ITEM 1. BUSINESS
GENERAL
Cullen/Frost Bankers, Inc. ("Cullen/Frost" or "Company"), a Texas business corporation incorporated in 1977 and headquartered in San Antonio, Texas, is a bank holding company within the meaning of the Bank Holding Company Act of 1956 ("the BHC Act") and as such is registered with the Board of Governors of the Federal Reserve System ("Federal Reserve Board"). The New Galveston Company, incorporated under the laws of Delaware, is a wholly owned second tier bank holding company subsidiary which owns all banking and non-banking subsidiaries with the exception of Cullen/Frost Capital Trust, a Delaware statutory business trust and wholly-owned subsidiary of the Corporation. At December 31, 1998, Cullen/Frost's principal assets consisted of all of the capital stock of two national banks. Including the acquisition of Keller State Bank, completed in the first quarter of 1999, Cullen/Frost had 79 financial centers across Texas with 19 locations in the San Antonio area, 22 in the Houston/Galveston area, 17 in the Fort Worth/Dallas area, five in Austin, ten in the Corpus Christi area, three in San Marcos, two in McAllen and one in New Braunfels. At December 31, 1998, Cullen/Frost had consolidated total assets of $6.9 billion and total deposits of $5.8 billion. Based on information from the Federal Reserve Board, at September 30, 1998, Cullen/Frost was the largest of the 106 unaffiliated bank holding companies headquartered in Texas.
Cullen/Frost provides policy direction to the Cullen/Frost subsidiary banks in, among others, the following areas: (i) asset and liability management; (ii) accounting, budgeting, planning and insurance; (iii) capitalization; and (iv) regulatory compliance.
CULLEN/FROST SUBSIDIARY BANKS
Each of the Cullen/Frost subsidiary banks is a separate entity which operates under the day-to-day management of its own board of directors and officers. The largest of these banks is The Frost National Bank ("Frost Bank"), the origin of which can be traced to a mercantile partnership organized in 1868. Frost Bank was chartered as a national banking association in 1899. At December 31, 1998, Frost Bank, which accounted for approximately 98 percent of consolidated assets, loans and deposits of Cullen/Frost, was the largest bank headquartered in San Antonio and South Texas. The Corporation's other subsidiary bank is United States National Bank of Galveston which had $151 million in assets at December 31, 1998.
SERVICES OFFERED BY THE CULLEN/FROST SUBSIDIARY BANKS
COMMERCIAL BANKING
The subsidiary banks provide commercial services for corporations and other business clients. Loans are made for a wide variety of purposes, including interim construction financing on industrial and commercial properties and financing on equipment, inventories, accounts receivable, leverage buyouts and recapitalizations and turnaround situations. Frost Bank provides financial services to business clients on both a national and international basis.
CONSUMER SERVICES
The subsidiary banks provide a full range of consumer banking services, including checking accounts, savings programs, automated teller machines, installment and real estate loans, home equity loans, drive-in and night deposit services, safe deposit facilities, credit card services and discount brokerage services.
INTERNATIONAL BANKING
Frost Bank provides international banking services to customers residing in or dealing with businesses located in Mexico. Such services consist of accepting deposits (in United States dollars only), making loans
(in United States dollars only), issuing letters of credit, handling foreign collections, transmitting funds and, to a limited extent, dealing in foreign exchange. Reference is made to pages 22 and 29 of this document.
TRUST SERVICES
The subsidiary banks provide a wide range of trust, investment, agency and custodial services for individual and corporate clients. These services include the administration of estates and personal trusts and the management of investment accounts for individuals, employee benefit plans and charitable foundations. At December 31, 1998, trust assets with a market value of approximately $11.7 billion were being administered by the subsidiary banks. These assets were comprised of discretionary assets of $5.4 billion and non-discretionary assets of $6.3 billion.
CORRESPONDENT BANKING
Frost Bank acts as correspondent for approximately 333 financial institutions, primarily banks in Texas. These banks maintain deposits with Frost Bank, which offers to the correspondents a full range of services including check clearing, transfer of funds, loan participations, and securities custody and clearance.
DISCOUNT BROKERAGE
Frost Brokerage Services was formed in March 1986 to provide discount brokerage services and perform other transactions or operations related to the sale and purchase of securities of all types. Frost Brokerage Services is a subsidiary of Frost Bank.
INSURANCE
Frost Insurance Agency, Inc., a wholly-owned subsidiary of The Frost National Bank, will offer corporate and personal property and casualty insurance as well as group health and life insurance products to individuals and businesses. Frost Insurance Agency, Inc. generated no income during 1998.
SERVICES OFFERED BY THE CULLEN/FROST NON-BANKING SUBSIDIARIES
Main Plaza Corporation ("Main Plaza") is a wholly-owned non-banking subsidiary. Main Plaza occasionally makes loans to qualified borrowers. Loans are funded with borrowings against Cullen/Frost's current cash or borrowings against credit lines.
Daltex General Agency, Inc. ("Daltex"), a wholly-owned non-banking subsidiary, is a managing general insurance agency. Daltex provides vendor's single interest insurance.
COMPETITION
The subsidiary banks encounter intense competition in their commercial banking businesses, primarily from other banks located in their respective service areas. The subsidiary banks also compete with insurance, finance and mortgage companies, savings and loan institutions, credit unions, money market funds and other financial institutions. In the case of some larger customers, competition exists with institutions in other major metropolitan areas in Texas and in the remainder of the United States, some of which are larger than the Cullen/Frost subsidiary banks in terms of capital, resources and personnel.
SUPERVISION AND REGULATION
CULLEN/FROST
Cullen/Frost is a legal entity separate and distinct from its bank subsidiaries and is a registered bank holding company under the BHC Act. The BHC Act generally prohibits Cullen/Frost from engaging in any business activity other than banking, managing and controlling banks, furnishing services to a bank which it owns and controls or engaging in non-banking activities closely related to banking.
As a bank holding company, Cullen/Frost is primarily regulated by the Federal Reserve Board which has established guidelines with respect to the maintenance of appropriate levels of capital and payment of
dividends by bank holding companies. Cullen/Frost is required to obtain prior approval of the Federal Reserve Board for the acquisition of more than five percent of the voting shares or certain assets of any company (including a bank) or to merge or consolidate with another bank holding company.
The Federal Reserve Act and the Federal Deposit Insurance Act ("FDIA") impose restrictions on loans by the subsidiary banks to Cullen/Frost and certain of its subsidiaries, on investments in securities thereof and on the taking of such securities as collateral for loans. Such restrictions generally prevent Cullen/Frost from borrowing from the subsidiary banks unless the loans are secured by marketable obligations. Further, such secured loans, other transactions, and investments by each of such bank subsidiaries are limited in amount as to Cullen/Frost or to certain other subsidiaries to ten percent of the lending bank subsidiary's capital and surplus and as to Cullen/Frost and all such subsidiaries to an aggregate of 20 percent of the lending bank subsidiary's capital and surplus.
Under Federal Reserve Board policy, Cullen/Frost is expected to act as a source of financial strength to its banks and to commit resources to support such banks in circumstances where it might not do so absent such policy. In addition, any loans by Cullen/Frost to its banks would be subordinate in right of payment to deposits and to certain other indebtedness of its banks.
SUBSIDIARY BANKS
The two subsidiary national banks are organized as national banking associations under the National Bank Act and are subject to regulation and examination by the Office of the Comptroller of the Currency (the "Comptroller of the Currency").
Federal and state laws and regulations of general application to banks have the effect, among others, of regulating the scope of the business of the subsidiary banks, their investments, cash reserves, the purpose and nature of loans, collateral for loans, the maximum interest rates chargeable on loans, the amount of dividends that may be declared and required capitalization ratios. Federal law imposes restrictions on extensions of credit to, and certain other transactions with, Cullen/Frost and other subsidiaries, on investments in stock or other securities thereof and on the taking of such securities as collateral for loans to other borrowers.
The Comptroller of the Currency with respect to Cullen/Frost's bank subsidiaries has authority to prohibit a bank from engaging in what, in such agency's opinion, constitutes an unsafe or unsound practice in conducting its business. It is possible, depending upon the financial condition of the bank in question and other factors, that such agency could claim that the payment of dividends or other payments might, under some circumstances, be such an unsafe or unsound practice.
The principal source of Cullen/Frost's cash revenues is dividends from its bank subsidiaries, and there are certain limitations on the payment of dividends to Cullen/Frost by such bank subsidiaries. The prior approval of the Comptroller of the Currency is required if the total of all dividends declared by a national bank in any calendar year would exceed the bank's net profits, as defined, for that year combined with its retained net profits for the preceding two calendar years less any required transfers to surplus. In addition, a national bank may not pay dividends in an amount in excess of its undivided profits less certain bad debts. Although not necessarily indicative of amounts available to be paid in future periods, Cullen/Frost's subsidiary banks had approximately $53.3 million available for the payment of dividends, without prior regulatory approval, at December 31, 1998.
CAPITAL ADEQUACY
Bank regulators have adopted risk-based capital guidelines for bank holding companies and banks. The minimum ratio of qualifying total capital to risk-weighted assets (including certain off-balance sheet items) is eight percent. At least half of the total capital is to be comprised of common stock, retained earnings, perpetual preferred stocks, minority interests and for bank holding companies, a limited amount of qualifying cumulative perpetual preferred stock, less certain intangibles including goodwill ("Tier 1 capital"). The remainder ("Tier 2 capital") may consist of other preferred stock, certain other instruments, and limited amounts of subordinated debt and the allowance for loan and lease losses.
In addition, bank regulators have established minimum leverage ratio (Tier 1 capital to average total assets) guidelines for bank holding companies and banks. These guidelines provide for a minimum leverage ratio of 3 percent for bank holding companies and banks that meet certain specified criteria, including that they have the highest regulatory rating. All other banking organizations will be required to maintain a leverage ratio of at least 4 percent plus an additional cushion where warranted. The guidelines also provide that banking organizations experiencing internal growth or making acquisitions will be expected to maintain strong capital positions substantially above the minimum supervisory levels, without significant reliance on intangible assets. Furthermore, the guidelines indicate that the Federal Reserve Board will continue to consider a "Tangible Tier 1 Leverage Ratio" in evaluating proposals for expansion or new activities. The Tangible Tier 1 Leverage Ratio is the ratio of Tier 1 capital, less intangibles not deducted from Tier 1 capital, to average total assets. The bank regulators have not advised Cullen/Frost or any bank subsidiary of any specific minimum leverage ratio applicable to it. For information concerning Cullen/Frost's capital ratios, see the discussion under the caption "Capital" on page 30 and Note L "Capital" on page 46.
FDICIA
The Federal Deposit Insurance Corporation Improvements Act of 1991 ("FDICIA"), among other things, requires the Federal banking agencies to take "prompt corrective action" in respect to depository institutions that do not meet minimum capital requirements. FDICIA established five capital tiers: "well capitalized," "adequately capitalized," "undercapitalized," "significantly undercapitalized" and "critically undercapitalized". Under the final rules adopted by the Federal banking regulators relating to these capital tiers, an institution is deemed to be: well capitalized if the institution has a total risk-based capital ratio of 10.0 percent or greater, a Tier 1 risk-based capital ratio of 6.0 percent or greater, and a leverage ratio of 5.0 percent or greater, and the institution is not subject to an order, written agreement, capital directive, or prompt corrective action directive to meet and maintain a specific capital level for any capital measure; adequately capitalized if the institution has a total risk-based capital ratio of 8.0 percent or greater, a Tier 1 risk-based capital ratio of 4.0 percent or greater, and a leverage ratio of 4.0 percent or greater (or a leverage ratio of 3.0 percent for bank holding companies which meet certain specified criteria, including having the highest regulatory rating); undercapitalized if the institution has a total risk-based capital ratio that is less than 8.0 percent, a Tier 1 risk-based capital ratio less than 4.0 percent or a leverage ratio less than 4.0 percent (or a leverage ratio less than 3.0 percent if the institution is rated composite 1 in its most recent report of examination, subject to appropriate Federal banking agency guidelines); significantly undercapitalized if the institution has a total risk-based capital ratio less than 6.0 percent, a Tier 1 risk-based capital ratio less than 3.0 percent, or a leverage ratio less than 3.0 percent; and critically undercapitalized if the institution has a ratio of tangible equity to total assets equal to or less than 2.0 percent.
At December 31, 1998, the two subsidiaries of Cullen/Frost that are insured depository institutions -- Frost Bank and U.S. National Bank -- were considered "well capitalized".
FDICIA generally prohibits a depository institution from making any capital distributions (including payment of a dividend) or paying any management fee to its holding company if the depository institution would thereafter be undercapitalized. Undercapitalized institutions are subject to growth limitations and are required to submit a capital restoration plan. The agencies may not accept such a plan without determining, among other things, that the plan is based on realistic assumptions and is likely to succeed in restoring the depository institution's capital. In addition, for a capital restoration plan to be acceptable, the depository institution's parent holding company must guarantee that the institution will comply with such capital restoration plan. The aggregate liability of the parent holding company is limited to the lesser of (i) an amount equal to 5 percent of the depository institution's total assets at the time it became undercapitalized and (ii) the amount which is necessary (or would have been necessary) to bring the institution into compliance with all capital standards applicable with respect to such institution as of the time it fails to comply with the plan. If a depository institution fails to submit an acceptable plan, it is treated as if it is significantly undercapitalized.
"Significantly undercapitalized" depository institutions may be subject to a number of requirements and restrictions, including orders to sell sufficient voting stock to become "adequately capitalized,"
requirements to reduce total assets, and cessation of receipt of deposits from correspondent banks. "Critically undercapitalized" institutions are subject to the appointment of a receiver or conservator.
FDICIA also contains a variety of other provisions that affect the operations of Cullen/Frost, including reporting requirements, regulatory standards for real estate lending, "truth in savings" provisions, and the requirement that a depository institution give 90 days prior notice to customers and regulatory authorities before closing any branch. The Federal regulatory agencies have issued standards establishing loan-to-value limitations on real estate lending. These standards have not had a significant effect on Cullen/Frost and are not expected to have a significant effect in the future.
Any loans by a bank holding company to any of its subsidiary banks are subordinate in right of payment to deposits and to certain other indebtedness of such subsidiary banks. In the event of a bank holding company's bankruptcy, any commitment by the bank holding company to a federal bank regulatory agency to maintain the capital of a subsidiary bank will be assumed by the bankruptcy trustee and be entitled to a priority of payment.
DEPOSIT INSURANCE
Cullen/Frost's subsidiary banks are subject to FDIC deposit insurance assessments and to certain other statutory and regulatory provisions applicable to FDIC-insured depository institutions. The risk-based assessment system imposes insurance premiums based upon a matrix that takes into account a bank's capital level and supervisory rating.
A depository institution insured by the FDIC can be held liable for any loss incurred by, or reasonably expected to be incurred by, the FDIC, in connection with (i) the default of a commonly controlled FDIC-insured depository institution or (ii) any assistance provided by the FDIC to a commonly controlled, FDIC-insured depository institution in danger of default. "Default" is defined generally as the appointment of a conservator or receiver, and "in danger of default" is defined generally as the existence of certain conditions indicating that a "default" is likely to occur in the absence of regulatory assistance.
DEPOSITOR PREFERENCE
Deposits and certain claims for administrative expenses and employee compensation against an insured depository institution are afforded priority over other general unsecured claims against such an institution, including federal funds and letters of credit, in the "liquidation or other resolution" of such an institution by any receiver.
ACQUISITIONS
The BHC Act generally limits acquisitions by Cullen/Frost to commercial banks and companies engaged in activities that the Federal Reserve Board has determined to be so closely related to banking as to be a proper incident thereto. Cullen/Frost's direct activities are generally limited to furnishing to its subsidiaries services that qualify under the "closely related" and "proper incident" tests. Prior Federal Reserve Board approval is required under the BHC Act for new activities and acquisitions of most nonbanking companies.
The BHC Act, the Federal Bank Merger Act, and the Texas Banking Code regulate the acquisition of commercial banks. The BHC Act requires the prior approval of the Federal Reserve Board for the direct or indirect acquisition of more than five percent of the voting shares of a commercial bank or bank holding company. With respect to Cullen/Frost's subsidiary banks, the approval of the Comptroller of the Currency is required for branching, purchasing the assets of other banks and bank mergers in which the continuing bank is a national bank.
In reviewing bank acquisition and merger applications, the bank regulatory authorities will consider, among other things, the competitive effect and public benefits of the transactions, the capital position of the combined organization, and the applicant's record under the Community Reinvestment Act and fair housing laws.
The Corporation regularly evaluates acquisition opportunities and conducts due diligence activities in connection with possible acquisitions. As a result, acquisition discussions and, in some cases negotiations, regularly take place and future acquisitions could occur.
INTERSTATE BANKING AND BRANCHING LEGISLATION
The Riegle-Neal Interstate Branching Efficiency Act of 1994 ("IBBEA"), authorizes interstate acquisitions of banks and bank holding companies without geographic limitation beginning one year after enactment. In addition, as of June 1, 1997, IBBEA authorized a bank to merge with a bank in another state as long as neither of the states has opted out of interstate branching between the date of enactment of IBBEA and May 31, 1997. IBBEA further provided that states may enact laws permitting interstate bank merger transactions prior to June 1, 1997. A bank may establish a de novo branch in a state in which the bank does not maintain a branch if the state expressly permits de novo branching. Once a bank has established branches in a state through an interstate merger transaction, the bank may establish and acquire additional branches at any location in the state where any bank involved in the merger transaction could have established or acquired branches under applicable federal or state law. A bank that has established a branch in a state through de novo branching may establish and acquire additional branches in such state in the same manner and to the same extent as a bank having a branch in such state as a result of an interstate merger. If a state opts out of interstate branching within the specified time period, no bank in any other state may establish a branch in the opting out state, whether through an acquisition or de novo. On August 28, 1995, Texas enacted legislation opting out of interstate branching; however in the second quarter of 1998, the OCC approved a series of merger transactions requested by a non-Texas based institution that ultimately resulted in the merger of its Texas based bank into the non-Texas based institution. Although challenged in the courts, the final legal ruling allowed the merger to proceed. In addition, on May 13, 1998, the Texas Banking Commissioner began accepting applications filed by state banks to engage in interstate mergers and branching.
