10-K 1 d95136e10-k.txt FORM 10-K FOR FISCAL YEAR END DECEMBER 31, 2001 -------------------------------------------------------------------------------- -------------------------------------------------------------------------------- SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549-1004 FORM 10-K [X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE FISCAL YEAR ENDED DECEMBER 31, 2001 OR [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE TRANSITION PERIOD FROM _________ TO _________ COMMISSION FILE NUMBER 0-7275 CULLEN/FROST BANKERS, INC. (Exact name of registrant as specified in its charter) TEXAS 74-1751768 ---------------------------------- ------------------- (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification No.) 100 W. HOUSTON STREET SAN ANTONIO, TEXAS 78205 ---------------------------------- ------------------- (Address of principal executive (Zip Code) offices) REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE: (210) 220-4011 SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT:

COMMON STOCK, $.01 PAR VALUE (WITH ATTACHED RIGHTS) THE NEW YORK STOCK EXCHANGE ---------------------------- --------------------------- (Title of Class) (Name of Exchange on which Registered)

SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT: NONE 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 if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of the registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. [ ] The aggregate market value of the voting stock held by non-affiliates of the registrant was $1,746,517,082 based on the closing price of such stock as of March 15, 2002. Indicate the number of shares outstanding of each of the registrant's classes of common stock, as of the latest practicable date.

Outstanding at Class March 15, 2002 ----- -------------- COMMON STOCK, $.01 PAR VALUE 51,153,999

DOCUMENTS INCORPORATED BY REFERENCE (1) Proxy Statement for Annual Meeting of Shareholders to be held May 22, 2002 (Part III) -------------------------------------------------------------------------------- -------------------------------------------------------------------------------- TABLE OF CONTENTS

PAGE ---- PART I ------ ITEM 1. BUSINESS.................................................... 3 ITEM 2. PROPERTIES.................................................. 11 ITEM 3. LEGAL PROCEEDINGS........................................... 11 ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS......... 11 PART II ------- ITEM 5. MARKET FOR REGISTRANT'S COMMON STOCK AND RELATED STOCKHOLDER MATTERS..................................................... 12 ITEM 6. SELECTED FINANCIAL DATA..................................... 13 ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS................................... 15 ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK........................................................ 42 ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA................. 43 ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE.................................... 80 PART III -------- ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT.......... 80 ITEM 11. EXECUTIVE COMPENSATION...................................... 80 ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.................................................. 80 ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.............. 80 PART IV ------- ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K......................................................... 81

