XNYS:CFR Cullen/Frost Bankers Inc Quarterly Report 10-Q Filing - 3/31/2012

Effective Date 3/31/2012

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Table of Contents

 

 

United States

Securities and Exchange Commission

Washington, D.C. 20549

Form 10-Q

 

x Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

For the quarterly period ended: March 31, 2012

Or

 

¨ Transition Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

For the transition period from                      to

Commission file number: 001-13221

Cullen/Frost Bankers, Inc.

(Exact name of registrant as specified in its charter)

 

Texas   74-1751768
(State or other jurisdiction of
incorporation or organization)
  (I.R.S. Employer
Identification No.)
100 W. Houston Street, San Antonio, Texas   78205
(Address of principal executive offices)   (Zip code)

(210) 220-4011

(Registrant’s telephone number, including area code)

N/A

(Former name, former address and former fiscal year, if changed since last report)

Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes  x    No  ¨

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes  x    No  ¨

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

 

Large accelerated filer   x    Accelerated filer   ¨
Non-accelerated filer   ¨  (Do not check if a smaller reporting company)    Smaller reporting company   ¨

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act).    Yes  ¨    No  x

As of April 19, 2012, there were 61,372,763 shares of the registrant’s Common Stock, $.01 par value, outstanding.

 

 

 


Table of Contents

Cullen/Frost Bankers, Inc.

Quarterly Report on Form 10-Q

March 31, 2012

Table of Contents

 

     Page  

Part I - Financial Information

  
   Item 1.    Financial Statements (Unaudited)   
      Consolidated Balance Sheets      3   
      Consolidated Statements of Income      4   
      Consolidated Statements of Comprehensive Income      5   
      Consolidated Statements of Changes in Shareholders’ Equity      6   
      Consolidated Statements of Cash Flows      7   
      Notes to Consolidated Financial Statements      8   
   Item 2.    Management’s Discussion and Analysis of Financial Condition and Results of Operations      38   
   Item 3.    Quantitative and Qualitative Disclosures About Market Risk      59   
   Item 4.    Controls and Procedures      60   

Part II - Other Information

  
   Item 1.    Legal Proceedings      61   
   Item 1A.    Risk Factors      61   
   Item 2.    Unregistered Sales of Equity Securities and Use of Proceeds      61   
   Item 3.    Defaults Upon Senior Securities      61   
   Item 4.    Mine Safety Disclosures      61   
   Item 5.    Other Information      61   
   Item 6.    Exhibits      61   

Signatures

     62   

 

2


Table of Contents

Part I. Financial Information

Item 1. Financial Statements (Unaudited)

Cullen/Frost Bankers, Inc.

Consolidated Balance Sheets

(Dollars in thousands, except per share amounts)

 

     March 31,
2012
    December 31,
2011
    March 31,
2011
 

Assets:

      

Cash and due from banks

   $ 623,204      $ 574,039      $ 587,655   

Interest-bearing deposits

     1,497,478        2,314,251        2,101,014   

Federal funds sold and resell agreements

     8,052        19,302        10,002   
  

 

 

   

 

 

   

 

 

 

Total cash and cash equivalents

     2,128,734        2,907,592        2,698,671   

Securities held to maturity, at amortized cost

     365,603        365,996        341,034   

Securities available for sale, at estimated fair value

     8,568,215        7,789,700        5,662,211   

Trading account securities

     16,846        13,609        20,746   

Loans, net of unearned discounts

     8,126,713        7,995,129        8,025,080   

Less: Allowance for loan losses

     (107,181     (110,147     (124,321
  

 

 

   

 

 

   

 

 

 

Net loans

     8,019,532        7,884,982        7,900,759   

Premises and equipment, net

     321,681        319,042        313,233   

Goodwill

     535,560        528,072        527,684   

Other intangible assets, net

     11,033        10,604        13,215   

Cash surrender value of life insurance policies

     135,035        133,967        130,910   

Accrued interest receivable and other assets

     314,942        363,681        333,181   
  

 

 

   

 

 

   

 

 

 

Total assets

   $ 20,417,181      $ 20,317,245      $ 17,941,644   
  

 

 

   

 

 

   

 

 

 

Liabilities:

      

Deposits:

      

Non-interest-bearing demand deposits

   $ 6,784,112      $ 6,672,555      $ 5,413,002   

Interest-bearing deposits

     10,124,909        10,084,193        9,296,557   
  

 

 

   

 

 

   

 

 

 

Total deposits

     16,909,021        16,756,748        14,709,559   

Federal funds purchased and repurchase agreements

     637,098        722,202        553,571   

Junior subordinated deferrable interest debentures

     123,712        123,712        123,712   

Other long-term borrowings

     100,022        100,026        250,040   

Accrued interest payable and other liabilities

     326,615        331,020        207,411   
  

 

 

   

 

 

   

 

 

 

Total liabilities

     18,096,468        18,033,708        15,844,293   

Shareholders’ Equity:

      

Preferred stock, par value $0.01 per share; 10,000,000 shares authorized; none issued

     —          —          —     

Common stock, par value $0.01 per share; 210,000,000 shares authorized; 61,372,763, shares issued at March 31, 2012, 61,271,603 shares issued at December 31, 2011 and 61,244,157 shares issued at March 31, 2011

     614        613        613   

Additional paid-in capital

     688,150        680,803        668,237   

Retained earnings

     1,387,553        1,354,759        1,273,826   

Accumulated other comprehensive income, net of tax

     244,396        247,734        154,818   

Treasury stock, 7,640 shares at December 31, 2011 and 2,464 shares at March 31, 2011, at cost

     —          (372     (143
  

 

 

   

 

 

   

 

 

 

Total shareholders’ equity

     2,320,713        2,283,537        2,097,351   
  

 

 

   

 

 

   

 

 

 

Total liabilities and shareholders’ equity

   $ 20,417,181      $ 20,317,245      $ 17,941,644   
  

 

 

   

 

 

   

 

 

 

See Notes to Consolidated Financial Statements.

 

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Table of Contents

Cullen/Frost Bankers, Inc.

Consolidated Statements of Income

(Dollars in thousands, except per share amounts)

 

     Three Months Ended
March 31,
 
     2012     2011  

Interest income:

    

Loans, including fees

   $ 97,351      $ 98,488   

Securities:

    

Taxable

     36,066        31,185   

Tax-exempt

     22,503        22,733   

Interest-bearing deposits

     930        1,171   

Federal funds sold and resell agreements

     15        16   
  

 

 

   

 

 

 

Total interest income

     156,865        153,593   

Interest expense:

    

Deposits

     4,572        5,951   

Federal funds purchased and repurchase agreements

     34        131   

Junior subordinated deferrable interest debentures

     1,674        1,672   

Other long-term borrowings

     878        4,080   
  

 

 

   

 

 

 

Total interest expense

     7,158        11,834   

Net interest income

     149,707        141,759   

Provision for loan losses

     1,100        9,450   
  

 

 

   

 

 

 

Net interest income after provision for loan losses

     148,607        132,309   

Non-interest income:

    

Trust and investment management fees

     20,652        19,471   

Service charges on deposit accounts

     20,794        21,250   

Insurance commissions and fees

     12,377        10,494   

Interchange and debit card transaction fees

     4,117        8,045   

Other charges, commissions and fees

     7,350        7,228   

Net gain (loss) on securities transactions

     (491     5   

Other

     7,180        5,840   
  

 

 

   

 

 

 

Total non-interest income

     71,979        72,333   

Non-interest expense:

    

Salaries and wages

     63,702        62,430   

Employee benefits

     16,701        15,311   

Net occupancy

     11,797        11,652   

Furniture and equipment

     13,420        12,281   

Deposit insurance

     2,497        4,760   

Intangible amortization

     1,011        1,120   

Other

     32,912        32,507   
  

 

 

   

 

 

 

Total non-interest expense

     142,040        140,061   
  

 

 

   

 

 

 

Income before income taxes

     78,546        64,581   

Income taxes

     17,513        12,653   
  

 

 

   

 

 

 

Net income

   $ 61,033      $ 51,928   
  

 

 

   

 

 

 

Earnings per common share:

    

Basic

   $ 0.99      $ 0.85   

Diluted

     0.99       
0.85
  

See Notes to Consolidated Financial Statements.

 

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Table of Contents

Cullen/Frost Bankers, Inc.

Consolidated Statements of Comprehensive Income

(Dollars in thousands)

 

     Three Months Ended
March 31,
 
     2012     2011  

Net income

   $ 61,033      $ 51,928   

Other comprehensive income (loss), before tax:

    

Securities available for sale:

    

Change in net unrealized gain/loss during the period

     1,882        8,290   

Reclassification adjustment for net (gains) losses included in net income

     491        (5
  

 

 

   

 

 

 

Total securities available for sale

     2,373        8,285   

Defined-benefit post-retirement benefit plans:

    

Change in the net actuarial gain/loss

     1,229        783   

Derivatives:

    

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

     (427     65   

Reclassification adjustments for (gains) losses included in net income:

    

Interest rate swaps on variable-rate loans

     (9,345     (9,345

Interest rate swap on junior subordinated deferrable interest debentures

     1,033        1,086   
  

 

 

   

 

 

 

Total derivatives

     (8,739     (8,194
  

 

 

   

 

 

 

Other comprehensive income (loss), before tax

     (5,137     874   

Deferred tax expense (benefit) related to other comprehensive income

     (1,799     306   
  

 

 

   

 

 

 

Other comprehensive income (loss), net of tax

     (3,338     568   
  

 

 

   

 

 

 

Comprehensive income

   $ 57,695      $ 52,496   
  

 

 

   

 

 

 

See Notes to Consolidated Financial Statements.

 

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Table of Contents

Cullen/Frost Bankers, Inc.

Consolidated Statements of Changes in Shareholders’ Equity

(Dollars in thousands, except per share amounts)

 

     Three Months Ended
March 31,
 
     2012     2011  

Total shareholders’ equity at beginning of period

   $ 2,283,537      $ 2,061,680   

Net income

     61,033        51,928   

Other comprehensive income (loss)

     (3,338     568   

Stock option exercises (108,800 shares in 2012 and 114,293 shares in 2011)

     5,542        5,769   

Stock compensation expense recognized in earnings

     2,555        3,737   

Tax benefits (deficiencies) related to stock compensation

     (377     89   

Purchase of treasury stock (3,464 shares in 2011)

     —          (201

Common stock issued/sold to the 401(k) stock purchase plan (22,680 shares in 2011)

     —          1,360   

Cash dividends ($0.46 per share in 2012 and $0.45 per share in 2011)

     (28,239     (27,579
  

 

 

   

 

 

 

Total shareholders’ equity at end of period

   $ 2,320,713      $ 2,097,351   
  

 

 

   

 

 

 

See Notes to Consolidated Financial Statements.

 

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Table of Contents

Cullen/Frost Bankers, Inc.

