United States Securities and Exchange CommissionWashington, D.C. 20549
Form 10-Q
X
Quarterly Report Under Section 13 or 15(d) of the Securities Exchange Act of 1934
For the quarterly period ended:
March 31, 2003
or
Transition Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
For the transition period from _______________ to ________________
Commission file number:
0-7275
Cullen/Frost Bankers, Inc.
(Exact name of registrant as specified in its charter)
Texas
74-1751768
(State or other jurisdiction of incorporation or organization)
(I.R.S. Employer Identification No.)
100 W. Houston Street, San Antonio, Texas
78205
(Address of principal executive offices)
(Zip code)
(210) 220-4011
(Registrant's telephone number, including area code)
N/A
(Former name, former address and former fiscal year, if changed since last report)
Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements
for the past 90 days.
Yes
No
Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the
Exchange Act).
As of April 16, 2003, there were 51,364,175 shares of Common Stock, $.01 par value, outstanding.
Part I. Financial Information
(dollars in thousands, except per share amounts)
Three Months EndedMarch 31,
2003
2002
Interest Income:
Loans, including fees
$
60,042
66,602
Securities:
Taxable
29,236
28,304
Tax-exempt
2,117
1,981
Interest-bearing deposits
42
Federal funds sold and securities purchased under resale agreements
2,286
476
Total Interest Income
93,723
97,405
Interest Expense:
Deposits
10,651
15,311
Federal funds purchased and securities sold under repurchase agreements
1,422
1,187
Guaranteed preferred beneficial interests in junior subordinated deferrable
interest debentures
2,119
Subordinated notes payable and other long-term debt
1,357
1,883
Total Interest Expense
15,549
20,500
Net Interest Income
78,174
76,905
Provision for possible loan losses
3,600
6,800
Net Interest Income After Provision For Possible Loan Losses
74,574
70,105
Non-Interest Income:
Trust fees
10,865
12,115
Service charges on deposit accounts
21,104
18,407
Insurance commissions
6,947
5,606
Other service, collection and exchange charges, commissions and fees
3,649
3,832
Other
9,408
8,499
Total Non-Interest Income
51,973
48,459
Non-Interest Expense:
Salaries and wages
36,497
34,534
Employee benefits
10,591
8,735
Net occupancy
7,070
7,347
Furniture and equipment
5,459
5,774
Intangible amortization
1,685
1,877
19,769
18,856
Total Non-Interest Expense
81,071
77,123
Income From Continuing Operations Before Income Taxes
45,476
41,441
Income taxes
14,606
13,221
Income from continuing operations
30,870
28,220
Loss from discontinued operations, net of tax (Note 9)
-
(503
)
Net Income
27,717
Basic Per Share:
0.60
0.55
Net income
0.54
Diluted Per Share:
0.59
0.53
0.52
Dividends Per Share
0.22
0.215
Consolidated Balance Sheets
March 31,
December 31,
Assets
Cash and due from banks
1,246,769
1,331,136
846,975
1,881
8,661
14,305
950,925
724,150
107,150
Total cash and cash equivalents
2,199,575
2,063,947
968,430
Securities held to maturity
33,802
36,135
46,631
Securities available for sale (loaned under agreement to repurchase:
$524,090 at March 31, 2003; $395,671 at December 31, 2002;
and none at March 31, 2002)
2,585,905
2,417,126
2,020,110
Trading account securities
4,995
646
Loans, net of unearned discounts
4,511,095
4,518,913
4,559,092
Less: Allowance for possible loan losses
(83,410
(82,584
(77,300
Net loans
4,427,685
4,436,329
4,481,792
Premises and equipment, net
167,933
169,927
144,856
Goodwill
98,873
97,838
96,462
Other intangible assets, net
20,202
21,330
25,812
Accrued interest receivable and other assets
286,657
304,691
287,020
Total Assets
9,820,632
9,552,318
8,071,759
Liabilities
Non-interest-bearing demand deposits:
Commercial and individual
2,205,018
2,165,033
1,802,284
Correspondent banks
923,089
1,001,713
521,389
Public funds
62,758
62,306
53,023
Total non-interest-bearing demand deposits
3,190,865
3,229,052
2,376,696
Interest-bearing deposits:
Savings and interest-on-checking
1,071,637
1,030,227
1,042,347
Money market accounts
2,109,033
1,925,924
1,846,255
Time accounts
1,037,234
1,090,140
1,168,964
345,321
352,800
339,604
Total interest-bearing deposits
4,563,225
4,399,091
4,397,170
Total deposits
7,754,090
7,628,143
6,773,866
947,492
811,218
317,849
Subordinated notes payable and other borrowings
162,807
167,002
171,452
Guaranteed preferred beneficial interests in junior subordinated deferrable interest debentures, net
98,691
98,678
98,636
Accrued interest payable and other liabilities
139,283
143,487
105,757
Total Liabilities
9,102,363
8,848,528
7,467,526
Shareholders' Equity
Common stock, par value $.01 per share; 90,000,000 shares authorized; 53,561,616 shares issued
536
Surplus
197,075
196,830
193,376
Retained earnings
568,539
549,422
497,377
Deferred compensation
(1,788
(1,957
(3,462
Accumulated other comprehensive income (loss), net of tax
26,143
32,548
(13,680
Treasury stock, 2,214,841, 2,266,141 and 2,373,125 shares, at cost
(72,236
(73,589
(69,914
Total Shareholders' Equity
718,269
703,790
604,233
Total Liabilities and Shareholders' Equity
Consolidated Statements of Changes in Shareholders' Equity
(dollars in thousands)
Three Months Ended
Total shareholders' equity at beginning of period
594,919
Comprehensive income:
Other comprehensive income:
Change in fair value of securities available for sale of $(9,854) in 2003 and
$500 in 2002, net of tax effect of $(3,449) in 2003 and $175 in 2002
(6,405
325
Total comprehensive income
24,465
28,042
Stock option exercises and employee stock purchase plan purchases
894
3,454
Tax benefit from stock option exercises
245
1,447
Purchase of treasury stock
(13,113
Repurchase of restricted stock
(47
Amortization of deferred compensation
169
525
Cash dividends
(11,294
(10,994
Total shareholders' equity at end of period
Consolidated Statements of Cash Flows
March 31
Adjustments to reconcile net income to net cash from operating activities:
Deferred tax expense (benefit)
675
(467
Accretion of loan discounts
(1,098
(1,297
Securities (discount accretion) premium amortization, net
(139
688
Net (gain) loss on sale of assets
(196
78
Depreciation and amortization
6,510
6,911
Originations of loans held for sale
(17,291
(21,019
Proceeds from sales of loans held for sale
79
10,801
Earnings on life insurance policies
(1,221
(1,338
Net change in:
(528)
21,636
87,426
(4,999
2,944
Net cash from operating activities
43,835
120,688
Investing Activities
Securities held to maturity:
Purchases
(1,000
Maturities, calls and principal repayments
3,326
4,588
Securities available for sale:
(402,294
(84,402
223,807
169,364
Net change in loans
22,061
(31,122
Net cash paid in acquisitions
(750
Proceeds from sales of premises and equipment
201
147
Purchases of premises and equipment
(1,675
(1,200
Proceeds from sales of repossessed properties
275
Net cash from investing activities
(155,799
57,650
Financing Activities:
Net change in deposits
125,947
(324,141
Net change in short-term borrowings
136,274
12,465
Principal payments on notes payable and other borrowings
(4,229
(8,234
Proceeds from stock option exercises and employee stock purchase plan purchases
Cash dividends paid
Net cash from financing activities
247,592
(340,610
Net change in cash and cash equivalents
135,628
(162,272
Cash and equivalents at beginning of period
1,130,702
Cash and equivalents at end of period
Supplemental disclosures:
Cash paid for interest
22,282
27,266
Cash paid for income taxes
2,101
Notes to Consolidated Financial Statements
(table amounts in thousands, except per share amounts)
Note 1 - Basis of Presentation
The consolidated financial statements include the accounts of Cullen/Frost Bankers, Inc. ("Cullen/Frost" or the "Corporation") and its wholly owned subsidiaries. All significant intercompany balances and transactions have been eliminated in consolidation. The consolidated financial statements have not been audited by independent accountants, but in the opinion of management, reflect all adjustments necessary for a fair presentation of the financial position and results of operations. All such adjustments were of a normal and recurring nature. The consolidated financial statements have been prepared in accordance with the instructions to Form 10-Q as prescribed by the Securities and Exchange Commission (SEC) and, therefore, do not purport to contain all necessary financial disclosures required by generally accepted accounting principles that might otherwise be necessary in the circumstances, and should be read in conjunction with our consolidated financial statements, and notes thereto, for the year ended December 31, 2002, included in our
Certain reclassifications have been made to make prior periods comparable, including the effects of discontinued operations (
The Corporation accounts for its stock-based employee compensation plans based on the "intrinsic value method" provided in Accounting Principles Board Opinion (APB) No. 25, "Accounting for Stock Issued to Employees," and related Interpretations. 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 on option plans. Compensation expense for restricted stock awards is based on the market price of the stock on the date of grant and is recognized ratably over the vesting period of the award.