REGULATORY ECONOMIC POLICIES
The earnings of the subsidiary banks are affected not only by general economic conditions but also by the policies of various governmental regulatory authorities. The Federal Reserve Board regulates the supply of credit in order to influence general economic conditions, primarily through open market operations in United States government obligations, varying the discount rate on financial institution borrowings, varying reserve requirements against financial institution deposits and restricting certain borrowings by such financial institutions and their subsidiaries. The deregulation of interest rates has had and is expected to continue to have an impact on the competitive environment in which the subsidiary banks operate.
Governmental policies have had a significant effect on the operating results of commercial banks in the past and are expected to continue to do so in the future. However, Cullen/Frost cannot accurately predict the nature or extent of any effect such policies may have on its future business and earnings.
EMPLOYEES
At December 31, 1998, Cullen/Frost employed 3,095 full-time equivalent employees. Employees of Cullen/Frost enjoy a variety of employee benefit programs, including a retirement plan, 401(k) stock purchase plans, various comprehensive medical, accident and group life insurance plans and paid vacations. Cullen/Frost considers its employee relations to be good.
EXECUTIVE OFFICERS OF THE REGISTRANT
The names, ages, recent business experience and positions or offices held by each of the executive officers during 1998 of Cullen/Frost are as follows:
Diane Jack, age 50, has been an officer of Frost Bank since 1984 and Secretary of Cullen/Frost from October 1993 to present.
There are no arrangements or understandings between any executive officer of Cullen/Frost and any other person pursuant to which he was or is to be selected as an officer.
ITEM 2.
ITEM 2. PROPERTIES
The executive offices of Cullen/Frost, as well as the principal banking quarters of Frost Bank, are housed in both a 21-story office tower and a nine-story office building located on approximately 3.5 acres of land in downtown San Antonio. Cullen/Frost and Frost Bank lease approximately 50 percent of the office tower. The nine-story office building was purchased in April 1994. Frost Bank also leases space in a seven-story parking garage adjacent to the banking quarters. In June 1987, Frost Bank consummated the sale of its office tower and leased back a portion of the premises under a 13-year primary lease term with options allowing for occupancy up to 50 years. The Bank also sold its related parking garage facility and leased back space in that structure under a 12-year primary lease term with options allowing for occupancy up to 50 years. Both leases allow for purchase of the related asset under specific terms.
The subsidiary bank located in Galveston is housed in facilities which, together with tracts of adjacent land used for parking and drive-in facilities, are either owned or leased by the subsidiary bank.
ITEM 3.
ITEM 3. LEGAL PROCEEDINGS
Certain subsidiaries of Cullen/Frost are defendants in various matters of litigation which have arisen in the normal course of conducting a commercial banking business. In the opinion of management, the disposition of such pending litigation will not have a material effect on Cullen/Frost's consolidated financial position.
ITEM 4.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None.
PART II
ITEM 5.
ITEM 5. MARKET FOR REGISTRANT'S COMMON STOCK AND RELATED STOCKHOLDER MATTERS
COMMON STOCK MARKET PRICES AND DIVIDENDS
The table below sets forth for each quarter the high and low sales prices for Cullen/Frost's common stock and the dividends per share paid for each quarter. The Company's common stock began trading on The New York Stock Exchange ("NYSE") on August 14, 1997 under the symbol: CFR. Therefore high and low sales prices for the period August 14, 1997 through December 31, 1998 are as reported by the NYSE. For the period January 1, 1997 through August 13, 1997 prices are as reported through the NASDAQ National Market System. Prices quoted on the NASDAQ National Market System reflect inter-dealer prices, without retail mark-up, mark-down or commissions and represent actual transactions.
1998 1997 -------------------- -------------------- MARKET PRICE (per share) HIGH LOW High Low - ---------------------------------------------------------------------------- First Quarter................... $ 61.19 $ 50.75 $ 38.63 $ 32.63 Second Quarter.................. 60.69 49.50 43.25 33.75 Third Quarter................... 58.00 40.88 48.00 40.38 Fourth Quarter.................. 56.94 43.63 62.75 47.44
The number of record holders of common stock at February 19, 1999 was 2,647.
CASH DIVIDENDS (per share) 1998 1997 - ----------------------------------------------------------- First Quarter........................ $ .25 $ .21 Second Quarter....................... .30 .25 Third Quarter........................ .30 .25 Fourth Quarter....................... .30 .25 -------------------- Total........................... $ 1.15 $ .96 ====================
The Corporation's management is committed to the continuation of the payment of regular cash dividends, however there is no assurance as to future dividends because they are dependent on future earnings, capital requirements and financial conditions. See "Capital" section on page 30 in Item 7 for further discussion and Note K "Dividends" on page 46.
ITEM 6.
ITEM 6. SELECTED FINANCIAL DATA
CONSOLIDATED STATEMENTS OF OPERATIONS (dollars in thousands, except per share amounts)
Historical amounts have been restated to reflect the merger with Overton Bancshares, Inc.
SELECTED FINANCIAL DATA (dollars in thousands, except per share amounts)
*1993 basic and diluted earnings per share before cumulative effect of an accounting change were $1.70 and $1.66, respectively.
**1998 basic and diluted earnings per share before the after-tax merger related charge were $3.20 and $3.11, respectively.
***Includes dividends paid by Overton and excludes the after-tax impact of the $12.2 million merger related charge in 1998.
ITEM 7.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
FINANCIAL REVIEW
Discussed below are the operating results for Cullen/Frost Bankers, Inc. and Subsidiaries ("Cullen / Frost" or the "Corporation") for the years 1996 through 1998. During the second quarter of 1998, the Corporation completed the merger with Overton Bancshares, Inc., as discussed below. The merger was accounted for as a "pooling of interests" transaction and as such, historical amounts have been restated to reflect the merger. In addition, as described below, the Corporation completed acquisitions during the first quarter of 1998 and 1997 and two during the first quarter of 1996. These acquisitions were all accounted for as purchase transactions and as such their results of operations are included from the date of acquisition.
All balance sheet amounts presented in the following financial review are averages unless otherwise indicated. Certain reclassifications have been made to make prior periods comparable. Taxable-equivalent adjustments assume a 35 percent federal tax rate. Dollar amounts in tables are stated in thousands, except for per share amounts.
MERGER AND ACQUISITIONS
On May 29, 1998, the Corporation completed the merger of Overton Bancshares, Inc., ("Overton") in Fort Worth, Texas, and its wholly-owned subsidiary Overton Bank & Trust, N.A. The merger was the Corporation's first entry into the Fort Worth market. With the merger, the Corporation had twelve locations in Fort Worth/Arlington and two in Dallas. The Corporation issued approximately 4.38 million common shares as part of this transaction. As a result of the transaction, the Corporation recorded a merger related charge of $12.2 million primarily consisting of severance payments and other employee benefits, and investment banking fees. In addition, shortly after the merger was consummated the Corporation reclassified approximately $116 million of held to maturity securities of Overton to available for sale securities.
On January 2, 1998, the Corporation paid approximately $55.3 million to acquire Harrisburg Bancshares, Inc., including its subsidiary Harrisburg Bank in Houston, Texas. The Corporation acquired loans of approximately $125 million and deposits of approximately $222 million. Total intangibles associated with the acquisition amounted to approximately $34.2 million. This acquisition did not have a material impact on the Corporation's 1998 net income.
On March 7, 1997, the Corporation paid approximately $32.2 million to acquire Corpus Christi Bancshares, Inc., including its subsidiary Citizens State Bank, based in Corpus Christi, Texas. Total intangibles associated with the acquisition were approximately $20.9 million. The Corporation acquired loans of approximately $108 million and deposits of approximately $184 million. This acquisition did not have a material impact on the Corporation's 1997 net income.
On January 5, 1996, the Corporation paid approximately $17.7 million to acquire S.B.T. Bancshares, Inc., including its subsidiary, State Bank and Trust Company in San Marcos, Texas. The Corporation acquired deposits of approximately $112 million. Total intangibles associated with the acquisition were approximately $11.0 million. On February 15, 1996, the Corporation paid approximately $33.5 million to acquire Park National Bank in Houston, Texas. The Corporation acquired deposits of approximately $225 million. Total intangibles associated with the acquisition were $16.0 million. These acquisitions did not have a material impact on the Corporation's 1996 net income.
RESULTS OF OPERATIONS
For the year ended December 31, 1998, the Corporation reported net income of $75.6 million or $2.77 per diluted common share, an all-time high. Operating earnings for the year ended December 31, 1998 were $85.2 million or $3.11 per diluted common share. Operating earnings exclude the after-tax impact of the merger related charge of $12.2 million associated with the merger of Overton. Net income for 1997 was $73.0 million or $2.67 per diluted common share, compared with $62.9 million or $2.31 per diluted
common share for 1996. The Corporation's return on average assets for 1998 was 1.18 percent compared with 1.28 percent in 1997 and 1.23 percent in 1996, while return on average equity was 15.44 percent in 1998 compared with 16.38 percent in 1997 and 15.63 percent in 1996. Operating return on average assets and average equity for 1998 were 1.33 percent and 17.38 percent, respectively.
* Operating basic and diluted earnings per share for 1998 were $3.20 and $3.11, respectively. Operating ROA and ROE for 1998 were 1.33 percent and 17.38 percent, respectively.
RESULTS OF SEGMENT OPERATIONS
The Corporation's operations are managed along two major Operating Segments: Banking and the Financial Management Group. A description of each business and the methodologies used to measure financial performance are described in Note V to the Consolidated Financial Statements on page 57. The following table summarizes operating earnings and net income by Operating Segment for each of the last three years:
YEAR ENDED DECEMBER 31 ------------------------------- (dollars in thousands) 1998 1997 1996 - ---------------------------------------------------------------------- Banking.............................. $ 78,826 $ 68,312 $ 57,801 Financial Management Group........... 14,497 12,878 9,244 Non-Banks............................ (8,167) (8,223) (4,107) ------------------------------- Consolidated operating earnings...... $ 85,156* $ 72,967 62,938 Consolidated net income.............. $ 75,645 $ 72,967 $ 62,938 ===============================
* Excludes the after-tax impact of the $12.2 million Overton merger related charge. See discussion on page 13.
The increase in Banking net income in both 1998 and 1997 was due primarily to loan growth and higher service charge income coupled with the impact of the acquisitions of Corpus Christi Bancshares, Inc. and Harrisburg Bancshares, Inc.
The increase in the Financial Management Group net income in both years was due mainly to the appreciation in market value of Trust assets, new accounts and the acquisition of Corpus Christi Bancshares, Inc.
The increase in the operating loss in Non-Banks during 1997 reflects partially increased funding costs due to the issuance of the Trust Preferred Capital Securities.
NET INTEREST INCOME
Net interest income on a taxable equivalent basis for 1998 was $270.8 million, an increase from $237.1 million recorded in 1997 and the $213.0 million recorded in 1996. The primary reason for the yearly increase has been the consistent growth in loans generated both internally and through acquisitions. See "Consolidated Average Balance Sheets" on pages 60 and 61 and "Rate Volume Analysis" on page 62. The net interest margin, was 4.93 percent for the year ended December 31, 1998, compared to 4.87 percent and 4.91 percent for the years 1997 and 1996, respectively. The increase in the net interest margin from a year ago is due to higher loan volumes and lower deposit costs. The slight decrease in the net interest margin in 1997 from 1996 is reflective of higher deposit costs and interest expense related to the $100 million Trust Preferred Capital Securities issued in early 1997, see Note I "Borrowed Funds" on Page 44. Net interest spread for 1998 increased five basis points to 4.04 percent. The increase in net interest spread for 1998 is primarily due to the Corporation's ability to maintain its earnings on funds with higher loan volumes and the favorable impact of the acquisitions, while deposit costs decreased. Net interest spread was 3.99 percent and 4.10 percent for 1997 and 1996, respectively. The decrease in net interest spread for 1997 is largely the result of the issuance of the $100 million Trust Preferred Capital Securities.
The net interest spread as well as the net interest margin could be impacted by future changes in short-and long-term interest rate levels.
MARKET RISK DISCLOSURE -- INTEREST RATE SENSITIVITY
Market risk is the potential loss arising from adverse changes in the fair value of a financial instrument due to the changes in market rates and prices. In the ordinary course of business, the Corporation's market risk is primarily that of interest rate risk. The Corporation's interest rate sensitivity and liquidity are monitored by its Asset/Liability Management Committee on an ongoing basis. The Committee seeks to avoid fluctuating net interest margins and to maintain consistent growth of net interest income through periods of changing interest rates. A variety of measures are used to provide for a comprehensive view of the magnitude of interest rate risk, the distribution of risk, level of risk over time and exposure to changes in certain interest rate relationships.
The Corporation utilizes an earnings simulation model as the primary quantitative tool in measuring the amount of interest rate risk associated with changing market rates. The model quantifies the effects of various interest rate scenarios on the projected net interest income and net income over the ensuing 12 month period. The model was used to measure the impact on net interest income relative to a base case scenario, of rates increasing or decreasing ratably 200 basis points over the next 12 months. These simulations incorporate assumptions regarding balance sheet growth and mix, pricing and the repricing and maturity characteristics of the existing and projected balance sheet. All off-balance sheet financial instruments such as derivatives are included in the model. Other interest rate-related risks such as prepayment, basis and option risk are also considered. The resulting model simulations show that a 200 basis point increase in rates will result in a positive variance in net interest income of 0.7 percent relative to the base case over the next 12 months, while a decrease of 200 basis points will result in a negative variance in net interest income of 0.7 percent. This compares to last year when a 200 basis points increase in rates resulted in a positive variance in net interest income of 1.3 percent relative to the base case over the next 12 months while a decrease of 200 basis points resulted in a negative variance in net interest income of 1.7 percent. The Corporation's trading portfolio is immaterial and as such separate quantitative disclosure is not presented.
As the table below indicates, the Corporation is liability-sensitive, on a cumulative basis, at time periods of one year or less (assuming non-maturity deposits are immediately rate sensitive). This gap analysis is based on a point in time and may not be meaningful because assets and liabilities must be categorized according to contractual maturities and repricing periods rather than estimating more realistic behaviors as is done in the sensitivity model discussed above. Also, the gap analysis does not consider subsequent changes in interest rate levels or spreads between asset and liability categories.
The Corporation continuously monitors and manages the balance between interest rate-sensitive assets and liabilities. The Corporation's objective is to manage the impact of fluctuating market rates on net interest income within acceptable levels. In order to meet this objective, the Corporation may lengthen or shorten the duration of assets or liabilities or enter into derivative contracts to mitigate potential market risk.
In developing the classifications used for this analysis, it was necessary to make certain assumptions and approximations in assigning assets and liabilities to different maturity categories. For example, savings and Interest-on-Checking are subject to immediate withdrawal and as such are presented as repricing within the earliest period presented even though their balances have historically not shown significant sensitivity to changes in interest rates.
Loans are included net of unearned discount of $3,357,000. Consumer loans are distributed in the immediately rate-sensitive category for those tied to market rates or to other categories according to the repayment schedule.
The above table does not reflect interest rate swaps further discussed on page 27.
LIQUIDITY Asset liquidity is provided by cash and assets which are readily marketable or pledgeable or which will mature in the near future. Liquid assets include cash, short-term time deposits in banks, securities available for sale, maturities and cash flow from securities held to maturity, and Federal funds sold and securities purchased under resale agreements.
Liability liquidity is provided by access to funding sources which include core depositors and correspondent banks in the Corporation's natural trade area which maintain accounts with and sell Federal funds to subsidiary banks of the Corporation, as well as Federal funds purchased and securities sold under repurchase agreements from upstream banks. The liquidity position of the Corporation is continuously monitored and adjustments are made to the balance between sources and uses of funds as deemed appropriate.
NON-INTEREST INCOME
Non-interest income of $138.7 million was reported for 1998, compared with $121.7 million for 1997 and $104.2 million for 1996. Excluding securities transactions, total non-interest income increased 14.1 percent from 1997. The non-interest income growth in 1998 and 1997 was favorably impacted by the acquisitions of Harrisburg Bancshares, Inc. and Corpus Christi Bancshares, Inc. in the first quarter of 1998 and 1997, respectively.
Trust income was up $3.6 million or 8.3 percent during 1998. Trust fees increased during 1998 as the market value of trust assets continued to grow impacted by the market and the addition of new accounts. The volatility of general market conditions experienced throughout 1998 did have some impact on the overall level of growth in trust fees; however, some of the growth experienced in other service charges and other non-interest income is attributable to fees collected through financial management services, such as mutual fund fees, brokerage commissions and annuity income. The market value of trust assets increased to $11.7 billion from $10.8 billion last year. The December 31, 1998 trust assets were comprised of discretionary assets of $5.4 billion and non-discretionary assets of $6.3 billion compared to $5.5 billion and $5.3 billion last year, respectively. The $6.4 million or 17.3 percent increase in trust income from 1996 to 1997 is attributable to the increase in the number of accounts held and trust asset growth resulting from improvement in the stock and bond market.
Deposit service charges increased $6.0 million or 12.5 percent from 1997. The increase occurred as the result of some fee increases and broad based deposit growth that generated increases in overdraft charges, cash management fees on commercial and individual deposits, as well as increases in ATM income. Deposit service charges increased $6.1 million or 14.6 percent from 1996. The increase was due mainly to higher service charges related to commercial deposits, volumes processed for correspondent banks and overdraft charges. Other service charges and fees increased $4.1 million or 36.4 percent when compared to 1997. This increase was primarily due to higher fees in accounts receivable factoring and mutual fund fees collected through financial management services. The $2.2 million or 23.4 percent increase in other service charges from 1996 to 1997 was primarily due to the same factors mentioned above for the growth in 1998 offset by lower bankcard discounts resulting from the Corporation's outsourcing of its bankcard processing operation which was completed in May 1996.
During 1998 and 1997, the Corporation sold portions of its available for sale investment portfolio resulting in net gains of $359,000 and $498,000, respectively. This compares to an $892,000 loss in 1996 which resulted primarily from the Corporation restructuring a portion of its available for sale investment portfolio by replacing lower-yielding securities with higher-yielding securities.
Other non-interest income increased $3.4 million or 18.0 percent to $22.4 million in 1998 compared to an 8.9 percent increase in 1997. The increase in 1998 is primarily due to growth in VISA check card income, gains on the sale of student and mortgage loans and gains on the disposition of foreclosed assets.
The increase in 1997 from 1996 was primarily due to gains recorded on the sale of student loans, mineral interest income and VISA check card income. These increases were offset by higher gains on the disposition of certain loans and foreclosed assets recorded by the Corporation in 1996.