Consolidated Statements of Cash Flows

(Dollars in thousands)

 

     Three Months Ended
March 31,
 
     2012     2011  

Operating Activities:

    

Net income

   $ 61,033      $ 51,928   

Adjustments to reconcile net income to net cash from operating activities:

    

Provision for loan losses

     1,100        9,450   

Deferred tax expense (benefit)

     (2,539     (139

Accretion of loan discounts

     (2,962     (2,366

Securities premium amortization (discount accretion), net

     4,539        2,368   

Net (gain) loss on securities transactions

     491        (5

Depreciation and amortization

     9,497        9,191   

Net loss on sale/write-down of assets/foreclosed assets

     477        1,597   

Stock-based compensation

     2,555        3,737   

Net tax benefit (deficiency) from stock-based compensation

     (418     (65

Excess tax benefits from stock-based compensation

     (41     (154

Earnings on life insurance policies

     (1,068     (988

Net change in:

    

Trading account securities

     (3,237     (5,645

Accrued interest receivable and other assets

     41,769        27,621   

Accrued interest payable and other liabilities

     (9,286     (25,293
  

 

 

   

 

 

 

Net cash from operating activities

     101,910        71,237   

Investing Activities:

    

Securities held to maturity:

    

Purchases

     —          (57,547

Maturities, calls and principal repayments

     315        156   

Securities available for sale:

    

Purchases

     (10,984,308     (6,195,353

Sales

     9,985,078        5,547,541   

Maturities, calls and principal repayments

     218,136        148,979   

Net change in loans

     (133,759     75,427   

Net cash paid in acquisitions

     (7,199     —     

Proceeds from sales of premises and equipment

     214        988   

Purchases of premises and equipment

     (8,276     (3,586

Proceeds from sales of repossessed properties

     4,522        3,599   
  

 

 

   

 

 

 

Net cash from investing activities

     (925,277     (479,796

Financing Activities:

    

Net change in deposits

     152,273        230,217   

Net change in short-term borrowings

     (85,104     77,898   

Principal payments on long-term borrowings

     (4     (5

Proceeds from stock option exercises

     5,542        5,769   

Excess tax benefits from stock-based compensation

     41        154   

Purchase of treasury stock

     —          (201

Cash dividends paid

     (28,239     (27,579
  

 

 

   

 

 

 

Net cash from financing activities

     44,509        286,253   
  

 

 

   

 

 

 

Net change in cash and cash equivalents

     (778,858     (122,306

Cash and equivalents at beginning of period

     2,907,592        2,820,977   
  

 

 

   

 

 

 

Cash and equivalents at end of period

   $ 2,128,734      $ 2,698,671   
  

 

 

   

 

 

 

See Notes to Consolidated Financial Statements.

 

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Table of Contents

Cullen/Frost Bankers, Inc.

Notes to Consolidated Financial Statements

(Table amounts in thousands, except for share and per share amounts)

Note 1 - Significant Accounting Policies

Nature of Operations. Cullen/Frost Bankers, Inc. (Cullen/Frost) is a financial holding company and a bank holding company headquartered in San Antonio, Texas that provides, through its subsidiaries, a broad array of products and services throughout numerous Texas markets. In addition to general commercial and consumer banking, other products and services offered include trust and investment management, investment banking, insurance, brokerage, leasing, asset-based lending, treasury management and item processing.

Basis of Presentation. The consolidated financial statements in this Quarterly Report on Form 10-Q include the accounts of Cullen/Frost and all other entities in which Cullen/Frost has a controlling financial interest (collectively referred to as the “Corporation”). All significant intercompany balances and transactions have been eliminated in consolidation. The accounting and financial reporting policies the Corporation follows conform, in all material respects, to accounting principles generally accepted in the United States and to general practices within the financial services industry.

The consolidated financial statements in this Quarterly Report on Form 10-Q have not been audited by an independent registered public accounting firm, but in the opinion of management, reflect all adjustments necessary for a fair presentation of the Corporation’s financial position and results of operations. All such adjustments were of a normal and recurring nature. The consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States for interim financial information and with the instructions to Form 10-Q adopted by the Securities and Exchange Commission (SEC). Accordingly, the financial statements do not include all of the information and footnotes required by accounting principles generally accepted in the United States for complete financial statements and should be read in conjunction with the Corporation’s consolidated financial statements, and notes thereto, for the year ended December 31, 2011, included in the Corporation’s Annual Report on Form 10-K filed with the SEC on February 3, 2012 (the “2011 Form 10-K”). Operating results for the interim periods disclosed herein are not necessarily indicative of the results that may be expected for a full year or any future period.

Use of Estimates. The preparation of financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements. Actual results could differ from those estimates. The allowance for loan losses, the fair value of stock-based compensation awards, the fair values of financial instruments and the status of contingencies are particularly subject to change.

Cash Flow Reporting. Additional cash flow information was as follows:

 

      Three Months Ended
March 31,
 
     2012      2011  

Cash paid for interest

   $ 9,377       $ 16,634   

Cash paid for income tax

     —           —     

Significant non-cash transactions:

     

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

     1,071         7,434   

Common stock/treasury stock issued to the Corporation’s 401(k) stock purchase plan

     —           1,360   

Reclassifications. Certain items in prior financial statements have been reclassified to conform to the current presentation. Mutual fund investment management fees previously reported as a component of other charges, commissions and fees are now included with trust fees and reported as trust and investment management fees in the consolidated statements of income. Additionally, interchange and debit card transaction fees (including automated teller machine fees) previously reported as components of service charges on deposit accounts; other charges, commissions and fees; or other non-interest income are now reported as interchange and debit card transaction fees in the consolidated statements of income.

 

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Note 2 - Securities

A summary of the amortized cost and estimated fair value of securities, excluding trading securities, is presented below.

 

     March 31, 2012      December 31, 2011  
     Amortized
Cost
     Gross
Unrealized
Gains
     Gross
Unrealized
Losses
     Estimated
Fair Value
     Amortized
Cost
     Gross
Unrealized
Gains
     Gross
Unrealized
Losses
     Estimated
Fair Value
 

Held to Maturity

                       

U. S. Treasury

   $ 247,893       $ 29,275       $ —         $ 277,168       $ 247,797       $ 31,715       $ —         $ 279,512   

Residential mortgage-backed securities

     11,547         178         —           11,725         11,874         153         —           12,027   

States and political subdivisions

     105,163         7,773         —           112,936         105,325         6,597         —           111,922   

Other

     1,000         —           —           1,000         1,000         —           —           1,000   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 365,603       $ 37,226       $ —         $ 402,829       $ 365,996       $ 38,465       $ —         $ 404,461   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Available for Sale:

                       

U. S. Treasury

   $ 3,018,660       $ 29,607       $ 219       $ 3,048,048       $ 2,020,621       $ 36,111       $ —         $ 2,056,732   

U.S. government agencies/corporations

     250,000         782         —           250,782         250,000         884         —           250,884   

Residential mortgage-backed securities

     2,967,744         156,222         1         3,123,965         3,135,064         154,386         180         3,289,270   

States and political subdivisions

     1,942,118         165,320         27         2,107,411         1,996,703         158,133         23         2,154,813   

Other

     38,009         —           —           38,009         38,001         —           —           38,001   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 8,216,531       $ 351,931       $ 247       $ 8,568,215       $ 7,440,389       $ 349,514       $ 203       $ 7,789,700   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

All mortgage-backed securities included in the above table were issued by U.S. government agencies and corporations. Securities with limited marketability, such as stock in the Federal Reserve Bank and the Federal Home Loan Bank, are carried at cost and are reported as other available for sale securities in the above table. The carrying value of securities pledged to secure public funds, trust deposits, repurchase agreements and for other purposes, as required or permitted by law was $2.2 billion at March 31, 2012 and $2.4 billion and December 31, 2011.

As of March 31, 2012, securities, with unrealized losses segregated by length of impairment, were as follows:

 

     Less than 12 Months      More than 12 Months      Total  
     Estimated      Unrealized      Estimated      Unrealized      Estimated      Unrealized  
     Fair Value      Losses      Fair Value      Losses      Fair Value      Losses  

Available for Sale

                 

U.S. Treasury

   $ 250,332       $ 219       $ —         $ —         $ 250,332       $ 219   

Residential mortgage-backed securities

     16         —           49         1         65         1   

States and political subdivisions

     2,225         27         —           —           2,225         27   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 252,573       $ 246       $ 49       $ 1       $ 252,622       $ 247   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Declines in the fair value of held-to-maturity and available-for-sale securities below their cost that are deemed to be other than temporary are reflected in earnings as realized losses to the extent the impairment is related to credit losses. The amount of the impairment related to other factors is recognized in other comprehensive income. In estimating other-than-temporary impairment losses, management considers, among other things, (i) the length of time and the extent to which the fair value has been less than cost, (ii) the financial condition and near-term prospects of the issuer, and (iii) the intent and ability of the Corporation to retain its investment in the issuer for a period of time sufficient to allow for any anticipated recovery in cost.

Management has the ability and intent to hold the securities classified as held to maturity in the table above until they mature, at which time the Corporation will receive full value for the securities. Furthermore, as of March 31, 2012, management does not have the intent to sell any of the securities classified as available for sale in the table above and believes that it is more likely than not that the Corporation will not have to sell any such securities before a recovery of cost. Any unrealized losses are largely due to increases in market interest rates over the yields available at the time the underlying securities were purchased. The fair value is expected to recover as the bonds approach their maturity date or repricing date or if market yields for such investments decline. Management does not believe any of the securities are impaired due to reasons of credit quality. Accordingly, as of March 31, 2012, management believes the impairments detailed in the table above are temporary and no impairment loss has been realized in the Corporation’s consolidated income statement.

 

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The amortized cost and estimated fair value of securities, excluding trading securities, at March 31, 2012 are presented below by contractual maturity. Expected maturities may differ from contractual maturities because issuers may have the right to call or prepay obligations. Residential mortgage-backed securities and equity securities are shown separately since they are not due at a single maturity date.

 

$0,000,000 $0,000,000 $0,000,000 $0,000,000
     Held to Maturity      Available for Sale  
     Amortized
Cost
     Estimated
Fair Value
     Amortized
Cost
     Estimated
Fair Value
 

Due in one year or less

   $ 1,000       $ 1,000       $ 14,850       $ 15,125   

Due after one year through five years

     247,893         277,168         3,360,602         3,396,548   

Due after five years through ten years

     3,320         3,623         208,835         224,491   

Due after ten years

     101,843         109,313         1,626,491         1,770,077   

Residential mortgage-backed securities

     11,547         11,725         2,967,744         3,123,965   

Equity securities

     —           —           38,009         38,009   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 365,603       $ 402,829       $ 8,216,531       $ 8,568,215   
  

 

 

    

 

 

    

 

 

    

 

 

 

Sales of securities available for sale were as follows:

 

$0,000,000 $0,000,000
     Three Months Ended
March 31,
 
     2012     2011  

Proceeds from sales

   $     9,985,078      $ 5,547,541   

Gross realized gains

     2,137        9   

Gross realized losses

     (2,628     (4

Tax (expense) benefit of securities gains/losses

     172        (2

Trading account securities, at estimated fair value, were as follows:

 

$0,000,000 $0,000,000
     March 31,     December 31,  
     2012     2011  

U.S. Treasury

   $ 13,409      $ 13,609   

States and political subdivisions

     3,437        —     
  

 

 

   

 

 

 

Total

   $ 16,846      $ 13,609   
  

 

 

   

 

 

 

Net gains and losses on trading account securities were as follows:

 

$0,000,000 $0,000,000
      Three Months Ended
March 31,
 
     2012     2011  

Net gain on sales transactions

   $ 323      $ 308   

Net mark-to-market gains (losses)

     (60     —     
  

 

 

   

 

 

 

Net gain on trading account securities

   $ 263      $ 308   
  

 

 

   

 

 

 

 

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Note 3 - Loans

Loans were as follows:

 

     March 31,     Percentage     December 31,     Percentage     March 31,     Percentage  
     2012     of Total     2011     of Total     2011     of Total  