2 PART I ITEM 1. BUSINESS ----------------- GENERAL ------- Cullen/Frost Bankers, Inc. ("Cullen/Frost" or "Corporation"), a Texas business corporation incorporated in 1977 and headquartered in San Antonio, Texas, is a financial holding company within the meaning of the Bank Holding Company Act of 1956, as partially amended by the Gramm-Leach-Bliley Act (the "Modernization Act") (collectively "the BHC Act"), and, as such, is registered with the Board of Governors of the Federal Reserve System ("Federal Reserve Board"). The New Galveston Company, incorporated under the laws of Delaware, is a wholly-owned second-tier financial holding company subsidiary which owns all banking and non-banking subsidiaries with the exception of Cullen/Frost Capital Trust I, a Delaware statutory business trust and wholly-owned subsidiary of the Corporation. At December 31, 2001, Cullen/Frost's principal assets consisted of all of the capital stock of The Frost National Bank ("Frost Bank"). Frost Bank operates 80 financial centers across Texas with 17 locations in the San Antonio area, 22 in the Houston/Galveston area, 15 in the Fort Worth area, 8 in the Corpus Christi area, 6 in Austin, 4 in Dallas, 3 in San Marcos, 2 in McAllen, 2 in the Boerne/Fair Oaks area, and 1 in New Braunfels. At December 31, 2001, Cullen/Frost had consolidated total assets of $8.4 billion and total deposits of $7.1 billion. Based on information from the Federal Reserve Board, at September 30, 2001, Cullen/Frost was the largest of the 124 bank holding companies headquartered in Texas. Cullen/Frost's operations are managed along three distinct operating segments consisting of Banking, the Financial Management Group and its investment banking subsidiary, Frost Securities Inc. (See Results of Segment Operations on page 22 and Note U on page 71). Cullen/Frost provides policy direction to Frost Bank in, among others, the following areas: (i) asset and liability management; (ii) accounting, budgeting, planning, insurance and investment banking; (iii) capitalization; (iv) regulatory compliance and (v) investor relations. Frost Bank is a separate entity that operates under the management of its own officers and also maintains a separate board of directors. Frost Bank, the origin of which can be traced to a mercantile partnership organized in 1868, was chartered as a national banking association in 1899. At December 31, 2001, Frost Bank, was the largest commercial bank headquartered in San Antonio and South Texas. SERVICES OFFERED BY FROST BANK ------------------------------ Commercial Banking Frost Bank provides commercial services for corporations and other business clients. Loans are made for a wide variety of general corporate purposes, including interim construction financing on industrial and commercial properties, and financing on equipment, inventories, accounts receivable, and acquisition financing, as well as commercial leasing. Frost Bank provides financial services to business clients on both a national and international basis. Consumer Services Frost Bank provides a full range of consumer banking services, including checking accounts, savings programs, automated teller machines, installment and real estate loans, home equity loans, drive-in and night deposit services, safe deposit facilities, and brokerage services. International Banking Frost Bank provides international banking services to customers residing in or dealing with businesses located in Mexico. These services consist of accepting deposits (in United States dollars only), making loans 3 (in United States dollars only), issuing letters of credit, handling foreign collections, transmitting funds and, to a limited extent, dealing in foreign exchange. Reference is made to pages 29 and 37 of this document. Correspondent Banking Frost Bank acts as correspondent for approximately 315 financial institutions, primarily banks in Texas. These banks maintain deposits with Frost Bank, which offers them a full range of services including check clearing, transfer of funds, loan participations, fixed income security services, and securities custody and clearance. Insurance Frost Insurance Agency, Inc., is a wholly-owned subsidiary of Frost Bank and brokers corporate and personal property and casualty insurance as well as group health and life insurance products to individuals and businesses. Trust Services Frost Bank provides a wide range of trust, investment, agency and custodial services for individual and corporate clients. These services include the administration of estates and personal trusts, as well as the management of investment accounts for individuals, employee benefit plans and charitable foundations. At December 31, 2001, trust assets with a market value of $13.3 billion were being administered by Frost Bank. These assets were comprised of managed assets of $6.0 billion and custody assets of $7.3 billion. Brokerage Services Frost Brokerage Services, a wholly-owned subsidiary of Frost Bank, was formed in March 1986 to provide brokerage services and perform other transactions or operations related to the sale and purchase of securities of all types. SERVICES OFFERED BY THE CULLEN/FROST NON-BANKING SUBSIDIARIES ------------------------------------------------------------- Frost Securities, Inc. ("FSI") is a full-service investment bank offering financial advisory services, mergers and acquisitions support, equity research, and institutional equity sales and trading. The firm provides institutional investors with in-depth research coverage in energy and communications technology. Main Plaza Corporation ("Main Plaza") is a wholly-owned non-banking subsidiary. Main Plaza occasionally makes loans to qualified borrowers. Loans are funded with borrowings against Cullen/Frost's current cash or borrowings against credit lines. Daltex General Agency, Inc. ("Daltex"), a wholly-owned non-banking subsidiary, is a managing general insurance agency. Daltex provides vendor's single interest insurance. Cullen/Frost Capital Trust I is a Delaware statutory business trust that issued $100 million in Trust Preferred Capital Securities in 1997, which are guaranteed by the Corporation. COMPETITION ----------- Frost Bank experiences a very competitive environment in its commercial banking businesses, primarily from other banks located in its respective service areas. Frost Bank also competes with insurance companies, finance and mortgage companies, savings and loan institutions, credit unions, money market funds, investment banks and other financial institutions. In the case of some larger customers, competition exists with institutions in other major metropolitan areas in Texas and in the remainder of the United States, some of which are larger than Frost Bank in terms of capital, resources and personnel. 4 Cullen/Frost and Frost Bank have been impacted by the Modernization Act, as it eliminated barriers between commercial banking, investment banking, and insurance sales. The elimination of barriers has created the potential for more competition by increasing the number of non-bank competitors. SUPERVISION AND REGULATION -------------------------- Cullen/Frost Cullen/Frost is a legal entity separate and distinct from its bank subsidiary and was designated a financial holding company under the Modernization Act effective March 11, 2000. The Modernization Act: (i) allows financial holding companies meeting management, capital and CRA standards to engage in a substantially broader range of financial activities and activities incidental to financial activities than was previously permissible, including insurance underwriting and making merchant banking investments in commercial and financial companies; (ii) allows insurers and other financial services companies to acquire banks; (iii) removes various restrictions that previously applied to bank holding company ownership of securities firms and mutual fund advisory companies; and (iv) established the overall regulatory structure applicable to bank holding companies that also engage in insurance and securities operations. Cullen/Frost is primarily regulated by the Federal Reserve Board, which has established guidelines with respect to the maintenance of appropriate levels of capital and payment of dividends by financial holding companies. If Frost Bank ceases to be "well capitalized" under applicable regulatory standards, the Federal Reserve Board may, among other actions, order Cullen/Frost to divest of Frost Bank or to conform its activities to those permissible for a bank holding company. In addition, if Frost Bank receives a rating under the CRA Act of less than satisfactory, Cullen/Frost will be prohibited from engaging in new activities or acquiring companies other than bank holding companies, banks or savings associations. The Modernization Act also modified laws related to financial privacy and community reinvestment. The new financial privacy provisions, which were not mandatory until July 1, 2001, generally prohibit financial institutions, including Cullen/Frost, from disclosing nonpublic personal financial information to third parties unless customers have the opportunity to "opt out" of the disclosure. The Federal Reserve Act and the Federal Deposit Insurance Act ("FDIA") impose restrictions on loans by Frost Bank to Cullen/Frost and certain of its subsidiaries, on investments in securities thereof and on the taking of such securities as collateral for loans. Such restrictions generally prevent Cullen/Frost from borrowing from Frost Bank unless the loans are secured by marketable obligations. Further, such secured loans, other transactions, and investments by Frost Bank are limited in amount as to Cullen/Frost or to certain other subsidiaries to ten percent of Frost Bank's capital and surplus and as to Cullen/Frost and all such subsidiaries to an aggregate of 20 percent of Frost Bank's capital and surplus. Under Federal Reserve Board policy, Cullen/Frost is expected to act as a source of financial strength to Frost Bank and to commit resources to support such bank in circumstances where it might not do so absent such policy. In addition, any loans by Cullen/Frost to its bank would be subordinate in right of payment to deposits and to certain other indebtedness of Frost Bank. In the event of a financial holding company's bankruptcy, any commitment by the financial holding company to a federal bank regulatory agency to maintain the capital of a subsidiary bank will be assumed by the bankruptcy trustee and be entitled to a priority of payment. Subsidiary Bank Frost Bank is organized as a national banking association under the National Bank Act and is subject to regulation and examination by the Office of the Comptroller of the Currency (the "Comptroller of the Currency"). Federal and state laws and regulations of general application to banks have the effect, among others, of regulating the scope of Frost Bank's business, investments, cash reserves, purpose and nature of loans, collateral for loans, maximum interest rates chargeable on loans, amount of dividends that may be declared 5 and required capitalization ratios. Federal law imposes restrictions on Frost Bank's extensions of credit to, and certain other transactions with, Cullen/Frost and other subsidiaries, investments in stock or other securities thereof and taking of such securities as collateral for loans to other borrowers. The Comptroller of the Currency has authority to prohibit a bank from engaging in activities that, in such agency's opinion, constitute an unsafe or unsound practice in conducting its business. It is possible, depending on the financial condition of the bank in question and other factors, that such agency could claim that the payment of dividends or other payments might, under some circumstances, be such an unsafe or unsound practice. The principal source of Cullen/Frost's cash revenues is dividends from Frost Bank and there are certain limitations on the payment of dividends to Cullen/Frost by Frost Bank. The prior approval of the Comptroller of the Currency is required if the total of all dividends declared by a national bank in any calendar year would exceed the bank's net profits, as defined, for that year combined with its retained net profits for the preceding two calendar years, less any regulatory required transfers to surplus. In addition, a national bank may not pay dividends in an amount in excess of its undivided profits less certain bad debts specified in regulatory requirements. Although not necessarily indicative of amounts available to be paid in future periods, Frost Bank had approximately $110.9 million available for the payment of dividends, without prior regulatory approval, at December 31, 2001. Capital Adequacy Bank regulators have adopted risk-based capital guidelines for financial holding companies and banks. The minimum ratio of qualifying total capital to risk-weighted assets (including certain off-balance sheet items) is eight percent. At least half of the total capital is to be comprised of common stock, retained earnings, non-cumulative perpetual preferred stocks, minority interests, (and for financial holding companies, a limited amount of qualifying cumulative perpetual preferred stock), less certain intangibles including goodwill ("Tier 1 capital"). The remainder ("Tier 2 capital") may consist of other preferred stock, certain other instruments, and limited amounts of subordinated debt and the allowance for loan and lease losses. In addition, bank regulators have established minimum leverage ratio (Tier 1 capital to average total assets) guidelines for financial holding companies and banks. These guidelines provide for a minimum leverage ratio of three percent for financial holding companies and banks that meet certain specified criteria, including that they have the highest regulatory rating. All other banking organizations will be required to maintain a leverage ratio of at least four percent plus an additional cushion where warranted. The guidelines also provide that banking organizations experiencing internal growth or making acquisitions will be expected to maintain strong capital positions substantially above the minimum supervisory levels, without significant levels of intangible assets. The bank regulators have not advised Cullen/Frost or Frost Bank of any specific minimum leverage ratio applicable to it. For information concerning Cullen/Frost's capital ratios, see the discussion under the caption "Capital and Liquidity" on page 38 and Note L "Capital" on page 58. Prompt Corrective Action The Federal Deposit Insurance Corporation Improvements Act of 1991 ("FDICIA"), among other things, requires the Federal banking agencies to take "prompt corrective action" with respect to depository institutions that do not meet minimum capital requirements. FDICIA established five capital tiers: "well capitalized," "adequately capitalized," "undercapitalized," "significantly undercapitalized" and "critically undercapitalized". Under the final rules adopted by the Federal banking regulators relating to these capital tiers, an institution is deemed to be: well capitalized if the institution has a total risk-based capital ratio of ten percent or greater, a Tier 1 risk-based capital ratio of six percent or greater, and a leverage ratio of five percent or greater, and the institution is not subject to an order, written agreement, capital directive, or prompt corrective action directive to meet and maintain a specific capital level for any capital measure; adequately capitalized if the institution has a total risk-based capital ratio of eight percent or greater, a Tier 1 risk-based capital ratio of four percent or greater, and a leverage ratio of four percent or greater (or a leverage ratio of three percent for financial holding companies which meet certain specified criteria, including having the 6 highest regulatory rating); undercapitalized if the institution has a total risk-based capital ratio that is less than eight percent, a Tier 1 risk-based capital ratio less than four percent or a leverage ratio less than four percent (or a leverage ratio less than three percent if the institution is rated composite one in its most recent report of examination, subject to appropriate Federal banking agency guidelines); significantly undercapitalized if the institution has a total risk-based capital ratio less than six percent, a Tier 1 risk-based capital ratio less than three percent, or a leverage ratio less than three percent; and critically undercapitalized if the institution has a ratio of tangible equity to total assets equal to or less than two percent. At December 31, 2001, Frost Bank, Cullen/Frost's only insured depository institution subsidiary was considered "well capitalized". FDICIA generally prohibits a depository institution from making any capital distributions (including payment of a dividend) or paying any management fee to its holding company if the depository institution would thereafter be undercapitalized. Undercapitalized institutions are subject to growth limitations and are required to submit a capital restoration plan. The agencies may not accept such a plan without determining, among other things, that the plan is based on realistic assumptions and is likely to succeed in restoring the depository institution's capital. In addition, for a capital restoration plan to be acceptable, the depository institution's parent holding company must guarantee that the institution will comply with such capital restoration plan. The aggregate liability of the parent holding company is limited to the lesser of (i) an amount equal to five percent of the depository institution's total assets at the time it became undercapitalized and (ii) the amount which is necessary (or would have been necessary) to bring the institution into compliance with all capital standards applicable with respect to such institution as of the time it fails to comply with the plan. If a depository institution fails to submit an acceptable plan, it is treated as if it is significantly undercapitalized. "Significantly undercapitalized" depository institutions may be subject to a number of requirements and restrictions, including orders to sell sufficient voting stock to become "adequately capitalized," requirements to reduce total assets, and cessation of receipt of deposits from correspondent banks. "Critically undercapitalized" institutions are subject to the appointment of a receiver or conservator. DEPOSIT INSURANCE ----------------- Frost Bank is subject to Federal Deposit Insurance Corporation ("FDIC") deposit insurance assessments and to certain other statutory and regulatory provisions applicable to FDIC-insured depository institutions. The risk-based assessment system imposes insurance premiums based upon a matrix that takes into account a bank's capital level and supervisory rating. Over the last several years many banks, including Frost Bank, have paid no deposit insurance premiums. It is possible that in the near term the FDIC could impose assessment rates on institutions such as Frost Bank in connection with declines in the insurance funds or increases in the amount of insurance coverage. A depository institution insured by the FDIC can be held liable for any loss incurred by, or reasonably expected to be incurred by, the FDIC in connection with (i) the default of a commonly controlled FDIC-insured depository institution or (ii) any assistance provided by the FDIC to a commonly controlled, FDIC-insured depository institution in danger of default. "Default" is defined generally as the appointment of a conservator or receiver, and "in danger of default" is defined generally as the existence of certain conditions indicating that a "default" is likely to occur in the absence of regulatory assistance. DEPOSITOR PREFERENCE -------------------- Deposits and certain claims for administrative expenses and employee compensation against an insured depository institution are afforded priority over other general unsecured claims against such an institution, including federal funds and letters of credit, in the "liquidation or other resolution" of such an institution by any receiver. 7 ACQUISITIONS ------------ The BHC Act generally limits acquisitions by bank holding companies that are not financial holding companies to commercial banks and companies engaged in activities that the Federal Reserve Board has determined to be so closely related to banking as to be a proper incident thereto and requires the prior approval of the Federal Reserve Board to consummate such acquisitions. Financial holding companies may acquire non-banking entities under the Modernization Act by providing a notice to the Federal Reserve Board after consummation of such an acquisition. The BHC Act, the Federal Bank Merger Act, and the Texas Banking Code regulate the acquisitions of commercial banks. The BHC Act requires the prior approval of the Federal Reserve Board for the direct or indirect acquisition of more than five percent of the voting shares of a commercial bank or bank holding company. With respect to Frost Bank, the approval of the Comptroller of the Currency is required for branching, purchasing the assets or assuming deposits of other banks and bank mergers in which the continuing bank is a national bank. In reviewing bank acquisition and merger applications, the bank regulatory authorities will consider, among other things, the competitive effect and public benefits of the transactions, the capital position of the combined organization, and the applicant's record under the Community Reinvestment Act and fair housing laws. Cullen/Frost regularly evaluates acquisition opportunities and conducts due diligence activities in connection with possible acquisitions. As a result, acquisition discussions and, in some cases, negotiations may take place and future acquisitions involving cash, debt or equity securities may occur. Acquisitions typically involve the payment of a premium over book and market values, and, therefore, some dilution of the Corporation's book value and net income per common share may occur in connection with any future transactions. INTERSTATE BANKING AND BRANCHING LEGISLATION -------------------------------------------- The Riegle-Neal Interstate Branching Efficiency Act ("IBBEA"), authorizes interstate acquisitions of banks and bank holding companies without geographic limitation. IBBEA also authorizes a bank to merge with a bank in another state as long as neither of the states has opted out of interstate branching. A bank may establish a de novo branch in a state in which the bank does not maintain a branch if the state expressly permits de novo branching. Once a bank has established branches in a state through an interstate merger transaction, the bank may establish and acquire additional branches at any location in the state where any bank involved in the merger transaction could have established or acquired branches under applicable federal or state law. A bank that has established a branch in a state through de novo branching may establish and acquire additional branches in such state in the same manner and to the same extent as a bank having a branch in such state as a result of an interstate merger. If a state opts out of interstate branching within the specified time period, no bank in any other state may establish a branch in the opting out state, whether through an acquisition or de novo. On August 28, 1995, Texas enacted legislation opting out of interstate branching; however, in the second quarter of 1998, the OCC approved a series of merger transactions requested by a non-Texas based institution that ultimately resulted in the merger of its Texas based bank into the non-Texas based institution. Although challenged in the courts, the final legal ruling allowed the merger to proceed. In addition, on May 13, 1998, the Texas Banking Commissioner began accepting applications filed by state banks to engage in interstate mergers and branching. REGULATORY ECONOMIC POLICIES ---------------------------- The earnings of Cullen/Frost are affected not only by general economic conditions but also by the policies of various governmental regulatory authorities. The Federal Reserve Board regulates the supply of credit in order to influence general economic conditions, primarily through open market operations in United States government obligations, as well as varying the discount rate on financial institution borrowings and 8 varying reserve requirements against financial institution deposits and by restricting certain borrowings by such financial institutions and their subsidiaries. The deregulation of interest rates has had, and is expected to continue to have, an impact on the competitive environment in which Frost Bank operates. Governmental policies have had a significant effect on the operating results of commercial banks in the past and are expected to continue to do so in the future. However, Cullen/Frost cannot accurately predict the nature or extent of any effect such policies may have on its future business and earnings. EMPLOYEES --------- At December 31, 2001, Cullen/Frost employed 3,387 full-time equivalent employees. Employees of Cullen/Frost enjoy a variety of employee benefit programs, including a deferred profit sharing plan, 401(k) stock purchase plans, various comprehensive medical, accident and group life insurance plans and paid vacations. Cullen/Frost considers its employee relations to be good. 9 EXECUTIVE OFFICERS OF THE REGISTRANT -------------------------------------------------------------------------------- The names, ages, recent business experience and positions or offices held by each of the executive officers of Cullen/Frost during 2001 are as follows:

