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Table of Contents

United States
Securities and Exchange Commission
Washington, D.C. 20549
Form 10-Q
ý Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
For the quarterly period ended: September 30, 2018
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 October 18, 2018 there were 63,944,066 shares of the registrant’s Common Stock, $.01 par value, outstanding.

Table of Contents

Cullen/Frost Bankers, Inc.
Quarterly Report on Form 10-Q
September 30, 2018
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)
 
September 30,
2018
 
December 31,
2017
Assets:
 
 
 
Cash and due from banks
$
505,333

 
$
545,542

Interest-bearing deposits
2,430,289

 
4,347,538

Federal funds sold and resell agreements
483,867

 
159,967

Total cash and cash equivalents
3,419,489

 
5,053,047

Securities held to maturity, at amortized cost
1,111,762

 
1,432,098

Securities available for sale, at estimated fair value
11,178,591

 
10,489,009

Trading account securities
22,238

 
21,098

Loans, net of unearned discounts
13,814,838

 
13,145,665

Less: Allowance for loan losses
(137,578
)
 
(155,364
)
Net loans
13,677,260

 
12,990,301

Premises and equipment, net
541,236

 
520,958

Goodwill
654,952

 
654,952

Other intangible assets, net
3,980

 
5,073

Cash surrender value of life insurance policies
182,603

 
180,477

Accrued interest receivable and other assets
431,291

 
400,867

Total assets
$
31,223,402

 
$
31,747,880

 
 
 
 
Liabilities:
 
 
 
Deposits:
 
 
 
Non-interest-bearing demand deposits
$
10,840,513

 
$
11,197,093

Interest-bearing deposits
15,508,341

 
15,675,296

Total deposits
26,348,854

 
26,872,389

Federal funds purchased and repurchase agreements
1,083,777

 
1,147,824

Junior subordinated deferrable interest debentures, net of unamortized issuance costs
136,227

 
136,184

Subordinated notes, net of unamortized issuance costs
98,669

 
98,552

Accrued interest payable and other liabilities
247,629

 
195,068

Total liabilities
27,915,156

 
28,450,017

 
 
 
 
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 September 30, 2018 and December 31, 2017
144,486

 
144,486

Common stock, par value $0.01 per share; 210,000,000 shares authorized; 64,236,306 shares issued at September 30, 2018 and December 31, 2017
642

 
642

Additional paid-in capital
962,917

 
953,361

Retained earnings
2,369,259

 
2,187,069

Accumulated other comprehensive income (loss), net of tax
(141,235
)
 
79,512

Treasury stock, at cost; 313,490 shares at September 30, 2018 and 760,720 shares at December 31, 2017
(27,823
)
 
(67,207
)
Total shareholders’ equity
3,308,246

 
3,297,863

Total liabilities and shareholders’ equity
$
31,223,402

 
$
31,747,880

See Notes to Consolidated Financial Statements.


3
Table of Contents

Cullen/Frost Bankers, Inc.
Consolidated Statements of Income
(Dollars in thousands, except per share amounts)
 
Three Months Ended 
 September 30,
 
Nine Months Ended 
 September 30,
 
2018
 
2017
 
2018
 
2017
Interest income:
 
 
 
 
 
 
 
Loans, including fees
$
172,333

 
$
138,400

 
$
487,668

 
$
392,073

Securities:
 
 
 
 
 
 
 
Taxable
21,339

 
23,203

 
63,085

 
72,032

Tax-exempt
59,200

 
54,939

 
173,209

 
167,321

Interest-bearing deposits
14,445

 
10,800

 
42,456

 
26,712

Federal funds sold and resell agreements
1,399

 
244

 
3,575

 
514

Total interest income
268,716

 
227,586

 
769,993

 
658,652

Interest expense:
 
 
 
 
 
 
 
Deposits
22,201

 
5,668

 
50,414

 
9,709

Federal funds purchased and repurchase agreements
2,292

 
523

 
3,557

 
849

Junior subordinated deferrable interest debentures
1,394

 
1,020

 
3,847

 
2,890

Other long-term borrowings
1,164

 
1,164

 
3,492

 
2,696

Total interest expense
27,051

 
8,375

 
61,310

 
16,144

Net interest income
241,665

 
219,211

 
708,683

 
642,508

Provision for loan losses
2,650

 
10,980

 
17,846

 
27,358

Net interest income after provision for loan losses
239,015

 
208,231

 
690,837

 
615,150

Non-interest income:
 
 
 
 
 
 
 
Trust and investment management fees
30,801

 
27,493

 
89,509

 
81,690

Service charges on deposit accounts
21,569

 
20,967

 
63,554

 
62,934

Insurance commissions and fees
11,037

 
10,892

 
37,573

 
34,441

Interchange and debit card transaction fees
3,499

 
5,884

 
10,103

 
17,150

Other charges, commissions and fees
9,580

 
10,493

 
27,860

 
29,983

Net gain (loss) on securities transactions
(34
)
 