Commercial and industrial:

            

Commercial

   $ 3,709,450        45.7   $ 3,553,989        44.5   $ 3,393,769        42.3

Leases

     193,162        2.4        193,412        2.4        194,692        2.4   

Asset-based

     140,240        1.7        169,466        2.1        134,783        1.7   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total commercial and industrial

     4,042,852        49.8        3,916,867        49.0        3,723,244        46.4   

Commercial real estate:

            

Commercial mortgages

     2,357,206        29.0        2,383,479        29.8        2,410,760        30.0   

Construction

     493,600        6.1        434,870        5.5        574,637        7.2   

Land

     184,078        2.2        202,478        2.5        227,297        2.8   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total commercial real estate

     3,034,884        37.3        3,020,827        37.8        3,212,694        40.0   

Consumer real estate:

            

Home equity loans

     288,961        3.6        282,244        3.5        274,952        3.4   

Home equity lines of credit

     190,371        2.4        191,960        2.4        187,573        2.3   

1-4 family residential mortgages

     43,284        0.5        45,943        0.6        53,587        0.7   

Construction

     18,910        0.2        17,544        0.2        23,504        0.3   

Other

     219,760        2.7        225,118        2.8        244,752        3.1   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total consumer real estate

     761,286        9.4        762,809        9.5        784,368        9.8   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total real estate

     3,796,170        46.7        3,783,636        47.3        3,997,062        49.8   

Consumer and other:

            

Consumer installment

     296,057        3.6        301,518        3.8        307,812        3.9   

Other

     8,415        0.1        11,018        0.1        17,310        0.2   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total consumer and other

     304,472        3.7        312,536        3.9        325,122        4.1   

Unearned discounts

     (16,781     (0.2     (17,910     (0.2     (20,348     (0.3
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total loans

   $ 8,126,713        100.0   $ 7,995,129        100.0   $ 8,025,080        100.0
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Loan Origination/Risk Management. The Corporation has certain lending policies and procedures in place that are designed to maximize loan income within an acceptable level of risk. Management reviews and approves these policies and procedures on a regular basis. A reporting system supplements the review process by providing management with frequent reports related to loan production, loan quality, concentrations of credit, loan delinquencies and non-performing and potential problem loans. Diversification in the loan portfolio is a means of managing risk associated with fluctuations in economic conditions.

Commercial and industrial loans are underwritten after evaluating and understanding the borrower’s ability to operate profitably and prudently expand its business. Underwriting standards are designed to promote relationship banking rather than transactional banking. Once it is determined that the borrower’s management possesses sound ethics and solid business acumen, the Corporation’s management examines current and projected cash flows to determine the ability of the borrower to repay their obligations as agreed. Commercial and industrial loans are primarily made based on the identified cash flows of the borrower and secondarily on the underlying collateral provided by the borrower. The cash flows of borrowers, however, may not be as expected and the collateral securing these loans may fluctuate in value. Most commercial and industrial loans are secured by the assets being financed or other business assets such as accounts receivable or inventory and may incorporate a personal guarantee; however, some short-term loans may be made on an unsecured basis. In the case of loans secured by accounts receivable, the availability of funds for the repayment of these loans may be substantially dependent on the ability of the borrower to collect amounts due from its customers.

Commercial real estate loans are subject to underwriting standards and processes similar to commercial and industrial loans, in addition to those of real estate loans. These loans are viewed primarily as cash flow loans and secondarily as loans secured by real estate. Commercial real estate lending typically involves higher loan principal amounts and the repayment of these loans is generally largely dependent on the successful operation of the property securing the loan or the business conducted on the property securing the loan. Commercial real estate loans may be more adversely affected by conditions in the real estate markets or in the general economy. The properties securing the Corporation’s commercial real estate portfolio are diverse in terms of type and geographic location. This diversity helps reduce the Corporation’s exposure to adverse economic events that affect any single market or industry. Management monitors and evaluates commercial real estate loans based on collateral, geography and risk grade criteria. As a general rule, the Corporation avoids financing single-purpose

 

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projects unless other underwriting factors are present to help mitigate risk. The Corporation also utilizes third-party experts to provide insight and guidance about economic conditions and trends affecting market areas it serves. In addition, management tracks the level of owner-occupied commercial real estate loans versus non-owner occupied loans. At March 31, 2012, approximately 58% of the outstanding principal balance of the Corporation’s commercial real estate loans were secured by owner-occupied properties.

With respect to loans to developers and builders that are secured by non-owner occupied properties that the Corporation may originate from time to time, the Corporation generally requires the borrower to have had an existing relationship with the Corporation and have a proven record of success. Construction loans are underwritten utilizing feasibility studies, independent appraisal reviews, sensitivity analysis of absorption and lease rates and financial analysis of the developers and property owners. Construction loans are generally based upon estimates of costs and value associated with the complete project. These estimates may be inaccurate. Construction loans often involve the disbursement of substantial funds with repayment substantially dependent on the success of the ultimate project. Sources of repayment for these types of loans may be pre-committed permanent loans from approved long-term lenders, sales of developed property or an interim loan commitment from the Corporation until permanent financing is obtained. These loans are closely monitored by on-site inspections and are considered to have higher risks than other real estate loans due to their ultimate repayment being sensitive to interest rate changes, governmental regulation of real property, general economic conditions and the availability of long-term financing.

The Corporation originates consumer loans utilizing a computer-based credit scoring analysis to supplement the underwriting process. To monitor and manage consumer loan risk, policies and procedures are developed and modified, as needed, jointly by line and staff personnel. This activity, coupled with relatively small loan amounts that are spread across many individual borrowers, minimizes risk. Additionally, trend and outlook reports are reviewed by management on a regular basis. Underwriting standards for home equity loans are heavily influenced by statutory requirements, which include, but are not limited to, a maximum loan-to-value percentage of 80%, collection remedies, the number of such loans a borrower can have at one time and documentation requirements.

The Corporation maintains an independent loan review department that reviews and validates the credit risk program on a periodic basis. Results of these reviews are presented to management. The loan review process complements and reinforces the risk identification and assessment decisions made by lenders and credit personnel, as well as the Corporation’s policies and procedures.

Concentrations of Credit. Most of the Corporation’s lending activity occurs within the State of Texas, including the four largest metropolitan areas of Austin, Dallas/Ft. Worth, Houston and San Antonio, as well as other markets. The majority of the Corporation’s loan portfolio consists of commercial and industrial and commercial real estate loans. Other than energy loans, as of March 31, 2012 there were no concentrations of loans related to any single industry in excess of 10% of total loans.

Foreign Loans. The Corporation has U.S. dollar denominated loans and commitments to borrowers in Mexico. The outstanding balance of these loans and the unfunded amounts available under these commitments were not significant at March 31, 2012 or December 31, 2011.

Non-Accrual and Past Due Loans. Loans are considered past due if the required principal and interest payments have not been received as of the date such payments were due. Loans are placed on non-accrual status when, in management’s opinion, the borrower may be unable to meet payment obligations as they become due, as well as when required by regulatory provisions. In determining whether or not a borrower may be unable to meet payment obligations for each class of loans, the Corporation considers the borrower’s debt service capacity through the analysis of current financial information, if available, and/or current information with regards to the Corporation’s collateral position. Regulatory provisions would typically require the placement of a loan on non-accrual status if (i) principal or interest has been in default for a period of 90 days or more unless the loan is both well secured and in the process of collection or (ii) full payment of principal and interest is not expected. Loans may be placed on non-accrual status regardless of whether or not such loans are considered past due. When interest accrual is discontinued, all unpaid accrued interest is reversed. Interest income on non-accrual loans is recognized only to the extent that cash payments are received in excess of principal due. A loan may be returned to accrual status when all the principal and interest amounts contractually due are brought current and future principal and interest amounts contractually due are reasonably assured, which is typically evidenced by a sustained period (at least six months) of repayment performance by the borrower.

 

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Non-accrual loans, segregated by class of loans, were as follows:

 

     March 31,      December 31,      March 31,  
     2012      2011      2011  

Commercial and industrial:

        

Energy

   $ —         $ —         $ —     

Other commercial

     49,588         43,874         58,681   

Commercial real estate:

        

Buildings, land and other

     41,892         43,820         53,920   

Construction

     1,285         1,329         6,888   

Consumer real estate

     4,322         4,587         3,741   

Consumer and other

     783         728         581   
  

 

 

    

 

 

    

 

 

 

Total

   $ 97,870       $ 94,338       $ 123,811   
  

 

 

    

 

 

    

 

 

 

Had non-accrual loans performed in accordance with their original contract terms, the Corporation would have recognized additional interest income, net of tax, of approximately $642 thousand for the three months ended March 31, 2012, compared to $1.3 million for the same period in 2011.

An age analysis of past due loans (including both accruing and non-accruing loans), segregated by class of loans, as of March 31, 2012 was as follows:

 

     Loans
30-89 Days

Past Due
     Loans
90 or  More
Days
Past Due
     Total
Past Due

Loans
     Current
Loans
    Total
Loans
    Accruing
Loans 90 or

More Days
Past Due
 

Commercial and industrial:

               

Energy

   $ —         $ —         $ —         $ 994,979      $ 994,979      $ —     

Other commercial

     13,297         21,651         34,948         3,012,925        3,047,873        6,805   

Commercial real estate:

               

Buildings, land and other

     23,678         24,308         47,986         2,493,298        2,541,284        9,473   

Construction

     1,247         1,791         3,038         490,562        493,600        1,743   

Consumer real estate

     5,565         4,504         10,069         751,217        761,286        2,408   

Consumer and other

     3,547         288         3,835         300,637        304,472        189   

Unearned discounts

     —           —           —           (16,781     (16,781     —     
  

 

 

    

 

 

    

 

 

    

 

 

   

 

 

   

 

 

 

Total

   $ 47,334       $ 52,542       $ 99,876       $ 8,026,837      $ 8,126,713      $ 20,618   
  

 

 

    

 

 

    

 

 

    

 

 

   

 

 

   

 

 

 

Impaired Loans. Loans are considered impaired when, based on current information and events, it is probable the Corporation will be unable to collect all amounts due in accordance with the original contractual terms of the loan agreement, including scheduled principal and interest payments. Impairment is evaluated in total for smaller-balance loans of a similar nature and on an individual loan basis for other loans. If a loan is impaired, a specific valuation allowance is allocated, if necessary, so that the loan is reported net, at the present value of estimated future cash flows using the loan’s existing rate or at the fair value of collateral if repayment is expected solely from the collateral. Interest payments on impaired loans are typically applied to principal unless collectibility of the principal amount is reasonably assured, in which case interest is recognized on a cash basis. Impaired loans, or portions thereof, are charged off when deemed uncollectible.

Regulatory guidelines require the Corporation to reevaluate the fair value of collateral supporting impaired collateral dependent loans on at least an annual basis. While the Corporation’s policy is to comply with the regulatory guidelines, the Corporation’s general practice is to reevaluate the fair value of collateral supporting impaired collateral dependent loans on a quarterly basis. Thus, appraisals are never considered to be outdated, and the Corporation does not need to make any adjustments to the appraised values. The fair value of collateral supporting impaired collateral dependent loans is evaluated by the Corporation’s internal appraisal services using a methodology that is consistent with the Uniform Standards of Professional Appraisal Practice. The fair value of collateral supporting impaired collateral dependent construction loans is based on an “as is” valuation.

 

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Impaired loans are set forth in the following table. No interest income was recognized on impaired loans subsequent to their classification as impaired.

