit relationships, large credit relationships and loans not reviewed by concurrence.
The reserve allocated to energy loans at June 30, 2017 decreased $6.4 million compared to December 31, 2016. As a result, reserves allocated to energy loans as a percentage of total energy loans totaled 3.85% at June 30, 2017 compared to 4.38% at December 31, 2016. This decrease was primarily related to decreases in specific valuation allowances, macroeconomic valuation allowances and historical valuation allowances partly offset by an increase in general valuation allowances. Specific valuation allowances for energy loans decreased $3.4 million from $3.8 million at December 31, 2016 to $350 thousand at June 30, 2017. Energy loan net charge-offs totaled $10.5 million during the first six months of 2017 compared to net charge-offs of $17.8 million during the first six months of 2016. The charge-offs in 2017 included $10.0 million related to two credit relationships that, as of December 31, 2016, had associated specific valuation allowances totaling $3.4 million. Macroeconomic valuation allowances related to energy loans decreased $3.0 million from $18.5 million at December 31, 2016 to $15.5 million at June 30, 2017, in part due to improving trends in the weighted-average risk grade of the energy loan portfolio, as discussed below, and decreased oil price volatility. The price per barrel of crude oil was approximately $54 at December 31, 2016 and $46 at June 30, 2017. Historical valuation allowances decreased $2.2 million from $34.6 million at December 31, 2016 to $32.5 million at June 30, 2017. The decrease was primarily related to decreases in the volume of classified energy loans and higher risk categories of non-classified energy loans partly offset by increases in the historical loss allocation factors for both non-classified and classified energy loans. Classified energy loans totaled $225.4 million at June 30, 2017 compared to $302.0 million at December 31, 2016, decreasing $76.6 million. Non-classified energy loans graded as “watch” and “special mention” totaled $159.3 million at June 30, 2017 compared to $229.4 million at December 31, 2016, decreasing $70.1 million, while "pass" grade energy loans increased $170.2 million from $854.7 million at December 31, 2016 to $1.0 billion at June 30, 2017. As a result of these changes, the weighted-average risk grade of energy loans decreased to 7.49 at June 30, 2017 from 7.95 at December 31, 2016. General valuation allowances increased $2.2 million primarily due to an increase in the allocation for excessive industry concentrations.
The reserve allocated to commercial real estate loans at June 30, 2017 increased $2.8 million compared to December 31, 2016. The increase was primarily related to increases in macroeconomic valuation allowances and historical valuation allowances. Macroeconomic valuation allowances increased $2.1 million from $8.2 million at December 31, 2016 to $10.3 million at June 30, 2017. The increase was primarily related to an increase in the general macroeconomic allocation (up $1.7 million) and the environmental risk adjustment (up $374 thousand). The increase reflects current economic trends impacting our Houston market area which has been impacted by decreased construction, higher rent concessions and higher vacancy rates. Historical valuation allowances increased $999 thousand primarily due to an increase in the volume of non-classified commercial real estate loans. Non-classified commercial real estate loans increased $150.7 million from December 31, 2016 to June 30, 2017 primarily due to an increase in commercial real estate loans graded as “pass.” Classified commercial real estate loans increased $7.7 million from $76.3 million at December 31, 2016 to $84.0 million at June 30, 2017 due to an increase in loans classified as “substandard - accrual” (risk grade 11). The weighted-average risk grade of commercial real estate loans was 7.00 at June 30, 2017 compared to 6.96 at December 31, 2016.
The reserve allocated to consumer real estate loans at June 30, 2017 increased $1.3 million compared to December 31, 2016. This increase was mostly due to a $580 thousand increase in macroeconomic valuation allowances, a $526 thousand increase in general valuation allowances, which was primarily related to an increase in allowances allocated for loans not reviewed by concurrence and a decrease in the reduction for recoveries, and a $191 thousand increase in historical valuation allowances.
The reserve allocated to consumer and other loans at June 30, 2017 increased $2.8 million compared to December 31, 2016. The increase was primarily related to increases in macroeconomic valuation allowances, historical valuation allowances and, to a lesser extent, an increase in general valuation allowances. The increase in macroeconomic valuation allowances was related to

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a $1.6 million increase in the general macroeconomic allocation, which was related to growth in unsecured personal lines of credit. The increase in historical valuation allowances was primarily due to an increase in the volume of non-classified consumer and other loans. The increase in general valuation allowances was primarily related to an increase in the allocation for loans not reviewed by concurrence and a decrease in the adjustment for recoveries.
Activity in the allowance for loan losses is presented in the following table.
 