NON-INTEREST EXPENSE
Excluding the merger-related charge of $12.2 million during the second quarter of 1998 which was associated with the merger of Overton, non-interest expense was $266.3 million for 1998 compared with $235.1 million for 1997 and $210.1 million for 1996. The acquisitions of Harrisburg Bancshares, Inc. and Corpus Christi Bancshares, Inc. in the first quarter of 1998 and 1997, respectively, impacted the growth in non-interest expense.
Salaries and wages increased by $12.5 million in 1998 and $13.2 million in 1997 or 12.7 percent and 15.4 percent, respectively. Salaries and wages in both years have experienced increases related to acquisitions and merit increases. Pension and other employee benefits increased by $1.4 million or 7.2 percent during 1998 as a result of retirement plan expense and the impact of the acquisition on payroll taxes and medical insurance. The $1.7 million or 9.1 percent increase in pension and other employee benefits from 1996 to 1997 was primarily due to the impact of the 1997 acquisition on payroll taxes and medical insurance expense offset by lower contributions to fund the employer match on the employee related stock plans due to the use of forfeited shares.
Net occupancy of banking premises increased $2.7 million or 11.7 percent during 1998 primarily attributable to higher property taxes, depreciation and lease expense as influenced by the acquisition and de novo branches opened late in 1997 and 1998. The 6.2 percent increase in 1997 compared to 1996 was higher building maintenance costs, property taxes and operating expenses, partially offset by higher tenant income. Furniture and equipment costs increased $2.8 million or 17.2 percent in 1998 primarily due to the continued expansion of the Corporation, as well as, technology initiatives and upgrades. Intangible amortization increased by $1.4 million or 11.5 percent and by $614,000 or 5.4 percent in 1998 and 1997, respectively, due to the acquisitions.
Also included in 1998 was a $12.2 million merger related charge associated with the merger of Overton. Of the $12.2 million charge, the majority was related to severance payments and other employee benefits, and investment banking fees.
Other non-interest expense increased $10.3 million or 15.8 percent during 1998 as a result of outside computer services related to the Year 2000 compliance program, see "Year 2000" on page 19, as well as, an increase in the volume of VISA check cards issued after its initial introduction in late 1997. Other non-interest expense was up 11.6 percent in 1997 mostly due to expenses related to the Year 2000 compliance program and higher operating expenses, such as, sales promotion, guard services, supplies, travel and telephone, which also were impacted by the acquisitions.
YEAR 2000
The Corporation has an extensive program in place to address the internal and external risks associated with the century date change to the Year 2000. Currently, the Corporation estimates that the dollar amount to be spent on incremental costs will be approximately $4.6 million over the three year period beginning in 1997, funded out of its earnings, with approximately $3.6 million spent through 1998. These costs are being expensed as incurred. Additionally, the Corporation is spending about 30 percent of its annual technology budget to facilitate progress on the Year 2000 program. The cost of compliance and completion dates is based upon management's best estimates, which were derived utilizing assumptions of future events, including the continued availability of resources.
The Corporation has systematically inventoried and assessed the importance of application software and system hardware and software during the now completed awareness and assessment phase of its information technology. The Corporation has also completed the renovation of mission critical systems and has implemented 99 percent of the renovated mission critical systems. The Corporation has completed the renovation, testing and installation of 99 percent of technology systems in its owned facilities, including vault doors, elevators, climate control systems, and security systems. In addition, the Corporation has completed 98 percent of the testing of mission critical systems. The Corporation expects to be completed with the non-mission critical applications by the second quarter of 1999. The Corporation has commenced, and will continue into 1999, integration testing to assure that logically related systems can interact and process information correctly.
During 1998, the Corporation reviewed the Year 2000 preparedness of its vendors and suppliers, and recently completed on-site due diligence visits with key service providers. The great majority of these suppliers appear to be making adequate progress. The Corporation will continue to monitor vendor and supplier progress and develop contingency plans where necessary and feasible. The Corporation is testing for key dates in the new century with critical third party service providers, although it may be necessary to rely on proxy testing in some cases. The majority of this work is expected to be done in the first half of 1999. The Corporation will make available testing documentation, known as proxy tests, to clients utilizing certain products and services. The Corporation also relies on entities such as the Federal Reserve System, Depository Trust Company, Participants Trust Company, Society for Worldwide Interbank Financial Telecommunications (SWIFT), and the Clearing House Interbank Payment Systems (CHIPS) in its securities processing and banking businesses, as do other financial services providers in similar businesses. Testing of data exchanges with organizations such as these is underway and is expected to be completed during by the second quarter of 1999.
Although the Corporation is attempting to monitor and validate the efforts of other parties, it cannot control the success of these efforts. The Corporation is developing contingency plans where practical to provide alternatives in situations where a third party furnishing a critical product or service experiences significant Year 2000 issues. The Corporation is also updating existing business continuity plans for the date change. This process is well underway and will continue through the third quarter, 1999, as plans are reviewed and validated.
As part of its credit analysis process, the Corporation has developed a project plan for assessing the Year 2000 readiness of its significant credit customers. An initial assessment of Year 2000 readiness has been completed for the customers who have responded to the Corporation's inquiries about their progress, which make up the majority of its credit customers and represent most of its credit exposure. The Corporation will continue to monitor the progress of these customers.
The Financial Management Group's (FMG) mission critical systems, such as the trust and brokerage accounting and trading systems, are and have been included in the Corporation's evaluation and testing of systems. FMG is also updating current contingency plans to include possible Year 2000 circumstances. In addition to the systems aspect, the FMG recognizes that there could be other types of risks and is in the process of reviewing the managed assets comprising the investment portfolios of FMG clients. The review process includes obtaining public information provided by companies/issuers to regulatory bodies, such as
the Securities and Exchange Commission. Other public information that may be relied upon for evaluating a company's/issuer's Year 2000 readiness are analysts' reports and/or official statements from companies/issuers.
Although the FMG is attempting to review and monitor the efforts of other parties, it cannot warrant the facts, circumstances, or the outcome of such efforts. Where the Corporation does not serve in a fiduciary capacity for a customer's assets it cannot provide any assurances on factors outside its control such as the quality of assets, potential economic uncertainties and other service providers. The Corporation also does not accept responsibility for ensuring that its clients' own systems are Year 2000 compliant. In addition, the Corporation does not guarantee that there will not be any disruptions on receipt or disbursements of income. There may be disruptions that are beyond the control of the Corporation. An example of this would be if an issuer/company or its paying agent does not pay income as scheduled.
The Corporation's program is regularly reviewed by examiners from various external agencies such as the Comptroller of the Currency and the Federal Reserve Bank.
The Corporation expects to successfully complete its Year 2000 effort as planned. However, it is subject to unique risks and uncertainties due to the interdependencies in business and financial markets, and the numerous activities and events outside of its control. Since the Corporation is still conducting external testing and monitoring of third parties, it is unable to make definitive assumptions as to the extent of Year 2000 failures that could result, nor quantify the potential adverse effect that such failures could have on the Corporation's operations, liquidity, and financial condition. Year 2000 risks will be continually evaluated and contingency plans revised throughout 1999.
INCOME TAXES
The Corporation recognized income tax expense of $42.1 million in 1998, compared to $39.6 million in 1997, and $34.4 million in 1996. The effective tax rate in 1998 was 35.75 percent compared to 35.15 percent in 1997 and 35.35 percent in 1996. For a detailed analysis of the Corporation's income taxes see Note O "Income Taxes" on page 52.
CASH EARNINGS
Historically, excluding the merger with Overton, the Corporation's acquisitions have been accounted for using the purchase method of accounting which results in the creation of intangible assets. These intangible assets are deducted from capital in the determination of regulatory capital. Thus, "cash" or "tangible" earnings represents the regulatory capital generated during the year and can be viewed as net income excluding intangible amortization, net of tax. While the definition of "cash" or "tangible" earnings may vary by company, we believe this definition is appropriate as it measures the per share growth of regulatory capital, which impacts the amount available for dividends and acquisitions. The following table reconciles reported earnings to net income excluding intangible amortization ("cash" earnings) for each of the three most recent year periods:
Year Ended December 31 ---------------------------------- ---------------------------------- Reported Intangible "Cash" Earnings Amortization Earnings - ------------------------------------- ----------------------------------- Income before income taxes........... $97,347 $ 11,306 $108,653 Income taxes......................... 34,409 3,267 37,676 ---------------------------------- Net income........................... $62,938 $ 8,039 $ 70,977 ================================== Net income per diluted common share(1)............................ $ 2.31 $ .30 $ 2.61 Return on assets(1).................. 1.23% 1.39 %* Return on equity(1).................. 15.63 17.63 **
(1) 1998 diluted operating earnings per share and diluted operating cash earnings per share were $3.11 and $3.48, respectively. Operating cash ROA and cash ROE for 1998 were 1.48 percent and 19.43 percent, respectively. Operating earnings exclude the after-tax impact of the $12.2 million merger related charge associated with the merger with Overton.
* CALCULATED AS A/B ** CALCULATED AS A/C
- -------------------
1998 1997 1996 --------- --------- --------- (A) Net income before intangible amortization (including goodwill and core deposit intangibles, net of tax).......................... $ 85,696 $ 81,742 $ 70,977 (B) Total average assets............. 6,417,569 5,687,577 5,113,495 (C) Average shareholders' equity..... 489,958 445,450 402,687
SOURCES AND USES OF FUNDS
Average assets for 1998 of $6.4 billion increased by 12.8 percent from 1997 levels and increased 11.2 percent between 1996 and 1997. Funding sources in 1998 reflected an increase in demand deposits and Federal funds purchased. The Corporation's uses of funds continued a trend which started in 1995 of replacing securities with loans as the largest component of earning assets. This reflects the increases in loan volumes from a year ago.
Percentage of Total Average ------------------------------- SOURCES AND USES OF FUNDS 1998 1997 1996 - ---------------------------------------------------------------------- Sources of Funds: Deposits: Demand..................... 25.4% 24.3% 24.0% Time....................... 59.7 61.4 62.2 Federal funds purchased......... 3.9 3.3 4.0 Equity capital.................. 7.6 7.8 7.9 Borrowed funds.................. 2.0 2.0 0.4 Other liabilities............... 1.4 1.2 1.5 ------------------------------- Total...................... 100.0% 100.0% 100.0% =============================== Uses of Funds: Loans........................... 53.5% 51.3% 47.8% Securities...................... 30.1 30.4 34.5 Federal funds sold.............. 2.0 4.0 2.8 Non-earning assets.............. 14.4 14.3 14.9 ------------------------------- Total...................... 100.0% 100.0% 100.0% ===============================
LOANS
Average loans for 1998 were $3.4 billion, an increase of 17.8 percent from 1997. This increase was driven by continued improved economic conditions in the Texas markets the Corporation serves and the 1998 acquisition.
Period-end loans increased to $3.6 billion at year-end 1998, up 17.0 percent from the previous year-end. Most of the increase in period-end loans is attributable to commercial and industrial loans and residential real estate loans which increased $222 million and $139 million, respectively. Home equity loans accounted for approximately 59 percent of the increase in residential real estate loans. The increase in period-end loans was offset by a $21 million decrease in consumer loans primarily related to a reduction in indirect lending. Approximately 76 percent of the increase in loans from a year ago resulted from internally generated growth.
Total real estate loans at December 31, 1998 were $1.7 billion, up 25.4 percent from year-end 1997. Amortizing permanent mortgages represented 58.3 percent of the total real estate loan portfolio at year end. Residential mortgages increased $139 million or 26.9 percent. Real estate loans categorized as "other" are primarily amortizing commercial and industrial loans with maturities of less than five years. Approximately 58 percent of all commercial real estate loans are owner occupied or have a major tenant (National or Regional company), which historically has resulted in a lower risk, provides financial stability and is less susceptible to economic swings. See page 25 for further discussion for the loan portfolio and "Loan Maturity and Sensitivity" on page 62.
MEXICAN LOANS
At December 31, 1998, the Corporation's cross-border outstandings to Mexico, excluding $19.8 million in loans secured by liquid U.S. assets, totaled $25.4 million, down from $48.6 million last year. The decrease from a year ago represents normal fluctuations in lines of credit used by Mexican banks to finance trade. Of the trade-related credits, approximately 65 percent are related to companies exporting from Mexico. In addition, loans insured by the Export Import Bank were made to Mexican businesses to
purchase goods of the United States. At December 31, 1998, 1997 and 1996, none of the Mexican-related loans were on non-performing status.
December 31 --------------------------------- --------------------------------- Percentage Percentage of Total of Total MEXICAN LOANS Amount Loans Assets - ------------------------------------- --------------------------------- Financial institutions............... $24,932 .9% .4% Commercial and industrial............ 5,000 .2 .1 ---------------------------------- Total................................ $29,932 1.1% .5% ==================================
The above table excludes $19,825,000, $24,314,000 and $15,630,000 in loans secured by liquid assets held in the United States in 1998, 1997 and 1996, respectively.
NON-PERFORMING ASSETS
Non-performing assets were $17.1 million at December 31, 1998, compared with $18.1 million at December 31, 1997 and $14.1 million at December 31, 1996. Non-performing assets as a percentage of total loans and foreclosed assets were .47 percent at December 31, 1998, down from .58 percent one year ago.
The Corporation did not have any restructured loans for the years ended December 31, 1998-1994.
Interest income that would have been recorded in 1998 on non-performing assets, had such assets performed in accordance with their original contract terms, was $1,262,000 on non-accrual loans and $392,000 on foreclosed assets. During 1998, the amount of interest income actually recorded on non-accrual loans was $742,000.
There were no foreign loans 90 days past due as of December 31, 1998.
Loans to a customer whose financial condition has deteriorated are considered for non-accrual status whether or not the loan is 90 days or more past due. All non-consumer loans 90 days or more past due are classified as non-accrual unless the loan is well secured and in the process of collection. When a loan is placed on non-accrual status, interest income is not recognized until collected, and any previously accrued but uncollected interest is reversed. A loan is considered to be restructured if it has been modified as to original terms, resulting in a reduction or deferral of principal and/or interest as a concession to the debtor. Classification of an asset in the non-performing category does not preclude ultimate collection of loan principal or interest.
At December 31, 1998, the Corporation had $5,597,000 in loans to borrowers experiencing financial difficulties which had not been included in either of the non-accrual or 90 days past due loan categories. Management monitors such loans closely and reviews their performance on a regular basis.
ALLOWANCE FOR POSSIBLE LOAN LOSSES
The allowance for possible loan losses was $53.6 million or 1.47 percent of period-end loans at December 31, 1998, compared to $48.1 million or 1.54 percent of period-end loans at year-end 1997. The
allowance for possible loan losses as a percentage of non-accrual loans was 412.5 percent at December 31, 1998, compared with 367.6 percent at December 31, 1997.
The Corporation recorded a $10.4 million provision for possible loan losses during 1998, compared to $9.2 million and $8.5 million recorded during 1997 and 1996, respectively. The provision is reflective of the continued growth in the loan portfolio. The provision is also influenced by prior loan portfolio losses; the current condition of the loan portfolio both as to specific and in the aggregate; the present business/economic environment within which the bank operates; and changes in other conditions which influence credit risk. These other conditions include but are not limited to; the bank's lending policies and procedures dealing with underwriting standards; the experience, ability, and depth of lending management and staff; the existence of any concentrations of credit and changes in the level of such concentrations; the effect of external factors such as competition and legal and regulatory requirements; and changes in the quality of the bank's loan review system and the degree of oversight by the bank's board of directors.
The Corporation recorded net charge-offs of $6.1 million for the year ended December 31, 1998, compared to net charge-offs of $6.0 million and $2.8 million in 1997 and 1996, respectively. The Corporation's gross charge-offs in 1998 consisted primarily of consumer loans which increased $871,000 to $8.1 million and commercial and industrial loans which increased $2.0 million to $4.0 million. The Corporation's gross charge-offs in 1997 consisted primarily of consumer loans which increased $3.4 million to $7.2 million and commercial and industrial loans which decreased $4.5 million to $2.0 million. The Corporation's gross charge-offs in 1996 consisted primarily of commercial and industrial loans which increased to $6.5 million from $739,000 in 1995 and consumer loans which decreased slightly from 1995.
There were no foreign charge-offs in 1998-1994.
The Corporation has certain lending policies and procedures in place which are designed to maximize loan income within an acceptable level of risk. These policies and procedures, some of which are described below, are reviewed regularly by senior management. A reporting system supplements this review process by providing management and the board of directors with frequent reports related to loan production, loan quality, concentrations of credit, loan delinquencies and non-performing and potential problem loans.
Commercial and industrial loans are a diverse group of loans to small, medium and large businesses. The purpose of these loans vary from supporting seasonal working capital needs to term financing of equipment. These loans are underwritten focusing on evaluating and understanding management's ability to operate profitably and prudently expand their business. Once it is determined management possess sound ethics and solid business acumen, current and projected cash flows are examined to determine the ability to repay their obligations as agreed upon. In addition, collateral must be of good quality and single purpose projects are avoided. Underwriting standards are designed to promote relationship banking rather than transactional banking. While some short-term loans may be made on an unsecured basis, most are secured by the assets being financed with appropriate collateral margins.
Diversification in the loan portfolio is a means of managing risk associated with fluctuations in economic conditions. At December 31, 1998, the Corporation had no concentration of commercial and industrial loans in any single industry that exceeded 10 percent of total loans.
The diversity of the commercial real estate portfolio allows the Corporation to reduce the impact of a decline in a single market or industry. In addition to monitoring and evaluating commercial real estate loans based on collateral, geography and risk grade criteria, management closely tracks its level of owner-occupied commercial real estate loans versus non-owner occupied loans. Additionally, the Corporation utilizes the knowledge of third party experts to provide insight and guidance about the economic conditions and dynamics of the markets served by the Corporation. Within the commercial real estate loan category, the Corporation's primary focus has been the growth of loans secured by owner-occupied properties. At December 31, 1998, a majority of the Corporation's commercial real estate loans were secured by owner-occupied properties. These loans are viewed primarily as cash flow loans and secondarily as loans secured by real estate. Consequently, these loans must withstand the analysis of a commercial loan and the underwriting process of a commercial real estate loan.
Loans secured by non-owner occupied commercial real estate are made to developers and builders who have a relationship with the Corporation and who have a proven record of success. These loans are underwritten through the use of feasibility studies, independent appraisal reviews, sensitivity analysis of absorption and lease rates and financial analysis of the developers and property owners. Sources of repayment for these types of loans may be pre-committed permanent loans from approved long-term lenders, sales of developed property or an interim loan commitment from the Corporation. These loans are closely monitored by on-site inspections and are considered to have higher risks than the other real estate loans due to their ultimate repayment being sensitive to interest rate changes, general economic conditions and the availability of long-term financing.