Statement of Financial Accounting Standards (SFAS) No. 123, "Accounting for Stock-Based Compensation," as amended by SFAS 148, requires pro forma disclosures of net income and earnings per share for companies not adopting its fair value accounting method for stock-based employee compensation. The pro forma disclosures below use the fair value method of SFAS 123 to measure compensation expense for stock-based employee compensation plans.
Net income, as reported
Add:
110
341
Less:
(1,694
(2,445
Pro forma net income
29,286
25,613
Earnings per share:
Basic - as reported
Basic - pro forma
0.57
0.50
Diluted - as reported
Diluted - pro forma
0.49
The fair value of stock options granted was estimated at the date of grant using the Black-Scholes option-pricing model. This model was developed for use in estimating the fair value of publicly traded options that have no vesting restrictions and are fully transferable. Additionally, the model requires the input of highly subjective assumptions. Because the Corporation's employee stock options have characteristics significantly different from those of publicly traded options, and because changes in the subjective input assumptions can materially affect the fair value estimate, in management's opinion, the Black-Scholes option-pricing model does not necessarily provide a reliable single measure of the fair value of the Corporation's employee stock options.
Note 2 - Allowance for Possible Loan Losses
The allowance for possible loan losses is a reserve established through a provision for loan losses charged to expense, which represents management's best estimate of probable losses that have been incurred within the existing portfolio of loans. The allowance, in the judgment of management, is necessary to reserve for estimated loan losses and risks inherent in the loan portfolio. The level of the allowance reflects management's continuing 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. Portions of allowance may be allocated for specific credits; however, the entire allowance is available for any credit that, in management's judgment, should be charged off. While management utilizes its best judgment and information available, the ultimate adequacy of the allowance is depend ent upon a variety of factors beyond the Corporation's control, including the performance of the Corporation's loan portfolio, the economy, changes in interest rates and the view of the regulatory authorities toward loan classifications.
Activity in the allowance for possible loan losses during the reported periods was as follows:
Balance at the beginning of the period
82,584
72,881
Net charge-offs:
Losses charged to the allowance
(3,932
(3,726
Recoveries
1,158
1,345
Net charge-offs
(2,774
(2,381
Balance at the end of the period
83,410
77,300
Note 3 - Impaired Loans
Loans are considered impaired when, based on current information and events, it is probable the Corporation will be unable to collect all amounts due in accordance with the original contractual terms of the loan agreement, including scheduled principal and interest payments. If a loan is impaired, a portion of the allowance is allocated so that the loan is reported net, at the present value of estimated future cash flows using the loan's existing rate or at the fair value of collateral if repayment is expected solely from the collateral. Interest payments on impaired loans are typically applied to principal unless collectability of the principal amount is reasonably assured, in which case interest is recognized on a cash basis. Impaired loans, or portions thereof, are charged off when deemed uncollectible.
Impaired loans were as follows:
Impaired loans with no allocated allowance
8,757
9,769
12,006
Impaired loans with an allocated allowance
25,891
19,247
21,348
Total recorded investment in impaired loans
34,648
29,016
33,354
Amount of the allowance allocated
12,633
9,275
7,068
All impaired loans are included in non-performing assets. The impaired loans included in the table above were primarily comprised of collateral dependent commercial loans. The average recorded investment in impaired loans was $31.8 million and $31.5 million during the three months ended March 31, 2003 and 2002. No interest income was recognized on these loans subsequent to their classification as impaired.
Note 4 - Common Stock and Earnings Per Share
Basic earnings per share is computed by dividing net income by the weighted-average number of shares outstanding during the period. Diluted earnings per share is computed using the weighted-average number of shares determined for the basic computation plus the dilutive effect of stock options and restricted stock granted using the treasury stock method.
Basic and diluted earnings per share computations were as follows:
Numerators for both basic and diluted earnings per share:
Denominators:
Weighted-average common shares outstanding for basic earnings per share
51,239
51,253
Dilutive effect of stock options
962
1,992
Weighted-average common shares outstanding for diluted earnings per share
52,201
53,245
Basic earnings per share:
(0.01
Diluted earnings per share:
Note 5 - Capital
Banks and bank holding companies are subject to various regulatory capital requirements administered by state and federal banking agencies. Capital adequacy guidelines and, additionally for banks, prompt corrective action regulations involve quantitative measures of assets, liabilities, and certain off-balance-sheet items calculated under regulatory accounting practices. Capital amounts and classifications are also subject to qualitative judgments by regulators about components, risk weighting and other factors.
Quantitative measures established by regulations to ensure capital adequacy require the maintaining of minimum amounts and ratios (set forth in the table below) of total and Tier 1 capital (as defined in the regulations) to risk-weighted assets (as defined), and of Tier 1 capital (as defined) to adjusted average assets (as defined).
Cullen/Frost's and Frost Bank's Tier 1 capital consists of shareholders' equity excluding unrealized gains and losses on securities available for sale, goodwill and other intangible assets. Tier 1 capital for Cullen/Frost also includes $100 million of 8.42 percent trust preferred securities. Cullen/Frost's and Frost Bank's total capital is comprised of Tier 1 capital plus $150 million of 6.875 percent subordinated notes payable and the permissible portion of the allowance for possible loan losses.
The Tier 1 and total capital ratios are calculated by dividing the respective capital amounts by the risk-weighted assets. Risk-weighted assets are calculated based on regulatory requirements and include total assets, excluding goodwill and other intangible assets, allocated by risk weight category and certain off-balance-sheet items (primarily loan commitments). The leverage ratio is calculated by dividing Tier 1 capital by adjusted average total assets, which exclude goodwill and other intangible assets, for the quarter.
Actual and required capital ratios for Cullen/Frost and Frost Bank were as follows:
Actual
Minimum Requiredfor Capital AdequacyPurposes
Required to be WellCapitalized UnderPrompt CorrectiveAction Regulations
CapitalAmount
Ratio
Total Capital to Risk-Weighted Assets
880,371
14.48
%
486,540
8.00
847,957
13.95
486,138
607,672
10.00
Tier 1 Capital to Risk-Weighted Assets
655,386
10.78
243,270
4.00
623,034
10.25
243,069
364,603
6.00
Leverage Ratio
7.07
370,682
6.73
370,305
462,881
5.00
December 31, 2002
859,518
14.16
485,529
814,889
13.44
485,188
606,485
634,733
10.46
242,764
590,157
9.73
242,594
363,891
7.25
350,268
6.75
349,879
437,349
March 31, 2002
813,689
14.31
450,046
785,995
13.84
454,433
568,041
593,776
10.44
227,523
566,180
9.97
227,216
340,825
7.41
320,462
7.06
320,777
400,972
Frost Bank has been notified by its regulator that, as of its most recent regulatory examination, it is regarded as well capitalized under the regulatory framework for prompt corrective action. Such determination has been made evaluating Frost Bank under Tier 1, total capital, and leverage ratios. There have been no conditions or events since this notification that management believes would change any of the well-capitalized categorizations of Frost Bank.