Three Months Ended 
 June 30,
 
Six Months Ended 
 June 30,
 
2017
 
2016
 
2017
 
2016
Balance at beginning of period
$
153,056

 
$
161,880

 
$
153,045

 
$
135,859

Provision for loan losses
8,426

 
9,189

 
16,378

 
37,689

Charge-offs:
 
 
 
 
 
 
 
Commercial and industrial
(5,579
)
 
(4,857
)
 
(9,106
)
 
(6,718
)
Energy
(6,317
)
 
(16,749
)
 
(10,595
)
 
(17,760
)
Commercial real estate
(14
)
 
(19
)
 
(14
)
 
(47
)
Consumer real estate
(2
)
 
(23
)
 
(13
)
 
(177
)
Consumer and other
(3,623
)
 
(3,252
)
 
(7,171
)
 
(5,976
)
Total charge-offs
(15,535
)
 
(24,900
)
 
(26,899
)
 
(30,678
)
Recoveries:
 
 
 
 
 
 
 
Commercial and industrial
718

 
891

 
1,516

 
1,620

Energy
81

 
2

 
134

 
2

Commercial real estate
477

 
502

 
522

 
598

Consumer real estate
113

 
97

 
220

 
350

Consumer and other
2,222

 
2,053

 
4,642

 
4,274

Total recoveries
3,611

 
3,545

 
7,034

 
6,844

Net charge-offs
(11,924
)
 
(21,355
)
 
(19,865
)
 
(23,834
)
Balance at end of period
$
149,558

 
$
149,714

 
$
149,558

 
$
149,714

 
 
 
 
 
 
 
 
Ratio of allowance for loan losses to:
 
 
 
 
 
 
 
Total loans
1.20
%
 
1.29
%
 
1.20
%
 
1.29
%
Non-accrual loans
173.07

 
175.87

 
173.07

 
175.87

Ratio of annualized net charge-offs to average total loans
0.39

 
0.74

 
0.33

 
0.42

The provision for loan losses decreased $21.3 million, or 56.5%, during the six months ended June 30, 2017 compared to the same period in 2016. The level of the provision for loan losses in 2016 was reflective of a significant increase in the volume of classified energy loans, specific valuation allowances taken on certain classified energy loans and increases in the weighted-average risk grades of our energy, commercial and industrial and commercial real estate loan portfolios. Classified energy, commercial and industrial and commercial real estate loans totaled $466.6 million at June 30, 2017 compared to $510.1 million at December 31, 2016 and $480.6 million at June 30, 2016. Specific valuation allowances related to energy, commercial and industrial and commercial real estate loans totaled $2.1 million at June 30, 2017 compared to $9.2 million at December 31, 2016 and $8.1 million at June 30, 2016. The overall weighted-average risk grade of our energy, commercial and industrial and commercial real estate loan portfolios was 6.81 at June 30, 2017 compared to 6.84 at December 31, 2016 and 6.81 at June 30, 2016. The level of the provision for loan losses during 2017 was mostly reflective of the level of net charge-offs during during the six months ended June 30, 2017, which totaled $19.9 million. These charge-offs were mostly related to five credit relationships, as discussed above. The ratio of the allowance for loan losses to total loans was 1.20% at June 30, 2017 compared to 1.28% at December 31, 2016. Management believes the recorded amount of the allowance for loan losses is appropriate based upon management’s best estimate of probable losses that have been incurred within the existing portfolio of loans. Should any of the factors considered by management in evaluating the appropriate level of the allowance for loan losses change, our estimate of probable loan losses could also change, which could affect the level of future provisions for loan losses.