The consumer loan portfolio has three distinct segments -- indirect consumer loans, which represent 41 percent of the consumer loan portfolio, direct non-real estate consumer loans, which represent 29 percent of the portfolio and direct real estate consumer loans, which represent 30 percent. The indirect segment is composed almost exclusively of new and used automobile financing. Non-real estate direct loans include automobile loans, unsecured revolving credit products, personal loans secured by cash and cash equivalents, and other similar types of credit facilities. The direct real estate loans are primarily Home Equity, home improvement and residential lot loans. Effective January 1, 1998, in accordance with a constitutional amendment allowing for the existence of Home Equity loans in the State of Texas, the Corporation began offering Home Equity loans up to 80 percent of the estimated value of the personal residence of the borrower less the balances on existing mortgage and home improvement loans. As of December 31, 1998, Home Equity loans aggregated approximately $82 million, and were originated for a general variety of purposes including: education, business start-ups, debt consolidation and automobile financing. It is anticipated this product will continue to grow and eventually represent the largest distinct segment of the
consumer portfolio. To date the primary growth of this product has been from existing customers. Underwriting standards for this product are heavily influenced by the statute requirements, which include but are not limited to; maximum loan-to-value percentage, collection remedies, the number of such loans a borrower can have at one time and documentation requirements.
A computer based credit scoring analysis is used to supplement the consumer loan underwriting process. To monitor and manage consumer loan risk, policies and procedures are developed and modified, as needed, jointly by line and staff personnel. This activity, coupled with relatively small loan amounts that are spread across many individual borrowers, minimizes the risk. Additionally, trend and outlook reports are provided to senior management on a frequent basis to aid in planning.
The Corporation has an independent Loan Review Division that reviews and validates the credit risk program on a periodic basis. Results of these reviews are presented to senior management and the board of directors. Loan Review's function complements and reinforces the risk identification and assessment decisions made by lenders and credit personnel as well as the Corporation's policies and procedures.
Loans identified as losses by management, internal loan review and/or bank examiners are charged-off. Furthermore, consumer loan accounts are charged-off automatically based on regulatory requirements.
An allowance for possible loan losses is maintained in an amount which, in management's judgment, provides an adequate reserve to absorb potential loan losses inherent in the loan portfolio. Industry concentrations, specific credit risks, loan loss experience, current loan portfolio quality, the impact of rising interest rates, experience level and effectiveness of employees, economic, competitive, political and regulatory conditions and other pertinent factors are all considered in determining the adequacy of the allowance.
An audit committee of non-management directors reviews the adequacy of the allowance for possible loan losses quarterly.
Allocation of a portion of the allowance does not preclude its availability to absorb losses in other categories. The unallocated portion of the allowance represents an additional amount beyond that specifically reserved for specific risks available to absorb unidentified losses in the current loan portfolio.
SECURITIES
Total securities, including securities available for sale, were $2.1 billion at year-end 1998 compared to $1.8 billion a year ago. Securities available for sale totaled $2.0 billion at December 31, 1998, compared to $1.5 billion at year-end 1997. These securities consist primarily of U.S. Treasury securities and obligations of U.S. Government agencies. Securities classified as held to maturity are carried at amortized cost and consist primarily of U. S. Government agency obligations. The remaining securities, consisting primarily of municipal bonds, are classified as trading and are carried at fair value.
Debt securities are classified as held to maturity when the Corporation has the positive intent and ability to hold the securities to maturity. Available for sale securities are stated at fair value, with unrealized gains and losses, net of tax, reported as a separate component of shareholders' equity. Trading securities held primarily for sale in the near term are valued at their fair values, with unrealized gains and losses included immediately in other income.
The average yield of the securities portfolio for the year ended December 31, 1998 was 6.32 percent compared with 6.43 percent for 1997. See page 63 "Maturity Distribution and Securities Portfolio Yields."
Total securities including trading, available for sale and held to maturity are summarized below:
INTEREST RATE SWAPS/FLOORS
The Corporation has off-balance sheet interest rate swaps to hedge its interest rate risk by essentially converting fixed-rate loans into synthetic variable-rate instruments. These swap transactions allow management to structure the interest rate sensitivity of the asset side of the Corporation's balance sheet to more closely match their view of the interest rate sensitivity of the Corporation's funding sources. The Corporation had 22 interest rate swaps at December 31, 1998 compared to 42 interest rate swaps at December 31, 1997. Each swap was a hedge against a specific commercial fixed-rate loan or against a specific pool of consumer fixed-rate loans, with a notional amount of $75 million and $267 million at December 1998 and 1997, respectively. In each case, the amortization of the interest rate swap generally matches the expected amortization of the underlying loan or pool of loans and was a hedge against either a specific commercial loan or a specific pool of consumer loans with lives ranging from two to ten years. Each counterparty to a swap transaction has a credit rating that is investment grade. The net amount payable or receivable under interest rate swap/floor is accrued as an adjustment to interest income and was not material in 1998 or 1997. In the third quarter of 1998, the Corporation terminated interest rate swaps hedging fixed rate consumer loans. The Corporation is amortizing the loss on the transaction of $1.9 million over the remaining term of the interest swaps ending in the second quarter of 2002.
During 1998, the Corporation terminated all three of its interest rate floor agreements with a notional amount totaling $500 million and an original term of three years. These interest rate floors were purchased in 1997 for the purpose of hedging floating interest rate exposure in commercial loan accounts in an environment of falling interest rates. The Corporation is amortizing the gain on the transaction of $2.8 million over the remaining term of the interest rate floors.
DEPOSITS
Total average demand deposits increased 17.9 percent from 1997. This can be attributed to an increase in commercial and individual levels of $244.0 million. The increase in commercial and individual is partially related to the 1998 acquisition. The Corporation has made a strategic effort in growing its correspondent bank relationships in the markets it serves. Reflective of this effort the Corporation ranks 26th in the United States for correspondent bank balances as of June 30, 1998.
Total average time deposits increased 9.7 percent from 1997 with the largest increase coming from money market deposit accounts partially related to the 1998 acquisition. In addition, time accounts of $100,000 or more and savings and Interest-on-Checking accounts also showed a strong increase from 1997 levels.
The following table summarizes the certificates of deposit in amounts of $100,000 or more as of December 31, 1998 by time remaining until maturity.
December 31 ------------------------ REMAINING MATURITY OF PRIVATE ------------------------ CERTIFICATES OF DEPOSIT PERCENTAGE OF $100,000 OR MORE AMOUNT OF TOTAL - ---------------------------------------------------------------- Three months or less................. $ 335,460 50.6% After three, within six months....... 175,914 26.6 After six, within twelve months...... 138,806 20.9 After twelve months.................. 12,743 1.9 ------------------------ Total........................... $ 662,923 100.0% ======================== Percentage of total private time deposits 17.8%
Other time deposits of $100,000 or more were $108.0 million at December 31, 1998. Of this amount 73.7 percent matures within three months, 18.0 percent matures between three and six months and the remainder matures between six months and one year.
Mexico is a part of the natural trade territory of the banking offices of Cullen/Frost. Thus, dollar-denominated foreign deposits from Mexican sources have traditionally been a significant source of funding. The Corporation's average foreign deposits increased 5.8 percent from 1997. The Mexican economic recovery and growth in manufacturing which began in 1996 continued to improve through 1998.
FOREIGN DEPOSITS 1998 1997 1996 - ------------------------------------------------------------------------- Average balance...................... $ 642,822 $ 607,642 $ 573,583 Percentage of total average deposits........................... 11.8% 12.5% 13.0%
SHORT-TERM BORROWINGS
The Corporation's primary source of short-term borrowings is Federal funds purchased from correspondent banks and securities sold under repurchase agreements in the natural trade territories of the Cullen/Frost subsidiary banks, as well as from upstream banks. The net purchase position experienced in 1998 was primarily the result of growth in earning assets over core deposit growth. In 1997, the increase in the net funds position is a direct result of the Corporation's use of funds acquired from the issuance of the $100 million Trust Preferred Capital Securities. The weighted-average interest rate on Federal funds purchased at December 31, 1998 and 1997 was 4.69 percent and 5.81 percent, respectively. Generally, securities sold under repurchase agreements are at 80 percent of Federal funds.
FEDERAL FUNDS PURCHASED AND Year Ended December 31 SECURITIES ---------------------------------- SOLD UNDER REPURCHASE AGREEMENTS 1998 1997 1996 - ------------------------------------------------------------------------- Balance at year end.................. $ 305,564 $ 200,774 $ 232,690 Maximum month-end balance............ 523,178 231,418 272,489
Other funding sources include a $7.5 million short-term line of credit to the parent Corporation used for short-term liquidity needs. There were no borrowings outstanding from this source at December 31, 1998 and 1997.
GUARANTEED PREFERRED BENEFICIAL INTEREST IN THE CORPORATION'S JUNIOR SUBORDINATED DEFERRABLE INTEREST DEBENTURES
During February 1997, the Corporation issued $100 million of its 8.42 percent Capital Securities, Series A which represent a beneficial interest in Cullen/Frost Capital Trust I, a Delaware statutory business trust and wholly-owned subsidiary of the Corporation. The Issuer Trust used the proceeds of the sale of the Capital Securities to purchase Junior Subordinated Debentures of Cullen/Frost. Of these proceeds, the Corporation used $55.3 million for the acquisition of Harrisburg Bancshares, Inc. and $17.8 million for the repurchase of shares of the Corporation. The $100 million Trust Preferred Capital Securities are included in the Tier 1 capital of Cullen/Frost for regulatory capital purposes and are reported as debt on the balance sheet. See Note I "Borrowed Funds" on page 44.
CAPITAL
At December 31, 1998, shareholders' equity reached the highest level in the Corporation's history, $512.9 million, an increase of 10.8 percent from $462.9 million at December 31, 1997. The increase in 1998 was due primarily to earnings growth partially offset by $30.5 million of dividends paid and $3.5 million paid for the repurchase of shares of the Corporation. The Corporation had an unrealized gain on securities available for sale, net of deferred taxes, of $7.7 million as of December 31, 1998 compared to $8.9 million as of December 31, 1997. Currently, under regulatory requirements, the unrealized gain or loss on securities available for sale is not included in the calculation of risk-based capital and leverage ratios.
The Corporation paid a quarterly dividend of $.25 per common share during the first quarter of 1998 increasing to $.30 per common share during the second, third and fourth quarters of 1998. The Corporation paid a quarterly dividend of $.21 per common share during the first quarter of 1997 increasing to $.25 per common share during the second, third and fourth quarters of 1997. The dividend payout ratio excluding the merger related charge was 35.8 percent for 1998. Cullen/Frost dividend payout ratio for 1997 (including income and dividends for Overton) was 30.5 percent.
The Federal Reserve Board utilizes capital guidelines designed to measure Tier 1 and Total Capital and take into consideration the risk inherent in both on-balance sheet and off-balance sheet items. For the Corporation's capital ratios at December 31, 1998 and 1997, see Note L "Capital" on page 46.
FORWARD-LOOKING STATEMENTS
The Corporation may from time to time make forward-looking statements (within the meaning of the Private Securities Litigation Reform Act of 1995) with respect to earnings per share, credit quality, its Year 2000 compliance program, corporate objectives and other financial and business matters. The Corporation cautions the reader that these forward-looking statements are subject to numerous assumptions, risks and uncertainties, including economic conditions, actions taken by the Federal Reserve Board, legislative and regulatory actions and reforms, competition, as well as other reasons, all of which change over time. Actual results may differ materially from forward-looking statements.
PARENT CORPORATION
Historically, a large portion of the parent Corporation's income, which provides funds for the payment of dividends to shareholders and for other corporate purposes, has been derived from Cullen/Frost's investments in subsidiaries. Dividends received from the subsidiaries are based upon each bank's earnings and capital position. See Note K "Dividends" on page 46. Management fees are not assessed.
NON-BANKING SUBSIDIARIES
The New Galveston Company is a wholly-owned second tier bank holding company subsidiary which holds all shares of each banking and non-banking subsidiary with the exception of Cullen/Frost Capital Trust I. Cullen/Frost has three principal non-banking subsidiaries. Main Plaza Corporation occasionally makes loans to qualified borrowers. Such loans are typically funded with borrowings against Cullen/Frost's current cash or borrowing against credit lines. Daltex General Agency, Inc., a managing general insurance agency, provides vendor's single interest insurance for Cullen/Frost subsidiary banks. Cullen/Frost Capital Trust I, a wholly-owned non-banking subsidiary, is a Delaware statutory trust. The sole purpose of the trust was to sell Capital Securities and to purchase Junior Debentures of the Corporation.
The Corporation formed a new subsidiary, Frost Insurance Agency, Inc., a wholly owned subsidiary of The Frost National Bank on April 16, 1998. Frost Insurance Agency will offer corporate and personal property and casualty insurance as well as group, health and life insurance products to individuals and businesses.
SUBSEQUENT EVENTS
PENDING ACQUISITIONS
On March 3, 1999, Frost Insurance Agency, a subsidiary of The Frost National Bank, signed a letter of intent to acquire Professional Insurance Agents, Inc. (PIA), a mid-sized independent insurance agency based in Victoria, Texas, with additional locations in San Antonio, New Braunfels and Refugio. PIA offers corporate and personal property and casualty insurance as well as group, health and life insurance products to individuals and businesses. The transaction is subject to regulatory approval, and is expected to close in the second quarter of 1999. The purchase method of accounting will be used to record the transaction.
On February 17, 1999, the Corporation entered into a definitive agreement to acquire Commerce Financial Corporation of Fort Worth, Texas which has deposits of approximately $174 million. The Corporation agreed to pay $42.25 million. The acquisition is expected to be completed in the second quarter of 1999 following shareholder and regulatory approval. This transaction will be accounted for as a purchase with total cash consideration being funded through internal sources.
INVESTMENT BANKING SUBSIDIARY
On January 26, 1999, the Corporation announced its intent to seek Federal Reserve Bank approval to form a Section 20 investment banking subsidiary. The new subsidiary, to be named Frost Securities, Inc., is expected to be operational by July 1 and will offer a full range of services including equity research, institutional sales, trading and investment banking services to institutional investors and corporate customers who need access to the capital markets.
COMPLETED ACQUISITION
On January 15, 1999, the Corporation paid approximately $18.7 million to acquire Keller State Bank, of Keller, Texas. The total cash consideration was funded through internal sources. The purchase method of accounting has been used to record the transaction and as such the purchase price has been allocated to the underlying assets and liabilities based on estimated fair values at the date of acquisition. Such estimates may be subsequently revised. The Corporation acquired loans of approximately $38 million and deposits of approximately $62 million. Total intangibles associated with the acquisition amounted to approximately $11.8 million. This acquisition is not expected to have a material impact on the Corporation's 1999 net income.
MANAGEMENT'S RESPONSIBILITY FOR FINANCIAL REPORTING
The management of Cullen/Frost Bankers, Inc. is responsible for the preparation of the financial statements, related financial data and other information in this annual report. The consolidated financial statements have been prepared in accordance with generally accepted accounting principles and include amounts based on management's estimates and judgment where appropriate. Financial information appearing throughout this annual report is consistent with the financial statements.
In meeting its responsibility both for the integrity and fairness of these financial statements and information, management depends on the accounting systems and related internal accounting controls that are designed to provide reasonable assurances that transactions are authorized and recorded in accordance with established procedures and that assets are safeguarded and that proper and reliable records are maintained.
The concept of reasonable assurance is based on the recognition that the cost of a system of internal controls should not exceed the related benefits. As an integral part of the system of internal controls, Cullen/Frost maintains an internal audit staff which monitors compliance with and evaluates the effectiveness of the system of internal controls and coordinates audit coverage with the independent auditors.
The Audit Committee of Cullen/Frost's Board of Directors, which is composed entirely of directors independent of management, meets regularly with management, regulatory examiners, internal auditors, the asset review staff and independent auditors to discuss financial reporting matters, internal controls, regulatory reports, internal auditing and the nature, scope and results of the audit efforts. Internal Audit and Asset Review report directly to the Audit Committee. The banking regulators, internal auditors and independent auditors have direct access to the Audit Committee.
The consolidated financial statements have been audited by Ernst & Young LLP, independent auditors, who render an independent opinion on management's financial statements. Their appointment was recommended by the Audit Committee and approved by the Board of Directors and by the shareholders. The audit by the independent auditors provides an additional assessment of the degree to which Cullen/Frost's management meets its responsibility for financial reporting. Their opinion on the financial statements is based on auditing procedures, which include their consideration of internal controls and performance of selected tests of transactions and records, as they deem appropriate. These auditing procedures are designed to provide an additional reasonable level of assurance that the financial statements are fairly presented in accordance with generally accepted accounting principles in all material respects.
Richard W. Evans, Jr. Phillip D. Green Chairman and Chief Senior Executive Vice President Executive Officer and Chief Financial Officer
ITEM 7A.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The information required by this Item is set forth in the section entitled "Market Risk -- Interest Rate Sensitivity" included under Item 7 of this document and is incorporated herein by reference.