Cullen/Frost is subject to the regulatory capital requirements administered by the Federal Reserve, while Frost Bank is subject to the regulatory capital requirements administered by the Office of the Comptroller of the Currency and the Federal Deposit Insurance Corporation. Regulatory authorities can initiate certain mandatory actions if Cullen/Frost or Frost Bank fails to meet the minimum requirements, which could have a direct material effect on the Corporation's financial statements. Management believes, as of March 31, 2003, that Cullen/Frost and Frost Bank meet all capital adequacy requirements to which they are subject.
Note 6 - Income Taxes
The following is an analysis of the Corporation's income taxes included in the consolidated statements of operations for the quarters ended March 31, 2003 and 2002:
Current income tax expense
13,931
13,688
Deferred income tax expense (benefit)
Income tax expense as reported, before discontinued operations
Current income tax benefit related to discontinued operations (Note 9)
(271
Net deferred tax assets totaled $19.1 million at March 31, 2003, $16.3 million at December 31, 2002 and $33.2 million at March 31, 2002. No valuation allowance was recorded against these deferred tax assets, as the amounts are recoverable through taxes paid in prior years.
Note 7 - Accounting Changes
Financial Accounting Standards Board Interpretation (FIN) No. 45, "Guarantor's Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others - an Interpretation of FASB Statements No. 5, 57 and 107 and Rescission of FASB Interpretation No. 34."
Note 8 - Operating Segments
The Corporation has two reportable operating segments: Banking and the Financial Management Group (FMG). These business units were identified through the products and services that are offered within each unit. Banking includes both commercial and consumer banking services, Frost Insurance Agency (FIA) and the continuing portion of Frost Securities, Inc. (
The accounting policies of each reportable segment are the same as those of the Corporation except for the following items, which impact the Banking and FMG segments. 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 and internal audit are allocated based on the direct expense level of the operating segment. Income tax expense for the individual segments is calculated essentially at the statutory rate. The parent company records the tax expense or benefit necessary to reconcile to the consolidated total.
Summarized operating results by segment were as follows:
Three Months Ended:
Banking
FMG
Non-Banks
DiscontinuedOperations
Consolidated
117,400
14,466
(1,719
- -
130,147
Net Income (loss)
31,985
1,210
(2,325
Revenues from (expenses to) external customers
111,383
16,045
(2,064
2,342
127,706
27,611
3,181
(2,572
Note 9 - Discontinued Operations
On July 23, 2002, the Corporation announced that its start-up securities firm, Frost Securities Inc., was exiting all capital markets-related activities at the close of business on that day. Conditions in the capital markets, combined with the uncertainty of the outlook for the future, made further investments by the Corporation in this segment uneconomic. The discontinued capital markets components included research, sales, trading, and capital markets-related investment banking. The move resulted in the elimination of approximately forty-four positions, or substantially all of the subsidiary's fifty employees. The Corporation maintains a small group of investment banking professionals to continue providing limited advisory and private equity services to middle market companies in its market area.
During the third quarter of 2002, the Corporation recognized a loss on the disposal of the discontinued operations of $6.7 million ($4.4 million, or $.08 diluted per share, after-tax). The loss on the disposal was primarily related to accelerated deferred compensation and severance expense.
The results of operations of the discontinued component are presented separately in the accompanying consolidated statement of income for the three months ended March 31, 2002, net of tax, following income from continuing operations. Details are presented in the table below:
Three MonthsEnded
Revenues
Expenses
3,116
Loss before income taxes
(774
Income tax benefit
271
Loss per share from discontinued operations:
Diluted
Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations
Financial Review
(taxable-equivalent basis - table dollars in thousands, except per share amounts)
The following discussion should be read in conjunction with our consolidated financial statements, and notes thereto, for the year ended December 31, 2002, included in our 2002 Form 10-K. Operating results for the three months ended March 31, 2003 are not necessarily indicative of the results for the year ending December 31, 2003, or any future period.
Forward-Looking Statements
Certain statements contained in this Quarterly Report on Form 10-Q that are not statements of historical fact constitute forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995 (the "Act"), notwithstanding that such statements are not specifically identified. In addition, certain statements may be contained in the Corporation's future filings with the SEC, in press releases, and in oral and written statements made by or with the approval of the Corporation that are not statements of historical fact and constitute forward-looking statements within the meaning of the Act. Examples of forward-looking statements include, but are not limited to: (i) projections of revenues, income or loss, earnings or loss per share, the payment or nonpayment of dividends, capital structure and other financial items; (ii) statements of plans and objectives of Cullen/Frost or its management or Board of Directors, including those relat ing to products or services; (iii) statements of future economic performance; and (iv) statements of assumptions underlying such statements. Words such as "believes", "anticipates", "expects", "intends", "targeted" and similar expressions are intended to identify forward-looking statements but are not the exclusive means of identifying such statements.
Forward-looking statements involve risks and uncertainties that may cause actual results to differ materially from those in such statements. Factors that could cause actual results to differ from those discussed in the forward-looking statements include, but are not limited to: (i) local, regional and international economic conditions and the impact they may have on the Corporation and its customers and the Corporation's assessment of that impact; (ii) changes in estimates of future reserve requirements based upon the periodic review thereof under relevant regulatory and accounting requirements; (iii) the effects of and changes in trade, monetary and fiscal policies and laws, including interest rate policies of the Federal Reserve Board; (iv) inflation, interest rate, market and monetary fluctuations; (v) political instability; (vi) acts of war or terrorism; (vii) the timely development and acceptance of new products and services and perceived overall value of these products and services by users; (viii) changes in consumer spending, borrowings and savings habits; (ix) technological changes; (x) acquisitions and integration of acquired businesses; (xi) the ability to increase market share and control expenses; (xii) changes in the competitive environment among financial holding companies; (xiii) the effect of changes in laws and regulations (including laws and regulations concerning taxes, banking, securities and insurance) with which the Corporation and its subsidiaries must comply; (xiv) the effect of changes in accounting policies and practices, as may be adopted by the regulatory agencies as well as the Financial Accounting Standards Board and other accounting standard setters; (xv) changes in the Corporation's organization, compensation and benefit plans; (xvi) the costs and effects of litigation and of unexpected or adverse outcomes in such litigation; (xvii) greater than expected costs or difficulties related to the integration of new lines of business; and (xviii) the Corporation's success at managing the risks involved in the foregoing.
Such forward-looking statements speak only as of the date on which such statements are made. Cullen/Frost undertakes no obligation to update any forward-looking statement to reflect events or circumstances after the date on which such statement is made, or to reflect the occurrence of unanticipated events.
Results of Operations
A discussion of the Corporation's results of operations is presented below. Certain reclassifications have been made to make prior periods comparable. Taxable-equivalent adjustments are the result of increasing income from tax-free loans and securities by an amount equal to the taxes that would be paid if the income were fully taxable assuming a 35 percent federal income tax rate, thus making tax-exempt asset yields comparable to taxable asset yields.
On July 23, 2002, the Corporation announced the closure the capital markets division of its investment banking subsidiary, Frost Securities, Inc. (FSI). All operating results, for this discontinued component of our operations have been reclassified to "discontinued operations" and are reported separately, net of tax, in the income statement. All prior periods have been restated to reflect this change.
Overview
The Corporation reported net income of $30.9 million, or $0.59 diluted per share for the first quarter of 2003 compared to $30.2 million, or $0.58 diluted per share, for the fourth quarter of 2002 and $27.7 million, or $0.52 diluted per share, for the first quarter of 2002. Returns on average assets and average equity were 1.33 percent and 17.63 percent, for the first quarter of 2003 compared to returns on average assets and average equity of 1.35 percent and 17.15 percent for the fourth quarter of 2002 and 1.39 percent and 18.36 percent for the first quarter of 2002.
Income from continuing operations was equal to reported net income for the first quarter of 2003 and the fourth quarter of 2002, while income from continuing operations totaled $28.2 million, or $0.53 diluted per share, for the first quarter of 2002. Income from continuing operations for the first quarter of 2002 does not include the effect of a $503 thousand loss from the discontinued FSI operations. Returns on average assets and average equity from continuing operations for the first quarter of 2002 were 1.42 percent and 18.70 percent.