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Capital and Liquidity
Capital. Shareholders’ equity totaled $3.2 billion at June 30, 2017 and $3.0 billion December 31, 2016. In addition to net income of $170.5 million, other sources of capital during the six months ended June 30, 2017 included $75.9 million of other comprehensive income, net of tax, $44.1 million in proceeds from stock option exercises and $6.3 million related to stock-based compensation. Uses of capital during the six months ended June 30, 2017 included $75.4 million of dividends paid on preferred and common stock.
The accumulated other comprehensive income/loss component of shareholders’ equity totaled a net, after-tax, unrealized gain of $51.3 million at June 30, 2017 compared to a net, after-tax, unrealized loss of $24.6 million at December 31, 2016. The change was primarily due to an $80.7 million net, after-tax, increase in the net unrealized gain on securities available for sale.
Under the Basel III Capital Rules, we have elected to opt-out of the requirement to include most components of accumulated other comprehensive income in regulatory capital. Accordingly, amounts reported as accumulated other comprehensive income/loss do not increase or reduce regulatory capital and are not included in the calculation of risk-based capital and leverage ratios. Regulatory agencies for banks and bank holding companies utilize capital guidelines designed to measure capital and take into consideration the risk inherent in both on-balance sheet and off-balance sheet items. See Note 8 - Capital and Regulatory Matters in the accompanying notes to consolidated financial statements included elsewhere in this report.
We paid a quarterly dividend of $0.54 and $0.57 per common share during the first and second quarters of 2017, respectively, and a quarterly dividend of $0.53 and $0.54 per common share during the first and second quarters of 2016. This equates to a common stock dividend payout ratio of 42.9% and 48.8% during the first six months of 2017 and 2016, respectively. Our ability to declare or pay dividends on, or purchase, redeem or otherwise acquire, shares of our capital stock may be impacted by certain restrictions under the terms of our junior subordinated deferrable interest debentures and our Series A Preferred Stock as described in Note 8 - Capital and Regulatory Matters in the accompanying notes to consolidated financial statements included elsewhere in this report.
Stock Repurchase Plans. From time to time, our board of directors has authorized stock repurchase plans. In general, stock repurchase plans allow us to proactively manage our capital position and return excess capital to shareholders. Shares purchased under such plans also provide us with shares of common stock necessary to satisfy obligations related to stock compensation awards. On October 27, 2016, our board of directors authorized a $100.0 million stock repurchase program, allowing us to repurchase shares of our common stock over a two-year period from time to time at various prices in the open market or through private transactions. As of June 30, 2017, no shares have been repurchased under the plan. See Part II, Item 2 - Unregistered Sales of Equity Securities and Use of Proceeds, included elsewhere in this report.
Liquidity. As more fully discussed in our 2016 Form 10-K, our liquidity position is continuously monitored and adjustments are made to the balance between sources and uses of funds as deemed appropriate. Liquidity risk management is an important element in our asset/liability management process. We regularly model liquidity stress scenarios to assess potential liquidity outflows or funding problems resulting from economic disruptions, volatility in the financial markets, unexpected credit events or other significant occurrences deemed problematic by management. These scenarios are incorporated into our contingency funding plan, which provides the basis for the identification of our liquidity needs. As of June 30, 2017, management is not aware of any events that are reasonably likely to have a material adverse effect on our liquidity, capital resources or operations. In addition, management is not aware of any regulatory recommendations regarding liquidity, that would have a material adverse effect on us.
Since Cullen/Frost is a holding company and does not conduct operations, its primary sources of liquidity are dividends upstreamed from Frost Bank and borrowings from outside sources. Banking regulations may limit the amount of dividends that may be paid by Frost Bank. See Note 8 - Capital and Regulatory Matters in the accompanying notes to consolidated financial statements included elsewhere in this report regarding such dividends. At June 30, 2017, Cullen/Frost had liquid assets, including cash and resell agreements, totaling $339.5 million.
Accounting Standards Updates
See Note 18 - Accounting Standards Updates in the accompanying notes to consolidated financial statements included elsewhere in this report for details of recently issued accounting pronouncements and their expected impact on our financial statements.


