CFR

Cullen/Frost Bankers, Inc. 2004 10-K Summary

Business Context and Reporting Period

This Form 10-K covers the fiscal year ended December 31, 2004. Cullen/Frost Bankers, Inc. is a Texas-based financial holding company and bank holding company headquartered in San Antonio. Through its primary subsidiary, The Frost National Bank, the Corporation provides commercial and consumer banking, trust and investment management, insurance brokerage, and other financial services across 12 Texas markets. As of year-end 2004, the Corporation held consolidated total assets of approximately $10.0 billion.

Key Financial Metrics

Material Changes vs. Prior Period

• Profitability Growth: Net income increased 8.3% to $141.3 million, driven by a $17.7 million increase in net interest income and a $9.7 million increase in non-interest income. This was partially offset by a $19.0 million increase in non-interest expenses.
• Loan Portfolio Expansion: Total loans grew 12.5% to $5.16 billion, primarily due to a 14.3% increase in commercial and industrial loans and a 13.1% increase in real estate loans.
• Asset Quality Improvement: Non-performing assets decreased 25.9% to $39.1 million. Consequently, the provision for possible loan losses dropped significantly from $10.5 million in 2003 to $2.5 million in 2004.
• Interest Rate Environment: The net interest margin improved to 4.05% from 3.98%, benefiting from rising interest rates and a shift in the asset mix toward higher-yielding loans and securities.
• Capital Management: The Corporation repurchased approximately 1.47 million shares of common stock in 2004 for a total cost of $65.2 million under two authorized plans.

Guidance, Outlook, and Risks

Management Commentary: Management attributes the improved results to better economic conditions, increased loan demand, and improved credit quality. The Corporation expects the rising interest rate environment to continue having a positive impact on net interest income.

Accounting Changes: The Corporation expects to adopt SFAS No. 123(R) regarding share-based payment on July 1, 2005. This change will require recognizing stock-based compensation as an expense based on fair value, which is expected to increase quarterly compensation costs by approximately $1.5 million beginning in the third quarter of 2005.

Risks and Contingencies:

• Regulatory Capital: The Federal Reserve Board proposed rules that may limit the amount of trust preferred securities included in Tier 1 capital. While the Corporation currently expects to include its $220 million in trust preferred securities in Tier 1 capital, future rule changes could impact this treatment.
• Interest Rate Risk: The Corporation's balance sheet is asset-sensitive. While rising rates currently benefit the net interest margin, sustained declines in rates could compress margins.
• Industry Concentration: The energy sector represents the largest industry concentration at 7.6% of total loans.

Investor Verification Checklist

• Stock-Based Compensation Impact: Verify the projected impact of the July 2005 adoption of SFAS 123(R) on future earnings per share.
• Trust Preferred Securities: Monitor final Federal Reserve rules regarding the inclusion of trust preferred securities in Tier 1 capital and potential redemption risks.
• Energy Sector Exposure: Review the specific credit quality and performance of the 7.6% loan concentration in the energy industry.
• Dividend Capacity: Confirm the subsidiary bank's ability to pay dividends to the holding company, noting the $207.2 million available without regulatory approval as of year-end 2004.
• Non-Performing Asset Trends: Track the continued reduction in non-performing assets and the adequacy of the allowance for loan losses relative to the growing loan portfolio.