AGE AS OF NAME AND POSITIONS OR OFFICES 12/31/01 RECENT BUSINESS EXPERIENCE ------------------------------------------ --------- ------------------------------------------------ T.C. Frost 74 Officer and Director of Frost Bank since 1950. Senior Chairman of the Board Chairman of the Board of Cullen/Frost from 1973 and Director to October 1995. Member of the Executive Committee of Cullen/Frost from 1973 to present. Chief Executive Officer of Cullen/Frost from July 1977 to October 1997. Senior Chairman of Cullen/Frost from October 1995 to present. Richard W. Evans, Jr. 55 Officer of Frost Bank since 1973. Executive Vice Chairman of the Board, President of Frost Bank from 1978 to April 1985. Chief Executive Officer and Director President of Frost Bank from April 1985 to August 1993. Chairman of the Board and Chief Executive Officer of Frost Bank from August 1993 to present. Director and Member of the Executive Committee of Cullen/Frost from August 1993 to present. Chairman of the Board and Chief Operating Officer of Cullen/Frost from October 1995 to October 1997. Chairman of the Board and Chief Executive Officer of Cullen/Frost from October 1997 to present. Patrick B. Frost 41 Officer of Frost Bank since 1985. President of President of Frost Bank Frost Bank from August 1993 to present. Director and Director of Cullen/Frost from May 1997 to present. Member of the Executive Committee of Cullen/Frost from July 1997 to present. Phillip D. Green 47 Officer of Frost Bank since July 1980. Vice Group Executive Vice President President and Controller of Frost Bank from and Chief Financial Officer January 1981 to January 1983. Senior Vice President and Controller of Frost Bank from January 1983 to July 1985. Senior Vice President and Treasurer of Cullen/Frost from July 1985 to April 1989. Executive Vice President and Treasurer of Cullen/Frost from May 1989 to October 1995. Executive Vice President and Chief Financial Officer of Cullen/Frost from October 1995 to July 1998. Senior Executive Vice President and Chief Financial Officer from July 1998 to May 2001. Group Executive Vice President and Chief Financial Officer from May 2001 to present.

Stan McCormick, age 56, has been an officer of Frost Bank since 1994 and Secretary of Cullen/Frost from June 1999 to present. There are no arrangements or understandings between any executive officer of Cullen/Frost and any other person pursuant to which such executive officer was or is to be selected as an officer. 10 ITEM 2. PROPERTIES ------------------- The executive offices of Cullen/Frost, as well as the principal banking headquarters of Frost Bank, are housed in both a 21-story office tower and a nine-story office building located on approximately 3.5 acres of land in downtown San Antonio. Cullen/Frost and Frost Bank lease approximately 50 percent of the office tower. The nine-story office building was purchased in April 1994. Frost Bank also leases space in a seven-story parking garage adjacent to the banking headquarters. In June 1987, Frost Bank consummated the sale of its office tower and leased back a portion of the premises under a 13-year primary lease term with options allowing for occupancy up to 50 years. The Bank also sold its adjacent parking garage facility and leased back space in that structure under a 12-year primary lease term with options allowing for occupancy up to 50 years. Both leases allow for purchase of the related asset under specific terms. Frost Bank has agreed to repurchase both the office tower and the adjacent parking garage facility. Closing of the purchase agreement on the properties is expected to take place in the second quarter of 2002, with the purchase price of the office tower and the adjacent parking garage being approximately $25.7 million and $15.0 million, respectively. ITEM 3. LEGAL PROCEEDINGS ------------------------- Certain subsidiaries of Cullen/Frost are defendants in various matters of litigation which have arisen in the normal course of conducting a commercial banking business. In the opinion of management, the disposition of such pending litigation will not have a material effect on Cullen/Frost's consolidated financial position. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS ------------------------------------------------------------ None. 11 PART II ITEM 5. MARKET FOR REGISTRANT'S COMMON STOCK AND RELATED STOCKHOLDER ---------------------------------------------------------------------- MATTERS -------- Common Stock Market Prices and Dividends The tables below set forth for each quarter the high and low sales prices for Cullen/Frost's common stock and the dividends per share paid for each quarter. The Company's common stock is traded on The New York Stock Exchange ("NYSE") under the symbol "CFR". High and low sales prices are as reported by the NYSE. The closing price on March 15, 2002 was $35.71.

2001 2000 --------------- --------------- MARKET PRICE (PER SHARE) HIGH LOW High Low ---------------------------------------------------------------------------------------------- First Quarter.............................................. $41.94 $32.23 $26.94 $19.63 Second Quarter............................................. 36.45 29.65 28.81 23.50 Third Quarter.............................................. 39.50 24.50 34.94 26.25 Fourth Quarter............................................. 31.00 23.61 43.44 28.13

The number of record holders of common stock at February 22, 2002 was 2,172.

CASH DIVIDENDS (PER SHARE) 2001 2000 --------------------------------------------------------------------------- First Quarter............................................... $.195 $.175 Second Quarter.............................................. .215 .195 Third Quarter............................................... .215 .195 Fourth Quarter.............................................. .215 .195 ------------- Total.................................................. $.840 $.760 =============

The Corporation's management is committed to continuing to pay regular cash dividends; however, there is no assurance as to future dividends because they are dependent on future earnings, capital requirements and financial conditions. See "Capital and Liquidity" section on page 38 in Item 7 for further discussion and Note K "Dividends" on page 57. 12 ITEM 6. SELECTED FINANCIAL DATA -------------------------------- CONSOLIDATED STATEMENTS OF OPERATIONS (dollars in thousands, except per share amounts)

Year Ended December 31 --------------------------------------------------------------- 2001 2000 1999 1998 1997 1996 -------------------------------------------------------------------------------------------------------------------------- INTEREST INCOME: Loans, including fees................................ $343,928 $394,073 $329,610 $300,721 $261,607 $219,279 Securities........................................... 106,933 109,248 113,561 120,259 110,070 112,921 Time deposits........................................ 331 505 164 Federal funds sold and securities purchased under resale agreements.................................. 9,784 8,505 4,245 7,111 12,423 7,506 --------------------------------------------------------------- TOTAL INTEREST INCOME........................... 460,976 512,331 447,580 428,091 384,100 339,706 INTEREST EXPENSE: Deposits............................................. 118,699 158,858 128,819 138,283 131,140 117,179 Federal funds purchased and securities sold under repurchase agreements.............................. 12,054 17,889 12,500 11,606 8,739 9,773 Guaranteed preferred beneficial interests in the Corporation's junior subordinated deferrable interest debentures................................ 8,475 8,475 8,475 8,475 7,652 Other borrowings..................................... 5,531 4,346 808 1,754 1,434 1,037 --------------------------------------------------------------- TOTAL INTEREST EXPENSE.......................... 144,759 189,568 150,602 160,118 148,965 127,989 --------------------------------------------------------------- NET INTEREST INCOME............................. 316,217 322,763 296,978 267,973 235,135 211,717 Provision for possible loan losses....................... 40,031 14,103 12,427 10,393 9,174 8,494 --------------------------------------------------------------- NET INTEREST INCOME AFTER PROVISION FOR POSSIBLE LOAN LOSSES................................... 276,186 308,660 284,551 257,580 225,961 203,223 NON-INTEREST INCOME: Trust fees........................................... 48,784 49,266 46,411 46,863 43,275 36,898 Service charges on deposit accounts.................. 70,534 60,627 58,787 53,601 47,627 41,570 Insurance commissions................................ 17,423 10,331 3,902 Other service charges, collection and exchange charges, commissions and fees...................... 24,999 20,143 13,779 13,293 10,352 8,323 Net gain (loss) on securities transactions........... 78 4 (86) 359 498 (892) Other................................................ 31,073 30,494 28,470 22,361 18,953 17,403 --------------------------------------------------------------- TOTAL NON-INTEREST INCOME....................... 192,891 170,865 151,263 136,477 120,705 103,302 NON-INTEREST EXPENSE: Salaries and wages................................... 144,787 138,643 122,104 109,781 98,126 84,989 Pension and other employee benefits.................. 35,477 29,163 26,096 21,295 19,874 18,224 Net occupancy........................................ 29,649 27,905 27,149 25,486 22,812 21,486 Furniture and equipment.............................. 23,919 21,495 19,958 18,921 16,147 14,697 Intangible amortization.............................. 15,127 15,625 15,000 13,293 11,920 11,306 Restructuring charges................................ 19,865 Merger related charges............................... 12,244 Other................................................ 83,782 80,449 76,886 75,297 65,265 58,476 --------------------------------------------------------------- TOTAL NON-INTEREST EXPENSE...................... 352,606 313,280 287,193 276,317 234,144 209,178 --------------------------------------------------------------- INCOME BEFORE INCOME TAXES AND CUMULATIVE EFFECT OF ACCOUNTING CHANGE.......................... 116,471 166,245 148,621 117,740 112,522 97,347 Income taxes............................................. 38,565 57,428 50,979 42,095 39,555 34,409 --------------------------------------------------------------- Income before cumulative effect of accounting change..... 77,906 108,817 97,642 75,645 72,967 62,938 Cumulative effect of change in accounting for derivatives, net of tax................................ 3,010 --------------------------------------------------------------- NET INCOME...................................... $ 80,916 $108,817 $ 97,642 $ 75,645 $ 72,967 $ 62,938 =============================================================== Basic per share: Income before cumulative effect of accounting change............................................. $ 1.51 $ 2.09 $ 1.83 $ 1.42 $ 1.38 $ 1.18 Cumulative effect of change in accounting, net of taxes.............................................. .06 --------------------------------------------------------------- NET INCOME...................................... $ 1.57 $ 2.09 $ 1.83 $ 1.42 $ 1.38 $ 1.18 =============================================================== Diluted per share: Income before cumulative effect of accounting change............................................. $ 1.46 $ 2.03 $ 1.78 $ 1.38 $ 1.33 $ 1.16 Cumulative effect of change in accounting, net of taxes.............................................. .06 --------------------------------------------------------------- NET INCOME...................................... $ 1.52 $ 2.03 $ 1.78 $ 1.38 $ 1.33 $ 1.16 =============================================================== Return on Average Assets................................. 1.03% 1.52% 1.42% 1.18% 1.28% 1.23% Return on Average Equity................................. 13.18 20.41 18.68 15.44 16.38 15.63