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Consolidated Average Balance Sheets and Interest Income Analysis - Quarter To Date
(Dollars in thousands - taxable-equivalent basis)
 
June 30, 2017
 
June 30, 2016
 
Average
Balance
 
Interest
Income/
Expense
 
Yield/
Cost
 
Average
Balance
 
Interest
Income/
Expense
 
Yield/
Cost
Assets:
 
 
 
 
 
 
 
 
 
 
 
Interest-bearing deposits
$
3,349,997

 
$
9,076

 
1.09
%
 
$
2,813,861

 
$
3,602

 
0.51
%
Federal funds sold and resell agreements
49,232

 
163

 
1.33

 
37,353

 
59

 
0.63

Securities:
 
 
 
 
 
 
 
 
 
 
 
Taxable
5,105,249

 
23,527

 
1.87

 
5,284,574

 
25,531

 
1.99

Tax-exempt
7,284,731

 
97,401

 
5.38

 
6,509,323

 
89,240

 
5.64

Total securities
12,389,980

 
120,928

 
3.93

 
11,793,897

 
114,771

 
4.00

Loans, net of unearned discounts
12,275,030

 
132,339

 
4.32

 
11,537,472

 
114,675

 
4.00

Total Earning Assets and Average Rate Earned
28,064,239

 
262,506

 
3.76

 
26,182,583

 
233,107

 
3.62

Cash and due from banks
495,954

 
 
 
 
 
493,333

 
 
 
 
Allowance for loan losses
(151,784
)
 
 
 
 
 
(163,155
)
 
 
 
 
Premises and equipment, net
521,275

 
 
 
 
 
561,486

 
 
 
 
Accrued interest and other assets
1,194,275

 
 
 
 
 
1,165,513

 
 
 
 
Total Assets
$
30,123,959

 
 
 
 
 
$
28,239,760

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Liabilities:
 
 
 
 
 
 
 
 
 
 
 
Non-interest-bearing demand deposits:
 
 
 
 
 
 
 
 
 
 
 
Commercial and individual
$
10,043,532

 
 
 
 
 
$
8,807,403

 
 
 
 
Correspondent banks
242,920

 
 
 
 
 
318,740

 
 
 
 
Public funds
407,830

 
 
 
 
 
491,245

 
 
 
 
Total non-interest-bearing demand deposits
10,694,282

 
 
 
 
 
9,617,388

 
 
 
 
Interest-bearing deposits:
 
 
 
 
 
 
 
 
 
 
 
Private accounts
 
 
 
 
 
 
 
 
 
 
 
Savings and interest checking
6,399,008

 
272

 
0.02

 
5,765,494

 
259

 
0.02

Money market deposit accounts
7,383,394

 
1,280

 
0.07

 
7,397,712

 
1,185

 
0.06

Time accounts
778,728

 
321

 
0.17

 
811,714

 
283

 
0.14

Public funds
405,658

 
300

 
0.30

 
429,684

 
46

 
0.04

Total interest-bearing deposits
14,966,788

 
2,173

 
0.06

 
14,404,604

 
1,773

 
0.05

Total deposits
25,661,070

 
 
 
 
 
24,021,992

 
 
 
 
Federal funds purchased and repurchase agreements
915,607

 
187

 
0.08

 
718,784

 
52

 
0.03

Junior subordinated deferrable interest debentures
136,150

 
962

 
2.83

 
136,092

 
803

 
2.36

Subordinated notes payable and other notes
98,459

 
1,164

 
4.73

 
99,918

 
321

 
1.29

Total Interest-Bearing Funds and Average Rate Paid
16,117,004

 
4,486

 
0.11

 
15,359,398

 
2,949

 
0.08

Accrued interest and other liabilities
140,945

 
 
 
 
 
238,168

 
 
 
 
Total Liabilities
26,952,231

 
 
 
 
 
25,214,954

 
 
 
 
Shareholders’ Equity
3,171,728

 
 
 
 
 
3,024,806

 
 
 
 
Total Liabilities and Shareholders’ Equity
$
30,123,959

 
 
 
 
 
$
28,239,760

 
 
 
 
Net interest income
 
 
$
258,020

 
 
 
 
 
$
230,158

 
 
Net interest spread
 
 
 
 
3.65
%
 
 
 
 
 
3.54
%
Net interest income to total average earning assets
 
 
 
 
3.70
%
 
 
 
 
 
3.57
%
For these computations: (i) average balances are presented on a daily average basis, (ii) information is shown on a taxable-equivalent basis assuming a 35% tax rate, (iii) average loans include loans on non-accrual status, and (iv) average securities include unrealized gains and losses on securities available for sale while yields are based on average amortized cost.