(4,867
)
 
(113
)
 
(4,917
)
Other
11,205

 
10,753

 
35,682

 
25,114

Total non-interest income
87,657

 
81,615

 
264,168

 
246,395

Non-interest expense:
 
 
 
 
 
 
 
Salaries and wages
87,547

 
84,388

 
259,434

 
247,895

Employee benefits
18,355

 
17,730

 
58,257

 
57,553

Net occupancy
19,894

 
19,391

 
59,089

 
57,781

Technology, furniture and equipment
21,004

 
18,743

 
61,142

 
54,983

Deposit insurance
4,694

 
4,862

 
14,178

 
15,347

Intangible amortization
336

 
405

 
1,093

 
1,301

Other
41,838

 
41,304

 
125,994

 
127,929

Total non-interest expense
193,668

 
186,823

 
579,187

 
562,789

Income before income taxes
133,004

 
103,023

 
375,818

 
298,756

Income taxes
15,160

 
9,892

 
40,153

 
35,131

Net income
117,844

 
93,131

 
335,665

 
263,625

Preferred stock dividends
2,016

 
2,016

 
6,047

 
6,047

Net income available to common shareholders
$
115,828

 
$
91,115

 
$
329,618

 
$
257,578

 
 
 
 
 
 
 
 
Earnings per common share:
 
 
 
 
 
 
 
Basic
$
1.80

 
$
1.43

 
$
5.13

 
$
4.02

Diluted
1.78

 
1.41

 
5.08

 
3.98

See Notes to Consolidated Financial Statements.

4
Table of Contents

Cullen/Frost Bankers, Inc.
Consolidated Statements of Comprehensive Income (Loss)
(Dollars in thousands)
 
Three Months Ended 
 September 30,
 
Nine Months Ended 
 September 30,
 
2018
 
2017
 
2018
 
2017
Net income
$
117,844

 
$
93,131

 
$
335,665

 
$
263,625

Other comprehensive income (loss), before tax:
 
 
 
 
 
 
 
Securities available for sale and transferred securities:
 
 
 
 
 
 
 
Change in net unrealized gain/loss during the period
(96,147
)
 
7,082

 
(286,935
)
 
131,283

Change in net unrealized gain on securities transferred to held to maturity
(3,764
)
 
(3,514
)
 
(8,424
)
 
(13,660
)
Reclassification adjustment for net (gains) losses included in net income
34

 
4,867

 
113

 
4,917

Total securities available for sale and transferred securities
(99,877
)
 
8,435

 
(295,246
)
 
122,540

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

 
—

 
—

 
—

Reclassification adjustment for net amortization of actuarial gain/loss included in net income as a component of net periodic cost (benefit)
1,250

 
1,357

 
3,751

 
4,072

Total defined-benefit post-retirement benefit plans
1,250

 
1,357

 
3,751

 
4,072

Other comprehensive income (loss), before tax
(98,627
)
 
9,792

 
(291,495
)
 
126,612

Deferred tax expense (benefit)
(20,711
)
 
3,427

 
(61,213
)
 
44,314

Other comprehensive income (loss), net of tax
(77,916
)
 
6,365

 
(230,282
)
 
82,298

Comprehensive income (loss)
$
39,928

 
$
99,496

 
$
105,383

 
$
345,923

See Notes to Consolidated Financial Statements.

5
Table of Contents

Cullen/Frost Bankers, Inc.
Consolidated Statements of Changes in Shareholders’ Equity
(Dollars in thousands, except per share amounts)
 
Preferred
Stock
 
Common
Stock
 
Additional
Paid-In
Capital
 
Retained
Earnings
 
Accumulated
Other
Comprehensive
Income (Loss),
Net of Tax
 
Treasury
Stock
 
Total
Three months ended:
 
 
 
 
 
 
 
 
 
 
 
 
 
September 30, 2018
 
 
 
 
 
 
 
 
 
 
 
 
 
Balance at beginning of period
$
144,486

 
$
642

 
$
960,121

 
$
2,297,099

 
$
(63,319
)
 
$
(29,517
)
 
$
3,309,512

Net income
—

 
—

 
—

 
117,844

 
—

 
—

 
117,844

Other comprehensive loss, net of tax
—

 
—

 
—

 
—

 
(77,916
)
 
—

 
(77,916
)
Stock option exercises/stock unit conversions (19,232 shares)
—

 
—

 
—

 
(575
)
 