Historical amounts have been restated for stock splits and to reflect the pooling-of-interests merger with Overton Bancshares, Inc., in 1998. 13 SELECTED FINANCIAL DATA (dollars in thousands, except per share amounts)

Year Ended December 31 --------------------------------------------------------------------------- 2001 2000 1999 1998 1997 1996 =========================================================================== BALANCE SHEET DATA Total assets..................... $8,369,584 $7,660,372 $6,996,680 $6,869,605 $6,045,573 $5,599,248 Guaranteed preferred beneficial interest in the Corporation's junior subordinated deferrable interest debentures, net....... 98,623 98,568 98,513 98,458 98,403 Shareholders' equity............. 594,919 573,026 509,311 512,919 462,929 424,786 Average shareholders' equity to average total assets........... 7.84% 7.46% 7.60% 7.63% 7.83% 7.87% Tier 1 risk-based capital ratio.......................... 10.14 10.08 11.04 12.23 11.21 11.39 Total risk-based capital ratio... 13.98 11.24 12.28 13.48 14.46 12.64 PER COMMON SHARE DATA Net income-basic*................ $ 1.57 $ 2.09 $ 1.83 $ 1.42 $ 1.38 $ 1.18 Net income-diluted*.............. 1.52 2.03 1.78 1.38 1.33 1.16 Cash dividends paid-CFR.......... .840 .760 .675 .575 .480 .403 Shareholders' equity............. 11.58 11.14 9.64 9.60 8.74 7.96 LOAN PERFORMANCE INDICATORS Non-performing assets............ $ 37,430 $ 18,933 $ 18,837 $ 17,104 $ 18,088 $ 14,069 Non-performing assets to: Total loans plus foreclosed assets...................... .83% .42% .45% .47% .58% .53% Total assets................... .45 .25 .27 .25 .30 .25 Allowance for possible loan losses......................... $ 72,881 $ 63,265 $ 58,345 $ 53,616 $ 48,073 $ 42,821 Allowance for possible loan losses to period-end loans..... 1.61% 1.40% 1.40% 1.47% 1.54% 1.60% Net loan charge-offs............. $ 30,415 $ 9,183 $ 8,764 $ 6,100 $ 6,027 $ 2,825 Net loan charge-offs to average loans.......................... .67% .21% .22% .18% .21% .12% COMMON STOCK DATA Common shares outstanding at period end..................... 51,355 51,430 52,823 53,425 52,940 53,365 Weighted average common shares... 51,530 52,123 53,368 53,150 52,999 53,195 Dilutive effect of stock options........................ 1,818 1,534 1,378 1,529 1,753 1,257 Dividends as a percentage of net income......................... 53.51% 36.35% 36.88% 40.29% 30.50% 29.80% NON-FINANCIAL DATA Number of employees.............. 3,387 3,394 3,336 3,095 3,045 2,743 Shareholders of record........... 2,179 2,250 2,442 2,624 2,358 2,336

* 2001 basic and diluted earnings per share before the after-tax restructuring charges were $1.82 and $1.76, respectively. 1998 basic and diluted earnings per share before the after-tax merger related charge were $1.60 and $1.56, respectively. 14 ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND ----------------------------------------------------------------------- RESULTS OF OPERATIONS --------------------- FINANCIAL REVIEW Discussed below are the operating results for Cullen/Frost Bankers, Inc. and Subsidiaries ("Cullen/ Frost" or the "Corporation") for the years 1999 through 2001. All of the acquisitions during this period were accounted for as purchase transactions, and as such, their related results of operations are included from the date of acquisition. All balance sheet amounts presented in the following financial review are averages unless otherwise indicated. Certain reclassifications have been made to make prior periods comparable. Taxable-equivalent adjustments are the result of increasing income from tax-free loans and investments by an amount equal to the taxes that would be paid if the income were fully taxable assuming a 35 percent federal tax rate, thus making tax-exempt yields comparable to taxable asset yields. Dollar amounts in tables are stated in thousands, except for per share amounts. FORWARD-LOOKING STATEMENTS -------------------------------------------------------------------------------- Certain statements contained in this Annual Report on Form 10-K that are not statements of historical fact constitute forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995 (the "Act"), even though they are not specifically identified as such. In addition, certain statements in future filings by Cullen/Frost with the Securities and Exchange Commission, in press releases, and in oral and written statements made by or with the approval of the Corporation which are not statements of historical fact constitute forward-looking statements within the meaning of the Act. Examples of forward-looking statements include, but are not limited to: (i) projections of revenues, income or loss, earnings or loss per share, the payment or nonpayment of dividends, capital structure and other financial items; (ii) statements of plans and objectives of Cullen/Frost or its management or Board of Directors, including those relating to products or services; (iii) statements of future economic performance; and (iv) statements of assumptions underlying such statements. Words such as "believes", "anticipates", "expects", "intends", "targeted" and similar expressions are intended to identify forward-looking statements but are not the exclusive means of identifying such statements. Forward-looking statements involve risks and uncertainties that may cause actual results to differ materially from those in such statements. Factors that could cause actual results to differ from those discussed in the forward-looking statements include, but are not limited to: (i) local, regional and international economic conditions and the impact they may have on Cullen/Frost and its customers; (ii) the effects of and changes in trade, monetary and fiscal policies and laws, including interest rate policies of the Federal Reserve Board; (iii) inflation, interest rate, market and monetary fluctuations; (iv) political instability; (v) acts of war or terrorism; (vi) the timely development and acceptance of new products and services and perceived overall value of these products and services by users; (vii) changes in consumer spending, borrowings and savings habits; (viii) technology changes; (ix) acquisitions and integration of acquired businesses; (x) the ability to increase market share and control expenses; (xi) changes in the competitive environment among financial holding companies; (xii) the effect of changes in laws and regulations (including laws and regulations concerning taxes, banking, securities and insurance) with which Cullen/Frost and its subsidiaries must comply; (xiii) the effect of changes in accounting policies and practices, as may be adopted by the regulatory agencies as well as the Financial Accounting Standards Board; (xiv) changes in the Corporation's organization, compensation and benefit plans; (xv) the costs and effects of litigation and of unexpected or adverse outcomes in such litigation; (xvi) costs or difficulties related to the integration of the businesses of Cullen/ Frost being greater than expected; and (xvii) the Corporation's success at managing the risks involved in the foregoing. Such forward-looking statements speak only as of the date on which such statements are made. Cullen/ Frost undertakes no obligation to update any forward-looking statement to reflect events or circumstances after the date on which such statement is made, or to reflect the occurrence of unanticipated events. 15 ACQUISITIONS --------------------- Cullen/Frost regularly evaluates acquisition opportunities and conducts due diligence activities in connection with possible acquisitions. As a result, acquisition discussions and, in some cases, negotiations, may take place and future acquisitions involving cash, debt or equity securities may occur. Acquisitions typically involve the payment of a premium over book and market values, and, therefore, some dilution of the Corporation's book value and net income per common share may occur in connection with any future transaction. All of the acquisitions during the period 1999 through 2001 were accounted for as purchase transactions, and as such, their related results of operations are included from the date of acquisition. None of the acquisitions had a material impact on Cullen/Frost's results of operations. Bank Acquisitions On May 20, 1999, Cullen/Frost paid approximately $42.3 million to acquire Commerce Financial Corporation and its four-location subsidiary, Bank of Commerce, in Fort Worth, Texas. The Corporation acquired loans of approximately $76 million and deposits of approximately $164 million. On January 15, 1999, Cullen/Frost paid approximately $18.7 million to acquire Keller State Bank which had three locations in Tarrant County, Texas. The Corporation acquired loans of approximately $38 million and deposits of approximately $62 million. Insurance Acquisitions On August 1, 2001, Frost Insurance Agency ("FIA"), a subsidiary of The Frost National Bank, completed its acquisition of AIS Insurance & Risk Management ("AIS"), an independent insurance agency based in Fort Worth. AIS offered a broad range of commercial insurance for small to mid-size businesses, including property and casualty, employee benefits (health, life and retirement plans), business succession planning and risk management services. On July 1, 2000 FIA acquired Nieman Hanks Puryear Partners and Nieman Hanks Puryear Benefits ("Nieman Hanks"), an Austin-based independent insurance agency. Nieman Hanks offered property and casualty insurance, professional and umbrella liability, homeowner and auto insurance, group health, life and disability policies and 401(k) retirement plans and executive planning. On April 1, 2000, FIA acquired Wayland Hancock Insurance Agency, Inc. ("Wayland Hancock"), a Houston-based independent insurance agency. Wayland Hancock offered a full range of property and casualty, life and health insurance products, as well as retirement and financial planning, to individuals and businesses. On May 1, 1999, FIA acquired Professional Insurance Agents, Inc. ("PIA"), a mid-sized independent insurance agency based in Victoria, Texas, with additional locations in San Antonio, New Braunfels and Refugio. PIA offered as agent, corporate and personal property and casualty insurance as well as group health and life insurance products to individuals and businesses. PIA was the newly formed FIA's first insurance agency acquisition. Investment Banking Subsidiary On August 2, 1999 Cullen/Frost began operations of its investment banking subsidiary in Dallas, Texas. Frost Securities, Inc. ("FSI") is a full-service investment bank offering financial advisory services, mergers and acquisitions support, equity research, and institutional equity sales and trading. The firm provides institutional investors with in-depth research coverage in energy and communications technology. 16 RESULTS OF OPERATIONS --------------------- For the year ended December 31, 2001, the Corporation reported net income of $80.9 million or $1.52 per diluted common share, compared to $108.8 million or $2.03 per diluted common share and $97.6 million or $1.78 per diluted common share for 2000 and 1999, respectively. Operating earnings for 2001 were $93.8 million or $1.76 per diluted common share. Operating earnings exclude $19.9 million of pre-tax restructuring charges that are discussed in detail on page 23. Operating earnings for 2001 were lower than the net income reported in 2000, primarily due to higher provision for possible loan losses and lower net interest income.