 

     Unpaid      Recorded      Recorded                    Average Recorded  
     Contractual      Investment      Investment      Total             Investment  
     Principal      With No      With      Recorded      Related      Quarter      Year  
     Balance      Allowance      Allowance      Investment      Allowance      To Date      To Date  

March 31, 2012

                    

Commercial and industrial:

                    

Energy

   $ —         $ —         $ —         $ —         $ —         $ —         $ —     

Other commercial

     55,632         28,932         15,804         44,736         5,356         42,034         42,034   

Commercial real estate:

                    

Buildings, land and other

     47,077         36,821         2,243         39,064         1,113         39,996         39,996   

Construction

     1,551         1,237         —           1,237         —           1,259         1,259   

Consumer real estate

     2,623         1,826         751         2,577         95         2,524         2,524   

Consumer and other

     547         535         —           535         —           544         544   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 107,430       $ 69,351       $ 18,798       $ 88,149       $ 6,564       $ 86,357       $ 86,357   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

December 31, 2011

                    

Commercial and industrial:

                    

Energy

   $ —         $ —         $ —         $ —         $ —         $ —         $ —     

Other commercial

     57,723         34,712         4,619         39,331         2,696         46,151         53,830   

Commercial real estate:

                    

Buildings, land and other

     51,163         38,686         2,243         40,929         1,113         41,522         48,635   

Construction

     1,568         1,281         —           1,281         —           1,527         4,339   

Consumer real estate

     2,499         1,719         751         2,470         95         2,484         1,845   

Consumer and other

     562         554         —           554         —           561         265   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 113,515       $ 76,952       $ 7,613       $ 84,565       $ 3,904       $ 92,245       $ 108,914   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

March 31, 2011

                    

Commercial and industrial:

                    

Energy

   $ —         $ —         $ —         $ —         $ —         $ —         $ —     

Other commercial

     70,411         27,742         25,245         52,987         13,066         54,215         54,215   

Commercial real estate:

                    

Buildings, land and other

     62,993         42,021         9,515         51,536         3,626         56,671         56,671   

Construction

     7,124         6,587         —           6,587         —           7,944         7,944   

Consumer real estate

     1,786         1,786         —           1,786         —           1,152         1,152   

Consumer and other

     102         101         —           101         —           51         51   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 142,416       $ 78,237       $ 34,760       $ 112,997       $ 16,692       $ 120,033       $ 120,033   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Troubled Debt Restructurings. The restructuring of a loan is considered a “troubled debt restructuring” if both (i) the borrower is experiencing financial difficulties and (ii) the creditor has granted a concession. Concessions may include interest rate reductions or below market interest rates, principal forgiveness, restructuring amortization schedules and other actions intended to minimize potential losses.

There were no troubled debt restructurings during the three months ended March 31, 2012. During the three months ended March 31, 2011, the Corporation had troubled debt restructurings of commercial real estate loans with an aggregate restructuring date balance of $4.2 million. All of the loans identified as troubled debt restructurings by the Corporation during the three months ended March 31, 2011 were previously on non-accrual status and reported as impaired loans prior to restructuring. The modifications primarily related to extending the amortization periods of the loans. The Corporation did not grant interest-rate concessions on any restructured loan. All loans restructured during the reported periods were on non-accrual status as of the end of those periods. Because the loans were classified and on non-accrual status both before and after restructuring, the modifications did not impact the Corporation’s determination of the allowance for loan losses. During the three months ended March 31, 2012, defaults on loans restructured during 2011 were not significant and such defaults did not significantly impact the Corporation’s determination of the allowance for loan losses.

 

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Credit Quality Indicators. As part of the on-going monitoring of the credit quality of the Corporation’s loan portfolio, management tracks certain credit quality indicators including trends related to (i) the weighted-average risk grade of commercial loans, (ii) the level of classified commercial loans, (iii) the delinquency status of consumer loans (see details above) (iv) net charge-offs, (v) non-performing loans (see details above) and (vi) the general economic conditions in the State of Texas.

The Corporation utilizes a risk grading matrix to assign a risk grade to each of its commercial loans. Loans are graded on a scale of 1 to 14. A description of the general characteristics of the 14 risk grades is as follows:

 

   

Grades 1, 2 and 3 - These grades include loans to very high credit quality borrowers of investment or near investment grade. These borrowers are generally publicly traded (grades 1 and 2), have significant capital strength, moderate leverage, stable earnings and growth, and readily available financing alternatives. Smaller entities, regardless of strength, would generally not fit in these grades.

 

   

Grades 4 and 5 - These grades include loans to borrowers of solid credit quality with moderate risk. Borrowers in these grades are differentiated from higher grades on the basis of size (capital and/or revenue), leverage, asset quality and the stability of the industry or market area.

 

   

Grades 6, 7 and 8 - These grades include “pass grade” loans to borrowers of acceptable credit quality and risk. Such borrowers are differentiated from Grades 4 and 5 in terms of size, secondary sources of repayment or they are of lesser stature in other key credit metrics in that they may be over-leveraged, under capitalized, inconsistent in performance or in an industry or an economic area that is known to have a higher level of risk, volatility, or susceptibility to weaknesses in the economy.

 

   

Grade 9 - This grade includes loans on management’s “watch list” and is intended to be utilized on a temporary basis for pass grade borrowers where a significant risk-modifying action is anticipated in the near term.

 

   

Grade 10 – This grade is for “Other Assets Especially Mentioned” in accordance with regulatory guidelines. This grade is intended to be temporary and includes loans to borrowers whose credit quality has clearly deteriorated and are at risk of further decline unless active measures are taken to correct the situation.

 

   

Grade 11 - This grade includes “Substandard” loans, in accordance with regulatory guidelines, for which the accrual of interest has not been stopped. By definition under regulatory guidelines, a “Substandard” loan has defined weaknesses which make payment default or principal exposure likely, but not yet certain. Such loans are apt to be dependent upon collateral liquidation, a secondary source of repayment or an event outside of the normal course of business.

 

   

Grade 12 - This grade includes “Substandard” loans, in accordance with regulatory guidelines, for which the accrual of interest has been stopped. This grade includes loans where interest is more than 120 days past due and not fully secured and loans where a specific valuation allowance may be necessary, but generally does not exceed 30% of the principal balance.

 

   

Grade 13 - This grade includes “Doubtful” loans in accordance with regulatory guidelines. Such loans are placed on non-accrual status and may be dependent upon collateral having a value that is difficult to determine or upon some near-term event which lacks certainty. Additionally, these loans generally have a specific valuation allowance in excess of 30% of the principal balance.

 

   

Grade 14 - This grade includes “Loss” loans in accordance with regulatory guidelines. Such loans are to be charged-off or charged-down when payment is acknowledged to be uncertain or when the timing or value of payments cannot be determined. “Loss” is not intended to imply that the loan or some portion of it will never be paid, nor does it in any way imply that there has been a forgiveness of debt.

 

15


Table of Contents

In monitoring credit quality trends in the context of assessing the appropriate level of the allowance for loan losses, the Corporation monitors portfolio credit quality by the weighted-average risk grade of each class of commercial loan. Individual relationship managers review updated financial information for all pass grade loans to recalculate the risk grade on at least an annual basis. When a loan has a calculated risk grade of 9, it is still considered a pass grade loan; however, it is considered to be on management’s “watch list,” where a significant risk-modifying action is anticipated in the near term. When a loan has a calculated risk grade of 10 or higher, a special assets officer monitors the loan on an on-going basis. The following table presents weighted average risk grades for all commercial loans by class.

 

     March 31, 2012      December 31, 2011      March 31, 2011  
     Weighted             Weighted             Weighted         
     Average             Average             Average         
     Risk Grade      Loans      Risk Grade      Loans      Risk Grade      Loans  

Commercial and industrial:

                 

Energy

                 

Risk grades 1-8

     5.37       $ 992,463         5.21       $ 868,561         5.35       $ 760,093   

Risk grade 9

     9.00         2,516         9.00         2,025         9.00         1,477   

Risk grade 10

     10.00         —           10.00         —           10.00         —     

Risk grade 11

     11.00         —           11.00         —           11.00         —     

Risk grade 12

     12.00         —           12.00         —           12.00         —     

Risk grade 13

     13.00         —           13.00         —           13.00         —     
     

 

 

       

 

 

       

 

 

 

Total energy

     5.38       $ 994,979         5.22       $ 870,586         5.36       $ 761,570   
     

 

 

       

 

 

       

 

 

 

Other commercial

                 

Risk grades 1-8

     6.20       $ 2,803,976         6.20       $ 2,802,037         6.22       $ 2,590,198   

Risk grade 9

     9.00         65,376         9.00         55,105         9.00         101,576   

Risk grade 10

     10.00         35,504         10.00         49,982         10.00         98,865   

Risk grade 11

     11.00         93,415         11.00         96,046         11.00         111,514   

Risk grade 12

     12.00         44,520         12.00         39,826         12.00         35,636   

Risk grade 13

     13.00         5,082         13.00         3,285         13.00         23,885   
     

 

 

       

 

 

       

 

 

 

Total other commercial

     6.55       $ 3,047,873         6.55       $ 3,046,281         6.75       $ 2,961,674   
     

 

 

       

 

 

       

 

 

 

Commercial real estate:

                 

Buildings, land and other

                 

Risk grades 1-8

     6.67       $ 2,233,155         6.69       $ 2,266,576         6.71       $ 2,253,835   

Risk grade 9

     9.00         104,727         9.00         103,894         9.00         138,117   

Risk grade 10

     10.00         33,641         10.00         45,278         10.00         79,306   

Risk grade 11

     11.00         127,869         11.00         126,594         11.00         101,357   

Risk grade 12

     12.00         40,486         12.00         41,747         12.00         58,064   

Risk grade 13

     13.00         1,406         13.00         1,868         13.00         7,378   
     

 

 

       

 

 

       

 

 

 

Total commercial real estate

     7.12       $ 2,541,284         7.14       $ 2,585,957         7.23       $ 2,638,057   
     

 

 

       

 

 

       

 

 

 

Construction

                 

Risk grades 1-8

     6.97       $ 454,674         6.95       $ 378,530         7.15       $ 497,355   

Risk grade 9

     9.00         16,062         9.00         30,376         9.00         28,173   

Risk grade 10

     10.00         15,442         10.00         16,186         10.00         30,128   

Risk grade 11

     11.00         6,137         11.00         8,449         11.00         12,170   

Risk grade 12

     12.00         1,285         12.00         1,329         12.00         6,587   

Risk grade 13

     13.00         —           13.00         —           13.00         —     

Risk grade 14

     14.00         —           14.00         —           14.00         224   
     

 

 

       

 

 

       

 

 

 

Total construction

     7.19       $ 493,600         7.30       $ 434,870         7.53       $ 574,637   
     

 

 

       

 

 

       

 

 

 

The Corporation has established maximum loan to value standards to be applied during the origination process of commercial and consumer real estate loans. The Corporation does not subsequently monitor loan-to-value ratios (either individually or on a weighted-average basis) for loans that are subsequently considered to be of a pass grade (grades 9 or better) and/or current with respect to principal and interest payments. As stated above, when an individual commercial real estate loan has a calculated risk grade of 10 or higher, a special assets officer analyzes the loan to determine whether the loan is impaired. At that time, the Corporation reassesses the loan to value position in the loan. If the loan is determined to be collateral dependent, specific allocations of the allowance for loan losses are made for the amount of any collateral deficiency. If a collateral deficiency is ultimately deemed to be uncollectible, the amount is charged-off. These loans and related assessments of collateral position are monitored on an individual, case-by-case basis. The Corporation does not monitor loan-to-value ratios on a weighted-average basis for commercial real estate loans having a calculated risk grade of 10 or higher. Nonetheless, there were five commercial real estate loans having a calculated risk grade of 10 or higher in excess

 

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of $5 million as of March 31, 2012. Four of the loans totaled $42.1million and had a weighted-average loan-to-value ratio of 73.3%. The fifth loan, totaling $6.0 million, is structured as a borrowing base facility secured by numerous rotating lots and single family residences that generally have a loan-to-value of 80% or less. When an individual consumer real estate loan becomes past due by more than 10 days, the assigned relationship manager will begin collection efforts. The Corporation only reassesses the loan to value position in a consumer real estate loan if, during the course of the collections process, it is determined that the loan has become collateral dependent, and any collateral deficiency is recognized as a charge-off to the allowance for loan losses. Accordingly, the Corporation does not monitor loan-to-value ratios on a weighted-average basis for collateral dependent consumer real estate loans.