—

 
1,694

 
1,119

Stock-based compensation expense recognized in earnings
—

 
—

 
2,796

 
—

 
—

 
—

 
2,796

Cash dividends – preferred stock (approximately $0.34 per share)
—

 
—

 
—

 
(2,016
)
 
—

 
—

 
(2,016
)
Cash dividends - common stock ($0.67 per share)
—

 
—

 
—

 
(43,093
)
 
—

 
—

 
(43,093
)
Balance at end of period
$
144,486

 
$
642

 
$
962,917

 
$
2,369,259

 
$
(141,235
)
 
$
(27,823
)
 
$
3,308,246

 
 
 
 
 
 
 
 
 
 
 
 
 
 
September 30, 2017
 
 
 
 
 
 
 
 
 
 
 
 
 
Balance at beginning of period
$
144,486

 
$
642

 
$
948,593

 
$
2,078,898

 
$
51,310

 
$
—

 
$
3,223,929

Net income
—

 
—

 
—

 
93,131

 
—

 
—

 
93,131

Other comprehensive income, net of tax
—

 
—

 
—

 
—

 
6,365

 
—

 
6,365

Stock option exercises/stock unit conversions (22,724 shares)
—

 
—

 
578

 
(393
)
 
—

 
1,088

 
1,273

Stock-based compensation expense recognized in earnings
—

 
—

 
2,722

 
—

 
—

 
—

 
2,722

Purchase of treasury stock (1,134,966 shares)
—

 
—

 
—

 
—

 
—

 
(100,000
)
 
(100,000
)
Cash dividends – preferred stock (approximately $0.34 per share)
—

 
—

 
—

 
(2,016
)
 
—

 
—

 
(2,016
)
Cash dividends – common stock ($0.57 per share)
—

 
—

 
—

 
(36,361
)
 
—

 
—

 
(36,361
)
Balance at end of period
$
144,486

 
$
642

 
$
951,893

 
$
2,133,259

 
$
57,675

 
$
(98,912
)
 
$
3,189,043


See accompanying Notes to Consolidated Financial Statements

6
Table of Contents

Cullen/Frost Bankers, Inc.
Consolidated Statements of Changes in Shareholders’ Equity (continued)
(Dollars in thousands, except per share amounts)
 
Preferred
Stock
 
Common
Stock
 
Additional
Paid-In
Capital
 
Retained
Earnings
 
Accumulated
Other
Comprehensive
Income (Loss),
Net of Tax
 
Treasury
Stock
 
Total
Nine months ended:
 
 
 
 
 
 
 
 
 
 
 
 
 
September 30, 2018
 
 
 
 
 
 
 
 
 
 
 
 
 
Balance at beginning of period
$
144,486

 
$
642

 
$
953,361

 
$
2,187,069

 
$
79,512

 
$
(67,207
)
 
$
3,297,863

Cumulative effect of accounting change
—

 
—

 
—

 
(2,285
)
 
—

 
—

 
(2,285
)
Total shareholders' equity at beginning of period, as adjusted
144,486

 
642

 
953,361

 
2,184,784

 
79,512

 
(67,207
)
 
3,295,578

Net income
—

 
—

 
—

 
335,665

 
—

 
—

 
335,665

Other comprehensive loss, net of tax
—

 
—

 
—

 
—

 
(230,282
)
 
—

 
(230,282
)
Reclassification of certain income tax effects related to the change in the U.S. statutory federal income tax rate under the Tax Cuts and Jobs Act
—

 
—

 
—

 
(9,535
)
 
9,535

 
—

 
—

Stock option exercises/stock unit conversions (447,831 shares)
—

 
—

 
—

 
(12,887
)
 
—

 
39,454

 
26,567

Stock-based compensation expense recognized in earnings
—

 
—

 
9,556

 
—

 
—

 
—

 
9,556

Purchase of treasury stock (601 shares)
—

 
—

 
—

 
—

 
—

 
(70
)
 
(70
)
Cash dividends – preferred stock (approximately $1.01 per share)
—

 
—

 
—

 
(6,047
)
 
—

 
—

 
(6,047
)
Cash dividends – common stock ($1.91 per share)
—

 
—

 
—

 
(122,721
)
 
—

 
—

 
(122,721
)
Balance at end of period
$
144,486

 
$
642

 
$
962,917

 
$
2,369,259

 
$
(141,235
)
 
$
(27,823
)
 
$
3,308,246

 
 
 
 
 
 
 
 
 
 
 
 
 
 
September 30, 2017
 
 
 
 
 
 
 
 
 
 
 
 
 
Balance at beginning of period
$
144,486

 
$
637

 
$
906,732

 
$
1,985,569

 
$
(24,623
)
 
$
(10,273
)
 