2001 Change 2000 Change EARNINGS SUMMARY 2001 From 2000 2000 From 1999 1999 ------------------------------------------------------------------------------------------------- Taxable-equivalent net interest income............................. $320,955 $ (6,302) $327,257 $25,777 $301,480 Taxable-equivalent adjustment........ 4,738 244 4,494 (8) 4,502 ---------------------------------------------------------- Net interest income.................. 316,217 (6,546) 322,763 25,785 296,978 Provision for possible loan losses... 40,031 25,928 14,103 1,676 12,427 Non-interest income: Net gain (loss) on securities transactions.................. 78 74 4 90 (86) Other........................... 192,813 21,952 170,861 19,512 151,349 ---------------------------------------------------------- Total non-interest income................... 192,891 22,026 170,865 19,602 151,263 Non-interest expense: Goodwill amortization........... 8,033 158 7,875 726 7,149 Other intangible amortization... 7,094 (656) 7,750 (101) 7,851 Restructuring charges........... 19,865 19,865 Other operating expenses........ 317,614 19,959 297,655 25,462 272,193 ---------------------------------------------------------- Total non-interest expense.................. 352,606 39,326 313,280 26,087 287,193 ---------------------------------------------------------- Income before income taxes and cumulative effect of accounting change............................. 116,471 (49,774) 166,245 17,624 148,621 Income taxes......................... 38,565 (18,863) 57,428 6,449 50,979 ---------------------------------------------------------- Income before cumulative effect of accounting change.................. 77,906 (30,911) 108,817 11,175 97,642 Cumulative effect of change in accounting for derivatives, net of tax................................ 3,010 3,010 ---------------------------------------------------------- Net income........................... $ 80,916 $(27,901) $108,817 $11,175 $ 97,642 ========================================================== Per common share: Net income-basic................ $ 1.57* $ (.52) $ 2.09 $ .26 $ 1.83 Net income-diluted.............. 1.52* (.51) 2.03 .25 1.78 Return on Average Assets............. 1.03%* (.49)% 1.52% .10% 1.42% Return on Average Equity............. 13.18* (7.23) 20.41 1.73 18.68

* Operating basic and diluted earnings per share for 2001 were $1.82 and $1.76, respectively. Operating ROA and ROE for 2001 were 1.20 percent and 15.28 percent, respectively. The provision for possible loan losses increased to $40.0 million for 2001, up from the $14.1 million recorded in 2000. This level of increase was considered necessary in light of credit deterioration in two large credits and continued uncertainty in the current economic environment. Loan loss reserves at the end of 2001 were built to $72.9 million or 1.61 percent of period-end loans. The operating results for 2001 were also impacted by an unprecedented decline in short term interest rates throughout the year, which resulted in lower net interest income, down two percent from 2000. With core deposits, especially demand deposits, being the predominant source of the Corporation's funding, the falling 17 interest rate environment caused margin compression due mainly to earning assets repricing faster than interest-bearing liabilities. More detail is available in the Net Interest Income section below. Also included in the 2001 results was a pre-tax gain of $5.7 million related to the sale of an interest rate floor, which was purchased as a hedge against falling interest rates. Of the total gain, $1.1 million was included in other non-interest income, with the remainder included, net of tax, as a $3.0 million cumulative effect of adopting Statement of Financial Accounting Standard ("SFAS") No. 133, which went into effect January 1, 2001. See the Interest Rate Swaps/Floor section on page 39 for further details. Given the impact of the higher provision for possible loan losses, lower net interest income, and $19.9 million in restructuring charges, return on average assets for 2001 was 1.03 percent, compared with 1.52 percent in 2000, while return on average equity was 13.18 percent in 2001, compared with 20.41 percent in 2000. Operating earnings return on average assets and return on average equity were 1.20 percent and 15.28 percent, respectively, for the year 2001. NET INTEREST INCOME ------------------- Net interest income, which accounted for 62 percent of Cullen/Frost's 2001 total revenue, is the Company's largest source of revenue. Net interest income is the difference between interest income on earning assets, such as loans and investment securities, and interest expense on liabilities, such as deposits and borrowings, which are used to fund those assets. The level of interest rates and the volume and mix of earning assets and interest-bearing liabilities impact net interest income. Net interest margin is the taxable-equivalent net interest income as a percentage of average earning assets for the period. This measure is followed closely by the analyst community. Net interest income on a tax equivalent basis for 2001 was $321.0 million, a two percent decrease from $327.3 million recorded in 2000 and up from the $301.5 million for 1999. The net interest margin was 4.89 percent for the year ended December 31, 2001, compared to 5.32 percent and 5.15 percent for the years 2000 and 1999, respectively. The decrease in the net interest income and net interest margin from a year ago is reflective of the impact of sharply reduced interest rates on the Corporation's asset-sensitive balance sheet (the company's earning assets are repricing faster than its interest-bearing liabilities). The federal funds rate (generally one-day loans of excess reserves from one bank to another) declined eleven times for a total of 4.75 percent during 2001. The Corporation is funded primarily by core deposits with demand deposits historically being a strong source of funds. This low cost funding base has historically been a positive to net interest income and margin. However, in a falling rate environment the Corporation suffers margin compression as (i) its earning assets are repricing quicker than its interest-bearing liabilities and (ii) its low cost funding base results in its inability to cut these rates proportionately with decreases in market rates. For 2001, the Corporation's ratio of average demand deposits to total average deposits was 33.4 percent, which was well above peer levels. See "Consolidated Average Balance Sheets" on pages 76 and 77 and "Rate Volume Analysis" on page 78. Net interest spread, which represents the difference between the rate earned on earning assets and the rates paid out on funds, decreased 18 basis points for 2001 to 4.15 percent. This compares to 4.33 percent and 4.34 percent for 2000 and 1999, respectively. The net interest spread as well as the net interest margin will be impacted by future changes in short-term and long-term interest rate levels, as well as the impact from the competitive environment. A discussion on the effects of changing interest rates on net interest income is included in the Market Risk Disclosure -- Interest Sensitivity section on page 39. The Corporation uses interest rate swaps and interest rate floors, commonly referred to as derivatives, to manage exposure to interest rates. Information on these swaps and floors is included in the Interest Rate Swaps/Floor section on page 39 and Notes A on page 47 and S on page 69 to the Consolidated Financial Statements. 18 NON-INTEREST INCOME ------------------- Non-interest income was $192.9 million for 2001, up $22 million or 12.9 percent when compared with $170.9 million for 2000, and up from $151.3 million for 1999. The $22 million increase from last year is primarily related to an increase in service charges on deposit accounts for both commercial and consumer accounts, an increase in insurance commissions, and higher revenues associated with FSI. The increase in non-interest income for 2000 compared to 1999 was broad based as all categories of fee income increased. The increase from 1999 to 2000 came from core growth and was also driven, in part, by the positive impact of the insurance agency acquisitions made during 2000 and FSI's first full year of operations. In addition to core growth, non-interest income was favorably impacted in 1999 by the first quarter acquisition of Keller State Bank and the second quarter acquisitions of Commerce Financial Corporation and PIA.

Year Ended December 31 ------------------------------------------------------------ 2001 2000 1999 ------------------ ------------------ ------------------ PERCENT Percent Percent NON-INTEREST INCOME AMOUNT CHANGE Amount Change Amount Change ------------------------------------------------------------------------------------------------ Trust fees........................ $ 48,784 - 1.0% $ 49,266 + 6.2% $ 46,411 - 1.0% Service charges on deposit accounts........................ 70,534 +16.3 60,627 + 3.1 58,787 + 9.7 Insurance commissions............. 17,423 +68.6 10,331 +164.8 3,902 Other service charges, collection and exchange charges, commissions and fees............ 24,999 +24.1 20,143 + 46.2 13,779 + 3.7 Net gain(loss) on securities transactions.................... 78 N/M 4 +104.7 (86) -124.0 Other............................. 31,073 +1.9 30,494 + 7.1 28,470 + 27.3 -------- -------- -------- Total........................ $192,891 +12.9 $170,865 + 13.0 $151,263 + 10.8 ======== ======== ========

Trust fees declined one percent compared to a year ago due to lower investment fees, which account for approximately 75 percent of trust fees. Investment fees are based on the market value of assets within a trust account. The market value of trust assets and the related investment fees were negatively impacted by the unfavorable equity market conditions during the year. The decline in investment fees ($1.6 million) was partially offset by higher fees on accounts with oil and gas properties ($1.2 million). These accounts are charged based on energy prices, which were higher during 2001 relative to 2000. In 2000, trust fees were up $2.9 million or 6.2 percent from 1999, mainly due to increases in investment fees and oil and gas fees, which partially offset decreases in management fees associated with small cap value funds. The market value of trust assets at the end of 2001 was $13.3 billion, up $400 million when compared to $12.9 billion at the end of 2000, with growth occurring in both managed and custody assets. Most of this growth occurred at the end of the year having little impact on investment fees in 2001. Trust assets were comprised of managed assets of $6.0 billion and custody assets of $7.3 billion at year-end 2001 compared to $5.7 billion and $7.2 billion, respectively, last year. Service charges on deposits increased $9.9 million or 16.3 percent from 2000. This increase can be attributed to higher revenues associated with both commercial and individual accounts and higher overdraft fees partially offset by lower non-sufficient funds charges. The increase associated with commercial accounts resulted primarily from higher treasury management services. Due in part to a lower earnings credit rate, the Corporation received more payment for services through fees than through the use of balances. The increase in revenues from individual accounts continues to result from the simplification of deposit account offerings in 1999. This simplification process resulted in fewer product offerings while enhancing the remaining available products ultimately resulting in a better value for the customer. In 2000, deposit service charges increased $1.8 million or 3.1 percent from 1999. This increase was due to higher overdraft charges and higher revenues associated with individual accounts. The previously discussed simplification of deposit account offerings, which began in 1999, was the primary reason for the increase in individual account revenues. 19 Insurance commissions increased $7.1 million or 68.6 percent from a year ago. Excluding the impact of the acquisition of AIS in the third quarter of 2001, insurance commissions would have increased 56.8 percent. This increase was the combined result of the impact of continued selling efforts and the effect of higher insurance premiums on commission revenues, as the insurance market has started to tighten the availability of certain products. Insurance commissions increased $6.4 million to $10.3 million in 2000 compared to $3.9 million in 1999. The increase in insurance commission income was positively impacted by the two agency acquisitions during 2000. Other service charges and fees increased $4.9 million or 24.1 percent when compared to 2000. The primary contributor to this increase was growth in equity sales commission revenue at FSI. Other service charges and fees increased $6.4 million or 46.2 percent from 1999 to 2000. Primary contributors to this growth were revenues from FSI, as it completed its first full year of operation. Other non-interest income increased $579 thousand or 1.9 percent to $31.1 million in 2001 compared to $30.5 million in 2000. The increase is related to the 2001 purchase of bank owned life insurance on certain employees where the Corporation is the beneficiary. The increase in cash surrender value on these insurance policies during 2001 was $3.4 million and was recorded in other non-interest income. This revenue and higher revenues received from larger balances held by the provider of the Corporation's official checks program were the primary reasons for the increase from a year ago. Additionally, a $1.1 million gain was recognized from the sale of an interest rate floor. These increases were offset somewhat by the $2 million non-recurring pre-tax gain from the sale of the mortgage servicing rights in 2000 and lower gain on the sale of student loans. Other non-interest income increased $2.0 million or 7.1 percent to $30.5 million in 2000 compared to $28.5 million in 1999. The increase in 2000 from 1999 resulted from higher income primarily related to increased usage of the Visa check card and annuity sales income and the previously mentioned $2 million gain from the sale of the mortgage servicing rights in 2000. These increases were partially offset by fewer mortgage loan origination fees, which resulted from the Corporation's outsourcing mortgage loans through the co-branding arrangement with GMAC Mortgage, and lower gains on the sale of student loans. NON-INTEREST EXPENSE -------------------- Non-interest expense was $352.6 million for 2001, an increase of $39.3 million or 12.6 percent compared with $313.3 million for 2000 and $287.2 million for 1999. Non-interest expense would have been $332.7 million, an increase of $19.5 million or 6.2 percent from 2000 excluding the restructuring charges included in the table and discussed below. Excluding the restructuring charge, approximately 65 percent of the increase from 2000 related to salaries and benefits. The increase in non-interest expense for 2000 was impacted by the insurance agency acquisitions made during 2000. In addition, the increase was impacted by a full years cost associated with Frost Securities and Commerce Financial Corporation. The acquisitions of Keller State Bank, Commerce Financial Corporation, and PIA, as well as the formation of FSI, impacted the growth in expenses in 1999.