Generally, a commercial loan, or a portion thereof, is charged-off immediately when it is determined, through the analysis of any available current financial information with regards to the borrower, that the borrower is incapable of servicing unsecured debt, there is little or no prospect for near term improvement and no realistic strengthening action of significance is pending or, in the case of secured debt, when it is determined, through analysis of current information with regards to the Corporation’s collateral position, that amounts due from the borrower are in excess of the calculated current fair value of the collateral. Notwithstanding the foregoing, generally, commercial loans that become past due 180 cumulative days are classified as a loss and charged-off. Generally, a consumer loan, or a portion thereof, is charged-off in accordance with regulatory guidelines which provide that such loans be charged-off when the Corporation becomes aware of the loss, such as from a triggering event that may include new information about a borrower’s intent/ability to repay the loan, bankruptcy, fraud or death, among other things, but in no case should the charge-off exceed specified delinquency timeframes. Such delinquency timeframes state that closed-end retail loans (loans with pre-defined maturity dates, such as real estate mortgages, home equity loans and consumer installment loans) that become past due 120 cumulative days and open-end retail loans (loans that roll-over at the end of each term, such as home equity lines of credit) that become past due 180 cumulative days should be classified as a loss and charged-off.

Net (charge-offs)/recoveries, segregated by class of loans, were as follows:

 

      Three Months Ended
March 31,
 
     2012     2011  

Commercial and industrial:

    

Energy

   $ 4      $ —     

Other commercial

     (1,675     (6,830

Commercial real estate:

    

Buildings, land and other

     (2,360     (3,165

Construction

     10        (156

Consumer real estate

     234        (530

Consumer and other

     (279     (764
  

 

 

   

 

 

 

Total

   $ (4,066   $ (11,445
  

 

 

   

 

 

 

In assessing the general economic conditions in the State of Texas, management monitors and tracks the Texas Leading Index (“TLI”), which is produced by the Federal Reserve Bank of Dallas. The TLI is a single summary statistic that is designed to signal the likelihood of the Texas economy’s transition from expansion to recession and vice versa. Management believes this index provides a reliable indication of the direction of overall credit quality. The TLI is a composite of the following eight leading indicators: (i) Texas Value of the Dollar, (ii) U.S. Leading Index, (iii) real oil prices (iv) well permits, (v) initial claims for unemployment insurance, (vi) Texas Stock Index, (vii) Help-Wanted Index and (viii) average weekly hours worked in manufacturing. The TLI totaled 122.8 at February 28, 2012 (most recent date available), 120.4 at December 31, 2011 and 122.0 at March 31, 2011. A higher TLI value implies more favorable economic conditions.

Allowance for Loan Losses. The allowance for loan losses is a reserve established through a provision for loan losses charged to expense, which represents management’s best estimate of probable losses that have been incurred within the existing portfolio of loans. The allowance, in the judgment of management, is necessary to reserve for estimated loan losses and risks inherent in the loan portfolio. The Corporation’s allowance for loan loss methodology follows the accounting guidance set forth in U.S. generally accepted accounting principles and the Interagency Policy Statement on the Allowance for Loan and Lease Losses, which was jointly issued by the Corporation’s regulatory agencies. In that regard, the Corporation’s allowance for loan losses includes allowance allocations calculated in accordance with ASC Topic 310, “Receivables” and allowance allocations calculated in accordance with ASC Topic 450, “Contingencies.” Accordingly, the methodology is based on historical loss experience by type of credit and internal risk grade, specific homogeneous risk pools and specific loss allocations, with adjustments for current events and conditions. The Corporation’s process for determining the appropriate level of the allowance for loan losses is designed to account for credit deterioration as it occurs. The provision for loan losses reflects loan quality trends, including the levels of and trends related to non-accrual loans, past due loans, potential problem loans, criticized loans and net charge-offs or recoveries, among other factors. The provision for loan losses

 

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also reflects the totality of actions taken on all loans for a particular period. In other words, the amount of the provision reflects not only the necessary increases in the allowance for loan losses related to newly identified criticized loans, but it also reflects actions taken related to other loans including, among other things, any necessary increases or decreases in required allowances for specific loans or loan pools.

The level of the allowance reflects management’s continuing evaluation of industry concentrations, specific credit risks, loan loss and recovery experience, current loan portfolio quality, present economic, political and regulatory conditions and unidentified losses inherent in the current loan portfolio. Portions of the allowance may be allocated for specific credits; however, the entire allowance is available for any credit that, in management’s judgment, should be charged off. While management utilizes its best judgment and information available, the ultimate determination of the appropriate level of the allowance is dependent upon a variety of factors beyond the Corporation’s control, including, among other things, the performance of the Corporation’s loan portfolio, the economy, changes in interest rates and the view of the regulatory authorities toward loan classifications. The Corporation monitors whether or not the allowance for loan loss allocation model, as a whole, calculates an appropriate level of allowance for loan losses that moves in direct correlation to the general macroeconomic and loan portfolio conditions the Corporation experiences over time.

The Corporation’s allowance for loan losses consists of three elements: (i) specific valuation allowances determined in accordance with ASC Topic 310 based on probable losses on specific loans; (ii) historical valuation allowances determined in accordance with ASC Topic 450 based on historical loan loss experience for similar loans with similar characteristics and trends, adjusted, as necessary, to reflect the impact of current conditions; and (iii) general valuation allowances determined in accordance with ASC Topic 450 based on general economic conditions and other risk factors both internal and external to the Corporation.

The allowances established for probable losses on specific loans are based on a regular analysis and evaluation of problem loans. Loans are classified based on an internal credit risk grading process that evaluates, among other things: (i) the obligor’s ability to repay; (ii) the underlying collateral, if any; and (iii) the economic environment and industry in which the borrower operates. This analysis is performed at the relationship manager level for all commercial loans. When a loan has a calculated grade of 10 or higher, a special assets officer analyzes the loan to determine whether the loan is impaired and, if impaired, the need to specifically allocate a portion of the allowance for loan losses to the loan. Specific valuation allowances are determined by analyzing the borrower’s ability to repay amounts owed, collateral deficiencies, the relative risk grade of the loan and economic conditions affecting the borrower’s industry, among other things.

Historical valuation allowances are calculated based on the historical gross loss experience of specific types of loans and the internal risk grade of such loans at the time they were charged-off. The Corporation calculates historical gross loss ratios for pools of similar loans with similar characteristics based on the proportion of actual charge-offs experienced to the total population of loans in the pool. The historical gross loss ratios are periodically updated based on actual charge-off experience. A historical valuation allowance is established for each pool of similar loans based upon the product of the historical gross loss ratio and the total dollar amount of the loans in the pool. The Corporation’s pools of similar loans include similarly risk-graded groups of commercial and industrial loans, commercial real estate loans, consumer real estate loans and consumer and other loans.

The components of the general valuation allowance include (i) the additional reserves allocated to specific loan portfolio segments as a result of applying an environmental risk adjustment factor to the base historical loss allocation, (ii) the additional reserves allocated to specific loan portfolio segments for loans to borrowers in distressed industries and (iii) the additional reserves that are not allocated to specific loan portfolio segments including allocations for groups of similar loans with risk characteristics that exceed certain concentration limits established by management.

The environmental adjustment factor is based upon a more qualitative analysis of risk and is calculated through a survey of senior officers who are involved in credit making decisions at a corporate-wide and/or regional level. On a quarterly basis, survey participants rate the degree of various risks utilizing a numeric scale that translates to varying grades of high, moderate or low levels of risk. The results are then input into a risk-weighting matrix to determine an appropriate environmental risk adjustment factor. The various risks that may be considered in the determination of the environmental adjustment factor include, among other things, (i) the experience, ability and effectiveness of the bank’s lending management and staff; (ii) the effectiveness of the Corporation’s loan policies, procedures and internal controls; (iii) changes in asset quality; (iv) the impact of legislative and governmental influences affecting industry sectors; (v) the effectiveness of the internal loan review function; (vi) the impact of competition on loan structuring and pricing; and (vii) the impact of rising interest rates on portfolio risk. In periods where the surveyed risks are perceived to be higher, the risk-weighting matrix will generally result in a higher environmental adjustment factor, which, in turn will result in higher levels of general valuation allowance allocations. The opposite holds true in periods where the surveyed risks are perceived to be lower. The environmental adjustment factor resulted in additional general valuation allowance allocations to the various loan portfolio segments totaling $10.8 million at March 31, 2012, $12.8 million at December 31, 2011 and $12.7 million at March 31, 2011.

 

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During the fourth quarter of 2011, the Corporation refined its methodology for the determination of reserves allocated to specific loan portfolio segments to provide reserves for loans to borrowers in distressed industries. To determine the amount of the allocation for each loan portfolio segment, management calculates the weighted-average risk grade for all loans to borrowers in distressed industries by loan portfolio segment. A multiple is then applied to the amount by which the weighted-average risk grade for loans to borrowers in distressed industries exceeds the weighted-average risk grade for all pass-grade loans within the loan portfolio segment to derive an allocation factor for loans to borrowers in distressed industries. The amount of the allocation for each loan portfolio segment is the product of this allocation factor and the outstanding balance of pass-grade loans within the identified distressed industries that have a risk grade of 6 or higher. Reserves allocated for distressed industries totaled $5.7 million ($4.7 million related to commercial and industrial loans and $972 thousand related to commercial real estate loans) at March 31, 2012 and $5.0 million ($4.1 million related to commercial and industrial loans and $922 thousand related to commercial real estate loans) at December 31, 2011. This change in the Corporation’s methodology for the determination of reserves allocated to specific loan portfolio segments did not significantly impact the provision for loan losses recorded during 2011. Management identifies potential distressed industries by analyzing industry trends related to delinquencies, classifications and charge-offs. At March 31, 2012 and December 31, 2011, contractors were considered to be a distressed industry based on elevated levels of delinquencies, classifications and charge-offs relative to other industries within the Corporation’s loan portfolio. Furthermore, the Corporation determined, through a review of borrower financial information that, as a whole, contractors have experienced, among other things, decreased revenues, reduced backlog of work, compressed margins and little, if any, net income.