$
3,002,528

Net income
—

 
—

 
—

 
263,625

 
—

 
—

 
263,625

Other comprehensive income, net of tax
—

 
—

 
—

 
—

 
82,298

 
—

 
82,298

Stock option exercises/stock unit conversions (774,799 shares)
—

 
5

 
36,148

 
(2,134
)
 
—

 
11,403

 
45,422

Stock-based compensation expense recognized in earnings
—

 
—

 
9,013

 
—

 
—

 
—

 
9,013

Purchase of treasury stock (1,135,435 shares)
—

 
—

 
—

 
—

 
—

 
(100,042
)
 
(100,042
)
Cash dividends – preferred stock (approximately $1.01 per share)
—

 
—

 
—

 
(6,047
)
 
—

 
—

 
(6,047
)
Cash dividends – common stock ($1.68 per share)
—

 
—

 
—

 
(107,754
)
 
—

 
—

 
(107,754
)
Balance at end of period
$
144,486

 
$
642

 
$
951,893

 
$
2,133,259

 
$
57,675

 
$
(98,912
)
 
$
3,189,043


See accompanying Notes to Consolidated Financial Statements


7
Table of Contents

Cullen/Frost Bankers, Inc.
Consolidated Statements of Cash Flows
(Dollars in thousands)
 
Nine Months Ended 
 September 30,
 
2018
 
2017
Operating Activities:
 
 
 
Net income
$
335,665

 
$
263,625

Adjustments to reconcile net income to net cash from operating activities:
 
 
 
Provision for loan losses
17,846

 
27,358

Deferred tax expense (benefit)
39,198

 
(9,505
)
Accretion of loan discounts
(10,470
)
 
(11,567
)
Securities premium amortization (discount accretion), net
73,748

 
66,455

Net (gain) loss on securities transactions
113

 
4,917

Depreciation and amortization
37,452

 
35,819

Net (gain) loss on sale/write-down of assets/foreclosed assets
(6,122
)
 
(2,045
)
Stock-based compensation
9,556

 
9,013

Net tax benefit from stock-based compensation
3,378

 
5,844

Earnings on life insurance policies
(2,510
)
 
(2,367
)
Net change in:
 
 
 
Trading account securities
(1,094
)
 
(3,018
)
Accrued interest receivable and other assets
(19,047
)
 
10,495

Accrued interest payable and other liabilities
(17,545
)
 
(39,580
)
Net cash from operating activities
460,168

 
355,444

 
 
 
 
Investing Activities:
 
 
 
Securities held to maturity:
 
 
 
Purchases
(1,500
)
 
—

Sales
—

 
—

Maturities, calls and principal repayments
300,340

 
780,562

Securities available for sale:
 
 
 
Purchases
(14,983,642
)
 
(9,138,457
)
Sales
13,838,566

 
8,993,963

Maturities, calls and principal repayments
182,028

 
283,278

Proceeds from sale of loans
21,318

 
—

Net change in loans
(718,551
)
 
(745,702
)
Benefits received on life insurance policies
384

 
462

Proceeds from sales of premises and equipment
12,859

 
1,553

Purchases of premises and equipment
(56,781
)
 
(23,796
)
Proceeds from sales of repossessed properties
1,106

 
517

Net cash from investing activities
(1,403,873
)
 
152,380

 
 
 
 
Financing Activities:
 
 
 
Net change in deposits
(523,535
)
 
591,694

Net change in short-term borrowings
(64,047
)
 
20,927

Proceeds from issuance of subordinated notes
—

 
98,434

Principal payments on subordinated notes
—

 
(100,000
)
Proceeds from stock option exercises
26,567

 
45,422

Purchase of treasury stock
(70
)
 
(100,042
)
Cash dividends paid on preferred stock
(6,047
)
 
(6,047
)
Cash dividends paid on common stock
(122,721
)
 
(107,754
)
Net cash from financing activities
(689,853
)
 
442,634

 
 
 
 
Net change in cash and cash equivalents
(1,633,558
)
 
950,458

Cash and cash equivalents at beginning of period
5,053,047

 
4,141,445

Cash and cash equivalents at end of period
$
3,419,489

 
$
5,091,903


See Notes to Consolidated Financial Statements.