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Consolidated Average Balance Sheets and Interest Income Analysis - Year To Date
(Dollars in thousands - taxable-equivalent basis)
 
June 30, 2017
 
June 30, 2016
 
Average
Balance
 
Interest
Income/
Expense
 
Yield/
Cost
 
Average
Balance
 
Interest
Income/
Expense
 
Yield/
Cost
Assets:
 
 
 
 
 
 
 
 
 
 
 
Interest-bearing deposits
$
3,336,695

 
$
15,912

 
0.96
%
 
$
2,838,798

 
$
7,255

 
0.51
%
Federal funds sold and resell agreements
48,622

 
270

 
1.12

 
37,225

 
117

 
0.63

Securities:
 
 
 
 
 
 
 
 
 
 
 
Taxable
5,183,956

 
48,829

 
1.91

 
5,171,747

 
51,505

 
2.05

Tax-exempt
7,283,866

 
196,976

 
5.41

 
6,497,678

 
177,669

 
5.61

Total securities
12,467,822

 
245,805

 
3.96

 
11,669,425

 
229,174

 
4.03

Loans, net of unearned discounts
12,182,820

 
256,195

 
4.24

 
11,517,498

 
228,614

 
3.99

Total Earning Assets and Average Rate Earned
28,035,959

 
518,182

 
3.72

 
26,062,946

 
465,160

 
3.62

Cash and due from banks
514,146

 
 
 
 
 
512,475

 
 
 
 
Allowance for loan losses
(152,791
)
 
 
 
 
 
(151,186
)
 
 
 
 
Premises and equipment, net
522,948

 
 
 
 
 
559,422

 
 
 
 
Accrued interest and other assets
1,215,147

 
 
 
 
 
1,180,399

 
 
 
 
Total Assets
$
30,135,409

 
 
 
 
 
$
28,164,056

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Liabilities:
 
 
 
 
 
 
 
 
 
 
 
Non-interest-bearing demand deposits:
 
 
 
 
 
 
 
 
 
 
 
Commercial and individual
$
10,001,032

 
 
 
 
 
$
8,970,165

 
 
 
 
Correspondent banks
263,641

 
 
 
 
 
337,419

 
 
 
 
Public funds
445,397

 
 
 
 
 
530,689

 
 
 
 
Total non-interest-bearing demand deposits
10,710,070

 
 
 
 
 
9,838,273

 
 
 
 
Interest-bearing deposits:
 
 
 
 
 
 
 
 
 
 
 
Private accounts
 
 
 
 
 
 
 
 
 
 
 
Savings and interest checking
6,357,312

 
545

 
0.02

 
5,439,878

 
514

 
0.02

Money market deposit accounts
7,430,600

 
2,416

 
0.07

 
7,425,438

 
2,375

 
0.06

Time accounts
782,724

 
628

 
0.16

 
816,453

 
575

 
0.14

Public funds
459,706

 
452

 
0.20

 
469,020

 
96

 
0.04

Total interest-bearing deposits
15,030,342

 
4,041

 
0.05

 
14,150,789

 
3,560

 
0.05

Total deposits
25,740,412

 
 
 
 
 
23,989,062

 
 
 
 
Federal funds purchased and repurchase agreements
910,333

 
326

 
0.07

 
701,977

 
108

 
0.03

Junior subordinated deferrable interest debentures
136,143

 
1,870

 
2.75

 
136,085

 
1,553

 
2.28

Subordinated notes payable and other notes
81,416

 
1,532

 
3.76

 
99,903

 
608

 
1.22

Total Interest-Bearing Funds and Average Rate Paid
16,158,234

 
7,769

 
0.10

 
15,088,754

 
5,829

 
0.08

Accrued interest and other liabilities
153,320

 
 
 
 
 
245,886

 
 
 
 
Total Liabilities
27,021,624

 
 