Certain general valuation allowances are not allocated to specific loan portfolio segments and are reported as the unallocated portion of the allowance for loan losses. Included in these general valuation allowances are allocations for groups of similar loans with risk characteristics that exceed certain concentration limits established by management and/or the Corporation’s board of directors. Concentration risk limits have been established, among other things, for certain industry concentrations, large balance and highly leveraged credit relationships that exceed specified risk grades, and loans originated with policy, credit and/or collateral exceptions that exceed specified risk grades. Additionally, general valuation allowances are provided for loans that did not undergo a separate, independent concurrence review during the underwriting process (generally those loans under $1.0 million at origination). The Corporation’s allowance methodology for general valuation allowances also includes a reduction factor for recoveries of prior charge-offs to compensate for the fact that historical loss allocations are based upon gross charge-offs rather than net.

The following table presents details of the unallocated portion of the allowance for loan losses.

 

     March 31,     December 31,     March 31,  
     2012     2011     2011  

Excessive industry concentrations

   $ 7,820      $ 6,995      $ 2,476   

Large relationship concentrations

     1,885        2,232        2,108   

Highly-leveraged credit relationships

     4,133        3,530        3,798   

Policy exceptions

     2,107        2,121        2,220   

Credit and collateral exceptions

     2,198        1,603        1,921   

Loans not reviewed by concurrence

     8,098        9,030        9,323   

Adjustment for recoveries

     (13,982     (13,071     (11,676

General macroeconomic risk

     16,636        17,846        20,374   
  

 

 

   

 

 

   

 

 

 
   $ 28,895      $ 30,286      $ 30,544   
  

 

 

   

 

 

   

 

 

 

The Corporation monitors whether or not the allowance for loan loss allocation model, as a whole, calculates an appropriate level of allowance for loan losses that moves in direct correlation to the general macroeconomic and loan portfolio conditions the Corporation experiences over time. In assessing the general macroeconomic trends/conditions, the Corporation analyzes trends in the components of the TLI, as well as any available information related to regional, national and international economic conditions and events and the impact such conditions and events may have on the Corporation and its customers. With regard to assessing loan portfolio conditions, the Corporation analyzes trends in weighted-average portfolio risk-grades, classified and non-performing loans and charge-off activity. In periods where general macroeconomic and loan portfolio conditions are in a deteriorating trend or remain at deteriorated levels, based on historical trends, the Corporation would expect to see the allowance for loan loss allocation model, as a whole, calculate higher levels of required allowances than in periods where general macroeconomic and loan portfolio conditions are in an improving trend or remain at an elevated level, based on historical trends.

 

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The following table details activity in the allowance for loan losses by portfolio segment for the three months ended March 31, 2012 and 2011. Allocation of a portion of the allowance to one category of loans does not preclude its availability to absorb losses in other categories.

 

     Commercial
and

Industrial
    Commercial
Real Estate
    Consumer
Real  Estate
    Consumer
and Other
    Unallocated     Total  

March 31, 2012

            

Beginning balance

   $ 42,774      $ 20,912      $ 3,540      $ 12,635      $ 30,286      $ 110,147   

Provision for loan losses

     4,766        1,441        (75     (3,641     (1,391     1,100   

Charge-offs

     (3,012     (2,842     (289     (1,985     —          (8,128

Recoveries

     1,341        492        523        1,706        —          4,062   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net charge-offs

     (1,671     (2,350     234        (279     —          (4,066
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Ending balance

   $ 45,869      $ 20,003      $ 3,699      $ 8,715      $ 28,895      $ 107,181   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Period-end amount allocated to:

            

Loans individually evaluated for impairment

   $ 17,842      $ 2,879      $ 95      $ —        $ —        $ 20,816   

Loans collectively evaluated for impairment

     28,027        17,124        3,604        8,715        28,895        86,365   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Ending balance

   $ 45,869      $ 20,003      $ 3,699      $ 8,715      $ 28,895      $ 107,181   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

March 31, 2011

            

Beginning balance

   $ 57,789      $ 28,534      $ 3,223      $ 11,974      $ 24,796      $ 126,316   

Provision for loan losses

     1,841        (662     792        1,731        5,748        9,450   

Charge-offs

     (7,597     (3,877     (820     (2,302     —          (14,596

Recoveries

     767        556        290        1,538        —          3,151   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net charge-offs

     (6,830     (3,321     (530     (764     —          (11,445
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Ending balance

   $ 52,800      $ 24,551      $ 3,485      $ 12,941      $ 30,544      $ 124,321   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Period-end amount allocated to:

            

Loans individually evaluated for impairment

   $ 31,065      $ 7,640      $ —        $ —        $ —        $ 38,705   

Loans collectively evaluated for impairment

     21,735        16,911        3,485        12,941        30,544        85,616   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Ending balance

   $ 52,800      $ 24,551      $ 3,485      $ 12,941      $ 30,544      $ 124,321   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

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Table of Contents

The Corporation’s recorded investment in loans as of March 31, 2012, December 31, 2011 and March 31, 2011 related to each balance in the allowance for loan losses by portfolio segment and disaggregated on the basis of the Corporation’s impairment methodology was as follows:

 

     Commercial
and
Industrial
     Commercial
Real Estate
     Consumer
Real  Estate
     Consumer
and Other
     Unearned
Discounts
    Total  

March 31, 2012

                

Loans individually evaluated for impairment

   $ 178,521       $ 226,266       $ 2,577       $ 535       $ —        $ 407,899   

Loans collectively evaluated for impairment

     3,864,331         2,808,618         758,709         303,937         (16,781     7,718,814   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

   

 

 

 

Ending balance

   $ 4,042,852       $ 3,034,884       $ 761,286       $ 304,472       $ (16,781   $ 8,126,713   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

   

 

 

 

December 31, 2011

                

Loans individually evaluated for impairment

   $ 189,139       $ 241,451       $ 2,470       $ 554       $ —        $ 433,614   

Loans collectively evaluated for impairment

     3,727,728         2,779,376         760,339         311,982         (17,910     7,561,515   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

   

 

 

 

Ending balance

   $ 3,916,867       $ 3,020,827       $ 762,809       $ 312,536       $ (17,910   $ 7,995,129   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

   

 

 

 

March 31, 2011

                

Loans individually evaluated for impairment

   $ 269,900       $ 295,214       $ —         $ —         $ —        $ 565,114   

Loans collectively evaluated for impairment

     3,453,344         2,917,480         784,368         325,122         (20,348     7,459,966   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

   

 

 

 

Ending balance

   $ 3,723,244       $ 3,212,694       $ 784,368       $ 325,122       $ (20,348   $ 8,025,080   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

   

 

 

 

Note 4 - Goodwill and Other Intangible Assets

Goodwill and other intangible assets are presented in the table below. The increases in goodwill and certain other intangible assets were related to the acquisition of Stone Partners Inc. (“Stone”), a human resource consulting firm that specializes in compensation, benefits and outsourcing services, on January 1, 2012. Stone was based in Houston with additional offices in Dallas and Austin. Stone was fully integrated into Frost Insurance Agency subsequent to acquisition. The acquisition of Stone did not significantly impact the Corporation’s financial statements.

 

     March 31,      December 31,  
     2012      2011  

Goodwill

   $ 535,560       $ 528,072   
  

 

 

    

 

 

 

Other intangible assets:

     

Core deposits

   $ 7,469       $ 8,234   

Customer relationship

     2,798         2,113   

Non-compete agreements

     766         257   
  

 

 

    

 

 

 
   $ 11,033       $ 10,604   
  

 

 

    

 

 

 

The estimated aggregate future amortization expense for intangible assets remaining as of March 31, 2012 is as follows:

 

Remainder of 2012

   $ 2,886   

2013

     3,115   

2014

     2,270   

2015

     1,490   

2016

     777   

Thereafter

     495   
  

 

 

 
   $ 11,033   
  

 

 

 

 

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Table of Contents

Note 5 - Deposits

Deposits were as follows:

 

     March 31,      Percentage     December 31,      Percentage     March 31,      Percentage  
     2012      of Total     2011      of Total     2011      of Total  

Non-interest-bearing demand deposits:

            

Commercial and individual

   $ 6,006,806         35.5   $ 5,848,840         34.9   $ 4,903,053         33.3

Correspondent banks

     331,114         2.0        370,275         2.2        290,099         2.0   

Public funds

     446,192         2.6        453,440         2.7        219,850         1.5   
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 

Total non-interest-bearing demand

deposits

     6,784,112         40.1        6,672,555         39.8        5,413,002         36.8   

Interest-bearing deposits:

            

Private accounts:

            

Savings and interest checking

     2,950,197         17.4        2,912,937         17.4        2,484,668         16.9   

Money market accounts

     5,750,104         34.0        5,664,780         33.8        5,243,830         35.6   

Time accounts of $100,000 or more

     532,544         3.2        533,682         3.2        609,166         4.2   

Time accounts under $100,000

     500,623         3.0        522,887         3.1        546,167         3.7   
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 

Total private accounts

     9,733,468         57.6        9,634,286         57.5        8,883,831         60.4   

Public funds:

            

Savings and interest checking

     208,760         1.2        265,747         1.6        183,752         1.3   

Money market accounts

     42,488         0.3        44,590         0.3        85,745         0.6   

Time accounts of $100,000 or more

     136,817         0.8        136,422         0.8        139,221         0.9   

Time accounts under $100,000

     3,376         —          3,148         —          4,008         —     
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 

Total public funds

     391,441         2.3        449,907         2.7        412,726         2.8   
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 

Total interest-bearing deposits

     10,124,909         59.9        10,084,193         60.2        9,296,557         63.2   
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 

Total deposits

   $ 16,909,021         100.0   $ 16,756,748         100.0   $ 14,709,559         100.0
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 

The following table presents additional information about the Corporation’s deposits:

 

     March 31,      December 31,      March 31,  
     2012      2011      2011  

Money market deposits obtained through brokers

   $ —         $ 24,500       $ 24,852   

Deposits from the Certificate of Deposit Account Registry Service (CDARS) deposits

     25,541         45,005         48,005   

Deposits from foreign sources (primarily Mexico)

     830,685         744,669         759,297   

Note 6 - Commitments and Contingencies

Financial Instruments with Off-Balance-Sheet Risk. 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. 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, to varying degrees, elements of credit risk and interest rate 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. Substantially all of the Corporation’s commitments to extend credit are contingent upon customers maintaining specific credit standards at the time of loan funding. Standby letters of credit are written conditional commitments issued by the Corporation to guarantee the performance of a customer to a third party. 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 were funded, the Corporation would be entitled to seek recovery from the customer. The Corporation’s policies generally require that standby letter of credit arrangements contain security and debt covenants similar to those contained in loan agreements.

 

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The Corporation considers the fees collected in connection with the issuance of standby letters of credit to be representative of the fair value of its obligation undertaken in issuing the guarantee. In accordance with applicable accounting standards related to guarantees, the Corporation defers fees collected in connection with the issuance of standby letters of credit. The fees are then recognized in income proportionately over the life of the standby letter of credit agreement. The deferred standby letter of credit fees represent the fair value of the Corporation’s potential obligations under the standby letter of credit guarantees.

Financial instruments with off-balance-sheet risk were as follows:

 

     March 31,      December 31,  
     2012      2011  

Commitments to extend credit

   $ 5,386,634       $ 5,147,363   

Standby letters of credit

     205,692         235,903   

Deferred standby letter of credit fees

     1,379         1,488   

Lease Commitments. The Corporation leases certain office facilities and office equipment under operating leases. Rent expense for all operating leases totaled $5.5 million during both the three months ended March 31, 2012 and 2011. There has been no significant change in the future minimum lease payments payable by the Corporation since December 31, 2011. See the 2011 Form 10-K for information regarding these commitments.