Year Ended December 31 ------------------------------------------------------------ 2001 2000 1999 ------------------ ------------------ ------------------ PERCENT Percent Percent NON-INTEREST EXPENSE AMOUNT CHANGE Amount Change Amount Change --------------------------------------------------------------------------------------------------- Salaries and wages................... $144,787 + 4.4% $138,643 +13.5% $122,104 +11.2% Pension and other employee benefits........................... 35,477 +21.7 29,163 +11.8 26,096 +22.5 Net occupancy........................ 29,649 + 6.2 27,905 + 2.8 27,149 + 6.5 Furniture and equipment.............. 23,919 +11.3 21,495 + 7.7 19,958 + 5.5 Intangible amortization.............. 15,127 - 3.2 15,625 + 4.2 15,000 +12.8 Restructuring charges................ 19,865 Other................................ 83,782 + 4.1 80,449 + 4.6 76,886 + 2.1 -------- -------- -------- Total........................... $352,606 +12.6 $313,280 + 9.1 $287,193 + 3.9 ======== ======== ========

20 Salaries and wages increased by $6.1 million or 4.4 percent in 2001 and $16.5 million or 13.5 percent in 2000. Salaries and wages in both years have experienced increases related to FSI, the Corporation's investment banking subsidiary which began operations in August of 1999, and acquisitions made by FIA as well as normal market and merit increases based on performance in 2000. Offsetting part of the increase from the year 2000 was a decrease from the elimination of management bonuses for 2001. Also, included in 2000 were approximately $600 thousand in severance costs related to the outsourcing of mortgage loans. Pension and other employee benefits increased by $6.3 million or 21.7 percent during 2001 as a result of higher retirement plan expense, higher payroll taxes and higher medical expenses. For the year 2000 compared to 1999, pension and other employee benefits increased 11.8 percent as a result of two insurance acquisitions and the first full year of operations for FSI, as well as, higher medical expenses throughout the Corporation. Net occupancy increased $1.7 million or 6.2 percent during 2001 primarily reflecting higher general building maintenance and utility expenses and higher property tax expense related to a full year of operations for the two insurance acquisitions made in 2000 and five months of operations for the August 2001 acquisition. In 2000, net occupancy expense increased $756 thousand or 2.8 percent due to higher building lease expense and general building maintenance and utility expenses affected by de novo branches opened in 2000 and the second and third quarter 2000 insurance acquisitions. De novo branches are branches originally established by the bank and not acquired from another institution by purchase or merger. These increases were offset somewhat by lower property tax expense. Furniture and equipment costs increased $2.4 million or 11.3 percent in 2001 primarily due to higher software maintenance and amortization primarily related to the Corporation's e-commerce efforts and enhanced web site introduced in November of 2000. In 2000, furniture and equipment costs increased $1.5 million or 7.7 percent, which was also primarily due to higher amortized software and software maintenance. Intangible amortization for 2001 includes $8.0 million of goodwill amortization and $7.1 million of other intangible amortization, primarily related to core deposit intangibles. Intangible amortization for 2000 includes $7.9 million of goodwill amortization and $7.7 million of other intangible amortization, primarily related to core deposit intangibles. The increase in amortized goodwill was due to goodwill associated with acquisitions by FIA. Other intangible amortization decreased due to the run-off of core deposit intangibles associated with bank acquisitions in earlier years. See the discussion in the Cash Earnings section on page 24 for a discussion of SFAS No. 142, which will impact intangible amortization expense effective in 2002. The restructuring charges recorded in 2001 included separation and benefit charges of $11.5 million related to a voluntary early retirement program effective as of December 31, 2001, which was accepted by about four percent of the staff. The $11.5 million charge consisted of approximately $6.0 million related to additional pension benefits, $1.4 million associated with future medical benefits, with the remainder due to cash payments based on length of service. The restructuring charges also included $6.7 million due to the freezing of the Corporation's defined benefit pension plan (replaced by a deferred profit sharing plan). The remaining $1.7 million related to severance and outplacement services for a two percent reduction in workforce. Anticipated savings from the reduction in workforce and the voluntary early retirement program ("ERW") are expected to be approximately $13.2 million in 2002. The freeze of the defined benefit plan and its replacement by a deferred profit sharing plan should reduce the volatility in retirement plan expense going forward. However, the Corporation still has funding obligations related to the defined benefit plan and could recognize retirement expense related to this plan in future years, which would be dependent on the return earned on plan assets, the level of interest rates and employee turnover. Other non-interest expense increased $3.3 million or 4.1 percent during 2001 primarily due to higher professional, advertising, and travel expenses related to the Corporation's fee business expansion efforts. Federal Reserve service charges were also up from last year due to the lower rate environment, as the Corporation paid more for services through fees than through the use of balances held at the Federal Reserve. Somewhat offsetting this increase in expenses was lower educational and telephone expense. Other non-interest expense increased $3.6 million or 4.6 percent during 2000 and was broad-based throughout several operational accounts including professional expenses, business development and travel expenses. 21 RESULTS OF SEGMENT OPERATIONS ----------------------------- The Corporation's operations are managed along three Operating Segments: Banking, the Financial Management Group ("FMG") and FSI, which began operations in August of 1999. A description of each business and the methodologies used to measure financial performance are described in Note U to the Consolidated Financial Statements on page 71. The following table summarizes operating earnings by Operating Segment for each of the last three years:

Year Ended December 31 ----------------------------- 2001 2000 1999 ------------------------------------------------------------------------------------------- Banking..................................................... $ 91,639 $105,613 $93,427 Financial Management Group.................................. 11,353 16,164 15,262 Frost Securities Inc. ...................................... (3,650) (3,350) (2,387) Non-Banks................................................... (5,514) (9,610) (8,660) Restructuring charges (after tax)........................... (12,912) -- -- ----------------------------- Consolidated Net Income..................................... $ 80,916 $108,817 $97,642 =============================

Banking Operating earnings were $91.6 million for 2001, down 13.2 percent from $105.6 million for 2000 and down from $93.4 million for 1999. The decrease in operating earnings in 2001 versus 2000 reflects the impact of a $26.0 million increase in the provision for possible loan losses, mainly related to a deterioration of two large credits and continued uncertainty in the current economic environment. The loan loss reserve was built to $72.9 million or 1.61 percent of period-end loans. Net interest income was lower due to the decline in short-term interest rates, from 6.50 percent at the beginning of the year to 1.75 percent by year-end. The bank is primarily funded by non-interest bearing demand deposits representing 33.3 percent of total deposits at year-end 2001. This high level of demand deposits has been a positive for the bank's net interest income in the past. In a falling rate environment, however, margin compression can occur more rapidly as rates on this funding source cannot go any lower. Partially offsetting the adverse impacts of higher provision for loan losses and lower net interest income were higher service charges on deposits, increased insurance commissions, and the pre-tax gain of $5.7 million related to the sale of an interest rate floor. The $9.9 million increase in service charges on deposits, up 16.4 percent, over 2000 can be attributed to higher revenues associated with both commercial and individual accounts and higher overdraft fees partially offset by lower non-sufficient funds charges. FIA, which is included in the banking operating segment, had gross revenues of $18.8 million during 2001 as compared with $11.1 million in 2000. Insurance commissions were the largest component of these revenues. The $7.1 million or 68.6 percent increase over 2000 reflects the acquisition on August 1, 2001 of AIS and the full year impact of the acquisitions made in the third and second quarters of 2000. It also reflects the impact of tightening insurance markets for some products, as well as continued selling efforts. Referrals made by employees across the organization, including commercial banking, are expected to be an important source of growth for FIA. During 2001, FIA was successful on about 60 percent of their proposals made to qualified referrals provided by other employees of the bank. There were no bank acquisitions during 2001 or 2000. Results for the year 2000 reflect the full year impact of the acquisition in May 1999 of PIA and the two bank acquisitions made in the first and second quarters of 1999. Financial Management Group Operating earnings for 2001 were $11.4 million, compared to $16.2 million for 2000 and $15.3 million for 1999. Net interest income was down $2.7 million compared to the previous year as the lower rate environment has reduced the funds transfer price paid on FMG's securities sold under repurchase agreements. Total non-interest income was up $1.0 million from 2000. The leading component of FMG non-interest income, trust 22 fees, were down slightly due to equity market conditions and the resulting impact to investment fees, which represent approximately 75 percent of trust fees. Other fees, not included in trust fees, such as brokerage commissions from the sale of mutual funds, money markets and annuities, account for most of the increase year over year. This was slightly offset by a decrease in brokerage commissions from less sales of equities. Operating expenses were up $3.0 million from last year. Most of the increase was due to salaries and benefits, as well as litigation expenses and sundry losses. Salaries and benefits were up, in part, to support business initiatives within FMG through expansion of the brokerage sales force, securities lending and fixed income management. Comparing 2000 to 1999, the increase in operating earnings can be attributed to growth in investment fees and oil and gas fees. While oil and gas fees were influenced by the higher market prices of oil and gas, investment fees were positively impacted by a larger fee base due to growth in the number of trust accounts combined with increased market values associated with managed assets. Frost Securities Inc. FSI's operating loss of $3.7 million for 2001 increased from a $3.4 million loss for 2000, and from a $2.4 million loss for less than a half year of operations in 1999. Investment banking fees have been adversely impacted by market conditions in the energy and technology sectors. Both years were further impacted by expenses as the company continued to expand this business segment during its startup phase. Total revenues were up $4.1 million or 63.9 percent over 2000 driven primarily by equities sales commissions, which represented about 90 percent of FSI's 2001 revenue. FSI revenues represented approximately six percent of the Corporation's non-interest income during 2001. Non-interest expenses for 2001 were up $4.5 million or 39.4 percent to $16 million. Approximately one half of the increase was in salaries and benefits associated with an increase in overall average headcount of 23 percent year-over-year. Also impacting higher salaries were increases in sales commissions related to higher revenue from equity sales. Business development expenses were up due to an increase in institutional sales marketing activity. Clearing fees were higher as a result of increased commission revenue. Additional market data and trading floor communication systems and recruiting expenses also added to the increase in non-interest expenses. Staffing levels at the end of 2001 included 46 employees compared to 43 at the end of 2000 and 28 at the end of 1999. As of year-end 2001 there were 39 energy and 24 technology stocks under coverage. Non-Banks The reduction in operating loss for non-banks in 2001 was due to a decrease in expenses relating to elimination of management bonuses. The increased loss in 2000 compared with 1999 was due to increased incentive compensation and fees for professional services. Restructuring Charges The restructuring charges, after tax, recorded in 2001 included separation and benefit charges of $7.5 million after tax related to a voluntary early retirement program effective as of December 31, 2001, which was accepted by about four percent of the staff. The $7.5 million after tax charge consisted of approximately $3.9 million after tax related to additional pension benefits, $900 thousand after tax associated with future medical benefits, with the remainder due to cash payments based on length of service. The restructuring charges also included $4.3 million after tax due to the freezing of the Corporation's defined benefit pension plan (replaced by a deferred profit sharing plan). The remaining $1.1 million after tax related to severance and outplacement services for a two percent reduction in workforce. 23 INCOME TAXES ------------ Cullen/Frost recognized income tax expense of $40.2 million in 2001, compared to $57.4 million in 2000, and $51.0 million in 1999. The effective tax rate in 2001 was 33.18 percent compared to 34.54 percent in 2000 and 34.30 percent in 1999. The lower effective tax rate in 2001 compared to 2000 was mainly due to an increase in tax exempt income resulting from the purchase of bank owned life insurance during 2001. For a detailed analysis of the Corporation's income taxes see Note O "Income Taxes" on page 65. CASH EARNINGS ------------- Historically, excluding the merger with Overton Bancshares, Inc. in 1998, the Corporation's acquisitions have been accounted for using the purchase method of accounting, which results in the creation of intangible assets. These intangible assets are deducted from capital in the determination of regulatory capital. Thus, "cash" or "tangible" earnings represents the regulatory capital generated during the year and can be viewed as net income excluding intangible amortization, net of tax. While the definition of "cash" or "tangible" earnings may vary by company, the Corporation believes this definition is appropriate as it measures the per share growth of regulatory capital, which impacts the amount available for dividends, acquisitions, and growth. Statement of Financial Accounting Standards ("SFAS") No. 142, issued in July 2001, replaces the practice of amortizing goodwill and indefinite lived intangible assets with an annual review for impairment. See Note A "Accounting Changes" section on page 49 for further discussion on this statement. The following table reconciles reported earnings to net income excluding intangible amortization ("cash" earnings) for each of the three most recent year periods:

Year Ended December 31 ----------------------------------------------------------------------------------------------------------- 2001 2000 1999 ---------------------------------- ---------------------------------- --------------------------------- REPORTED INTANGIBLE "CASH" Reported Intangible "Cash" Reported Intangible "Cash" EARNINGS AMORTIZATION EARNINGS Earnings Amortization Earnings Earnings Amortization Earnings ---------------------------------------------------------------------------------------------------------------------------------- Income before income taxes and cumulative effect of accounting change............. $116,471 $15,127 $131,598 $166,245 $15,625 $181,870 $148,621 $15,000 $163,621 Income taxes......... 38,565 3,277 41,842 57,428 3,437 60,865 50,979 3,434 54,413 ----------------------------------------------------------------------------------------------------------- Income before cumulative effect of accounting change............. 77,906 11,850 89,756 108,817 12,188 121,005 97,642 11,566 109,208 Cumulative effect of accounting change, net of tax......... 3,010 3,010 ----------------------------------------------------------------------------------------------------------- Net income........... $ 80,916 $11,850 $ 92,766 $108,817 $12,188 $121,005 $ 97,642 $11,566 $109,208 =========================================================================================================== Net income per diluted common share.............. $ 1.52 $ .22 $ 1.74 $ 2.03 $ .23 $ 2.26 $ 1.78 $ .21 $ 1.99 Return on assets..... 1.03% 1.18%* 1.52% 1.69%* 1.42% 1.59%* Return on equity..... 13.18 15.11** 20.41 22.70** 18.68 20.89**

* Calculated as A/B ** Calculated as A/C ---------------------

2001 2000 1999 ---------- ---------- ---------- Net income before intangible amortization (including (A) goodwill and core deposit intangibles, net of tax).......... $ 92,766 $ 121,005 $ 109,208 (B) Total average assets........................................ 7,836,731 7,149,684 6,875,436 (C) Average shareholders' equity................................ 614,010 533,125 522,770

24 SOURCES AND USES OF FUNDS ------------------------- Average assets for 2001 of $7.8 billion increased by 9.6 percent from 2000 levels and increased 4.0 percent between 1999 and 2000. Deposits remain the primary source of funding for Cullen/Frost. Funding sources in 2001 reflected an increase in demand deposits and other liabilities offsetting a decrease in time deposits. In addition, borrowed funds increased due to the third quarter 2001 issuance by Frost Bank of $150 million of its 6 7/8 percent Subordinated Bank Notes due 2011. Demand deposits in particular have shown an improving trend over the three year period, which has been a key factor in the Corporation's ability to maintain a low cost of funds while funding loan growth. For 2001, average demand deposits were 33.4 percent of total average deposits compared with 31.3 percent during 2000, and 30.6 percent during 1999. Loans continue to be the largest component of the earning assets mix. However, non-earning assets increased 2.3 percent from levels a year ago because of float associated with higher demand deposit balances. Non-earning assets include cash, due from banks, banking premises, accrued interest and other assets.

Percentage of Total Average Assets ------------------------------------ SOURCES AND USES OF FUNDS 2001 2000 1999 -------------------------------------------------------------------------------------------------- Sources of Funds: Deposits: Demand............................................ 27.9% 26.5% 26.1% Time.............................................. 55.7 58.1 59.0 Federal funds purchased................................ 4.5 4.6 4.2 Equity capital......................................... 7.8 7.5 7.6 Borrowed funds......................................... 2.5 2.3 1.6 Other liabilities...................................... 1.6 1.0 1.5 ------------------------------------ Total............................................. 100.0% 100.0% 100.0% ==================================== Uses of Funds: Loans.................................................. 58.0% 60.9% 57.2% Securities............................................. 22.5 23.2 26.8 Federal funds sold..................................... 3.2 1.9 1.2 Non-earning assets..................................... 16.3 14.0 14.8 ------------------------------------ Total............................................. 100.0% 100.0% 100.0% ====================================

25 LOANS ----- Total period-end loans for 2001 were $4.5 billion, which were flat compared to 2000. However, excluding shared national credits purchased ("SNCs"), 1-4 family residential mortgages and the indirect lending portfolio, loans increased by 5.3 percent over 2000. The Corporation withdrew from the mortgage origination business, as well as the indirect lending business during 2000, and these portfolios continue to decrease through payoffs and refinancings. The SNCs portfolio has decreased steadily over the past year. See NPA section on page 30 for further discussion. The mortgage and indirect portfolios are also discussed in more detail later in this section.

December 31 ------------------------------------------------------------------------------ 2001 -------------------------- LOAN PORTFOLIO ANALYSIS PERCENTAGE OF (PERIOD-END BALANCES) AMOUNT TOTAL LOANS 2000 1999 1998 1997 -------------------------------------------------------------------------------------------------------- Real estate: Construction: Commercial......... $ 373,431 8.3% $ 342,944 $ 325,156 $ 270,976 $ 162,406 Consumer........... 44,623 1.0 44,078 53,951 21,121 16,462 Land: Commercial......... 128,782 2.8 148,777 118,290 69,157 54,003 Consumer........... 7,040 .2 9,282 10,009 5,839 6,330 Commercial real estate mortgages.......... 994,485 22.0 1,011,105 849,906 726,793 642,964 1-4 Family residential mortgages.......... 244,897 5.4 310,946 340,213 415,036 375,976 Other consumer real estate............. 278,849 6.2 267,790 240,229 171,579 68,289 ------------------------------------------------------------------------------ Total real estate..... 2,072,107 45.9 2,134,922 1,937,754 1,680,501 1,326,430 Commercial and industrial............ 1,985,447 43.9 1,873,809 1,635,097 1,263,517 1,066,224 Consumer: Indirect.............. 65,217 1.4 136,921 211,246 288,698 362,271 Other................. 345,899 7.7 341,546 352,155 351,463 288,111 Other, including foreign............... 54,943 1.2 54,796 36,693 65,781 77,053 Unearned discount....... (5,005) (.1) (7,349) (6,217) (3,357) (3,194) ------------------------------------------------------------------------------ Total................. $4,518,608 100.0% $4,534,645 $4,166,728 $3,646,603 $3,116,895 ============================================================================== Percent change from previous year......... -.4% +8.8% +14.3% +17.0% +16.6%

At December 31, 2001, the majority of the loan portfolio was comprised of real estate loans totaling $2.1 billion or 45.9 percent of total loans and the commercial and industrial loan portfolio totaling $2.0 billion or 43.9 percent of total loans. The real estate total includes both commercial and consumer balances. At December 31, 2001 and 2000, the Corporation had no concentration, by Standard Industrial Classification code ("SIC"), in any single industry that exceeded 10 percent of total loans. The SIC code is a federally designed standard numbering system identifying companies by industry. Cullen/Frost uses the SIC code to categorize loans by the recipient's type of business. The largest single concentration by SIC code at year-end 26 2001 was in energy at 6.5 percent of total loans. The following table categorizes loan portfolio concentrations by SIC code, illustrating the diversity in the Corporation's total loan portfolio:

Percentage of Period End Loans December 31 INDUSTRY CONCENTRATION OF LOAN ---------------- PORTFOLIO BY SIC CODE 2001 2000 ------------------------------------------------------------------------------ Energy...................................................... 6.5% 6.2% Manufacturing, other........................................ 6.3 6.5 Services.................................................... 5.3 4.5 Building construction....................................... 4.8 4.5 Retail...................................................... 3.3 2.8 General and specific trade contractors...................... 3.2 2.7 Wholesale equipment......................................... 3.2 3.0 Medical services............................................ 3.2 3.0 All other (33 categories)................................... 64.2 66.8 ---------------- Total loans................................................. 100.0% 100.0% ================