 
 
 
25,172,913

 
 
 
 
Shareholders’ Equity
3,113,785

 
 
 
 
 
2,991,143

 
 
 
 
Total Liabilities and Shareholders’ Equity
$
30,135,409

 
 
 
 
 
$
28,164,056

 
 
 
 
Net interest income
 
 
$
510,413

 
 
 
 
 
$
459,331

 
 
Net interest spread
 
 
 
 
3.62
%
 
 
 
 
 
3.54
%
Net interest income to total average earning assets
 
 
 
 
3.67
%
 
 
 
 
 
3.58
%
For these computations: (i) average balances are presented on a daily average basis, (ii) information is shown on a taxable-equivalent basis assuming a 35% tax rate, (iii) average loans include loans on non-accrual status, and (iv) average securities include unrealized gains and losses on securities available for sale while yields are based on average amortized cost.



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Table of Contents

Item 3. Quantitative and Qualitative Disclosures About Market Risk
The disclosures set forth in this item are qualified by the section captioned “Forward-Looking Statements and Factors that Could Affect Future Results” included in Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations of this report and other cautionary statements set forth elsewhere in this report.
Refer to the discussion of market risks included in Item 7A. Quantitative and Qualitative Disclosures About Market Risk in the 2016 Form 10-K. There has been no significant change in the types of market risks we face since December 31, 2016.
We utilize an earnings simulation model as the primary quantitative tool in measuring the amount of interest rate risk associated with changing market rates. The model quantifies the effects of various interest rate scenarios on projected net interest income and net income over the next 12 months. The model measures the impact on net interest income relative to a flat-rate case scenario of hypothetical fluctuations in interest rates over the next 12 months. These simulations incorporate assumptions regarding balance sheet growth and mix, pricing and the repricing and maturity characteristics of the existing and projected balance sheet. The impact of interest rate derivatives, such as interest rate swaps, caps and floors, is also included in the model. Other interest rate-related risks such as prepayment, basis and option risk are also considered.
For modeling purposes, as of June 30, 2017, the model simulations projected that 100 and 200 basis point ratable increases in interest rates would result in positive variances in net interest income of 1.0% and 2.8%, respectively, relative to the flat-rate case over the next 12 months, while 100 and 125 basis point ratable decreases in interest rates would result in a negative variances in net interest income of 4.8% and 10.1%, respectively, relative to the flat-rate case over the next 12 months. The June 30, 2017 model simulations were impacted by the assumption, for modeling purposes, that we will begin to pay interest on commercial demand deposits (those not already receiving an earnings credit rate) in the third quarter of 2017, as further discussed below. For modeling purposes, as of June 30, 2016, the model simulations projected that 100 and 200 basis point ratable increases in interest rates would result in positive variances in net interest income of 0.3% and 1.3%, respectively, relative to the flat-rate case over the next 12 months, while a decrease in interest rates of 50 basis points would result in a negative variance in net interest income of 5.7% relative to the flat-rate case over the next 12 months. The June 30, 2016 model simulations were impacted by the assumption, for modeling purposes, that we would begin to pay interest on commercial demand deposits (those not already receiving an earnings credit rate) in the third quarter of 2016, as further discussed below. The likelihood of a decrease in interest rates beyond 125 basis points as of June 30, 2017 and 50 basis points as of June 30, 2016 was considered to be remote given prevailing interest rate levels.
The model simulations as of June 30, 2017 indicate that our balance sheet is more asset sensitive in comparison to our balance sheet as of June 30, 2016. The shift to a more asset sensitive position was primarily due to a decrease in the assumed interest rates paid on projected commercial demand deposits and an increase in the relative proportion of federal funds sold to projected average interest-earning assets. Federal funds sold are more immediately impacted by changes in interest rates in comparison to other categories of earning assets.
As mentioned above, financial regulatory reform legislation entitled the “Dodd-Frank Wall Street Reform and Consumer Protection Act” (the “Dodd-Frank Act”) repealed the federal prohibition on the payment of interest on demand deposits, thereby permitting depository institutions to pay interest on business transaction and other accounts beginning July 21, 2011. To date, we have not experienced any significant additional interest costs as a result of the repeal; however, we may begin to incur interest costs associated with certain demand deposits in the future as market conditions warrant. If this were to occur, our balance sheet would likely become less asset sensitive. Because the interest rate that will ultimately be paid on these demand deposits depends upon a variety of factors, some of which are beyond our control, we assumed an aggressive pricing structure for the purposes of the model simulations discussed above with interest payments beginning in the third quarter of 2017. Should the actual interest rate paid on demand deposits be less than the rate assumed in the model simulations, or should the interest rate paid for demand deposits become an administered rate with less direct correlation to movements in general market interest rates, our balance sheet could be more asset sensitive than the model simulations might otherwise indicate.
As of June 30, 2017, the effects of a 200 basis point increase and a 125 basis point decrease in interest rates on our derivative holdings would not result in a significant variance in our net interest income.
The effects of hypothetical fluctuations in interest rates on our securities classified as “trading” under ASC Topic 320, “Investments—Debt and Equity Securities,” are not significant, and, as such, separate quantitative disclosure is not presented.