8
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, 2017, included in our Annual Report on Form 10-K filed with the SEC on February 7, 2018 (the “2017 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:
 
Nine Months Ended 
 September 30,
 
2018
 
2017
Cash paid for interest
$
59,764

 
$
15,611

Cash paid for income taxes
5,112

 
41,969

Significant non-cash transactions:
 
 
 
Unsettled purchases/sales of securities
74,191

 
41,763

Loans foreclosed and transferred to other real estate owned and foreclosed assets
2,898

 
257

Accounting Changes, Reclassifications and Restatements. Certain items in prior financial statements have been reclassified to conform to the current presentation. In addition, we adopted ASU 2018-02, "Income Statement - Reporting Comprehensive Income (Topic 220) - Reclassification of Certain Tax Effects from Accumulated Other Comprehensive Income" as of January 1, 2018. In accordance with ASU 2018-02, we elected to reclassify certain income tax effects related to the change in the U.S. statutory federal income tax rate under the Tax Cuts and Jobs Act, which was enacted on December 22, 2017 (see Note 13 - Income Taxes), from accumulated other comprehensive income to retained earnings. Such amounts, which totaled $9.5 million, related to a net actuarial loss on defined benefit post-retirement plans and unrealized gains on securities available for sale and securities transferred to held to maturity. See Note 14 - Other Comprehensive Income. The effects of the Tax Cuts and Jobs Act on deferred taxes related to amounts initially recorded in accumulated other comprehensive income are provisional. As we finalize the accounting for the tax effects of the Tax Cuts and Jobs Act, additional reclassification adjustments may be recorded in future periods. See Note 13 - Income Taxes. Notwithstanding this election made in accordance with ASU 2018-02, our policy is to release such income tax effects only when the entire portfolio to which the underlying transactions relate is liquidated, sold or extinguished.

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Table of Contents

We also adopted ASU 2014-09, "Revenue from Contracts with Customers (Topic 606)” as of January 1, 2018. Using a modified retrospective transition approach for contracts that were not complete as of our adoption, we recognized a cumulative effect reduction to beginning retained earnings totaling $2.3 million. The amount was related to certain revenue streams within trust and investment management fees. Additionally, based on our underlying contracts, ASU 2014-09 requires us to report network costs associated with debit card and ATM transactions netted against the related fee income from such transactions. Previously, such network costs were reported as a component of other non-interest expense. For the three and nine months ended September 30, 2018, gross interchange and debit card transaction fees totaled $6.5 million and $19.0 million, respectively, while related network costs totaled $3.0 million and $8.9 million, respectively. On a net basis, we reported $3.5 million and $10.1 million as interchange and debit card transaction fees in the accompanying Consolidated Statement of Income for the three and nine months ended September 30, 2018, respectively. For the three and nine months ended September 30, 2017, we reported interchange and debit card transaction fees totaling $5.9 million and $17.2 million, respectively, on a gross basis in the accompanying Consolidated Statement of Income while related network costs totaling $3.0 million and $9.1 million were reported as a component of other non-interest expense for the three and nine months ended September 30, 2017, respectively. ASU 2014-09 also required us to change the way we recognize certain recurring revenue streams reported as components of trust and investment management fees, insurance commissions and fees and other categories of non-interest income, however, such changes were not significant to our financial statements for the nine months ended September 30, 2018.
Under ASU 2014-09, we adopted new policies related to revenue recognition. In general, for revenue not associated with financial instruments, guarantees and lease contracts, we apply the following steps when recognizing revenue from contracts with customers: (i) identify the contract, (ii) identify the performance obligations, (iii) determine the transaction price, (iv) allocate the transaction price to the performance obligations and (v) recognize revenue when performance obligation is satisfied. Our contracts with customers are generally short term in nature, typically due within one year or less or cancellable by us or our customer upon a short notice period. Performance obligations for our customer contracts are generally satisfied at a single point in time, typically when the transaction is complete, or over time. For performance obligations satisfied over time, we primarily use the output method, directly measuring the value of the products/services transferred to the customer, to determine when performance obligations have been satisfied. We typically receive payment from customers and recognize revenue concurrent with the satisfaction of our performance obligations. In most cases, this occurs within a single financial reporting period. For payments received in advance of the satisfaction of performance obligations, revenue recognition is deferred until such time the performance obligations have been satisfied. In cases where we have not received payment despite satisfaction of our performance obligations, we accrue an estimate of the amount due in the period our performance obligations have been satisfied. For contracts with variable components, only amounts for which collection is probable are accrued. We generally act in a principal capacity, on our own behalf, in most of our contracts with customers. In such transactions, we recognize revenue and the related costs to provide our services on a gross basis in our financial statements. In some cases, we act in an agent capacity, deriving revenue through assisting other entities in transactions with our customers. In such transactions, we recognized revenue and the related costs to provide our services on a net basis in our financial statements. These transactions primarily relate to insurance and brokerage commissions and fees derived from our customers' use of various interchange and ATM/debit card networks.
In August 2018, the Securities and Exchange Commission (“SEC”) issued Final Rule Release No. 33-10532 - “Disclosure Update and Simplification.” This rule amends various SEC disclosure requirements that have been determined to be redundant, duplicative, overlapping, outdated, or superseded. The changes are generally expected to reduce or eliminate certain disclosures; however, the amendments did expand interim period disclosure requirements related to changes in shareholders' equity. Although the final rule does not become effective until November 5, 2018, we elected to expand our presentation of the Statement of Changes in Shareholders' Equity, as will be required under the new rule, in our financial statements as of and for the three and nine months ended September 30, 2018.