Net income totaled $30.9 million for the first quarter of 2003, increasing $716 thousand, or 2.4 percent, compared to $30.2 million for the fourth quarter of 2002 and increasing $3.2 million, or 11.4 percent, compared to $27.7 million for the first quarter of 2002. The increase in net income from the fourth quarter of 2002 was primarily the result of a $2.3 million increase in non-interest income and a $900 thousand decrease in the provision for possible loan losses partly offset by a $1.7 million increase in non-interest expense and a $407 thousand decrease in net interest income. The increase in net income from the first quarter of 2002 was primarily the result of a $1.3 million increase in net interest income, a $3.2 million decrease in the provision for possible loan losses and a $3.5 million increase in non-interest income. The impact of these items was partly offset by a $3.9 million increas e in non-interest expense. Details of the changes in the various components of net income are further discussed below.
Selected Results of Operations Data
December 31
Taxable-equivalent net interest income
79,477
79,917
78,126
Taxable-equivalent adjustment
1,303
1,336
1,221
Net interest income
78,581
4,500
Net interest income after provision for possible loan losses
74,081
Non-interest income
49,678
Non-interest expense
79,416
Income from continuing operations before income taxes
44,343
14,189
30,154
Loss from discontinued operations, net of tax
Diluted per share income from continuing operations
0.58
Return on average assets
1.33
1.35
1.42
Return on average equity
17.63
17.15
18.70
Diluted per share net income
1.39
18.36
Net interest income is the difference between interest income on earning assets, such as loans and securities, and interest expense on liabilities, such as deposits and borrowings, which are used to fund those assets. Net interest income is the Corporation's largest source of revenue, representing 60.1 percent of total revenue during the first quarter of 2003. Net interest margin is the taxable-equivalent net interest income as a percentage of average earning assets for the period. The level of interest rates and the volume and mix of earning assets and interest-bearing liabilities impact net interest income and net interest margin.
The general market rates of interest, including the deposit and loan rates offered by many financial institutions, are influenced by the Federal Reserve. The Corporation's loan portfolio is significantly affected by changes in the prime interest rate. The prime interest rate, which is the rate offered on loans to borrowers with strong credit, began 2002 at 4.75 percent and remained stable until the fourth quarter when the rate decreased 50 basis points to 4.25 percent. During 2003, the prime rate has remained at 4.25 percent. The federal funds rate, which is the cost of immediately available overnight funds, decreased in a similar manner beginning 2002 at 1.75 percent and decreasing 50 basis points in the fourth quarter. During 2003, the federal funds rate has remained at 1.25 percent.
The Corporation's balance sheet is asset sensitive, meaning that earning assets generally reprice more quickly than interest-bearing liabilities. Therefore, the Corporation's net interest margin is likely to increase in periods of rising interest rates in the market and decrease in periods of declining interest rates. The Corporation is primarily funded by core deposits, with demand deposits historically being a strong source of funds. This lower-cost funding base has historically had a positive impact on the Corporation's net interest income and net interest margin. However, in a sustained declining interest rate environment, such as the interest rate environment experienced since early 2001, the Corporation experiences compression of its net interest margin. This compression results from resistance to further reductions in interest rates paid on the Corporation's already low cost deposit base, which results in a disproportionately larger decrease in the y ields on earning assets. Further analysis of the components of the Corporation's net interest margin is presented below.
Net interest income on a taxable-equivalent basis totaled $79.5 million for the first quarter of 2003, compared to $79.9 for the fourth quarter of 2002 and $78.1 million for the first quarter of 2002. Taxable-equivalent net interest income for the first quarter of 2003 decreased $440 thousand from the fourth quarter of 2002 and increased $1.4 million from the first quarter of 2002. The decrease from the fourth quarter of 2002 was primarily due to a decrease in number of days in the quarter. Net interest income for the first quarter of 2003 included 90 days compared to 92 days for the fourth quarter of 2002. On an equivalent basis, considering the additional days, net interest income for the first quarter of 2003 would have effectively increased by approximately $1.3 million from the fourth quarter of 2002. The increase from the first quarter of 2002 and the effective increase from the fourth quarter of 2002 primarily resulted from increases in the average volume of earning assets. The average volume of earning assets for the first quarter of 2003 increased $561.0 million from the fourth quarter of 2002 and $1.1 billion from the first quarter of 2002.
The majority of the growth in earning assets over the comparable periods was in federal funds sold and securities purchased under resale agreements. Funding for this growth was primarily provided by increases in dollar-roll repurchase agreements. During the fourth quarter of 2002, the Corporation began to leverage earning assets by utilizing dollar-roll repurchase agreements. By doing this, the Corporation is able to capitalize on the spread between the yield earned on federal funds sold and securities purchased under resale agreements and the cost of the dollar-roll repurchase agreements. This spread has a positive effect on the dollar amount of net interest income; however, because the funds are invested in lower yielding federal funds sold and securities purchased under resale agreements, which had an average yield of 1.27 percent during the first quarter of 2003, the Corporation's net interest margin is negatively impacted. The average yield on earning a ssets decreased from 5.90 percent for the first quarter of 2002 and 5.34 percent for the fourth quarter of 2002 to 4.91 percent for the first quarter of 2003. Over the same time frame, the average cost of interest-bearing liabilities decreased from 1.66 percent for the first quarter of 2002 and 1.33 percent for the fourth quarter of 2002 to 1.11 percent for the first quarter of 2003. As a result of these changes, the Corporation's net interest margin decreased from 4.68 percent for the first quarter of 2002 and 4.41 percent for the fourth quarter of 2002 to 4.10 percent for the first quarter of 2003.
Other earning asset growth of significance was in U.S. government agency securities, which had an average yield of 5.03 percent during the first quarter of 2003. Funding for this growth was primarily provided by deposit growth. The average cost of deposits was 0.97 percent during the first quarter of 2003. The average volume of loans, the Corporation's primary category of earning assets, remained fairly stable over the comparable periods and had an average yield of 5.38 percent during the first quarter of 2003.
The following table presents the changes in net interest income and identifies the change due to differences in the average volume of earning assets and interest-bearing liabilities and the change due to changes in the average interest rate on those assets and liabilities. The changes in net interest income due to changes in both average volume and average interest rate have been allocated to average volume or average interest rate change in proportion to the absolute amounts of the change in each.
1st Quarter
2003 vs.
4th Quarter
Change in Taxable-Equivalent Net Interest Income
Due to changes in average volume
7,376
3,803
Due to changes in average interest rates
(6,025
(4,243
Total change
1,351
(440
Non-Interest Income
Total non-interest income increased $2.3 million, or 4.6 percent, from the fourth quarter of 2002 and increased $3.5 million, or 7.3 percent, from the first quarter of 2002. Changes in the components of non-interest income are discussed below.
11,609
20,705
6,307
3,847
7,210
Total
Trust fee income decreased $744 thousand, or 6.4 percent, from the fourth quarter of 2002 and decreased $1.3 million, or 10.3 percent, from the first quarter of 2002. The decreases were primarily related to decreases in estate fees and investment fees. Investment fees are the most significant component of trust fees, making up approximately 74 percent of total trust fees for the first quarter of 2003. Investment and other custodial account fees are generally based on the market value of assets within a trust account. The continued decline and volatility in the equity markets negatively impacts the market value of trust assets and the related investment fees. At March 31, 2003, trust assets, including both managed assets and custody assets, were primarily composed of fixed income securities (40.0 percent of trust assets), equity securities (38.3 percent of trust assets) and cash equivalents (13.9 percent of trust assets). The market value of trust assets was $12.3 billion (including managed assets of $5.8 billion and custody assets of $6.5 million) at March 31, 2003, compared to $12.6 billion (including managed assets of $5.9 billion and custody assets of $6.7 million) at December 31, 2002 and $13.6 billion (including managed assets of $6.1 billion and custody assets of $7.5 million) at March 31, 2002.
Service charges on deposit accounts for the first quarter of 2003 increased $399 thousand, or 1.9 percent, from the fourth of quarter 2002 and increased $2.7 million, or 14.7 percent, from the first quarter of 2002. The increases were primarily due to higher treasury management revenues on commercial accounts. These higher revenues resulted primarily from a lower earnings credit rate as well as higher levels of billable services. The earnings credit rate is the value given to deposits maintained by treasury management customers. In a lower rate environment, deposit balances are not as valuable because of a lower earnings credit rate. This results in customers paying for most of their services through fees rather than through the use of deposit balances. The increases were also partly due to an increase in overdraft fees on individual and commercial accounts.