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Table of Contents

Item 4. Controls and Procedures
As of the end of the period covered by this Quarterly Report on Form 10-Q, an evaluation was carried out by management, with the participation of its Chief Executive Officer and Chief Financial Officer, of the effectiveness of our disclosure controls and procedures (as defined in Rule 13a-15(e) under the Securities Exchange Act of 1934). Based upon that evaluation, the Chief Executive Officer and Chief Financial Officer concluded that the disclosure controls and procedures were effective as of the end of the period covered by this report. No change in our internal control over financial reporting (as defined in Rule 13a-15(f) under the Securities Exchange Act of 1934) occurred during the last fiscal quarter that materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

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Table of Contents

Part II. Other Information
Item 1. Legal Proceedings
We are 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 our financial statements.
Item 1A. Risk Factors
There has been no material change in the risk factors disclosed under Item 1A. of our 2016 Form 10-K.
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
The following table provides information with respect to purchases we made or were made on our behalf or any “affiliated purchaser” (as defined in Rule 10b-18(a)(3) under the Securities Exchange Act of 1934), of our common stock during the three months ended June 30, 2017. Dollar amounts in thousands.
Period
Total Number of
Shares Purchased
 
Average Price
Paid Per Share
 
Total Number of
Shares Purchased
as Part of Publicly
Announced Plan
 
Maximum
Number of Shares
(or Approximate
Dollar Value)
That May Yet Be
Purchased Under
the Plan at the
End of the Period
April 1, 2017 to April 30, 2017

 
$

 

 
$
100,000

May 1, 2017 to May 31, 2017

 

 

 
100,000

June 1, 2017 to June 30, 2017

 

 

 
100,000

Total

 
$

 

 
 


Item 3. Defaults Upon Senior Securities
None.
Item 4. Mine Safety Disclosures
None.
Item 5. Other Information
None.
Item 6. Exhibits
(a) Exhibits
Exhibit
Number
Description
31.1
Rule 13a-14(a) Certification of the Corporation's Chief Executive Officer
31.2
Rule 13a-14(a) Certification of the Corporation's Chief Financial Officer
32.1+
Section 1350 Certification of the Corporation's Chief Executive Officer
32.2+
Section 1350 Certification of the Corporation's Chief Financial Officer
101
Interactive Data File
+
This exhibit shall not be deemed “filed” for purposes of Section 18 of the Securities Exchange Act of 1934, or otherwise subject to the liability of that section, and shall not be deemed to be incorporated by reference into any filing under the Securities Act of 1933 or the Securities Exchange Act of 1934.

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Table of Contents

Signatures
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

 
 
 
 
 
 
 
 
 
Cullen/Frost Bankers, Inc.
 
 
 
 
(Registrant)
 
 
 
 
 
 
 
Date:
July 27, 2017
 
By:  
/s/ Jerry Salinas
 
 
 
 
 
Jerry Salinas
 
 
 
 
 
Group Executive Vice President
 
 
 
 
 
and Chief Financial Officer
 
 
 
 
 
(Duly Authorized Officer, Principal Financial
 
 
 
 
 
Officer and Principal Accounting Officer)
 

57