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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.
 
September 30, 2018
 
December 31, 2017
 
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
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Residential mortgage-backed securities
$
3,040

 
$
8

 
$
94

 
$
2,954

 
$
3,610

 
$
15

 
$
38

 
$
3,587

States and political subdivisions
1,107,222

 
7,232

 
2,057

 
1,112,397

 
1,428,488

 
26,462

 
2,746

 
1,452,204

Other
1,500

 
—

 
6

 
1,494

 
—

 
—

 
—

 
—

Total
$
1,111,762

 
$
7,240

 
$
2,157

 
$
1,116,845

 
$
1,432,098

 
$
26,477

 
$
2,784

 
$
1,455,791

Available for Sale
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
U.S. Treasury
$
3,454,899

 
$
—

 
$
52,020

 
$
3,402,879

 
$
3,453,391

 
$
7,494

 
$
15,732

 
$
3,445,153

Residential mortgage-backed securities
756,649

 
11,254

 
11,532

 
756,371

 
648,288

 
19,048

 
2,250

 
665,086

States and political subdivisions
7,052,156

 
40,759

 
116,225

 
6,976,690

 
6,185,711

 
167,293

 
16,795

 
6,336,209

Other
42,651

 
—

 
—

 
42,651

 
42,561

 
—

 
—

 
42,561

Total
$
11,306,355

 
$
52,013

 
$
179,777

 
$
11,178,591

 
$
10,329,951

 
$
193,835

 
$
34,777

 
$
10,489,009

All mortgage-backed securities included in the above table were issued by U.S. government agencies and corporations. At September 30, 2018, approximately 98.4% of the securities in our municipal bond portfolio were issued by political subdivisions or agencies within the State of Texas, of which approximately 68.0% 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 and that do not have readily determinable fair values are carried at cost minus impairment, if any, plus or minus changes resulting from observable price changes in orderly transactions for identical or similar securities of the same issuer. These securities include stock in the Federal Reserve Bank and the Federal Home Loan Bank 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 $3.7 billion at September 30, 2018 and $3.8 billion at December 31, 2017.
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 September 30, 2018 totaled $3.1 million ($2.5 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.

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Table of Contents

Unrealized Losses. As of September 30, 2018, 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
$
413

 
$
19

 
$
1,850

 
$
75

 
$
2,263

 
$
94

States and political subdivisions
403,965

 
2,057

 
—

 
—

 
403,965

 
2,057

Other
1,494

 
6

 
—

 
—

 
1,494

 
6

Total
$
405,872

 
$
2,082

 
$
1,850

 
$
75

 
$
407,722

 
$
2,157

Available for Sale
 
 
 
 
 
 
 
 
 
 
 
U.S. Treasury
$
2,295,611

 
$
34,315

 
$
1,107,268

 
$
17,705

 
$
3,402,879

 
$
52,020

Residential mortgage-backed securities
294,839

 
5,979

 
98,757

 
5,553

 
393,596

 
11,532

States and political subdivisions
3,585,212

 
65,581

 
810,732

 
50,644

 
4,395,944

 
116,225

Total
$
6,175,662

 
$
105,875

 
$
2,016,757

 
$
73,902

 
$
8,192,419

 
$
179,777

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 September 30, 2018, 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 securities approach their maturity date or repricing date or if market yields for such investments decline. Management does not believe any of the securities are impaired due to reasons of credit quality. Accordingly, as of September 30, 2018, 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 September 30, 2018 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
$
56,511

 
$
57,181

 
$
858,235

 
$
851,163

Due after one year through five years
131,987

 
133,521

 
3,243,532

 
3,204,804

Due after five years through ten years
492,460

 
492,354

 
489,960

 
487,536

Due after ten years
427,764

 
430,835

 
5,915,328

 
5,836,066

Residential mortgage-backed securities
3,040

 
2,954

 
756,649

 
756,371

Equity securities
—

 
—

 
42,651

 
42,651

Total
$
1,111,762

 
$
1,116,845

 
$
11,306,355

 
$
11,178,591


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Table of Contents

Sales of Securities. Sales of securities available for sale were as follows:
 
Three Months Ended 
 September 30,
 
Nine Months Ended 
 September 30,
 
2018
 
2017
 
2018
 
2017
Proceeds from sales
$
2,948,178

 
$
746,524

 
$
13,838,566

 
$
8,993,963

Gross realized gains
—

 
—

 
3

 
—

Gross realized losses
(34
)
 
(4,867
)
 
(116
)
 