Insurance commissions increased $640 thousand, or 10.1 percent, from the fourth quarter of 2002 and increased $1.3 million, or 23.9 percent, from the first quarter of 2002. The increase in both periods was primarily the combined result of continued selling efforts and the effect of a tighter market for certain products resulting in higher insurance premiums and related commission revenues.
Other service charges and fees decreased $198 thousand, or 5.1 percent, from the fourth quarter of 2002 and deceased $183 thousand, or 4.8 percent, from the first quarter of 2002. The decreases were primarily related to lower letter of credit fees due to the deferral of certain fees in accordance with a new accounting standard (see
Other non-interest income increased $2.2 million, or 30.5 percent, from the fourth quarter of 2002 and increased $909 thousand, or 10.7 percent, from the first quarter of 2002. The increase from the fourth quarter of 2002 is primarily related to the seasonal effect of rebate income received from various insurance carriers related to the performance of insurance policies previously placed. The Corporation generally receives this income in the first quarter of each year. The increase from the first quarter of 2002 primarily resulted from increases in rebate income received from various insurance carriers, income from sales of annuity products and royalty income from mineral interests. The increase from these items was partly offset by a decrease in automated services income generated from a data processing center sold in the first quarter of 2002.
Non-Interest Expense
Total non-interest expense increased $1.7 million, or 2.1 percent, from the fourth quarter of 2002 and increased $3.9 million, or 5.1 percent, from the first quarter of 2002. Changes in the components of non-interest expense are discussed below.
34,831
9,034
7,008
5,783
1,735
21,025
Salaries and wages increased $1.7 million, or 4.8 percent, from the fourth quarter of 2002 and increased $2.0 million, or 5.7 percent, from the first quarter of 2002. The increases over the comparable periods are primarily related to merit increases, and commissions paid in connection with increased revenues associated with Frost Insurance Agency.
Employee benefits increased by $1.6 million, or 17.2 percent, when compared to the fourth quarter of 2002 and up $1.9 million, or 21.2 percent, from the first quarter of 2002. The increases over the comparable periods are primarily related to increased retirement plan expense, increased payroll taxes and increased 401(k) matching expense.
Net occupancy expense for the first quarter of 2003 remained fairly stable compared the fourth quarter of 2002 and decreased $277 thousand, or 3.8 percent, from the first quarter of 2002. The decrease from the first quarter of 2002 was primarily the result of decreased lease expense resulting from the purchases of the twenty-one story Frost Bank office tower and the adjacent parking garage facility in downtown San Antonio, in the second quarter of 2002. The Corporation also experienced an increase in parking garage income as a result of the purchase. The impact of these items was partially offset by higher lease expense related to various other facilities and higher depreciation expense related to the purchased office tower and garage.
Furniture and equipment expense decreased $324 thousand, or 5.6 percent, from the fourth quarter of 2002 and decreased $315 thousand, or 5.5 percent, from the first quarter of 2002. The decrease from the fourth quarter of 2002 is primarily related to decreases in software amortization and software maintenance expenses, which were partly offset by increased service contract expense. The decrease from the first quarter of 2002 is related to decreases in furniture and equipment depreciation and software amortization.
Intangible amortization for the first quarter of 2003 remained fairly stable compared to the fourth quarter of 2002 and decreased $192 thousand, or 10.2 percent, compared with the first quarter of 2002. The decrease from the first quarter of 2002 is primarily related to the completion of the amortization of certain intangible assets in the first quarter of 2002.
Other non-interest expense decreased $1.3 million, or 6.0 percent, from the fourth quarter of 2002 and increased $913 thousand, or 4.8 percent, from the first quarter of 2002. The largest portion of the decrease from the fourth quarter of 2002 related to losses associated with foreclosed assets and other professional expense. The Corporation realized losses on foreclosed assets of $711 thousand in the fourth quarter of 2002. Such losses were not significant during the first quarter of 2003. Other professional expense decreased $460 thousand from the fourth quarter of 2002. The increase from the first quarter of 2002 is primarily related to higher attorney fees and higher federal reserve service charges due to the lower interest rate environment.
Results of Segment Operations
The Corporation's operations are managed along two operating segments: Banking and the Financial Management Group ("FMG"). A description of each business and the methodologies used to measure financial performance is described in
Financial Management Group
Discontinued operations
Consolidated net income
Net income totaled $32.0 million for the first quarter of 2003, increasing $4.4 million, or 15.8 percent, compared to $27.6 million for the first quarter of 2002. The increase in net income was primarily the result of a $1.5 million increase in net interest income, a $3.2 million decrease in the provision for possible loan losses and a $4.5 million increase in non-interest income. The impact of these items was partly offset by a $2.8 million increase in non-interest expense.
Net interest income increased $1.5 million, despite the impact of the continued decline in market interest rates on the banking group's asset-sensitive balance sheet, primarily due to an increase in the average volume of earning assets. The impact of the increase in the average volume of earning assets was somewhat constrained as the majority of the growth in earning assets was in lower-yielding federal funds sold and securities purchased under resale agreements. See analysis of net interest income included in the section captioned
The provision for possible loan losses totaled $3.6 million for the first quarter of 2003 compared to $6.8 million for the first quarter of 2002. See analysis of the provision for possible loan losses included in the section captioned
Non-interest income increased $4.5 million, or 13.4 percent, from the first quarter of 2002 primarily due to increases in service charges on deposit accounts and insurance commissions. See analysis of service charges on deposit accounts and insurance commissions included in the section captioned
Non-interest expense increased $2.8 million, or 4.4 percent, from the first quarter of 2002. The increase was primarily related to increases in salaries and wages and employee benefits. Combined, these categories of non-interest expense increased $3.3 million. The increase was primarily the result of merit increases, increases in commissions paid in connection with increased revenues associated with FIA, increases in payroll taxes and increases related to 401(k) matching and retirement plan expense.
FIA, which is included in the Banking operating segment, had gross revenues of $8.7 million during the first quarter of 2003 compared to $6.6 million in the first quarter of 2002. Insurance commissions were the largest component of these revenues, increasing $1.3 million, or 23.3 percent. The increase was primarily the result of continued selling efforts and the effect of a tighter market resulting in higher insurance premiums and related commission revenues. The remainder of the increase was primarily from increases in rebate income received from various insurance carriers related to the performance of insurance policies previously placed. The rebate income is seasonal in nature and is generally received in the first quarter of each year.
Net income for the first quarter of 2003 totaled $1.2 million, decreasing $2.0 million, or 62.0 percent, compared to $3.2 million for the first quarter of 2002. The decrease was primarily due to decreases in net interest income and trust fee income and increases in salaries and wages, employee benefits and other non-interest expense.
Net interest income decreased $247 thousand primarily because the lower interest rate environment has reduced the funds transfer price paid on FMG's securities sold under repurchase agreements.
Non-interest income decreased $1.3 million primarily due to decreases in estate fees, investment fees and other service charges. The impact of these items was partly offset by an increase in other non-interest income. Investment fees are the most significant component of trust fees, making up approximately 74 percent of total trust fees for the first quarter of 2003. Investment and other custodial account fees are generally based on the market value of assets within a trust account. The continued decline and volatility in the equity markets has had a negative impact on the market value of trust assets and the related investment fees. See analysis of trust fees included in the section captioned
Non-interest expense increased $1.2 million primarily due to increases in salaries and wages, employee benefits and other non-interest expense. The $557 thousand increase in salaries and wages and employee benefits was primarily the result of merit increases, increases in payroll taxes and increases related to 401(k) matching and retirement plan contributions. The $760 thousand increase in other non-interest expense was primarily due to general increases in the various components of other non-interest expense, including cost allocations.
The $247 thousand decrease in the net loss for Non-Banks operating segment for the first quarter of 2003 compared the first quarter of 2002 was primarily due to an increase in royalty income from mineral interests and other miscellaneous items.