ITEM 8.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
CONSOLIDATED STATEMENTS OF OPERATIONS (dollars in thousands, except per share amounts)
Year Ended December 31 -------------------------------- 1998 1997 1996 - ------------------------------------------------------------------------ INTEREST INCOME: Loans, including fees........... $300,721 $261,607 $219,279 Securities: Taxable....................... 117,261 108,249 111,334 Tax-exempt.................... 2,998 1,821 1,587 -------------------------------- Total securities........... 120,259 110,070 112,921 Federal funds sold and securities purchased under resale agreements............. 7,111 12,423 7,506 -------------------------------- TOTAL INTEREST INCOME... 428,091 384,100 339,706 INTEREST EXPENSE: Deposits........................ 138,283 131,140 117,179 Federal funds purchased and securities sold under repurchase agreements......... 11,606 8,739 9,773 Guaranteed preferred beneficial interests in the Corporation's subordinated debentures....... 8,475 7,652 Other borrowings................ 1,754 1,434 1,037 -------------------------------- TOTAL INTEREST EXPENSE............... 160,118 148,965 127,989 -------------------------------- NET INTEREST INCOME..... 267,973 235,135 211,717 Provision for possible loan losses... 10,393 9,174 8,494 -------------------------------- NET INTEREST INCOME AFTER PROVISION FOR POSSIBLE LOAN LOSSES................ 257,580 225,961 203,223 NON-INTEREST INCOME: Trust fees...................... 46,863 43,275 36,898 Service charges on deposit accounts...................... 53,601 47,627 41,570 Other service charges, collection and exchange charges, commissions and fees.......................... 15,482 11,349 9,199 Net gain (loss) on securities transactions.................. 359 498 (892) Other........................... 22,361 18,953 17,403 -------------------------------- TOTAL NON-INTEREST INCOME................ 138,666 121,702 104,178 NON-INTEREST EXPENSE: Salaries and wages.............. 111,423 98,874 85,646 Pension and other employee benefits...................... 21,295 19,874 18,224 Net occupancy of banking premises...................... 25,486 22,812 21,486 Furniture and equipment......... 18,921 16,147 14,697 Intangible amortization......... 13,293 11,920 11,306 Merger related charge........... 12,244 Other........................... 75,844 65,514 58,695 -------------------------------- TOTAL NON-INTEREST EXPENSE............... 278,506 235,141 210,054 -------------------------------- INCOME BEFORE INCOME TAXES................. 117,740 112,522 97,347 Income taxes......................... 42,095 39,555 34,409 -------------------------------- NET INCOME.............. $ 75,645 $ 72,967 $ 62,938 ================================ Net income per share: Basic........................... $ 2.85 $ 2.75 $ 2.37 Diluted......................... 2.77 2.67 2.31 Dividends per share.................. 1.15 .96 .81
See notes to consolidated financial statements.
CONSOLIDATED BALANCE SHEETS (dollars in thousands, except per share amounts)
December 31 -------------------------- 1998 1997 - ----------------------------------------------------------------- ASSETS Cash and due from banks.............. $ 684,941 $ 637,613 Securities held to maturity (market value: 1998 -- $113,682; 1997 -- $261,225).................. 111,439 255,428 Securities available for sale........ 1,979,555 1,514,050 Trading account securities........... 709 1,940 Federal funds sold................... 102,900 190,000 Loans, net of unearned discount of $3,357 in 1998 and $3,194 in 1997............................... 3,646,603 3,116,895 Less: Allowance for possible loan losses.......................... (53,616) (48,073) -------------------------- Net loans....................... 3,592,987 3,068,822 Banking premises and equipment....... 137,290 128,710 Accrued interest and other assets.... 259,784 249,010 -------------------------- TOTAL ASSETS.................. $ 6,869,605 $ 6,045,573 ========================== LIABILITIES Demand deposits: Commercial and individual.......... $ 1,585,891 $ 1,353,242 Correspondent banks................ 201,355 140,443 Public funds....................... 56,253 54,880 -------------------------- Total demand deposits......... 1,843,499 1,548,565 Time deposits: Savings and Interest-on-Checking... 961,597 855,783 Money market deposit accounts...... 1,493,778 1,255,237 Time accounts...................... 1,264,121 1,216,145 Public funds....................... 282,492 293,360 -------------------------- Total time deposits........... 4,001,988 3,620,525 -------------------------- Total deposits................ 5,845,487 5,169,090 Federal funds purchased and securities sold under repurchase agreements......................... 305,564 200,774 Accrued interest and other liabilities........................ 107,177 114,377 Guaranteed preferred beneficial interest in the Corporation's junior subordinated deferrable interest debentures, net........... 98,458 98,403 -------------------------- TOTAL LIABILITIES............. 6,356,686 5,582,644 SHAREHOLDERS' EQUITY Common stock, par value per share: $.01; $5........................... 267 133,775 Shares authorized: 1998 -- 90,000,000; 1997 -- 60,000,000 Shares issued: 1998 -- 26,712,648; 1997 -- 26,754,960 Surplus.............................. 183,151 53,647 Retained earnings.................... 321,754 278,994 Accumulated other comprehensive income, net of tax................. 7,747 8,917 Treasury stock at cost (284,887)..... (12,404) -------------------------- TOTAL SHAREHOLDERS' EQUITY.... 512,919 462,929 -------------------------- TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY......... $ 6,869,605 $ 6,045,573 ==========================
See notes to consolidated financial statements.
CONSOLIDATED STATEMENTS OF CASH FLOWS (dollars in thousands) Year Ended December 31 --------------------------------------- 1998 1997 1996 - ------------------------------------------------------------------------------ OPERATING ACTIVITIES Net income........................... $ 75,645 $ 72,967 $ 62,938 Adjustments to reconcile net income to net cash provided by operating activities: Provision for possible loan losses........................ 10,393 9,174 8,494 Provision for real estate losses........................ 161 43 55 Credit for deferred taxes....... (5,574) (6,703) (3,865) Accretion of discounts on loans......................... (2,841) (1,212) (970) Accretion of securities' discounts..................... (3,911) (11,960) (15,568) Amortization of securities' premiums...................... 5,824 3,847 2,827 Decrease (increase) in trading account securities............ 1,231 (1,153) (351) Net realized (gain) loss on securities transactions....... (359) (498) 892 Net gain on sale of assets...... (773) (654) (1,406) Depreciation and amortization... 30,024 26,459 24,923 Decrease (increase) in accrued interest receivable........... 660 (6,374) (3,507) (Decrease) increase in accrued interest payable.............. (4,072) 4,453 1,051 Originations of mortgages held-for-sale................. (181,219) (104,271) (79,392) Proceeds from sales of mortgages held-for-sale................. 177,160 102,728 79,404 Net change in other assets and liabilities................... 13,000 (38,614) 1,069 --------------------------------------- NET CASH PROVIDED BY OPERATING ACTIVITIES.................... 115,349 48,232 76,594 INVESTING ACTIVITIES Proceeds from maturities of securities held to maturity........ 36,906 40,606 41,938 Purchases of securities held to maturity (9,650) (32,040) (21,153) Proceeds from sales of securities available for sale................. 900,398 434,488 240,078 Proceeds from maturities of securities available for sale...... 1,145,806 908,197 574,360 Purchases of securities available for sale............................... (2,314,252) (1,354,280) (717,162) Net increase in loan portfolio....... (407,212) (342,559) (335,832) Proceeds from sales of equipment..... 30 49 2,768 Purchases of premises and equipment.. (18,798) (18,104) (21,380) Proceeds from sales of repossessed properties......................... 2,982 2,038 1,331 Net cash and cash equivalents (paid) received from bank acquisitions.... (8,899) 14,277 19,198 --------------------------------------- NET CASH USED BY INVESTING ACTIVITIES.................... (672,689) (347,328) (215,854) FINANCING ACTIVITIES Net increase in demand deposits, IOC accounts, and savings accounts..... 566,136 159,070 518,195 Net decrease in certificates of deposit............................ (111,941) (16,532) (144,254) Net increase (decrease) in Federal funds purchased and securities sold under repurchase agreements........ 89,361 (31,916) 76,326 Net proceeds from issuance of guaranteed preferred beneficial interest in the Corporation's subordinated debentures............ 98,353 Net proceeds from issuance of common stock.............................. 7,983 3,735 1,182 Purchase of treasury stock........... (3,495) (17,834) (1,164) Dividends paid....................... (30,476) (22,256) (18,754) --------------------------------------- NET CASH PROVIDED BY FINANCING ACTIVITIES.................... 517,568 172,620 431,531 --------------------------------------- (DECREASE) INCREASE IN CASH AND CASH EQUIVALENTS.............. (39,772) (126,476) 292,271 Cash and cash equivalents at beginning of year.................. 827,613 954,089 661,818 --------------------------------------- CASH AND CASH EQUIVALENTS AT END OF YEAR....................... $ 787,841 $ 827,613 $ 954,089 =======================================
See notes to consolidated financial statements.
CONSOLIDATED STATEMENT OF CHANGES IN SHAREHOLDERS' EQUITY (dollars in thousands)
See notes to consolidated financial statements.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE A -- SUMMARY OF ACCOUNTING POLICIES
Cullen/Frost Bankers, Inc., ("Cullen/Frost" or "the Corporation") through its wholly-owned subsidiary banks provides a broad array of products and services throughout 10 Texas markets. In addition to general commercial banking, other products and services offered include trust and investment management, mortgage banking, leasing, asset-based lending, treasury management and item processing.
The accounting and reporting policies followed by Cullen/Frost are in accordance with generally accepted accounting principles and conform to general practices within the banking industry. The more significant accounting and reporting policies are summarized below.
BASIS OF PRESENTATION -- The consolidated financial statements include the accounts of Cullen/Frost and its wholly-owned subsidiaries. Condensed parent company financial statements reflect investments in subsidiaries using the equity method of accounting. All significant intercompany balances and transactions have been eliminated in consolidation. The consolidated financial statements have been prepared to give retroactive effect to the May 29, 1998 merger with Overton Bancshares, Inc. which was accounted for as a pooling of interests. Certain reclassifications have been made to make prior years comparable.
USE OF ESTIMATES -- The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the amounts reported in the consolidated financial statements and accompanying notes. Actual results could differ from those estimates.
SECURITIES -- Securities are classified as held to maturity and carried at amortized cost when the Corporation has the intent and ability to hold the securities until maturity. Securities held for resale in anticipation of short-term market movements are classified as trading and are carried at market value with both net realized and unrealized gains and losses included in other income during the period. Securities to be held for indefinite periods of time are classified as available for sale and stated at fair value, with the unrealized gains and losses, net of tax, reported as a separate component of shareholders' equity. The adjusted carrying value of the specific security sold is used to compute gain or loss on the sale of securities. Declines in value other than temporary declines are adjusted against the security with a charge to operations.
LOANS -- Interest on loans is accrued and accreted to operations based on the principal amount outstanding. Interest on certain consumer loans is recognized over their respective terms using a method which approximates the interest method. Generally, loans are placed on a non-accrual status if principal or interest payments become 90 days past due and/or management deems the collectability of the principal and/or interest to be in question as well as when required by regulatory regulations. Once interest accruals are discontinued, uncollected but accrued interest is charged to current year operations. Subsequent receipts on nonaccrual loans are recorded as a reduction of principal, and interest income is recorded once principal recovery is reasonably assured. Loans which are determined to be uncollectible are charged to the allowance for possible loan losses. The collectability of loans is continually reviewed by management.
ALLOWANCE FOR POSSIBLE LOAN LOSSES -- The allowance for possible loan losses is established through a provision for possible loan losses charged to current operations. The amount maintained in the allowance reflects management's continuing assessment of the potential losses inherent in the portfolio based on evaluations of industry concentrations, specific credit risks, loan loss experience, current loan portfolio quality, present economic, political and regulatory conditions and unidentified losses inherent in the current loan portfolio. The methodolgy used by the company to determine the level and adequacy of the allowance is consistent with the requirements and recommendations of the primary regulator. Certain loans are accounted for under the provisions of SFAS No. 114, "Accounting by Creditors for Impairment of a Loan," as amended by SFAS No. 118, "Accounting by Creditors for Impairment of a Loan -- Income Recognition and Disclosure." These standards require an allowance to be established as a component of the allowance for loan losses for certain loans when its is probable that all amounts due pursuant to the
contractual terms of the loan will not be collected and the recorded investment in the loan exceeds the fair value. The allowance for possible loan losses related to loans that are impaired as defined by SFAS No. 114 and SFAS No. 118 is based on discounted cash flows using the loan's initial effective interest rate or the fair value of the collateral for certain collateral dependent loans. Income on impaired loans is recognized in accordance with SFAS No. 118 which is based on the collectability of the principal amount.
FORECLOSED ASSETS -- Foreclosed assets consist of property which has been formally repossessed. Collateral obtained through foreclosure is recorded at the lower of fair value less estimated selling costs or the underlying loan amounts. Write-downs are provided for subsequent declines in value. A loan is classified as in-substance foreclosure when the Corporation has taken possession of the collateral regardless of whether formal foreclosure proceedings have taken place.
BANKING PREMISES AND EQUIPMENT -- Banking premises and equipment are stated at cost, less accumulated depreciation and amortization. Depreciation and amortization are generally computed on a straight-line basis over the estimated useful lives of the assets. Leasehold improvements are generally amortized over the lesser of the term of the respective leases or the estimated useful lives of the improvements.
On January 1, 1996, the Company adopted SFAS No. 121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed Of." This statement requires that long-lived assets and certain identifiable intangibles be reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable on an undiscounted basis. If impairment is indicated the present value of expected future cash flows from the use of the asset and its eventual disposition are less than the carrying amount of the asset, an impairment loss is recognized. The adoption did not have a material impact on financial position or results of operations.
INTANGIBLE ASSETS -- The excess of cost over fair value of net assets of businesses acquired (goodwill) is amortized on a straight-line and accelerated basis (as appropriate) over periods generally not exceeding twenty-five years. Core deposit and other intangibles are amortized on an accelerated basis over their estimated lives ranging from five to ten years. Intangible assets are included in other assets. All such intangible assets are periodically evaluated as to the recoverability of their carrying value.
FEDERAL INCOME TAXES -- Cullen/Frost files a consolidated federal income tax return which includes the taxable income of all of its principal subsidiaries. Applicable federal income taxes of the individual subsidiaries are generally determined on a separate return basis. Deferred tax assets and liabilities are recognized for the expected future tax consequences of temporary differences between the financial reporting bases and the tax bases of assets and liabilities. If it is more likely than not that some portion or all of a deferred tax asset will not be realized, a valuation allowance is recognized.
STOCK OPTION PLANS -- On January 1, 1996 the Corporation adopted SFAS No. 123, "Accounting for Stock Based Compensation." The Statement allows the continued use of Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees," (APB No. 25) and related Interpretations. The Corporation continues to account for its stock option plans in accordance with APB No. 25. Under APB No. 25, because the exercise price of the Corporation's employee stock options equals the market price of the underlying stock on the date of grant, no compensation expense is recognized. SFAS No. 123 also allows for the fair value method of accounting for employees stock options. The continued use of APB No. 25 requires pro forma disclosures of net income and earnings per share as if the fair value method of accounting had been applied.
FINANCIAL DERIVATIVES -- Derivatives are used to hedge interest rate exposure by modifying the interest rate characteristics of related balance sheet instruments. The specific criteria required for derivatives used for these purposes are described below. Derivatives that do not meet these criteria are carried at market value with changes in value recognized currently in earnings.
Derivatives used as hedges must be effective at reducing the risk associated with the exposure being hedged and must be designated as a hedge at the inception of the derivative contract. Derivatives currently used for hedging purposes include interest rate swaps. These swap transactions allow management to
structure the interest rate sensitivity of the asset side of the Corporation's balance sheet to more closely match its view of the interest rate sensitivity of the Corporation's funding sources. The fair value of derivative contracts are carried off-balance sheet and the unrealized gains and losses on derivative contracts are generally deferred. The interest component associated with derivatives used as hedges or to modify the interest rate characteristics of assets and liabilities is recognized over the life of the contract in net interest income. Upon contract settlement or early termination, the cumulative change in the market value of such derivatives is recorded as an adjustment to the carrying value of the underlying asset or liability and recognized in net interest income over the expected remaining life of the derivative contract. In instances where the underlying instrument is repaid, the cumulative change in the value of the associated derivative is recognized immediately in earnings.
ACCOUNTING CHANGES -- The following is a brief discussion of the SFAS pronouncements issued by the FASB in 1997, and 1998 which apply to the Corporation.
As of January 1, 1998, the Corporation adopted SFAS No. 130, "Reporting Comprehensive Income" (SFAS No. 130). SFAS No. 130 establishes new rules for the reporting and display of comprehensive income and its components; however, the adoption of this statement had no impact on the Corporation's net income or shareholders' equity. SFAS No. 130 requires unrealized gains and losses on the Corporation's available-for-sale securities, which prior to adoption were reported separately in shareholders' equity to be included in other comprehensive income. Prior year financial statements have been reclassified to conform to the requirements of SFAS No. 130.
In June 1997, the FASB issued SFAS No. 131, "Disclosures about Segments of an Enterprise and Related Information." The statement establishes standards for the method that public entities use to report information about operating segments in annual financial statements and requires that those enterprises report selected information about operating segments in interim financial reports issued to shareholders. The Corporation adopted the provisions of this statement in this annual report. These disclosure requirements had no impact on the financial position or operating results of the Corporation.
In February 1998, the FASB issued SFAS No. 132, "Employer's Disclosures about Pensions and Other Post Retirement Benefits." This statement revises employer's disclosures about pension and other post retirement benefit plans but does not change the measure of recognition of those plans. The statement standardizes the disclosure requirements to the extent practicable, requires additional information on changes in the benefit obligation and the fair value of plan assets that will aid financial analysis, and eliminates certain disclosures that are no longer useful. The Corporation adopted the provisions of this statement in this annual report. These disclosure requirements had no impact on the financial position or operating results of the Corporation.
In June 1998, the FASB issued SFAS No. 133, "Accounting for Derivative Instruments and Hedging Activities." This statement requires that all derivatives be marked-to-market on an on-going basis. The statement continues to allow derivatives to be used to hedge various risks and provides for specific criteria to be used to determine when hedge accounting can be used. It also provides for offsetting changes in fair value or cash flows of both the derivative and the hedged asset or liability to be recognized in earnings in the same period. In addition, any changes in fair value or cash flow that represent the ineffective portion of a hedge are required to be recognized in earnings and cannot be deferred. For derivatives not accounted for as hedges, changes in fair value are required to be recognized in earnings. SFAS No. 133 is effective for fiscal years beginning after June 15, 1999. Even though early adoption is allowed, the Corporation has no plans to adopt this statement prior to the effective date. The impact on future results will depend on the financial position of the Corporation and the nature and purpose of the derivatives in use by the Corporation at that time.
NOTE B -- ACQUISITIONS
The transactions listed below, with the exception of the merger with Overton, have been accounted for as purchase transactions with the total cash consideration funded through internal sources. The purchase price has been allocated to the underlying assets and liabilities based on estimated fair value at the date of
acquisition. Results of operations are included from the date of acquisition. The Overton acquisition has been accounted for under the pooling-of-interests method of accounting which requires the assets, liabilities and shareholders' equity of the merged entity to be retroactively combined with the Corporation's respective accounts at recorded value. Prior period financial statements have been restated to give effect to the pooling-of-interests method.