Litigation. The Corporation is subject to various claims and legal actions that have arisen in the course of conducting business. Management does not expect the ultimate disposition of these matters to have a material adverse impact on the Corporation’s financial statements.

Note 7 - Regulatory Matters

Regulatory Capital Requirements. 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 maintenance 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 to adjusted quarterly 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, the accumulated gain or loss on effective cash flow hedging derivatives, the net actuarial gain/loss on the Corporation’s defined benefit post-retirement benefit plans, goodwill and other intangible assets. Tier 1 capital for Cullen/Frost also includes $120 million of trust preferred securities issued by its unconsolidated subsidiary trust. Cullen/Frost’s and Frost Bank’s total capital is comprised of Tier 1 capital for each entity plus a permissible portion of the allowance for loan losses. The Corporation’s aggregate $100 million of floating rate subordinated notes are not included in Tier 1 capital but are included in total capital of Cullen/Frost.

The Tier 1 and total capital ratios are calculated by dividing the respective capital amounts by 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 quarterly average total assets, which exclude goodwill and other intangible assets.

 

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Actual and required capital ratios for Cullen/Frost and Frost Bank were as follows:

 

     

Actual
    Minimum Required
for Capital Adequacy
Purposes
    Required to be
Considered Well
Capitalized
 
      Capital
Amount
    
Ratio
    Capital
Amount
    
Ratio
    Capital
Amount
    
Ratio
 

March 31, 2012

               

Total Capital to Risk-Weighted Assets

               

Cullen/Frost

   $ 1,844,944         16.10   $ 916,676         8.00   $ 1,145,845         10.00

Frost Bank

     1,657,936         14.48        916,245         8.00        1,145,307         10.00   

Tier 1 Capital to Risk-Weighted Assets

               

Cullen/Frost

     1,657,763         14.47        458,338         4.00        687,507         6.00   

Frost Bank

     1,550,755         13.54        458,123         4.00        687,184         6.00   

Leverage Ratio

               

Cullen/Frost

     1,657,763         8.68        764,255         4.00        955,319         5.00   

Frost Bank

     1,550,755         8.12        763,906         4.00        954,882         5.00   

December 31, 2011

               

Total Capital to Risk-Weighted Assets

               

Cullen/Frost

   $ 1,835,428         16.24   $ 903,970         8.00   $ 1,129,962         10.00

Frost Bank

     1,641,921         14.54        903,427         8.00        1,129,284         10.00   

Tier 1 Capital to Risk-Weighted Assets

               

Cullen/Frost

     1,625,281         14.38        451,985         4.00        677,977         6.00   

Frost Bank

     1,531,774         13.56        451,713         4.00        677,570         6.00   

Leverage Ratio

               

Cullen/Frost

     1,625,281         8.66        750,643         4.00        938,304         5.00   

Frost Bank

     1,531,774         8.17        750,249         4.00        937,811         5.00   

Management believes that, as of March 31, 2012, Cullen/Frost and its bank subsidiary, Frost Bank, were “well capitalized” based on the ratios presented above.

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 (“OCC”) (see the section captioned “Charter Conversion” below) and the Federal Deposit Insurance Corporation (“FDIC”). Regulatory authorities can initiate certain mandatory actions if Cullen/Frost or Frost Bank fail to meet the minimum capital requirements, which could have a direct material effect on the Corporation’s financial statements. Management believes, as of March 31, 2012, that Cullen/Frost and Frost Bank meet all capital adequacy requirements to which they are subject.

Dividend Restrictions. In the ordinary course of business, Cullen/Frost is dependent upon dividends from Frost Bank to provide funds for the payment of dividends to shareholders and to provide for other cash requirements. Banking regulations may limit the amount of dividends that may be paid. Approval by regulatory authorities is required if the effect of dividends declared would cause the regulatory capital of Frost Bank to fall below specified minimum levels. Approval is also required if dividends declared exceed the net profits for that year combined with the retained net profits for the preceding two years. Under the foregoing dividend restrictions and while maintaining its “well capitalized” status, at March 31, 2012, Frost Bank could pay aggregate dividends of up to $233.8 million to Cullen/Frost without prior regulatory approval.

Trust Preferred Securities. In accordance with the applicable accounting standard related to variable interest entities, the accounts of the Corporation’s wholly owned subsidiary trust, Cullen/Frost Capital Trust II, have not been included in the Corporation’s consolidated financial statements. However, the $120.0 million in trust preferred securities issued by this subsidiary trust have been included in the Tier 1 capital of Cullen/Frost for regulatory capital purposes pursuant to guidance from the Federal Reserve. On July 21, 2010, financial regulatory reform legislation entitled the “Dodd-Frank Wall Street Reform and Consumer Protection Act” (the “Dodd-Frank Act”) was signed into law. Certain provisions of the Dodd-Frank Act will require the Corporation to deduct, over three years beginning on January 1, 2013, all trust preferred securities from the Corporation’s Tier 1 capital. Nonetheless, excluding trust preferred securities from Tier 1 capital at March 31, 2012 would not affect the Corporation’s ability to meet all capital adequacy requirements to which it is subject.

Charter Conversion. On February 3, 2012, Frost Bank, the sole banking subsidiary of the Corporation, applied to the Texas Department of Banking to become a Texas state chartered bank and notified the Federal Reserve Bank of Dallas of its intention to become a state chartered bank and a member of the Federal Reserve System. If the applications are approved, the Texas Department of Banking and the Federal Reserve Bank of Dallas will become the primary regulators of Frost Bank, and Frost Bank will no longer be regulated by the OCC. Deposits at Frost Bank that are currently insured by the FDIC will continue to be so insured up to applicable limits.

 

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Table of Contents

Note 8 - Derivative Financial Instruments

The fair value of derivative positions outstanding is included in accrued interest receivable and other assets and accrued interest payable and other liabilities in the accompanying consolidated balance sheets and in the net change in each of these financial statement line items in the accompanying consolidated statements of cash flows.

Interest Rate Derivatives. The Corporation utilizes interest rate swaps, caps and floors to mitigate exposure to interest rate risk and to facilitate the needs of its customers. The Corporation’s objectives for utilizing these derivative instruments is described below:

The Corporation has entered into certain interest rate swap contracts that are matched to specific fixed-rate commercial loans or leases that the Corporation has entered into with its customers. These contracts have been designated as hedging instruments to hedge the risk of changes in the fair value of the underlying commercial loan/lease due to changes in interest rates. The related contracts are structured so that the notional amounts reduce over time to generally match the expected amortization of the underlying loan/lease.

In October 2007, the Corporation entered into three interest rate swap contracts on variable-rate loans with a total notional amount of $1.2 billion. The interest rate swap contracts were designated as hedging instruments in cash flow hedges with the objective of protecting the overall cash flows from the Corporation’s monthly interest receipts on a rolling portfolio of $1.2 billion of variable-rate loans outstanding throughout the 84-month period beginning in October 2007 and ending in October 2014 from the risk of variability of those cash flows such that the yield on the underlying loans would remain constant. As more fully discussed in the 2011 Form 10-K, the Corporation terminated portions of the hedges and settled portions of the interest rate swap contracts during November 2009 and terminated the remaining portions of the hedges and settled the remaining portions of the interest rate swap contracts during November 2010. The deferred accumulated after-tax gain applicable to the settled interest rate swap contracts included in accumulated other comprehensive income totaled $62.4 million at March 31, 2012. The deferred gain will be reclassified into earnings through October 2014.

In October 2008, the Corporation entered into an interest rate swap contract on junior subordinated deferrable interest debentures with a total notional amount of $120.0 million. The interest rate swap contract was designated as a hedging instrument in a cash flow hedge with the objective of protecting the quarterly interest payments on the Corporation’s $120.0 million of junior subordinated deferrable interest debentures issued to Cullen/Frost Capital Trust II throughout the five-year period beginning in December 2008 and ending in December 2013 from the risk of variability of those payments resulting from changes in the three-month LIBOR interest rate. Under the swap, the Corporation will pay a fixed interest rate of 5.47% and receive a variable interest rate of three-month LIBOR plus a margin of 1.55% on a total notional amount of $120.0 million, with quarterly settlements.

The Corporation has entered into certain interest rate swap, cap and floor contracts that are not designated as hedging instruments. These derivative contracts relate to transactions in which the Corporation enters into an interest rate swap, cap and/or floor with a customer while at the same time entering into an offsetting interest rate swap, cap and/or floor with another financial institution. In connection with each swap transaction, the Corporation agrees to pay interest to the customer on a notional amount at a variable interest rate and receive interest from the customer on a similar notional amount at a fixed interest rate. At the same time, the Corporation agrees to pay another financial institution the same fixed interest rate on the same notional amount and receive the same variable interest rate on the same notional amount. The transaction allows the Corporation’s customer to effectively convert a variable rate loan to a fixed rate. Because the Corporation acts as an intermediary for its customer, changes in the fair value of the underlying derivative contracts for the most part offset each other and do not significantly impact the Corporation’s results of operations.

 

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Table of Contents

The notional amounts and estimated fair values of interest rate derivative contracts outstanding at March 31, 2012 and December 31, 2011 are presented in the following table. The Corporation obtains dealer quotations to value its interest rate derivative contracts designated as hedges of cash flows, while the fair values of other interest rate derivative contracts are estimated utilizing internal valuation models with observable market data inputs.

 

     March 31, 2012     December 31, 2011  
      Notional
Amount
     Estimated
Fair Value
    Notional
Amount
     Estimated
Fair Value
 

Interest rate derivatives designated as hedges of fair value:

          

Commercial loan/lease interest rate swaps

   $ 67,517       $ (7,736   $ 71,181       $ (8,376

Interest rate derivatives designated as hedges of cash flows:

          

Interest rate swap on junior subordinated deferrable interest debentures

     120,000         (7,205     120,000         (7,807

Non-hedging interest rate derivatives:

          

Commercial loan/lease interest rate swaps

     637,356         57,105        613,883         61,137   

Commercial loan/lease interest rate swaps

     637,356         (57,314     613,883         (61,393

Commercial loan/lease interest rate caps

     20,000         28        20,000         50   

Commercial loan/lease interest rate caps

     20,000         (28     20,000         (50

The weighted-average rates paid and received for interest rate swaps outstanding at March 31, 2012 were as follows:

 

     Weighted-Average  
     Interest
Rate
Paid
    Interest
Rate
Received
 

Interest rate swaps:

    

Fair value hedge commercial loan/lease interest rate swaps

     4.30     0.24

Cash flow hedge interest rate swaps on junior subordinated deferrable interest debentures

     5.47        1.86   

Non-hedging interest rate swaps

     1.81        4.89   

Non-hedging interest rate swaps

     4.89        1.81   

The weighted-average strike rate for outstanding interest rate caps was 3.10% at March 31, 2012.

Commodity Derivatives. The Corporation enters into commodity swaps and option contracts that are not designated as hedging instruments primarily to accommodate the business needs of its customers. Upon the origination of a commodity swap or option contract with a customer, the Corporation simultaneously enters into an offsetting contract with a third party to mitigate the exposure to fluctuations in commodity prices.

The notional amounts and estimated fair values of commodity derivative positions outstanding are presented in the following table. The Corporation obtains dealer quotations to value its commodity derivative positions.