Discontinued Operations
During the third quarter of 2002 the Company discontinued all capital market related activities of Frost Securities, Inc. See
Income Taxes
The Corporation recognized income tax expense on continuing operations of $14.6 million, for an effective rate of 32.1 percent, in the first quarter of 2003, compared to $14.2 million, for an effective rate of 32.0 percent, in the fourth quarter of 2002, and $13.2 million, for an effective rate of 31.9 percent, in the first quarter of 2002. The effective income tax rates differed from the U.S. statutory rate of 35 percent during the comparable periods primarily due to the effect of tax-exempt income from loans, securities and life insurance policies.
Balance Sheet
Average assets of $9.4 billion increased $556.4 million, or 25.1 percent, on an annualized basis from the fourth quarter of 2002 and increased $1.3 billion, or 16.6 percent, from the first quarter of 2002. Average loans for the first quarter of 2003 were $4.5 billion representing a 1.7 percent increase on an annualized basis from the fourth quarter of 2002. Average loans remained relatively flat compared to the first quarter of 2002. Average federal funds sold and securities purchased under resale agreements increased 253.0 percent on an annualized basis from the fourth quarter of 2002 and 603.5 percent from the first quarter of 2002. The increase in average federal funds sold and securities purchased under resale agreements was primarily the result of the Corporation's use of dollar-roll repurchase agreements to capitalize on yield spreads. See analysis of dollar-roll transactions under the section captioned
Loans
Loans, net of unearned discounts, totaled $4.5 billion at March 31, 2003, and remained relatively stable compared to December 31, 2002 and decreased $48.0 million, or 1.1 percent, from March 31, 2002. Excluding shared national credits purchased ("SNCs"), 1-4 family residential mortgages, the indirect lending portfolio and student loans, loans increased 1.7 percent on an annualized basis from December 31, 2002 and increased 3.0 percent from March 31, 2002. SNCs, which are discussed further below, are participations purchased from upstream financial organizations and tend to be larger in size than the Corporation's originated portfolio. The Corporation stopped originating mortgage and indirect consumer loans during 2000, and as such, these portfolios are excluded when analyzing the growth of the loan portfolio. Additionally, the student loan portfolio decreased from last year as a result of the accelerated sale during the second quarter of 2002 of loans which normally would have been sold in the ordinary course of business over an extended period of time.
End of period loans were as follows:
Percentage
Loan Portfolio
of Total
Commercial and industrial
2,142,884
47.5
2,155,550
2,052,952
Real estate:
Construction:
Commercial
335,120
7.4
315,340
390,724
Consumer
45,230
1.0
45,152
41,500
Land:
152,030
3.4
158,271
120,496
6,188
0.2
8,231
10,550
Commercial real estate mortgages
1,060,626
23.5
1,050,957
1,000,888
1-4 Family residential mortgages
161,248
3.6
179,077
224,372
Other consumer real estate
273,601
6.1
276,429
279,183
Total real estate
2,034,043
45.2
2,033,457
2,067,713
Consumer non-real estate:
Indirect
19,746
0.4
25,262
52,667
304,236
6.7
289,190
371,197
Other, including foreign
18,383
23,295
20,851
Unearned discount
(8,197
(0.2
(7,841
(6,288
100.0
As shown in the table above, at March 31, 2003, the majority of the loan portfolio was comprised of commercial and industrial loans, which totaled $2.1 billion, or 47.5 percent of total loans, and real estate loans, which totaled $2.0 billion, or 45.2 percent of total loans. The real estate total includes both commercial and consumer balances.
Excluding SNCs, commercial and industrial loans increased 1.3 percent on an annualized basis from December 31, 2002 to $1.9 billion and increased 5.9 percent from March 31, 2002. The Corporation's commercial and industrial loans are a diverse group of loans to small, medium and large businesses. The purpose of these loans varies from supporting seasonal working capital needs to term financing of equipment. While some short term loans may be made on an unsecured basis, most are secured by the assets being financed with collateral margins that are consistent with the Corporation's loan policy guidelines. The commercial and industrial loan portfolio also includes the commercial lease and asset-based lending portfolios. At March 31, 2003, commercial leases totaled $60.7 million and asset-based loans totaled $47.5 million compared to $57.6 million and $49.8 million at December 31, 2002 and $43.5 million and $45.1 million at March 31, 2002.
The Corporation had a total SNCs portfolio of approximately $225.7 million outstanding at March 31, 2003, decreasing from $239.4 million at December 31, 2002 and $237.2 million at March 31, 2002. At March 31, 2003, approximately 53 percent of outstanding SNCs were related to the energy industry with the remainder diversified throughout various other industries. Additionally, almost all of the outstanding balance of SNCs were included in the commercial and industrial portfolio, with the remainder included in the real estate categories. SNC participations are originated in the normal course of business to meet the needs of the Corporation's customers. As a matter of general policy, the Corporation generally only participates in SNCs for companies headquartered in or which have significant operations within the Corporation's market areas. In addition, the Corporation must have direct access to the company's management, an existing banking relationship or the expectation of broadening the relationship with other banking products and services.
Real estate loans totaled $2.0 billion at March 31, 2003 and remained relatively stable compared to December 31, 2002 and decreased $33.7 million, or 1.6 percent, from March 31, 2002. Excluding 1-4 family residential mortgage loans, which are discussed below, total real estate loans increased $18.4 million, or 4.0 percent, on an annualized basis from December 31, 2002, and $29.5 million, or 1.6 percent, from March 31, 2002. Commercial real estate loans totaled $1.5 billion at March 31, 2003 and represented 76.1 percent of total real estate loans. The majority of this portfolio consists of commercial real estate mortgages, which includes both permanent and intermediate term loans. The Corporation's primary focus for the commercial real estate portfolio has been growth in loans 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 mus t undergo the analysis and underwriting process of a commercial and industrial loan, as well as that of a real estate loan. At March 31, 2003, approximately half of the Corporation's commercial real estate loans were secured by owner-occupied properties.
The consumer loan portfolio, including all consumer real estate totaled $810.2 million at March 31, 2003, decreasing 6.4 percent on an annualized basis from December 31, 2002 and 17.3 percent from March 31, 2002. However, excluding 1-4 family residential mortgages, indirect loans and student loans, total consumer loans decreased 4.8 percent on an annualized basis from December 31, 2002 and 3.5 percent from March 31, 2002.
As the following table illustrates as of the dates indicated, the consumer loan portfolio has four distinct segments - consumer real estate, consumer non-real estate, indirect consumer loans and 1-4 family residential mortgages.
Consumer Loan Portfolio
Consumer real estate:
Construction
Land
Total consumer real estate
325,019
329,812
331,233
Consumer non-real estate
Total Consumer loans
810,249
823,341
979,469
The consumer non-real estate loan portfolio primarily consists of automobile loans, unsecured revolving credit products, personal loans secured by cash and cash equivalents, student loans and other similar types of credit facilities. Consumer non-real estate loans increased 20.8 percent on an annualized basis from December 31, 2002 and decreased 18.0 percent from March 31, 2002. The increase from December 31, 2002 was primarily related to an increase in student loans. Excluding student loans, consumer non-real estate loans decreased 3.5 percent on an annualized basis from December 31, 2002. The majority of the decrease in consumer non-real estate loans from March 31, 2002 was the result of the acceleration in sales of student loans during the second quarter of 2002 that would have normally been sold in the ordinary course of business over an extended period of time.
The indirect consumer loan segment has continued to decrease since the Corporation's decision to discontinue originating these types of loans during 2001. At March 31, 2003, the majority of the portfolio was comprised of purchased home improvement and home equity loans (53.1 percent), as well as new and used automobile loans (43.9 percent). The portfolio is not expected to completely pay off before December 31, 2003 due to the longer life of the non-auto loans in this portfolio. However, the portfolio is expected to decrease by that time.
The Corporation also discontinued originating 1-4 family residential mortgage loans in 2000. Although this portfolio will continue to decline due to the decision to withdraw from the mortgage origination business, high levels of mortgage refinances due to the low interest rate environment have accelerated the decrease.
Loans to borrowers in Mexico, which are secured by liquid assets held in the United States, were $11.3 million at March 31, 2003, $9.6 million at December 31, 2002 and $10.3 million at March 31, 2002. The Corporation's cross-border credits outstanding to Mexico excluding these loans totaled $328 thousand at March 31, 2003 down from $368 thousand at December 31, 2002 and from $415 thousand at March 31, 2002. At March 31, 2003 and 2002, none of the Mexico-related loans were on non-performing status.