(4,917
)
Tax (expense) benefit of securities gains/losses
7

 
1,703

 
24

 
1,721

Premiums and Discounts. Premium amortization and discount accretion included in interest income on securities was as follows:
 
Three Months Ended 
 September 30,
 
Nine Months Ended 
 September 30,
 
2018
 
2017
 
2018
 
2017
Premium amortization
$
(27,381
)
 
$
(24,586
)
 
$
(80,104
)
 
$
(72,733
)
Discount accretion
2,569

 
1,783

 
6,356

 
6,278

Net (premium amortization) discount accretion
$
(24,812
)
 
$
(22,803
)
 
$
(73,748
)
 
$
(66,455
)
Trading Account Securities. Trading account securities, at estimated fair value, were as follows:
 
September 30,
2018
 
December 31,
2017
U.S. Treasury
$
21,804

 
$
19,210

States and political subdivisions
434

 
1,888

Total
$
22,238

 
$
21,098

Net gains and losses on trading account securities were as follows:
 
Three Months Ended 
 September 30,
 
Nine Months Ended 
 September 30,
 
2018
 
2017
 
2018
 
2017
Net gain on sales transactions
$
465

 
$
414

 
$
1,404

 
$
1,018

Net mark-to-market gains (losses)
(8
)
 
(8
)
 
(21
)
 
(51
)
Net gain (loss) on trading account securities
$
457

 
$
406

 
$
1,383

 
$
967


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Table of Contents

Note 3 - Loans
Loans were as follows:
 
September 30,
2018
 
Percentage
of Total
 
December 31,
2017
 
Percentage
of Total
Commercial and industrial
$
5,029,754

 
36.4
%
 
$
4,792,388

 
36.4
%
Energy:
 
 
 
 
 
 
 
Production
1,220,771

 
8.8

 
1,182,326

 
9.0

Service
164,889

 
1.2

 
171,795

 
1.3

Other
133,708

 
1.0

 
144,972

 
1.1

Total energy
1,519,368

 
11.0

 
1,499,093

 
11.4

Commercial real estate:
 
 
 
 
 
 
 
Commercial mortgages
4,078,787

 
29.5

 
3,887,742

 
29.6

Construction
1,208,870

 
8.7

 
1,066,696

 
8.1

Land
315,384

 
2.3

 
331,986

 
2.5

Total commercial real estate
5,603,041

 
40.5

 
5,286,424

 
40.2

Consumer real estate:
 
 
 
 
 
 
 
Home equity loans
352,292

 
2.5

 
355,342

 
2.7

Home equity lines of credit
326,876

 
2.4

 
291,950

 
2.2

Other
419,965

 
3.1

 
376,002

 
2.9

Total consumer real estate
1,099,133

 
8.0

 
1,023,294

 
7.8

Total real estate
6,702,174

 
48.5

 
6,309,718

 
48.0

Consumer and other
563,542

 
4.1

 
544,466

 
4.2

Total loans
$
13,814,838

 
100.0
%
 
$
13,145,665

 
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 September 30, 2018, there were no concentrations of loans related to any single industry in excess of 10% of total loans other than energy loans, which totaled 11.0% 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 $46.7 million, respectively, as of September 30, 2018.
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 September 30, 2018 or December 31, 2017.
Related Party Loans. In the ordinary course of business, we have granted loans to certain directors, executive officers and their affiliates (collectively referred to as “related parties”). Such loans totaled $238.6 million at September 30, 2018 and $166.4 million at December 31, 2017.
Non-Accrual and Past Due Loans. Non-accrual loans, segregated by class of loans, were as follows:
 
September 30,
2018
 
December 31,
2017
Commercial and industrial
$
12,278

 
$
46,186

Energy
51,802

 
94,302

Commercial real estate:
 
 
 
Buildings, land and other
15,913

 
7,589

Construction
—

 
—

Consumer real estate
971

 
2,109

Consumer and other
1,637

 
128

Total
$
82,601

 
$
150,314

Had non-accrual loans performed in accordance with their original contract terms, we would have recognized additional interest income, net of tax, of approximately $1.3 million and $4.2 million for the three and nine months ended September 30, 2018, compared to $783 thousand and $2.4 million for the three and nine months ended September 30, 2017.