1998 MERGERS AND ACQUISITIONS OVERTON BANCSHARES, INC. -- FORT WORTH
On May 29, 1998, the Corporation completed the merger of Overton Bancshares, Inc., in Fort Worth, Texas, and its wholly-owned subsidiary Overton Bank & Trust, N.A. The merger, which was accounted for as a "pooling-of-interests" transaction, was the Corporation's first entry into the Fort Worth market. With the merger, the Corporation had twelve locations in Fort Worth/Arlington and two in Dallas. The Corporation issued approximately 4.38 million common shares as part of this transaction. As a result of the transaction, the Corporation recorded a merger related charge of $12.2 million primarily consisting of severance payments and other employee benefits, and investment banking fees. In addition, shortly after the merger was consummated the Corporation reclassified approximately $116 million of held to maturity securities of Overton Bancshares, Inc. to available for sale securities.
HARRISBURG BANCSHARES, INC. -- HOUSTON
On January 2, 1998, the Corporation paid approximately $55.3 million to acquire Harrisburg Bancshares, Inc., including its subsidiary Harrisburg Bank in Houston, Texas. Goodwill associated with the transaction amounted to approximately $24.5 million and approximately $10.6 million of other intangibles associated with the acquisition were recorded. The Corporation acquired loans of approximately $125 million and deposits of approximately $222 million. This acquisition did not have a material impact on the Corporation's 1998 net income.
1997 ACQUISITION CORPUS CHRISTI BANCSHARES, INC. -- CORPUS CHRISTI
On March 7, 1997, the Corporation paid approximately $32.2 million to acquire Corpus Christi Bancshares, Inc., including its subsidiary Citizens State Bank, in Corpus Christi, Texas. Goodwill associated with the transaction amounted to approximately $13.8 million and approximately $7.1 million of other intangibles associated with the acquisition were recorded. The Corporation acquired loans of approximately $108 million and deposits of approximately $184 million. Cullen/Frost's results of operations would not have been materially impacted if the Corpus Christi Bancshares acquisition had occurred at the beginning of 1997 or 1996.
1996 ACQUISITIONS S.B.T. BANCSHARES, INC. -- SAN MARCOS
On January 5, 1996, the Corporation paid approximately $17.7 million to acquire S.B.T. Bancshares, Inc., including its subsidiary, State Bank and Trust Company in San Marcos, Texas. Goodwill associated with the transaction amounted to approximately $6.5 million and approximately $4.5 million of other intangibles associated with the acquisition were recorded. The Corporation acquired loans of approximately $51 million and deposits of approximately $112 million.
PARK NATIONAL BANK -- HOUSTON
On February 15, 1996, the Corporation paid approximately $33.5 million to acquire Park National Bank in Houston, Texas. Goodwill associated with the transaction amounted to approximately $8.4 million and approximately $7.6 million of other intangibles associated with the acquisition were recorded. The Corporation acquired loans of approximately $157 million and deposits of approximately $225 million. Cullen/Frost's results of operations would not have been materially impacted if the Park National Bank acquisition had occurred at the beginning of 1996.
NOTE C -- CASH AND DUE FROM BANKS
Cullen/Frost subsidiary banks are required to maintain cash or non-interest bearing reserves with the Federal Reserve Bank which are equal to specified percentages of deposits. The average amounts of reserve and contractual balances were $75.1 million for 1998 and $78.3 million for 1997.
NOTE D -- SECURITIES
A summary of the amortized cost and estimated fair value of securities is presented below.
The amortized cost and estimated fair value of securities at December 31, 1998 are presented below by contractual maturity. Actual maturities will differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without prepayment penalties.
Proceeds from sales of securities available for sale during 1998 were $900.4 million. During 1998, gross gains of $1,064,000 and gross losses of $705,000 were realized on those sales. Proceeds from sales of securities available for sale during 1997 were $434.5 million. During 1997, gross gains of $556,000 and gross losses of $58,000 were realized on those sales. Proceeds from sales of securities available for sale during 1996 were $240.1 million. During 1996, gross gains of $152,000 and gross losses of $1,044,000 were realized on those sales.
The carrying value of securities pledged to secure public funds, trust deposits, securities sold under repurchase agreements and for other purposes as required or permitted by law amounted to $1.2 billion at December 31, 1998 and 1997.
NOTE E -- LOANS AND ALLOWANCE FOR POSSIBLE LOAN LOSSES
A summary of loans outstanding follows:
December 31 -------------------------- (in thousands) 1998 1997 - ----------------------------------------------------------------- Real estate: Construction.................... $ 292,789 $ 179,201 Land............................ 75,397 60,339 Permanent mortgages: Commercial................. 346,479 259,320 Residential................ 655,484 516,345 Other........................... 349,255 355,475 Commercial and industrial............ 1,211,180 989,355 Consumer............................. 625,018 645,988 Financial institutions............... 7,416 3,767 Foreign.............................. 45,187 72,911 Other................................ 41,755 37,388 Unearned discount.................... (3,357) (3,194) -------------------------- Total loans..................... $ 3,646,603 $ 3,116,895 ==========================
In the normal course of business, in order to meet the financial needs of its customers, the Corporation is a party to financial instruments with off-balance sheet risk. These include commitments to extend credit and standby letters of credit which commit the Corporation to make payments on behalf of customers when certain specified future events occur. Both arrangements have credit risk essentially the same as that involved in extending loans to customers and are subject to the Corporation's normal credit policies. Collateral is obtained based on management's credit assessment of the customer. No material losses are anticipated as a result of these commitments. Commitments to extend credit and standby letters of credit amounted to $1.2 billion and $53.0 million, respectively, at December 31, 1998. Commitments to extend credit and standby letters of credit amounted to $1.2 billion and $59.4 million, respectively, at December 31, 1997. Commercial and industrial loan commitments represent approximately 71 percent and 74 percent of the total loan commitments outstanding at December 31, 1998 and 1997, respectively.
The majority of the Corporation's real estate loans are secured by real estate in San Antonio, Houston and Fort Worth. Mortgage loans of approximately $14.0 million and $10.0 million were held for sale by the Corporation and are included in residential permanent mortgages at December 31, 1998 and 1997, respectively. These loans are valued at the lower of cost or market, on an aggregate basis.
In the normal course of business, Cullen/Frost subsidiary banks make loans to directors and officers of both Cullen/Frost and its subsidiaries. These loans are made on substantially the same terms, including interest rates and collateral, as those prevailing at the time for comparable transactions with other persons. Loans made to directors and executive officers of Cullen/Frost and its significant subsidiaries, including loans made to their associates, amounted to $45.3 million and $51.9 million at December 31, 1998 and 1997, respectively. During 1998, additions to these loans amounted to $47.4 million, repayments totaled $53.7 million and other changes totaled $335,000. These other changes consist primarily of changes in related-party status. Standby letters of credit extended to directors and executive officers of Cullen/Frost and its significant subsidiaries and their associates amounted to $614,000 and $692,000 at December 31, 1998 and 1997, respectively.
A summary of the changes in the allowance for possible loan losses follows:
Year Ended December 31 ------------------------------- (in thousands) 1998 1997 1996 - ------------------------------------------------------------------------- Balance at the beginning of the year.... $ 48,073 $ 42,821 $ 36,525 Provision for possible loan losses...... 10,393 9,174 8,494 Loan loss reserve of acquired institutions.......................... 1,250 2,105 627 Net charge-offs: Losses charged to the allowance.... (12,548) (9,927) (10,621) Recoveries......................... 6,448 3,900 7,796 ------------------------------- Net charge-offs............... (6,100) (6,027) (2,825) ------------------------------- Balance at the end of the year.......... $ 53,616 $ 48,073 $ 42,821 ===============================
A loan within the scope of SFAS No. 114 is considered impaired when, based on current information and events, it is probable that the Corporation will be unable to collect all amounts due according to the contractual terms of the loan agreement, including scheduled principal and interest payments. All impaired loans are included in non-performing assets. At December 31, 1998, the majority of the impaired loans were real estate loans and collectability was measured based on the fair value of the collateral. Interest payments on impaired loans are typically applied to principal unless collectability of the principal amount is fully assured, in which case interest is recognized on the cash basis. Interest revenue recognized on impaired loans for 1998 and 1997 was $70,000 and $82,000, respectively. The total allowance for possible loan losses includes activity related to allowances calculated in accordance with SFAS No. 114 and activity related to other loan loss allowances determined in accordance with SFAS No. 5.
The following is a summary of loans considered to be impaired:
December 31 -------------------- (in thousands) 1998 1997 - -------------------------------------------------------------- Impaired loans with no valuation reserve............................... $ 1,924 $ 1,940 Impaired loans with a valuation reserve............................... 2,779 3,265 -------------------- Total recorded investment in impaired loans................................. $ 4,703 $ 5,205 ==================== Valuation reserve....................... $ 1,834 $ 2,199
The average recorded investment in impaired loans was $5.7 million and $5.5 million for the years ended December 31, 1998 and 1997, respectively.
NOTE F -- NON-PERFORMING ASSETS
A summary of non-performing assets follows:
December 31 -------------------- (in thousands) 1998 1997 - -------------------------------------------------------------- Non-accrual............................. $ 12,997 $ 13,077 Foreclosed assets....................... 4,107 5,011 -------------------- $ 17,104 $ 18,088 ====================
The Corporation did not have any restructured loans for the years ended December 31, 1998 and 1997, respectively.
Cullen/Frost recognized interest income on non-accrual and restructured loans of approximately $742,000, $594,000 and $302,000 in 1998, 1997 and 1996, respectively. Had these reduced earning and non-earning loans performed according to their original contract terms, Cullen/Frost would have recognized additional interest income of approximately $1,262,000 in 1998, $1,167,000 in 1997 and $1,239,000 in 1996.
NOTE G -- BANKING PREMISES AND EQUIPMENT
A summary of banking premises and equipment follows:
NOTE H -- DEPOSITS
A summary of deposits outstanding by category follows:
December 31 -------------------------- (in thousands) 1998 1997 - ----------------------------------------------------------------- Demand deposits...................... $ 1,843,499 $ 1,548,565 Savings and Interest-on-Checking..... 961,597 855,783 Money market deposit accounts........ 1,493,778 1,255,237 Time accounts of $100,000 or more.... 662,923 599,953 Time accounts under $100,000......... 601,198 616,192 Other................................ 282,492 293,360 -------------------------- Total deposits.................. $ 5,845,487 $ 5,169,090 ==========================
At December 31, 1999, the Corporation's aggregate amount of maturities of public and private time accounts are as follows: 1999 -- $1,295,565,000; 2000 -- $66,700,000; 2001 -- $6,466,000; 2002 -- $4,464,000; 2003 -- $2,303,000; and thereafter $217,000. Foreign deposits totaled $672,607,000 and $632,477,000 at December 31, 1998 and 1997, respectively.
NOTE I -- BORROWED FUNDS
Cullen/Frost has a $7.5 million revolving credit facility with another financial institution. The line of credit bears interest at prime. There were no borrowings outstanding on this line at December 31, 1998 and 1997.
The Corporation has received advances totaling $13,295,000 from the Federal Home Loan Bank (FHLB) under provisions of a credit facility designed to enable the Corporation to fund long-term loans. The advances mature on November 1, 2002 through July 2, 2018, bear interest at the FHLB's floating rate (average 6.11% at December 31, 1998), and are collateralized by a blanket floating lien on all first mortgage loans, the FHLB capital stock owned by the Corporation, and any Bank funds on deposit with the FHLB.
Scheduled payments and maturity due under terms of the advances are as follows:
(in thousands) FHLB Advances - ------------------------------------------------------ 1999................................. $ 3,775 2000................................. 568 2001................................. 604 2002................................. 749 2003................................. 6,021 Subsequent to 2003................... 1,578 -------------- Total........................... $ 13,295 ==============
The following table represents balances as they relate to securities sold under repurchase agreements:
Year Ended December 31 ---------------------- (in thousands) 1998 1997 - ------------------------------------------------------------- Balance at year end.................. $ 209,526 $ 175,839 Maximum month-end balance............ 209,526 175,839 For the year: Average daily balance.............. 175,699 153,586
Cullen/Frost Capital Trust I, a Delaware statutory business trust (the "Issuer Trust") and wholly-owned subsidiary of the Corporation, issued on February 6, 1997, $100 million of its 8.42 percent Capital Securities, Series A (the "Capital Securities"), which represent beneficial interests in the Issuer Trust, in an offering exempt from registration under the Securities Act of 1933 pursuant to Rule 144A. The Capital Securities will mature on February 1, 2027 and are redeemable in whole or in part at the option of the Corporation at any time after February 1, 2007 with the approval of the Federal Reserve and in whole at any time upon the occurrence of certain events affecting their tax or regulatory capital treatment. The Issuer Trust used the proceeds of the offering of the Capital Securities to purchase Junior Subordinated Debentures of the Corporation which constitute its only assets and which have terms substantially similar to the Capital Securities. Payments of distributions on the Capital Securities and payments on liquidation or redemption of the Capital Securities are guaranteed by the Corporation on a limited basis pursuant to a Guarantee. The Corporation has also entered into an Agreement as to Expenses and Liabilities with the Issuer Trust pursuant to which it has agreed on a subordinated basis to pay any costs, expenses or liabilities of the Issuer Trust other than those arising under the Capital Securities. The obligations of the Corporation under the Junior Subordinated Debentures, the related Indenture, the trust agreement establishing the Issuer Trust, the Guarantee and the Agreement as to Expenses and Liabilities, in the aggregate, constitute a full and unconditional guarantee by the Corporation of the Issuer Trust's obligations under the Capital Securities.
The Corporation used the majority of the proceeds of the sale of the Junior Subordinated Debentures for acquisitions and the repurchase of the Corporation's common stock. The Capital Securities are included in the Tier 1 capital of the Corporation for regulatory capital purposes and are reported as debt on the balance sheet, net of deferred issuance costs. The Corporation records distributions payable on the Capital Securities as interest expense. The Corporation has the right to defer payments of interest on the Junior Subordinated Debentures at any time or from time to time for a period of up to ten consecutive semi-annual periods with respect to each deferral period. Under the terms of the Junior Subordinated Debentures, in the event that under certain circumstances there is an event of default under the Junior Subordinated Debentures or the Corporation has elected to defer interest on the Junior Subordinated Debentures, the Corporation may not, with certain exceptions, declare or pay any dividends or distributions on its capital stock or purchase or acquire any of its capital stock.
On March 13, 1997, the Corporation and the Issuer Trust, filed a Registration Statement on Form S-4 with the Securities and Exchange Commission to register under the Securities Act of 1933 the exchange of up to $100 million aggregate Liquidation Amount of "new" 8.42 percent Capital Securities, Series A for
the then outstanding Capital Securities. On April 25, 1997, the Corporation exchanged all of the outstanding Capital Securities for registered Capital Securities. The "new" Capital Securities have the same terms as the "old" Capital Securities. This exchange enhanced the transferability of the Capital Securities and had no impact on redemption of the Capital Securities, the Junior subordinated Debentures issued by the Company, the Company's guarantee of the Capital Securities, or other matters described above.
NOTE J -- COMMON STOCK AND EARNINGS PER COMMON SHARE
In accordance with SFAS 128, the reconciliation of earnings per share for 1998, 1997 and 1996 follows:
December 31 ------------------------------- (in thousands, except per share amounts) 1998 1997 1996 - ------------------------------------------------------------------------- Numerators for both basic and diluted earnings per share, net income........ $ 75,645 $ 72,967 $ 62,938 =============================== Denominators: Denominators for basic earnings per share, average outstanding common shares................................ 26,575 26,499 26,597 Dilutive effect of stock options........ 764 877 629 =============================== Denominator for diluted earnings per share................................. 27,339 27,376 27,226 =============================== Earnings per share: Basic................................... $ 2.85 $ 2.75 $ 2.37 Diluted................................. 2.77 2.67 2.31
NOTE K -- DIVIDENDS
In the ordinary course of business Cullen/Frost is dependent upon dividends from its subsidiary banks to provide funds for the payment of dividends to shareholders and to provide for other cash requirements. The amount of dividends that subsidiary banks may declare is subject to regulations. Without prior regulatory approval, the subsidiary banks had approximately $53.3 million available for the payment of dividends to Cullen/Frost at December 31, 1998.
NOTE L -- CAPITAL
The table below reflects various measures of regulatory capital at year end 1998 and 1997 for the Corporation.
At December 31, 1998 and 1997, the Corporation's subsidiary banks were considered "well capitalized" as defined by the FDIC Improvement Act of 1991, the highest rating, and the Corporation's capital ratios were in excess of "well capitalized" levels. A financial institution is deemed to be well capitalized if the institution has a total risk-based capital ratio of 10.0 percent or greater, a Tier 1 risk-based capital ratio of 6.0 percent or greater, and a Tier 1 leverage ratio of 5.0 percent or greater and the institution is not subject to an order, written agreement, capital directive or prompt corrective action directive to meet and
maintain a specific capital level for any capital measure. The Corporation and its subsidiary banks currently exceed all minimum capital requirements. Management is not aware of any conditions or events that would have changed the Corporation's capital rating since December 31, 1998.
The Corporation is subject to the regulatory capital requirements administered by the Federal Reserve Bank. Regulators can initiate certain mandatory actions, if the Corporation fails to meet the minimum requirements, that could have a direct material effect on the Corporation's financial statements.
NOTE M -- LEASES AND RENTAL AGREEMENTS
Rental expense for all leases amounted to $13.9 million, $12.8 million and $12.1 million for the years ended December 31, 1998, 1997 and 1996, respectively.
In June 1987, Frost Bank consummated the sale of its office tower and leased back a portion of the premises under a 13-year primary lease term with options allowing for occupancy up to 50 years. The Bank also sold its related parking garage facility and leased back space in that structure under a 12-year primary lease term with options allowing for occupancy up to 50 years. Both leases allow for purchase of the related asset under specific terms.
A summary of the total future minimum rental commitments due under non-cancelable equipment leases and long-term agreements on banking premises at December 31, 1998 follows:
Total (in thousands) Commitments - --------------------------------------------------- 1999................................. $13,802 2000................................. 13,273 2001................................. 12,668 2002................................. 11,809 2003................................. 10,651 Subsequent to 2003................... 34,800 ----------- Total future minimum rental commitments.................... $97,003 ===========
It is expected that certain leases will be renewed, or equipment replaced with new leased equipment, as these leases expire.