Commitments to Extend Credit
In the normal course of business, the Corporation enters into various transactions, which, in accordance with generally accepted accounting principles, are not included in its consolidated balance sheets. These transactions are referred to as "off-balance-sheet commitments." The Corporation enters into these transactions to meet the financing needs of its customers. These transactions include commitments to extend credit and standby letters of credit, which involve elements of credit risk in excess of the amounts recognized in the consolidated balance sheets. The Corporation minimizes its exposure to loss under these commitments by subjecting them to credit approval and monitoring procedures.
The Corporation enters into contractual commitments to extend credit, normally with fixed expiration dates or termination clauses, at specified rates and for specific purposes. Customers use credit commitments to ensure that funds will be available for working capital purposes, for capital expenditures and to ensure access to funds at specified terms and conditions. Substantially all of the Corporation's commitments to extend credit are contingent upon customers maintaining specific credit standards at the time of loan funding. Management assesses the credit risk associated with certain commitments to extend credit in determining the level of the allowance for possible loan losses. Commitments to extend credit totaled $2.3 billion at March 31, 2003, $2.1 billion at December 31, 2002 and $2.3 billion at March 31, 2002.
Standby letters of credit are written conditional commitments issued by the Corporation to guarantee the performance of a customer to a third party. The Corporation's policies generally require that standby letters of credit arrangements contain security and debt covenants similar to those contained in loan agreements. In the event the customer does not perform in accordance with the terms of the agreement with the third party, the Corporation would be required to fund the commitment. The maximum potential amount of future payments the Corporation could be required to make is represented by the contractual amount of the commitment. If the commitment is funded, the Corporation would be entitled to seek recovery from the customer. Standby letters of credit totaled $174.2 million at March 31, 2003, $159.3 million at December 31, 2002 and $125.8 million at March 31, 2002. As of March 31, 2003, in accordance with a new accounting standard, $498&nbs p;thousand has been recorded as a liability for the Corporation's potential obligations under these guarantees. No liability was recorded for these guarantees prior to January 1, 2003. See
Non-Performing Assets
Non-performing assets and accruing past due loans were as follows:
Non-accrual loans:
Real estate
14,053
11,702
9,760
21,621
19,878
25,548
3,426
3,281
1,182
Total non-accrual loans
39,100
34,861
36,490
Foreclosed assets:
8,961
8,005
3,968
48
171
Total foreclosed assets
9,009
8,047
4,139
Total non-performing assets
48,109
42,908
40,629
Accruing Past Due Loans
30 to 89 days past due
40,836
30,766
29,345
90 or more days past due
11,290
9,081
6,568
Total accruing loans past due
52,126
39,847
35,913
Non-performing assets totaled $48.1 million at March 31, 2003 increasing 12.1 percent from $42.9 million at December 31, 2002 and increasing 18.4 percent from $40.6 million at March 31, 2002. Non-performing assets as a percentage of total loans and foreclosed assets increased to 1.06 percent at March 31, 2003 from 0.95 percent at December 31, 2002 and 0.89 percent at March 31, 2002. The increase during the first quarter of 2003 was primarily related to real estate and commercial and industrial loans.
Non-performing assets include non-accrual loans and foreclosed assets. Generally, loans are placed on non-accrual status if principal or interest payments become 90 days past due and/or management deems the collectibility of the principal and/or interest to be in question, as well as when required by regulatory provisions. Once interest accruals are discontinued, accrued but uncollected interest is charged to current year operations. Subsequent receipts on non-accrual loans are recorded as a reduction of principal, and interest income is recorded only after principal recovery is reasonably assured.
Foreclosed assets represent property acquired as the result of borrower defaults on loans. Foreclosed assets are valued at the lower of the loan balance or estimated fair value, less estimated selling costs, at the time of foreclosure. Write-downs occurring at foreclosure are charged against the allowance for possible loan losses. On an ongoing basis, properties are appraised as required by market indications and applicable regulations. Write-downs are provided for subsequent declines in value. Expenses related to maintaining foreclosed properties are included in other non-interest expense.
Potential problem loans consist of loans that are performing in accordance with contractual terms but for which management has concerns about the ability of an obligor to continue to comply with repayment terms because of the obligor's potential operating or financial difficulties. Management monitors these loans closely and reviews their performance on a regular basis. At March 31, 2003, the Corporation had $19.3 million in loans of this type which are not included in either of the non-accrual or 90 days past due loan categories. Approximately 56 percent of the total is related to a single credit to a company in several gas-related and equipment distribution businesses. Weakness in such company's operating performance combined with a slowdown in certain business sectors has caused us to heighten the attention given to this credit.
The after-tax impact (assuming a 35 percent marginal tax rate) of lost interest from non-performing assets was $406 thousand for the first quarter of 2003, compared to $365 thousand for the fourth quarter of 2002 and $561 thousand for the first quarter of 2002.
Allowance for Possible Loan Losses
The allowance for possible loan losses totaled $83.4 million, or 1.85 percent of loans at March 31, 2003, compared to $82.6 million, or 1.83 percent of loans at December 31, 2002 and $77.3 million, or 1.70 percent of loans at March 31, 2002. The allowance for possible loan losses as a percentage of non-accrual loans was 213.3 percent at March 31, 2003, compared to 236.9 percent at December 31, 2002 and 211.8 percent at March 31, 2002.
Net loan charge-offs (recoveries) were as follows:
Quarter Ended
285
841
59
2,211
1,986
1,900
278
592
413
(3
9
Total charge-offs
2,774
3,416
2,381
Allowance for possible loan losses
Charge-offs are loan balances that have been written off against the allowance for possible loan losses once the loan is determined to be uncollectible. As a percentage of average loans, net charge-offs were 0.25 percent in the first quarter of 2003 compared to 0.28 percent in the fourth quarter of 2002 and 0.21 percent in the first quarter of 2002. The allowance for possible loan losses is maintained at a level considered appropriate by management, based on estimated probable losses within the existing loan portfolio. The provision for possible loan losses reflects loan quality trends, including the level of net charge-offs or recoveries, among other factors. The provision for possible loan losses decreased $900 thousand from the fourth quarter of 2002 and $3.2 million from the first quarter of 2002. Higher provisions were considered necessary during 2002 due to the overall uncertainty in the economy. While economic conditions remain uncertain, mana gement believes the current level of the allowance for possible loan losses is adequate based on current loan portfolio quality. Should any of the factors considered by management in evaluating the adequacy of the allowance for possible loan losses change, the Corporation's estimate of probable loan losses could also change, which could affect the level of future provisions for possible loan losses.
Capital and Liquidity
At March 31, 2003, shareholders' equity totaled $718.3 million compared to $703.8 million at December 31, 2002 and $604.2 million at March 31, 2002. In addition to net income of $30.9 million, changes in shareholders' equity during the first quarter of 2003 included $11.3 million of dividends paid. The accumulated other comprehensive income component of shareholders' equity totaled $26.1 million at March 31, 2003 compared to $32.5 million as of December 31, 2002. This change resulted from the decline in the fair value of securities available for sale, net of taxes, of $6.4 million as of March 31, 2003. Under regulatory requirements, the unrealized gain or loss on securities available for sale does not increase or reduce regulatory capital and is not included in the calculation of risk-based capital and leverage ratios. Regulatory agencies for banks and bank holding companies utilize capital guidelines designed to measure Tier 1 and Total Capital and take into consideration the risk inherent in both on-balance sheet and off-balance sheet items. See
The Corporation paid a quarterly dividend of $0.22 per common share during both the first quarter of 2003 and fourth quarter of 2002 and a quarterly dividend of $0.215 per common share in the first quarter of 2002. This equates to a dividend payout ratio of 36.6 percent, 37.4 percent and 39.7 percent for each of these periods, respectively. In addition, the Corporation initiated a program during the third quarter of 2001 to repurchase up to 2.6 million shares of its common stock over a two-year period, from time to time, at various prices in the open market or through private transactions. The Corporation did not repurchase any shares under this program during the first quarter of 2003. As of March 31, 2003, 1.2 million shares at a cost of $39.2 million had been repurchased under this program.