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Table of Contents

An age analysis of past due loans (including both accruing and non-accruing loans), segregated by class of loans, as of September 30, 2018 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
$
33,985

 
$
10,250

 
$
44,235

 
$
4,985,519

 
$
5,029,754

 
$
3,963

Energy
3,251

 
2,221

 
5,472

 
1,513,896

 
1,519,368

 
818

Commercial real estate:
 
 
 
 
 
 
 
 
 
 
 
Buildings, land and other
21,596

 
2,980

 
24,576

 
4,369,595

 
4,394,171

 
2,606

Construction
784

 
1,042

 
1,826

 
1,207,044

 
1,208,870

 
1,042

Consumer real estate
7,743

 
1,773

 
9,516

 
1,089,617

 
1,099,133

 
1,432

Consumer and other
6,098

 
1,766

 
7,864

 
555,678

 
563,542

 
1,724

Total
$
73,457

 
$
20,032

 
$
93,489

 
$
13,721,349

 
$
13,814,838

 
$
11,585

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
September 30, 2018
 
 
 
 
 
 
 
 
 
Commercial and industrial
$
19,857

 
$
3,153

 
$
6,574

 
$
9,727

 
$
4,622

Energy
68,087

 
7,942

 
43,614

 
51,556

 
12,672

Commercial real estate:
 
 
 
 
 
 

 
 
Buildings, land and other
15,961

 
2,309

 
12,876

 
15,185

 
2,599

Construction
—

 
—

 
—

 
—

 
—

Consumer real estate
293

 
293

 
—

 
293

 
—

Consumer and other
1,595

 
—

 
1,595

 
1,595

 
1,595

Total
$
105,793

 
$
13,697

 
$
64,659

 
$
78,356

 
$
21,488

December 31, 2017
 
 
 
 
 
 
 
 
 
Commercial and industrial
$
60,781

 
$
28,038

 
$
15,722

 
$
43,760

 
$
7,553

Energy
99,606

 
33,080

 
61,162

 
94,242

 
13,267

Commercial real estate:
 
 
 
 
 
 
 
 
 
Buildings, land and other
10,795

 
6,394

 
—

 
6,394

 
—

Construction
—

 
—

 
—

 
—

 
—

Consumer real estate
1,214

 
1,214

 
—

 
1,214

 
—

Consumer and other
—

 
—

 
—

 
—

 
—

Total
$
172,396

 
$
68,726

 
$
76,884

 
$
145,610

 
$
20,820

The average recorded investment in impaired loans was as follows:
 
Three Months Ended 
 September 30,
 
Nine Months Ended 
 September 30,
 
2018
 
2017
 
2018

2017
Commercial and industrial
$
13,447

 
$
26,910

 
$
21,025

 
$
26,651

Energy
78,772

 
76,008

 
82,640

 
72,055

Commercial real estate:
 
 
 
 
 
 
 
Buildings, land and other
14,306

 
5,553

 
12,328

 
6,106

Construction
—

 
—

 
—

 
—

Consumer real estate
671

 
1,209

 
807

 
1,155

Consumer and other
1,073

 
—

 
805

 
13

Total
$
108,269

 
$
109,680

 
$
117,605

 
$
105,980


15
Table of Contents

Troubled Debt Restructurings. Troubled debt restructurings during the nine months ended September 30, 2018 and September 30, 2017 are set forth in the following table.
 
Nine Months Ended 
 September 30, 2018
 
Nine Months Ended 
 September 30, 2017
 
Balance at
Restructure
 
Balance at
Period-End
 
Balance at
Restructure
 
Balance at
Period-End
Commercial and industrial
$
2,203

 
$
—

 
$
4,026

 
$
3,875

Energy
13,708

 
—

 
56,097

 
55,023

 
$
15,911

 
$
—

 
$
60,123

 
$
58,898

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.
Additional information related to restructured loans as of or for the nine months ended September 30, 2018 and September 30, 2017 is set forth in the following table.
 
September 30, 2018
 
September 30, 2017
Restructured loans past due in excess of 90 days at period-end:
 
 
 
Number of loans
—

 
1

Dollar amount of loans
$
—

 
$
43,137

Restructured loans on non-accrual status at period end
—

 
54,082

Charge-offs of restructured loans:
 
 
 
Recognized in connection with restructuring
—

 
—

Recognized on previously restructured loans
4,650

 
9,951

Proceeds from sale of restructured loans
15,750

 
—

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 2017 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 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.

16
Table of Contents

The following tables present weighted-average risk grades for all commercial loans by class.
 
September 30, 2018
 
December 31, 2017
 
Weighted
Average
Risk Grade
 
Loans
 
Weighted
Average
Risk Grade
 
Loans
Commercial and industrial:
 
 
 
 
 
 
 
Risk grades 1-8
6.10

 
$
4,755,739

 
6.06

 
$
4,378,839

Risk grade 9
9.00

 
123,199

 
9.00

 
170,285

Risk grade 10
10.00

 
67,645

 
10.00

 
99,260

Risk grade 11
11.00

 
70,893

 
11.00

 
97,818

Risk grade 12
12.00

 
7,656

 
12.00

 
38,633

Risk grade 13
13.00

 
4,622

 
13.00

 
7,553

Total
6.31