NOTE N -- EMPLOYEE BENEFIT PLANS
RETIREMENT PLANS --
Cullen/Frost has a non-contributory defined benefit plan which covers substantially all employees who have completed at least one year of service and have attained the age of 21. Defined benefits are provided based on an employee's final average compensation, age at retirement and years of service. Cullen/Frost's funding policy is to contribute quarterly an amount necessary to satisfy the Employee Retirement Income Security Act (ERISA) funding standards. An eligible employee's right to receive benefits under the plan becomes fully vested upon the earlier of the date on which such employee has completed five years of service or the date on which such employee attains 65 years of age. Retirement benefits under the plan are paid to vested employees upon their (i) normal retirement at age 65 or later or (ii) early retirement at or after age 55, but before age 65. In addition, Cullen/Frost has a Restoration of Retirement Income Plan (providing benefits in excess of the limits under Section 415 of the Internal Revenue Code of 1986, as amended) for eligible employees which is designed to comply with the requirements of ERISA and the entire cost of which is provided by Cullen/Frost contributions. Both plans, as amended, provide for the payment of monthly retirement income pursuant to a formula based on an eligible employee's highest three consecutive years of final average compensation during the last ten consecutive years of employment.
The following table summarizes benefit obligation and plan asset activity for the plans.
(in thousands) 1998 1997 - -------------------------------------------------------------- CHANGE IN BENEFIT OBLIGATION: Benefit obligation at beginning of year............................... $ 51,776 $ 44,796 Service cost.......................... 2,915 2,741 Interest cost......................... 3,711 3,319 Plan Amendments....................... 6,071 Actuarial loss........................ 2,545 2,103 Benefits paid......................... (1,352) (1,183) -------------------- Benefit obligation at end of year..... $ 65,666 $ 51,776 CHANGE IN PLAN ASSETS: Fair value of plan assets at beginning of year............................... $ 42,357 $ 31,676 Actual return on plan assets.......... 6,601 4,550 Employer contributions................ 154 7,313 Benefits paid......................... (1,352) (1,183) -------------------- Fair value of plan assets at end of year.................................. $ 47,760 $ 42,356 Funded status of the plan............. $ 17,906 $ 9,420 Unrecognized net actuarial loss....... (7,329) (7,876) Unrecognized prior service cost....... (9,805) (4,292) Unrecognized net transition asset..... 490 590 -------------------- (Prepaid) accrued benefit cost........ $ 1,262 $ (2,158) ==================== WEIGHTED-AVERAGE ASSUMPTIONS AS OF DECEMBER 31 Discount rate......................... 6.75% 7.25% Expected return on plan assets........ 9.00 9.00 Rate of compensation increase......... 5.00 5.00
Net pension cost included the following components:
(in thousands) 1998 1997 1996 - ------------------------------------------------------------------------- Service cost for benefits earned during the year.............................. $ 2,915 $ 2,741 $ 2,035 Expected return on plan assets, net of expenses.............................. (3,765) (3,000) (2,401) Interest cost on projected benefit obligation............................ 3,711 3,319 2,947 Net amortization and deferral........... 714 742 1,361 ------------------------------- Net pension cost................... $ 3,575 $ 3,802 $ 3,942 ===============================
The Corporation has a supplemental executive retirement plan ("SERP") for certain key executives. The plan provides for target retirement benefits, as a percentage of pay, beginning at age 55. The target percentage is 45 percent of pay at age 55, increasing to 60 percent at age 60 and later. Benefits under the SERP are reduced, dollar-for-dollar, by benefits received under the Retirement and Restoration Plans, described above, and any social security benefits.
SAVINGS PLANS --
The Corporation maintains a 401(k) stock purchase plan (the "401(k) Plan"). The 401(k) Plan permits each participant to make before- or after-tax contributions up to 16 percent of eligible compensation. Cullen/Frost makes matching contributions to the 401(k) Plan based on the amount of each participant's contributions up to a maximum of six percent of eligible compensation. Eligible employees must complete 90 days of service to be eligible for enrollment and beginning on January 1, 1999, vest in the Corporation's matching contributions immediately. The Corporation's gross expenses related to the 401(k) Plan were $2.8 million, $2.3 million and $2.0 million for 1998, 1997 and 1996, respectively. During 1998, 1997 and 1996, the Corporation utilized forfeitures with a value of $199,000, $308,000 and $449,000, respectively, to offset this expense.
The 1991 Thrift Incentive Stock Purchase Plan ("1991 Stock Purchase Plan") was adopted to offer those employees whose participation in the 401(k) Plan is limited an alternative means of receiving comparable benefits. The Corporation's expenses related to the 1991 Stock Purchase Plan were $861,000, $743,000 and $754,000 for 1998, 1997 and 1996, respectively.
EXECUTIVE STOCK PLANS --
The Corporation has four executive stock plans and one outside director stock plan; the 1983 Nonqualified Stock Option Plan ("1983 Plan"), the 1988 Nonqualified Stock Option Plan ("1988 Plan"), the Restricted Stock Plan, the 1992 Stock Plan and the 1997 Outside Directors Stock plan ("1997 Plan"). The 1992 Stock Plan is an all-inclusive plan, with an aggregate of 2,805,029 shares of common stock authorized for award. The 1992 Stock Plan has replaced all other previously approved executive stock plans.
The 1992 Stock Plan allows the Corporation to grant restricted stock, incentive stock options, nonqualified stock options, stock appreciation rights, or any combination thereof to certain key executives of the Corporation.
The 1997 Outside Directors Plan allows the Corporation to grant nonqualified stock options to outside directors. The options may be awarded to outside directors in such number, and upon such terms, and at any time and from time to time as determined by the Compensation and Benefits Committee ("Committee"). Each award is evidenced by an award agreement that specifies the option price, the duration of the option, the number of shares to which the option pertains, and such other provisions as the Committee determines. The option price for each grant is at least equal to the fair market value of a share on the date of grant. Options granted expire at such time as the Committee determines at the date of grant and in no event does the exercise period exceed a maximum of ten years.
The following is a summary of option transactions in each of the last three years.
*Includes 453,113 options of which 391,753 are exercisable both with a weighted-average exercise price of $17.25.
**Includes 549,320 options of which 231,196 are exercisable both with a weighted-average exercise price of $27.92.
***Includes 589,600 options of which 34,800 are exercisable both with a weighted-average exercise price of $48.99.
There were 851,136, 649,978 and 533,473 options exercisable for 1998, 1997, and 1996 with a weighted-average exercise price of $21.37, $16.66 and $12.43, respectively. The 1998 options were awarded having a ten-year life with a three-year cliff vesting period. In general, options awarded prior to 1998 had a ten-year life with a five-year vesting period. These plans which were approved by shareholders were established to enable the Corporation to retain and motivate key employees. A committee of non-participating directors has sole authority to select the employees, establish the awards to be issued, and approve the terms and conditions of each award contract. The Corporation has common stock reserved for future issuance upon the grant and exercise of options of 2,660,130 shares.
In accounting for the impact of issuing stock options, the Corporation has elected to continue to follow the requirements of Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees" (APB 25) and Related Interpretation as allowed by SFAS No. 123, rather than to follow the recognition requirements of SFAS No. 123, which requires fair value accounting. SFAS No. 123 requires disclosure of pro forma net income and earnings per share information assuming that stock options granted in 1996, 1997 and 1998 have been accounted for in accordance with the fair value requirements of SFAS No. 123.
The fair value for these options was estimated at the date of grant using a Black-Scholes option pricing model. The Black-Scholes option valuation model was developed for use in estimating the fair value of traded options which have characteristics which are different from the Corporation's employee stock options. In addition, option valuation models require the input of highly subjective assumptions which can significantly impact the estimated fair value. As such, in management's opinion, the existing models do not necessarily provide a reliable single measure of the fair value of employee/outside director stock options.
The following weighted-average assumptions were used for 1998, 1997 and 1996, respectively: risk-free interest rates of 4.87 percent, 5.37 percent and 6.50 percent; dividend yield of 2.25 percent, 2.00 percent and 2.50 percent; volatility factors of the expected market price of the Corporation's common stock of 23 percent, 19 percent and 21 percent; and weighted-average expected lives of the options of 8 years. The weighted-average grant-date fair value of options granted during 1998, 1997 and 1996 was $16.71, $13.18, and $9.48, respectively. For purposes of proforma disclosures, the estimated fair value of the options is amortized to expense over the options' vesting period.
The Corporation's proforma information as if compensation expense had been recognized in accordance with SFAS 123 is summarized below:
(in thousands except per share amounts) 1998 1997 1996 - ---------------------------------------------------------------------- Proforma net income*................. $ 74,345 $ 72,265 $ 65,652 Proforma earnings per common share Basic........................... $ 2.80 $ 2.73 $ 2.36 Diluted......................... 2.79 2.72 2.36
*Because SFAS No. 123 is applicable only to options granted subsequent to December 31, 1994, its proforma effect is not necessarily indicative of its impact on future years.
In 1998, restricted stock grants of 41,500 were awarded under the 1992 Stock Plan. Restricted stock grants awarded under the 1992 Stock Plan totaled 58,500 and 3,000 shares for 1997 and 1996, respectively. The weighted-average price for these awards equaled the market price at the date of grant and was $49.30, $48.19, and $26.75 for 1998, 1997 and 1996, respectively. Deferred compensation expense related to the restricted stock was $1.5 million in 1998, $707,000 in 1997, and $472,000 in 1996. Restricted shares are generally awarded under a three- to four-year cliff vesting period. The market value of restricted shares at the date of grant is expensed over the restriction period.
The Corporation has change-in-control agreements with 19 of its executives. Under seven of these agreements, as revised, each covered person could receive, in the event of a change in control, one-half of his base compensation upon the effectiveness of the change in control, and from one and one-half times up to 2.49 times (depending on the executive) of his average annual W-2 compensation during the previous five years if such person is constructively terminated or discharged for reasons other than cause within two years following the change in control. Under the remaining 12 agreements, each covered person could receive from two times up to 2.99 times (depending on the executive) of his average W-2 compensation during the previous five years if such person is constructively terminated or discharged for reasons other than cause within two years following the change in control. These agreements, other than certain instances of stock appreciation and SERPS, limit payments to avoid being considered "parachute payments" as defined by the Internal Revenue Code. The maximum contingent liability under these agreements approximated $12 million at December 31, 1998.
The Corporation has no material liability for post-retirement or post-employment benefits other than pensions.
NOTE O -- INCOME TAXES
The following is an analysis of the Corporation's income taxes included in the consolidated statements of operations for the years ended December 31, 1998, 1997, and 1996.
(in thousands) 1998 1997 1996 - ---------------------------------------------------------------------- Current income tax expense........... $ 47,669 $ 46,236 $ 38,274 Deferred income tax.................. (5,574) (6,681) (3,865) ------------------------------- Income tax expense as reported....... $ 42,095 $ 39,555 $ 34,409 ===============================
The following is a reconciliation of the difference between income tax expense as reported and the amount computed by applying the statutory income tax rate to income before income taxes:
Year Ended December 31 --------------------------------- (in thousands) 1998 1997 1996 - ------------------------------------------------------------------------ Income before income taxes........... $ 117,740 $ 112,522 $ 97,347 Statutory rate....................... 35% 35% 35% --------------------------------- Income tax expense at the statutory rate............................... 41,209 39,383 34,071 Effect of tax-exempt interest........ (1,820) (1,298) (1,145) Amortization of goodwill............. 1,410 1,027 778 Acquisition costs.................... 931 Other................................ 365 443 705 --------------------------------- Income tax expense as reported....... $ 42,095 $ 39,555 $ 34,409 ================================= Tax (expense) benefits related to security transactions.............. $ (126) $ (174) $ 312 =================================
The tax effects of temporary differences that give rise to significant portions of deferred tax assets and liabilities at December 31, 1998, and 1997 are presented below:
(in thousands) 1998 1997 - ----------------------------------------------------------- Deferred tax assets: Allowance for possible loan losses......................... $ 18,766 $ 16,769 Building modification reserve... 1,592 1,592 Gain on sale of assets.......... 1,079 1,101 Net occupancy restructuring..... 211 Other........................... 1,601 1,076 -------------------- Total gross deferred tax assets.................. 23,038 20,749 Deferred tax liabilities: Prepaid expenses................ $ (569) $ (598) Unrealized gain on securities available for sale............. (4,172) (4,795) Intangibles..................... (3,896) (2,203) Bank premises and equipment..... (351) (446) Other........................... (500) (1,427) -------------------- Total gross deferred tax liabilities............. (9,488) (9,469) -------------------- Net deferred tax asset..... $ 13,550 $ 11,280 ====================
At December 31, 1998 and 1997, no valuation allowance for deferred tax assets was necessary because they were supported by recoverable taxes paid in prior years.
NOTE P -- NON-INTEREST EXPENSE
Significant components of other non-interest expense for the years ended December 31, 1998, 1997, and 1996 are presented below:
Year Ended December 31 ------------------------------- (in thousands) 1998 1997 1996 - ---------------------------------------------------------------------- Outside computer service............. $ 9,380 $ 7,936 $ 9,823 Other professional expenses.......... 6,327 5,793 10,425 Stationery, printing and supplies.... 6,024 5,850 7,199 Armored motor service................ 3,946 3,497 4,091 Postage and express.................. 3,830 3,558 4,204 Other................................ 46,337 38,880 22,953 ------------------------------- Total........................... $ 75,844 $ 65,514 $ 58,695 ===============================
NOTE Q -- CASH FLOW DATA
For purposes of reporting cash flow, cash and cash equivalents include the following:
December 31 ---------------------------------- (in thousands) 1998 1997 1996 - ---------------------------------------------------------------------------- Cash and due from banks................. $ 684,941 $ 637,613 $ 901,239 Federal funds sold...................... 102,900 190,000 52,850 ---------------------------------- Total.............................. $ 787,841 $ 827,613 $ 954,089 ==================================
Generally, Federal funds are sold for one-day periods and securities purchased under resale agreements are held for less than thirty-five days.
Supplemental cash flow information is as follows:
Year Ended December 31 ---------------------------------- (in thousands) 1998 1997 1996 - ---------------------------------------------------------------------------- Cash paid: Interest........................... $ 164,150 $ 144,512 $ 126,982 Income Taxes....................... 45,968 39,391 36,796 Non-cash items: Loans originated to facilitate the sale of foreclosed assets........ 269 1,690 848 Loan foreclosures.................. 1,995 4,240 3,449
NOTE R -- FAIR VALUES OF FINANCIAL INSTRUMENTS
Fair Values of Financial Instruments -- SFAS No. 107, "Disclosures about Fair Value of Financial Instruments" requires disclosure of fair value information about financial instruments, whether or not recognized in the balance sheet, for which it is practicable to estimate that value. In cases where quoted market prices are not available, fair values are based on estimates using present value or other valuation techniques. Those techniques are significantly affected by the assumptions used, including the discount rate and estimates of future cash flows. SFAS No. 107 excludes certain financial instruments and all non-financial instruments from its disclosure requirements. This disclosure does not and is not intended to represent the fair value of the Corporation.
The following methods and assumptions were used by the Corporation in estimating its fair value disclosures for financial instruments:
CASH AND CASH EQUIVALENTS: The carrying amounts reported in the consolidated balance sheet for cash and due from banks and Federal funds sold approximate their fair value.
SECURITIES: Estimated fair values are based on quoted market prices, if available. If a quoted market price is not available, fair value is estimated using quoted market prices for similar instruments.
LOANS: For variable-rate loans that reprice frequently and with no significant change in credit risk, fair values are based on carrying values. The fair values for certain mortgage loans are based on quoted market prices of similar loans sold, adjusted for differences in loan characteristics. The fair value for other loans is estimated using discounted cash flow analyses, using interest rates currently being offered for loans with similar terms to borrowers of similar credit quality. The carrying amount of accrued interest approximated its fair value.
DEPOSITS: SFAS No. 107 defines the fair value of demand deposits as the amount payable on demand, and prohibits adjusting fair value for any deposit base intangible. The deposit base intangible is not considered in the fair value amounts. The carrying amounts for variable-rate money market accounts approximate their fair value. The fair value of fixed-term certificates of deposit are estimated using a discounted cash flow calculation that applies interest rates currently being offered on certificates to a schedule of aggregated expected monthly maturities.
SHORT-TERM BORROWINGS: The carrying amount reported in the consolidated balance sheet approximates the estimated fair value.
LOAN COMMITMENTS, STANDBY AND COMMERCIAL LETTERS OF CREDIT: The Corporation's lending commitments have variable interest rates and "escape" clauses if the customer's credit quality deteriorates. Therefore the amounts committed approximate fair value.
GUARANTEED PREFERRED BENEFICIAL INTEREST IN CORPORATION'S JUNIOR SUBORDINATED DEFERRABLE INTEREST DEBENTURES: The fair value of the Trust Preferred Capital Securities is estimated based on the quoted market prices of the instruments.
INTEREST RATE SWAPS/FLOORS: The estimated fair value of the existing agreements are based on quoted market prices.
The estimated fair values of the Corporation's financial instruments are as follows:
NOTE S -- DERIVATIVE FINANCIAL INSTRUMENTS
The Corporation has off-balance sheet interest rate swaps to hedge its interest rate risk by essentially converting fixed-rate loans into synthetic variable-rate instruments. These swap transactions allow management to structure the interest rate sensitivity of the asset side of the Corporation's balance sheet to more closely match its view of the interest rate sensitivity of the Corporation's funding sources. The Corporation had 22 interest rate swaps at December 31, 1998 with a notional amount of $75 million compared to 42 interest rate swaps at December 31, 1997 with a notional amount of $267 million. Each swap was a hedge against a specific commercial fixed-rate loan or against a specific pool of consumer fixed-rate loans with lives ranging from two to ten years where the Corporation pays a fixed rate and receives a floating rate. In each case, the amortization of the interest rate swap generally matches the expected amortization of the underlying loan or pool of loans. These interest rate contracts involve the risk of dealing with counterparties and their ability to meet contractual terms. Each counterparty to a swap transaction has a credit rating that is investment grade. The net amount payable or receivable under interest rate swaps\floors is accrued as an adjustment to interest income and was not material in 1998 or 1997. In the third quarter of 1998, the Corporation terminated interest rate swaps hedging fixed rate consumer loans. The Corporation is amortizing the loss on the transaction of $1.9 million over the remaining term of the interest swaps ending in the second quarter of 2002. During 1998, the Corporation terminated all three of its interest rate floor agreements with a notional amount totaling $500 million and an original term of three years. These interest rate floors were purchased in 1997 for the purpose of hedging floating interest rate exposure in commercial loan accounts in an environment of falling interest rates. The Corporation is amortizing the gain on the transaction of $2.8 million over the remaining term of the interest rate floors.