Funding sources available at the holding company level include a $25.0 million short-term line of credit with another financial institution. The line of credit matures annually and bears interest at a fixed LIBOR-based rate or floats with the prime rate. There were no borrowings outstanding on this line of credit at March 31, 2003.
Liquidity measures the ability to meet current and future cash flow needs as they become due. The Corporation seeks to ensure these needs are met at a reasonable cost by maintaining a level of liquid funds through asset/liability management.
Asset liquidity is provided by liquid assets which are readily marketable or pledgeable or which will mature in the near future. Liquid assets include cash, interest-bearing 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 deposits and correspondent banks in the Corporation's natural trade area that maintain accounts with and sell federal funds to Frost Bank, 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. Management is not aware of any events that are reasonably likely to have a material adverse effect on the Corporation's liquidity, capital resources or operations. In addition, management is not aware of any regulatory recommendations regarding liquidity, which if implemented, would have a material adverse effect on the Corporation.
Consolidated Average Balance Sheets and Net Interest Income Analysis-By Quarter
(dollars in thousands - taxable-equivalent basis)
Interest
Average
Income/
Yield/
Balance
Expense
Cost
Assets:
10,690
1.59
13,220
30
0.90
U.S. Treasury
13,985
52
1.50
16,543
91
2.17
U.S. government agencies and corporations
2,293,277
28,829
5.03
2,033,449
27,529
5.42
States and political subdivisions
198,505
3,307
6.66
191,919
3,429
7.15
1,996
33
6.58
2,240
37
6.61
35,848
322
3.61
34,598
339
3.92
Total securities
2,543,611
32,543
5.12
2,278,749
31,425
5.52
Federal funds sold and securities purchased
under resale agreements
722,336
1.27
442,473
1,579
1.40
Loans, net of unearned discount
4,534,405
60,155
5.38
4,515,604
64,241
5.64
Total Earning Assets and Average Rate Earned
7,811,042
95,026
4.91
7,250,046
97,275
5.34
1,071,671
1,104,180
(83,485
(82,499
169,186
171,581
459,305
427,990
9,427,719
8,871,298
Liabilities:
1,996,745
2,023,906
842,247
793,306
56,332
48,779
Total demand deposits
2,895,324
2,865,991
1,015,103
272
0.11
992,806
354
0.14
Money market deposit accounts
2,014,095
5,393
1.09
1,933,820
5,874
1.20
1,072,929
3,934
1.49
1,118,686
4,984
1.77
345,697
1,052
1.23
340,398
1,103
1.30
Total time deposits
4,447,824
0.97
4,385,710
12,316
1.11
7,343,148
7,251,701
Federal funds purchased and securities sold
under repurchase agreements
922,834
0.62
512,323
1,377
1.05
Guaranteed preferred beneficial interests in
junior subordinated deferrable interest
debentures
98,685
8.60
98,671
Subordinated notes payable and other notes
payable
149,466
1,230
3.29
149,433
1,385
3.71
Other borrowings
14,532
127
3.56
18,331
162
3.51
Total Interest-Bearing Funds and Average
Rate Paid
5,633,341
5,164,468
17,358
188,866
143,119
8,717,531
8,173,578
710,188
697,720
Net interest spread
3.79
Net interest income to total average earning assets
4.10
4.41
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.
September 30, 2002
June 30, 2002
14,312
54
13,868
65
1.89
45,716
221
1.92
58,028
290
2.00
1,887,692
27,040
5.73
1,865,691
27,470
5.89
182,171
3,099
6.80
176,419
3,078
6.98
2,248
2,229
6.64
34,765
3.90
33,965
348
2,152,592
30,736
5.71
2,136,332
31,223
5.85
316,848
1,411
1.74
112,638
524
1.84
4,511,565
67,087
5.90
4,587,665
67,896
5.94
6,995,317
99,288
6,850,503
99,708
5.83
836,049
766,820
(80,555
(79,512
173,333
154,785
394,940
397,713
8,319,084
8,090,309
1,947,332
1,869,124
534,577
472,994
48,539
38,442
2,530,448
2,380,560
977,977
480
0.19
1,023,782
490
1,866,489
6,367
1,818,573
1.28
1,153,949
5,813
1,164,320
6,347
2.19
322,799
332,982
1,256
1.51
4,321,214
13,881
4,339,657
13,876
6,851,662
6,720,217
406,404
1,486
1.43
353,525
1,310
1.47
98,657
8.59
98,644
149,793
1,403
3.75
151,996
1,466
3.86
19,396
174
3.57
19,325
173
3.60
4,995,464
19,063
4,963,147
18,944
1.53
125,846
119,790
7,651,758
7,463,497
667,326
626,812
80,225
80,764
4.13
4.30
4.56
4.72
15,504
50
14,065
85
2.47
1,869,473
27,917
5.97
177,035
3,086
6.97
2,234
6.62
29,328
268
3.65
2,092,135
31,393
102,674
1.85
4,533,639
66,707
6,743,952
98,626
866,962
(74,912
147,677
401,632
8,085,311
1,927,435
408,367
43,689
2,379,491
1,020,878
475
1,808,156
5,835
1.31
1,186,800
7,624
2.61
353,275
1.58
4,369,109
6,748,600
327,692
1.45
98,630
152,170
1,648
4.33
22,929
235
4.16
4,970,530
1.66
123,173
7,473,194
612,117
4.24
4.68
Item 3. Quantitative and Qualitative Disclosures About Market Risks
There has been no significant change in the market risks faced by the Corporation since December 31, 2002. For information regarding the Corporation's market risk, refer to the Corporation's
Item 4. Controls and Procedures
Within the 90-day period prior to the filing of this Quarterly Report on Form 10-Q, an evaluation was carried out under the supervision and with participation of Cullen/Frost's management, including its Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of its disclosure controls and procedures (as defined in Rules 13a-14(c) and 15d-14(c) under the Securities Exchange Act of 1934). Based upon that evaluation, the Chief Executive Officer and Chief Financial Officer concluded that the disclosure controls and procedures were effective. No significant changes were made in Cullen/Frost's internal controls or in other factors that could significantly affect these controls subsequent to the date of their evaluation.
Part II: Other Information
Item 1. Legal Proceedings
The Corporation and its subsidiaries are subject to various claims and legal actions that have arisen in the normal course of conducting its business. Management does not expect the ultimate disposition of these matters to have a material adverse impact on the Corporation's financial statements.
Item 2. Changes in Securities and Use of Proceeds
None.
Item 3. Defaults Upon Senior Securities
Item 4. Submission of Matters to a Vote of Security Holders
Item 5. Other Information
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits
None
(b) Reports on Form 8-K
Signatures
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
(Registrant)
Date: April 23, 2003
By: /s/ Phillip D. Green
Phillip D. Green
Group Executive Vice President
and Chief Financial Officer
(Duly Authorized Officer and
Principal Accounting Officer)
Certification
I, Richard W. Evans, Jr., certify that:
1. I have reviewed this quarterly report on Form 10-Q of Cullen/Frost Bankers, Inc.;
2. Based on my knowledge, this quarterly report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this quarterly report;
3. Based on my knowledge, the financial statements, and other financial information included in this quarterly report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this quarterly report;
4. The registrant's other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:
(a) Designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this quarterly report is being prepared;
(b) evaluated the effectiveness of the registrant's disclosure controls and procedures as of a date within 90 days prior to the filing date of this quarterly report (the "Evaluation Date"); and
(c) presented in this quarterly report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based on our most recent evaluation, to the registrant's auditors and the audit committee of registrant's board of directors (or persons performing the equivalent function):
(a) All significant deficiencies in the design or operation of internal controls which could adversely affect the registrant's ability to record, process, summarize and report financial data and have identified for the registrant's auditors any material weaknesses in internal controls; and
(b) any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal controls; and
6. The registrant's other certifying officers and I have indicated in this quarterly report whether or not there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses.
/s/ Richard W. Evans, Jr.
Richard W. Evans, Jr.
Chief Executive Officer
April 23, 2003
I, Phillip D. Green, certify that:
/s/ Phillip D. Green
Group Executive Vice President and Chief Financial Officer