 

       March 31, 2012     December 31, 2011  
      Notional
Units
     Notional
Amount
     Estimated
Fair Value
    Notional
Amount
     Estimated
Fair Value
 

Non-hedging commodity swaps:

             

Oil

     Barrels         521       $ 2,505        459       $ 1,068   

Oil

     Barrels         521         (2,387     459         (963

Natural gas

     MMBTUs         990         2,321        1,905         3,540   

Natural gas

     MMBTUs         990         (2,289     1,905         (3,480

Non-hedging commodity options:

             

Oil

     Barrels         2,610         12,327        2,920         18,206   

Oil

     Barrels         2,610         (12,327     2,920         (18,206

Natural gas

     MMBTUs         600         581        480         490   

Natural gas

     MMBTUs         600         (581     480         (490

 

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Table of Contents

Foreign Currency Derivatives. The Corporation enters into foreign currency forward contracts that are not designated as hedging instruments primarily to accommodate the business needs of its customers. Upon the origination of a foreign currency denominated transaction with a customer, the Corporation simultaneously enters into an offsetting contract with a third party to negate the exposure to fluctuations in foreign currency exchange rates. The Corporation also utilizes foreign currency forward contracts that are not designated as hedging instruments to mitigate the economic effect of fluctuations in foreign currency exchange rates on certain short-term, non-U.S. dollar denominated loans. The notional amounts and fair values of open foreign currency forward contracts were not significant at March 31, 2012 and December 31, 2011.

Gains, Losses and Derivative Cash Flows. For fair value hedges, the changes in the fair value of both the derivative hedging instrument and the hedged item are included in other non-interest income or other non-interest expense. The extent that such changes in fair value do not offset represents hedge ineffectiveness. Net cash flows from interest rate swaps on commercial loans/leases designated as hedging instruments in effective hedges of fair value are included in interest income on loans. For cash flow hedges, the effective portion of the gain or loss due to changes in the fair value of the derivative hedging instrument is included in other comprehensive income, while the ineffective portion (indicated by the excess of the cumulative change in the fair value of the derivative over that which is necessary to offset the cumulative change in expected future cash flows on the hedge transaction) is included in other non-interest income or other non-interest expense. Net cash flows from interest rate swaps on variable-rate loans designated as hedging instruments in effective hedges of cash flows and the reclassification from other comprehensive income of deferred gains associated with the termination of those hedges are included in interest income on loans. Net cash flows from the interest rate swap on junior subordinated deferrable interest debentures designated as a hedging instrument in an effective hedge of cash flows are included in interest expense on junior subordinated deferrable interest debentures. For non-hedging derivative instruments, gains and losses due to changes in fair value and all cash flows are included in other non-interest income and other non-interest expense.

Amounts included in the consolidated statements of income related to interest rate derivatives designated as hedges of fair value were as follows:

 

      Three Months Ended
March  31,
 
     2012     2011  

Commercial loan/lease interest rate swaps:

    

Amount of gain (loss) included in interest income on loans

   $ (667   $ (1,005

Amount of (gain) loss included in other non-interest expense

     (12     (9

Amounts included in the consolidated statements of income and in other comprehensive income for the period related to interest rate derivatives designated as hedges of cash flows were as follows:

 

     Three Months Ended
March 31,
 
     2012     2011  

Interest rate swaps on variable-rate loans:

    

Amount reclassified from accumulated other comprehensive income to interest income on loans

   $  9,345      $  9,345   

Interest rate swaps on junior subordinated deferrable interest debentures:

    

Amount reclassified from accumulated other comprehensive income to interest expense on junior subordinated deferrable interest debentures

     1,033        1,086   

Amount of gain (loss) recognized in other comprehensive income

     (427     65   

No ineffectiveness related to interest rate derivatives designated as hedges of cash flows was recognized in the consolidated statements of income during the reported periods. The accumulated net after-tax gain related to effective cash flow hedges included in accumulated other comprehensive income totaled $58.0 million at March 31, 2012 and $63.6 million at December 31, 2011. The Corporation currently expects approximately $16.1 million of the net after-tax gain related to effective cash flow hedges included in accumulated other comprehensive income at March 31, 2012 will be reclassified into earnings during the remainder of 2012. This amount represents management’s best estimate given current expectations about market interest rates and volumes related to loan pools underlying the terminated cash flow hedges. Because actual market interest rates and volumes related to loan pools underlying the terminated cash flow hedges may differ from management’s expectations, there can be no assurance as to the ultimate amount that will be reclassified into earnings during 2012.

 

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Table of Contents

As stated above, the Corporation enters into non-hedge related derivative positions primarily to accommodate the business needs of its customers. Upon the origination of a derivative contract with a customer, the Corporation simultaneously enters into an offsetting derivative contract with a third party. The Corporation recognizes immediate income based upon the difference in the bid/ask spread of the underlying transactions with its customers and the third party. Because the Corporation acts only as an intermediary for its customer, subsequent changes in the fair value of the underlying derivative contracts for the most part offset each other and do not significantly impact the Corporation’s results of operations.

Amounts included in the consolidated statements of income related to non-hedging interest rate and commodity derivative instruments are presented in the table below. Amounts included in the consolidated statements of income related to foreign currency derivatives during the reported periods were not significant.

 

      Three Months Ended
March 31,
 
     2012     2011  

Non-hedging interest rate derivatives:

    

Other non-interest income

   $ 782      $ 274   

Other non-interest expense

     (47     (39

Non-hedging commodity derivatives:

    

Other non-interest income

     37        383   

Counterparty Credit Risk. Derivative contracts involve the risk of dealing with both bank customers and institutional derivative counterparties and their ability to meet contractual terms. Institutional counterparties must have an investment grade credit rating and be approved by the Corporation’s Asset/Liability Management Committee. The Corporation’s credit exposure on interest rate swaps is limited to the net favorable value and interest payments of all swaps by each counterparty, while the Corporation’s credit exposure on commodity swaps/options is limited to the net favorable value of all swaps/options by each counterparty. Credit exposure may be reduced by the amount of collateral pledged by the counterparty. There are no credit-risk-related contingent features associated with any of the Corporation’s derivative contracts. Certain derivative contracts with upstream financial institution counterparties may be terminated with respect to a party in the transaction, if such party does not have at least a minimum level rating assigned to either its senior unsecured long-term debt or its deposit obligations by certain third-party rating agencies.

The Corporation’s credit exposure relating to interest rate swaps and commodity swaps/options with bank customers was approximately $63.7 million at March 31, 2012. This credit exposure is partly mitigated as transactions with customers are generally secured by the collateral, if any, securing the underlying transaction being hedged. The Corporation had no credit exposure, net of collateral pledged, relating to interest rate swaps and commodity swaps/options with upstream financial institution counterparties at March 31, 2012. Collateral levels for upstream financial institution counterparties are monitored and adjusted as necessary.

The aggregate fair value of securities posted as collateral by the Corporation related to derivative contracts totaled $71.9 million at March 31, 2012. At such date, the Corporation also had $6.3 million in cash collateral on deposit with other financial institution counterparties.

Note 9 - Earnings Per Common Share

Earnings per common share is computed using the two-class method. Basic earnings per common share is computed by dividing net earnings allocated to common stock by the weighted-average number of common shares outstanding during the applicable period, excluding outstanding participating securities. Participating securities include non-vested stock awards/stock units and deferred stock units, though no actual shares of common stock related to non-vested stock units and deferred stock units have been issued. Non-vested stock awards/stock units and deferred stock units are considered participating securities because holders of these securities receive non-forfeitable dividends at the same rate as holders of the Corporation’s common stock. Diluted earnings per common share is computed using the weighted-average number of shares determined for the basic earnings per common share computation plus the dilutive effect of stock compensation using the treasury stock method.

 

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Table of Contents

The following table presents a reconciliation of the number of shares used in the calculation of basic and diluted earnings per common share.

 

      Three Months Ended
March 31,
 
     2012      2011  

Distributed earnings allocated to common stock

   $ 28,152       $ 27,470   

Undistributed earnings allocated to common stock

     32,691         24,252   
  

 

 

    

 

 

 

Net earnings allocated to common stock

   $ 60,843       $ 51,722   
  

 

 

    

 

 

 

Weighted-average shares outstanding for basic earnings per
common share

     61,200,627         61,018,169   

Dilutive effect of stock compensation

     332,674         316,295   
  

 

 

    

 

 

 

Weighted-average shares outstanding for diluted earnings
per common share

     61,533,301         61,334,464   
  

 

 

    

 

 

 

Note 10 - Stock-Based Compensation

A combined summary of activity in the Corporation’s active stock plans is presented in the following table.

 

                  Non-Vested Stock
Awards/Stock Units
Outstanding
     Stock Options
Outstanding
 
     Shares
Available
for Grant
    Director
Deferred
Stock Units
Outstanding
     Number
of Shares
     Weighted-
Average
Grant-Date
Fair Value
     Number of
Shares
    Weighted-
Average

Exercise
Price
 

Balance, January 1, 2012

     1,963,455        22,092         169,530       $ 50.33         4,968,822      $ 51.49   

Granted

     —          —           —           —           —          —     

Stock options exercised

     —          —           —           —           (108,800     50.94   

Stock awards vested

     —          —           —           —           —          —     

Forfeited

     1,875        —           —           —           (1,875     51.81   

Cancelled/expired

     (125     —           —           —           —       
  

 

 

   

 

 

    

 

 

       

 

 

   

Balance, March 31, 2012

     1,965,205        22,092         169,530       $ 50.33         4,858,147      $ 51.50   
  

 

 

   

 

 

    

 

 

       

 

 

   

During the three months ended March 31, 2012 and 2011, proceeds from stock option exercises totaled $5.5 million and $5.8 million. During the three months ended March 31, 2012, 101,160 shares issued in connection with stock option exercises were new shares issued from available authorized shares, while 7,640 shares were issued from available treasury stock.

Stock-based compensation expense is recognized ratably over the requisite service period for all awards. Stock-based compensation expense was as follows:

 

      Three Months Ended
March 31,
 
     2012      2011  

Stock options

   $ 2,201       $ 2,310   

Non-vested stock awards/stock units

     354         1,427   
  

 

 

    

 

 

 

Total

   $ 2,555       $ 3,737   
  

 

 

    

 

 

 

Unrecognized stock-based compensation expense at March 31, 2012 was as follows:

 

Stock options

   $ 16,811   

Non-vested stock awards/stock units

     2,742   
  

 

 

 

Total

   $ 19,553   
  

 

 

 

 

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Table of Contents

Note 11 - Defined Benefit Plans

The components of the combined net periodic cost (benefit) for the Corporation’s defined benefit pension plans were as follows:

 

      Three Months Ended
March 31,
 
     2012     2011  

Expected return on plan assets, net of expenses

   $ (2,603   $ (2,859

Interest cost on projected benefit obligation

     1,950        1,973   

Net amortization and deferral

     1,229        783   
  

 

 

   

 

 

 

Net periodic cost (benefit)

   $ 576      $ (103
  

 

 

   

 

 

 

The Corporation’s non-qualified defined benefit pension plan is not funded. No contributions to the qualified defined benefit pension plan were made during the three months ended March 31, 2012. The Corporation does not expect to make any contributions to the qualified defined benefit plan during the remainder of 2012.

Note 12 - Income Taxes

Income tax expense was as follows:

 

      Three Months Ended
March 31,
 
     2012     2011  

Current income tax expense

   $ 20,052      $ 12,792   

Deferred income tax benefit

     (2,539     (139
  

 

 

   

 

 

 

Income tax expense, as reported

   $ 17,513      $ 12,653   
  

 

 

   

 

 

 

Effective tax rate

     22.3