The Corporation's credit exposure on interest rate swaps\floors is limited to the net favorable value of all swaps\floors to each counterparty. In such cases collateral is required from the counterparties involved if the net value of the swaps\floors exceeds a nominal amount considered to be immaterial. At December 31, 1998, the Corporation's credit exposure relating to interest rate swaps\floors was immaterial. The fair value and related carrying amounts of the interest rate swaps can be found in footnote R on page 53.
Activity in the notional amounts of end-user derivatives for each of the three years ended December 31, 1998, 1997 and 1996, is summarized as follows:
NOTE T -- CONTINGENCIES
Certain subsidiaries of Cullen/Frost are defendants in various matters of litigation which have arisen in the normal course of conducting a commercial banking business. In the opinion of management, the disposition of such pending litigation will not have a material effect on Cullen/Frost's consolidated financial position.
NOTE U -- SUBSEQUENT EVENTS (UNAUDITED)
1999 ACQUISITION
KELLER STATE BANK -- KELLER
On January 15, 1999, the Corporation paid approximately $18.7 million to acquire Keller State Bank, of Keller, Texas. The total cash consideration was funded through internal sources. The purchase method of accounting has been used to record the transaction and as such the purchase price has been allocated to the underlying assets and liabilities based on estimated fair values at the date of acquisition. Such estimates may be subsequently revised. The Corporation acquired loans of approximately $38 million and deposits of approximately $62 million. Total intangibles associated with the acquisition amounted to approximately $11.8 million. This acquisition is not expected to have a material impact on the Corporation's 1999 net income.
INVESTMENT BANKING SUBSIDIARY
On January 26, 1999 the Corporation announced its intent to seek Federal Reserve Bank approval to form a Section 20 investment banking subsidiary to be based in Dallas, Texas. The new subsidiary, to be named Frost Securities, Inc. is expected to be operational by July 1 and will offer a full range of services including equity research, institutional sales, trading and investment banking services to institutional investors and corporate customers who need access to the capital markets.
PENDING ACQUISITIONS
COMMERCE FINANCIAL CORPORATION
On February 17, 1999, the Corporation entered into a definitive agreement to acquire Commerce Financial Corporation of Fort Worth, Texas which had deposits of $174 million and loans of $76 million at December 31, 1998. The Corporation agreed to pay approximately $42.25 million. The acquisition is expected to be completed in the second quarter of 1999 following shareholder and regulatory approval. This transaction will be accounted for as a purchase with total cash consideration being funded through internal sources.
PROFESSIONAL INSURANCE AGENTS, INC.
On March 3, 1999, Frost Insurance Agency, a subsidiary of The Frost National Bank, signed a letter of intent to acquire Professional Insurance Agents, Inc. (PIA), a mid-sized independent insurance agency based in Victoria, Texas, with additional locations in San Antonio, New Braunfels and Refugio. PIA offers corporate and personal property and casualty insurance as well as group, health and life insurance products to individuals and businesses. The transaction is subject to regulatory approval, and is expected to close in the second quarter of 1999. The purchase method of accounting will be used to record the transaction.
NOTE V -- OPERATING SEGMENTS
The Corporation has two reportable operating segments: Banking and the Financial Management Group. Banking includes both commercial and consumer banking services. Commercial services are provided to corporations and other business clients and include a wide array of lending and cash management products. Consumer banking services include direct and indirect lending, mortgage lending and depository services. The Financial Management Group includes fee based services within private trust, retirement services, and financial management services including personal wealth management and brokerage services. These business units were identified through the products and services that are offered within each unit.
The accounting policies of each reportable segment are the same as those of the Corporation described in Note A, except for the following items. The Corporation uses a match-funded transfer pricing process to assess operating segment performance. Expenses for consolidated back-office operations are allocated to operating segments based on estimated uses of those services. General overhead type expenses such as executive administration, accounting, internal audit, and personnel are allocated based on the direct expense level of the operating segment. Income tax expense for the individual segments is calculated basically at the statutory rate. Parent Company (included in Non-Banks) records the tax expense or benefit necessary to reconcile to the consolidated total.
* Excludes the after-tax impact of the $12.2 million Overton merger related charge. See discussion on page 13.
NOTE W -- CONDENSED PARENT CORPORATION FINANCIAL STATEMENTS Condensed financial information of the parent Corporation as of December 31, 1998 and 1997 and for each of the three years in the period ended December 31, 1998 follows:
Year Ended December 31 ------------------------------- STATEMENT OF OPERATIONS (in thousands) 1998 1997 1996 - ---------------------------------------------------------------------- INCOME: Dividends from second tier bank holding company subsidiary..... $ 91,673 $ 23,514 $ 66,137 Interest and other............... 2,943 5,075 713 ------------------------------- TOTAL INCOME................. 94,616 28,589 66,850 EXPENSES: Salaries and employee benefits... 6,698 3,350 4,504 Interest expense................. 8,761 7,962 56 Other............................ 6,635 1,414 1,197 ------------------------------- TOTAL EXPENSES............... 22,094 12,726 5,757 ------------------------------- INCOME BEFORE INCOME TAX CREDITS AND EQUITY IN UNDISTRIBUTED NET INCOME OF SUBSIDIARIES............... 72,522 15,863 61,093 Income tax credits................... 4,812 2,326 1,439 Equity in undistributed net income of subsidiaries....................... (1,689) 54,778 406 ------------------------------- NET INCOME................... $ 75,645 $ 72,967 $ 62,938 ===============================
December 31 -------------------- BALANCE SHEETS (in thousands) 1998 1997 - ----------------------------------------------------------- ASSETS Cash................................. $ 304 $ 241 Securities purchased under resale agreements......................... 100,830 43,990 Loans to non-bank subsidiaries....... 52 52 Investments in second tier bank holding company subsidiary......... 527,124 529,982 Other................................ 2,370 2,646 -------------------- TOTAL ASSETS................. $ 630,680 $ 576,911 ==================== LIABILITIES Other................................ $ 16,210 $ 12,486 Guaranteed preferred beneficial interest in the Corporation's junior subordinated deferrable interest debentures................ 101,551 101,496 -------------------- TOTAL LIABILITIES............ 117,761 113,982 SHAREHOLDERS' EQUITY................. 512,919 462,929 -------------------- TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY......... $ 630,680 $ 576,911 ====================
Year Ended December 31 ------------------------------- STATEMENTS OF CASH FLOWS (in thousands) 1998 1997 1996 - ---------------------------------------------------------------------- OPERATING ACTIVITIES Net income........................... $ 75,645 $ 72,967 $ 62,938 Adjustments to reconcile net income to net cash provided by operating activities: Net income of subsidiaries....... (89,984) (78,292) (66,543) Dividends from subsidiaries...... 91,673 23,514 66,137 Net change in other liabilities and assets..................... 5,557 1,523 1,427 ------------------------------- NET CASH PROVIDED BY OPERATING ACTIVITIES....... 82,891 19,712 63,959 INVESTING ACTIVITIES Capital contributions to subsidiaries....................... (88,211) (53,386) Net decrease in loans................ 160 986 ------------------------------- NET CASH USED BY INVESTING ACTIVITIES................. (88,051) (52,400) FINANCING ACTIVITIES Proceeds from issuance of guaranteed preferred beneficial interest in the Corporation's junior subordinated deferrable interest debentures......................... 101,446 Purchase of treasury stock........... (3,495) (17,834) (1,164) Net proceeds from issuance of common stock.............................. 7,983 3,735 1,182 Cash dividends....................... (30,476) (22,256) (18,754) ------------------------------- NET CASH PROVIDED (USED) BY FINANCING ACTIVITIES....... (25,988) 65,091 (18,736) ------------------------------- INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS....... 56,903 (3,248) (7,177) Cash and cash equivalents at beginning of year.................. 44,231 47,479 54,656 ------------------------------- CASH AND CASH EQUIVALENTS AT END OF YEAR................ $ 101,134 $ 44,231 $ 47,479 ===============================
Report of Ernst & Young LLP Independent Auditors
SHAREHOLDERS AND BOARD OF DIRECTORS CULLEN/FROST BANKERS, INC.
We have audited the accompanying consolidated balance sheets of Cullen/Frost Bankers, Inc. and Subsidiaries (Cullen/Frost) as of December 31, 1998 and 1997, and the related consolidated statements of operations, changes in shareholders' equity, and cash flows for each of the three years in the period ended December 31, 1998. These financial statements are the responsibility of the Corporation's management. Our responsibility is to express an opinion on these financial statements based on our audits. The consolidated financial statements give retroactive effect to the merger of Cullen/Frost and Overton Bancshares, Inc. and Subsidiaries (Overton) on May 29, 1998, which has been accounted for using the pooling of interests method as described in Note B to the consolidated financial statements. We did not audit the consolidated financial statements of Overton for the years ended December 31, 1997 and 1996, which statements reflect total assets constituting 14 percent in 1997 and net interest income of 16 percent in 1997 and 1996 of the related Cullen/Frost's consolidated totals. Those Overton statements were audited by other auditors whose report has been furnished to us, and our opinion, insofar as it relates to data included for Overton, is based solely on the report of other auditors.
We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits and the report of other auditors provide a reasonable basis for our opinion.
In our opinion, based on our audit and the report of other auditors, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of Cullen/Frost Bankers, Inc. and Subsidiaries at December 31, 1998 and 1997, and the consolidated results of their operations and their cash flows for each of the three years in the period ended December 31, 1998 in conformity with generally accepted accounting principles.
ERNST & YOUNG LLP San Antonio, Texas February 12, 1999
CONSOLIDATED AVERAGE BALANCE SHEETS (dollars in thousands -- taxable-equivalent basis)
The above information is shown on a taxable-equivalent basis assuming a 35 percent tax rate. Non-accrual loans are included in the average loan amounts outstanding for these computations.
FINANCIAL STATISTICS (dollars in thousands)
The following unaudited schedules and statistics are presented for additional information and analysis.
RATE/VOLUME ANALYSIS
The allocation of the rate/volume variance has been made on a pro-rata basis assuming absolute values. The above information is shown on a taxable-equivalent basis assuming a 35 percent tax rate.
LOAN MATURITY AND SENSITIVITY
Loans for 1-4 family housing totaling $611,759,000 and consumer loans totaling $625,018,000 and unearned income of $3,357,000 are not included in the amounts in the table.
MATURITY DISTRIBUTION AND SECURITIES PORTFOLIO YIELDS
Weighted average yields have been computed on a fully taxable-equivalent basis assuming a tax rate of 35 percent.
* Included in the totals are mortgage-backed securities and collateralized mortgage obligations of $1.7 billion which are included in maturity categories based on their stated maturity date.
QUARTERLY RESULTS OF OPERATIONS*
* All financial information has been restated for the merger with Overton Bancshares, Inc. accounted for as a pooling of interests. ** Includes net gain on securities transactions. *** Includes a merger related charge of $12.2 million associated with the second quarter 1998 merger with Overton Bancshares, Inc. Without the merger related charge after-tax operating earnings per diluted common share for the second quarter of 1998 were $.77.
CULLEN/FROST BANKERS, INC. AND SUBSIDIARIES BANK SUBSIDIARIES (in thousands)
- ------------------------------------------------------------------------------- DECEMBER 31, 1998 ------------------------------------- TOTAL TOTAL TOTAL ASSETS LOANS DEPOSITS ------------------------------------- Frost National Bank..................... $ 6,748,283 $ 3,580,240 $ 5,716,427 San Antonio, Austin, Corpus Christi, Dallas, Fort Worth, Houston, McAllen, New Braunfels and San Marcos Main Office: P. O. Box 1600, 100 West Houston Street San Antonio, Texas 78296 (210)220-4011 United States National Bank............. 150,773 66,118 138,109 P. O. Box 179, 2201 Market Street Galveston, Texas 77553 (409)763-1151
ITEM 9.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
None.
PART III
ITEM 10.
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The information regarding directors and executive officers called for by Item 10 is incorporated herein by reference to Cullen/Frost's Proxy Statement for its Annual Meeting of Shareholders to be held May 26, 1999.
The additional information regarding executive officers called for by Item 10 is included in Part I, Item 1 of this document under the heading "Executive Officers of the Registrant".
ITEM 11.
ITEM 11. EXECUTIVE COMPENSATION
The information called for by Item 11 is incorporated herein by reference to Cullen/Frost's Proxy Statement for its Annual Meeting of Shareholders to be held May 26, 1999.
ITEM 12.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The information called for by Item 12 is incorporated herein by reference to Cullen/Frost's Proxy Statement for its Annual Meeting of Shareholders to be held May 26, 1999.
ITEM 13.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The information called for by Item 13 is incorporated herein by reference to Cullen/Frost's Proxy Statement for its Annual Meeting of Shareholders to be held May 26, 1999.
PART IV
ITEM 14.
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K
(a) The following documents are filed as part of this Annual Report on Form 10-K:
1. Financial Statements -- Reference is made to Part II, Item 8, of this Annual Report on Form 10-K.
2. The Financial Statement Schedules are omitted, as the required information is not applicable. 3. Exhibits -- The following exhibits are filed as a part of this Annual Report on Form 10-K:
EXHIBIT NUMBER --------- 3.1 -- Articles of Incorporation, of Cullen/Frost Bankers, Inc. as amended (11) 3.2 -- Amended By-Laws of Cullen/Frost Bankers, Inc. (8) 4.1 -- Shareholder Protection Rights Agreement dated as of February 1, 1999 between Cullen/Frost Bankers, Inc. and The Frost National Bank, as Rights Agent (12) 10.1 -- Restoration of Retirement Income Plan for Participants in the Retirement Plan for Employees of Cullen/Frost Bankers, Inc. and its Affiliates (as amended and restated)* 10.2 -- Change-In-Control Agreement with one Executive Officer* 10.3 -- 1983 Non-qualified Stock Option Plan, as amended (1) 10.4 -- Form of Revised Change-In-Control Agreements with four Executive Officers (3)* 10.5 -- 1988 Non-qualified Stock Option Plan (2)* 10.6 -- The 401(k) Stock Purchase Plan for employees of Cullen/Frost Bankers, Inc. and its Affiliates (4)* 10.7 -- 1991 Thrift Incentive Stock Purchase Plan for Employees of Cullen/Frost Bankers, Inc. and its Affiliates (5)* 10.8 -- Cullen/Frost Bankers, Inc. Restricted Stock Plan (6)* 10.9 -- Cullen/Frost Bankers, Inc. Supplemental Executive Retirement Plan (7)* 10.10 -- Form of Revised Change-In-Control Agreements with one Executive Officer (7)* 10.11 -- Retirement agreement with one Executive Officer (9)* 10.12 -- Cullen/Frost Bankers, Inc. 1997 Directors Stock Plan (10) 10.13 -- Cullen/Frost Bankers, Inc. 1992 Stock Plan, as amended (10) 19.1 -- Annual Report on Form 11-K for the Year Ended December 31, 1998, for the 1991 Thrift Incentive Stock Purchase Plan (filed pursuant to Rule 15d-21 of the Securities and Exchange Act of 1934)(13) 19.2 -- Annual Report on Form 11-K for the Year Ended December 31, 1998, for the 401(k) Stock Purchase Plan (filed pursuant to Rule 15d-21 of the Securities and Exchange Act of 1934)(13) 21 -- Subsidiaries of Cullen/Frost 23.1 -- Consent of Independent Auditors 23.2 -- Consent of PricewaterhouseCoopers LLP Independent Auditors for Overton Bancshares, Inc. 24 -- Power of Attorney 27 -- Financial Date Schedule (EDGAR Version) 99 -- Report of PricewaterhouseCoopers LLP on Overton Bancshares, Inc. financial statements as of December 31, 1997 and for each of the years in the two year period ended December 31, 1997.
* Management contract or compensatory plan or arrangement required to be filed as an exhibit pursuant to Item 601 of Regulation S-K.
(b) Reports on Form 8-K -- No such reports were filed during the quarter ended December 31, 1998.
- ------------
(1) Incorporated herein by reference to the designated Exhibits to Cullen/Frost's Report on Form S-8 filed September 5, 1989 (File No. 33-30776)
(2) Incorporated herein by reference to the designated Exhibits to Cullen/Frost's Report on Form S-8 filed September 5, 1989 (File No. 33-30777)
(3) Incorporated herein by reference to the designated Exhibits to the Cullen/Frost Annual Report on Form 10-K for the Year Ended December 31, 1989 (File No. 0-7275)
(4) Incorporated herein by reference to the designated Exhibits to Cullen/Frost's Report on Form S-8 filed October 31, 1990 (File No. 33-37500)
(5) Incorporated herein by reference to the designated Exhibits to Cullen/Frost's Report on Form S-8 filed March 18, 1991 (File No. 33-39478)
(6) Incorporated herein by reference to the designated Exhibits to Cullen/Frost's Report on Form S-8 filed October 20, 1992 (File No. 33-53492)
(7) Incorporated herein by reference to the designated Exhibits to Cullen/Frost's Annual Report on Form 10-K for the Year Ended December 31, 1994 (File No. 0-7275)
(8) Incorporated herein by reference to the designated Exhibits to Cullen/Frost's Annual Report on Form 10-K/A for the Year Ended December 31, 1995 (File No. 0-7275)
(9) Incorporated herein by reference to the designated Exhibits to Cullen/Frost's Annual Report on Form 10-K for the Year Ended December 31, 1996 (File No. 0-7275)
(10) Incorporated herein by reference to the designated Exhibits to Cullen/Frost's Annual Report on Form 10-K for the Year Ended December 31, 1997 (File No. 0-7275)
(11) Incorporated herein by reference to the designated Exhibits to Cullen/Frost's Report on Form 8-A12B/A filed on August 31, 1998 (File No. 0-7275)
(12) Incorporated herein by reference to the designated Exhibits to Cullen/Frost's Current Report on Form 8-A12G/A dated February 1, 1999 (File No. 0-7275)
(13) To be filed as an amendment.
SIGNATURES
PURSUANT TO THE REQUIREMENTS OF SECTION 13 OR 15(D) 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.
Date: March 31, 1999 CULLEN/FROST BANKERS, INC. (Registrant)
By: /s/ PHILLIP D. GREEN -------------------- PHILLIP D. GREEN SENIOR EXECUTIVE VICE PRESIDENT AND CHIEF FINANCIAL OFFICER
PURSUANT TO THE REQUIREMENTS OF THE SECURITIES EXCHANGE ACT OF 1934, THIS REPORT HAS BEEN SIGNED BELOW BY THE FOLLOWING PERSONS ON BEHALF OF THE REGISTRANT AND IN THE CAPACITIES INDICATED ON MARCH 31, 1999.
SIGNATURES -- (CONTINUED)