The majority of the 5.3 percent growth in total loans over 2000 (excluding SNCs, mortgage loans and indirect lending) was in the commercial and industrial loan portfolio, which increased to $2.0 billion at year-end 2001. The Corporation's commercial and industrial loans are a diverse group of loans to small, medium and large businesses. The purpose of these loans varies from supporting seasonal working capital needs to term financing of equipment. While some short term loans may be made on an unsecured basis, most are secured by the assets being financed with appropriate collateral margins. The commercial and industrial loan portfolio also includes the commercial lease portfolio and asset based lending. At December 31, 2001, the commercial lease portfolio totaled $41.0 million and asset based loans totaled $48.6 million. These totals are both increases from December 31, 2000 balances of $40.0 million and $31.0 million, respectively. In addition, at December 31, 2001, over 97 percent of the outstanding balance of SNCs were included in the commercial and industrial portfolio, with the remainder included in the real estate categories. The Corporation had a total SNCs portfolio of approximately $237 million outstanding at year-end 2001, which is down from $316 million at the previous year end. Of the outstanding total at year-end 2001, approximately 35 percent were energy related with the remainder diversified throughout various industries. These participations are done in the normal course of business to meet the needs of the Corporation's customers. General corporate policy towards participations is to lend to companies either headquartered in or having significant operations within our markets. In addition, the Corporation must have an existing banking relationship or the expectation of broadening the relationship with other bank products. Total real estate loans at December 31, 2001 were $2.1 billion, down 2.9 percent from year-end 2000. However, excluding the decline in the 1-4 family residential mortgage portfolio, which is discussed below, total real estate loans remained relatively flat with year-end 2000. The commercial real estate portfolio, which totals $1.5 billion, represents over 72 percent of the total real estate loans at year-end 2001. The majority of this portfolio is commercial real estate mortgages, which includes both permanent and intermediate term loans. The diversity in the commercial real estate portfolio allows the Corporation to reduce the impact of a 27 decline in any single industry. The following table reflects the concentration by industry in the commercial real estate portfolio:

Percentage of Period End Balances December 31 -------------------- CONCENTRATION IN COMMERCIAL REAL ESTATE PORTFOLIO 2001 2000 ---------------------------------------------------------------------------------- Office building............................................. 18.2% 15.9% Office/warehouse............................................ 11.5 9.6 1-4 Family.................................................. 10.1 9.2 Non-farm/nonresidential..................................... 7.0 9.0 Retail...................................................... 6.6 8.1 Multi-family................................................ 5.1 5.8 All other................................................... 41.5 42.4 -------------------- 100.0% 100.0% ====================

The primary focus of the commercial real estate portfolio has been the growth of loans secured by owner-occupied properties. These loans are viewed primarily as cash flow loans and secondarily as loans secured by real estate. Consequently, these loans must undergo the analysis and underwriting process of a commercial and industrial loan, as well as a commercial real estate loan. At December 31, 2001, approximately 49 percent of the Corporation's commercial real estate loans were secured by owner-occupied properties. The consumer loan portfolio, including all consumer real estate, at December 31, 2001 totaled $987 million, down 11.2 percent from year-end 2000. However, excluding the decrease in the 1-4 family residential mortgage and the indirect lending portfolios, total consumer loans increased by 2.1 percent. As the following table illustrates, the consumer loan portfolio has four distinct segments -- consumer real estate, consumer non-real estate, indirect consumer loans and 1-4 family residential mortgages.

Period End Balances December 31 ------------------- CONSUMER LOAN PORTFOLIO (IN MILLIONS) 2001 2000 --------------------------------------------------------------------------------- Construction................................................ $ 44.6 $ 44.1 Land........................................................ 7.0 9.3 Other consumer real estate.................................. 278.9 267.8 ------------------- Total consumer real estate............................. 330.5 321.2 Consumer non-real estate.................................... 345.9 341.6 Indirect.................................................... 65.2 136.9 1-4 Family residential mortgages............................ 244.9 310.9 ------------------- $986.5 $1,110.6 ===================

The majority of the 2.1 percent growth in consumer loans, excluding mortgage and indirect lending, has occurred in the consumer real estate portfolio, which primarily consists of home equity, home improvement and residential lot loans. This segment has increased to $331 million at year-end 2001 from $321 million at the previous year-end. The Corporation offers home equity loans up to 80 percent of the estimated value of the personal residence of the borrower, less the value of existing mortgages and home improvement loans. Home equity loans, which were allowed in the state of Texas beginning January 1, 1998, account for almost half of the consumer real estate total at year-end 2001. The consumer non-real estate loan segment has grown to $346 million at year-end 2001 from $342 million at year-end 2000. Loans in this segment include automobile loans, unsecured revolving credit products, personal loans secured by cash and cash equivalents, and other similar types of credit facilities. The indirect consumer loan segment has continued to decrease by about $18 million per quarter since the Corporation's decision to discontinue originating these types of loans during 2000. At December 31, 2001, the majority of the portfolio was comprised of new and used automobile loans (60.1 percent of total), as well as purchased home improvement and home equity loans (37.4 percent of total). The portfolio is not expected to 28 completely pay off by year-end 2002 due to the longer life of the non-auto loans in this portfolio. However, the portfolio is expected to be substantially reduced by that time. The Corporation also discontinued originating 1-4 family residential mortgage loans in 2000. These types of loans are now offered through the Corporation's co-branding arrangement with GMAC Mortgage. At December 31, 2001, the 1-4 family residential loan segment totaled $245 million down from $311 million at year-end 2000. Although this portfolio will continue to decline due to the decision to withdraw from the mortgage origination business, the high level of mortgage refinancings during 2001's falling interest rate environment drove the substantial decrease during 2001. The following table details the Corporation's total loan portfolio by a regional breakout at year-end 2001 and 2000. The "Other portfolios" category includes indirect lending, 1-4 family residential mortgages, SNCs and student loans. The decreases in the major components of this category have been previously discussed.

December 31 ------------------------- Percent (IN MILLIONS) 2001 CHANGE 2000 --------------------------------------------------------------------------------------- Fort Worth/Dallas........................................... $1,122 15.2% $ 974 Houston..................................................... 1,006 4.7 961 San Antonio................................................. 860 (5.4) 909 Austin...................................................... 400 (1.2) 405 Corpus Christi.............................................. 215 10.3 195 Rio Grande Valley........................................... 94 8.0 87 Other portfolios............................................ 822 (18.1) 1,004 ------ ------ $4,519 $4,535 ====== ======

The majority of the 2001 loan growth in dollars occurred in the higher growth markets of Fort Worth/ Dallas and Houston, two important and growing Texas markets. Part of this growth results from the fact that the Corporation has a smaller market share in these regions. The Corporation has sought to expand its market share by (i) hiring new loan officers, primarily from banks with larger market shares and (ii) growing business through customers who previously did business with banks with larger market share in these regions. The loan decline in the San Antonio region is reflective of the mature market share that the Corporation has achieved in its headquarters market. The growth in the Austin region remained relatively flat for 2001 from 2000, mainly due to the overall slowing economy in that market, heavily influenced by the decline in their technology sector. Loans from Mexico are secured by liquid assets held in the United States were $10.8 million, $16.8 million, and $17.9 million for the years ended 2001, 2000, and 1999, respectively. Cullen/Frost's cross-border outstandings to Mexico excluding these loans totaled $63 thousand, $490 thousand and $2.4 million at December 31, 2001, 2000, and 1999, respectively. At December 31, 2001 and 2000, none of the Mexico-related loans were on non-performing status compared to $342 thousand at December 31, 1999. LOAN COMMITMENTS ---------------- In the normal course of business, in order to meet the financial needs of its customers, Cullen/Frost is a party to financial instruments with off-balance sheet risk. These include commitments to extend credit and standby letters of credit which commit the Corporation to make payments to or on behalf of customers when certain specified future events occur. Both arrangements have credit risk essentially the same as that involved in extending loans to customers and are subject to the Corporation's normal credit policies. Collateral is obtained based on management's credit assessment of the customer. Commitments to extend credit and standby letters of credit amounted to $2.3 billion and $123.5 million, respectively, at December 31, 2001, and $2.1 billion and $105.8 million respectively, at December 31, 2000. Commercial and industrial loan commitments represent approximately 75 percent and 69 percent of the total loan commitments outstanding at December 31, 2001 and 2000. Acceptances due from customers at December 31, 2001 were $3.9 million. 29 NON-PERFORMING ASSETS --------------------- Non-performing assets were $37.4 million at December 31, 2001, compared with $18.9 million at December 31, 2000 and $18.8 million at December 31, 1999. The increase from last year is due to two large SNCs that went on non-accrual status during 2001. One loan, to an electronics distribution company, went on non-accrual status during the first quarter. Approximately $13 million of this credit has been charged-off with $6.3 million remaining in non-accrual loans. The second loan, which went on non-accrual status in the third quarter, was made to a private company in the marketing and sales promotion industry, an industry that was dramatically affected by the terrorist attack on September 11, 2001. Approximately $9 million of the second loan has been charged-off with $8.2 million remaining in non-accrual loans. Non-performing assets include non-accrual loans and foreclosed assets. Loans upon which interest income is not currently accrued because of the borrower's financial problems are classified as non-accrual. Foreclosed assets represent property acquired as the result of borrower defaults on loans. Non-performing assets as a percentage of total loans and foreclosed assets were .83 percent at December 31, 2001, compared to .42 percent one year ago. In addition, non-performing assets as a percentage of total assets were .45 percent at year end 2001 compared to .25 percent at year-end 2000. The Corporation anticipates non-performing assets as a percentage of total assets for 2002 to range plus or minus 10 percent of year-end 2001 levels.

December 31 --------------------------------------------------- NON-PERFORMING ASSETS 2001 2000 1999 1998 1997 ---------------------------------------------------------------------------------------------- Non-accrual.............................. $33,196 $16,662 $14,854 $12,997 $13,077 Foreclosed assets........................ 4,234 2,271 3,983 4,107 5,011 --------------------------------------------------- Total............................... $37,430 $18,933 $18,837 $17,104 $18,088 =================================================== As a percentage of total assets.......... .45% .25% .27% .25% .30% As a percentage of total loans plus foreclosed assets...................... .83 .42 .45 .47 .58 After-tax impact of lost interest per common share........................... $ .03 $ .03 $ .02 $ .02 $ .02 Accruing loans 90 days past due: Consumer............................... $ 521 $ 498 $ 733 $ 1,347 $ 3,410 All other.............................. 13,080 7,474 6,177 9,434 3,412 --------------------------------------------------- Total............................... $13,601 $ 7,972 $ 6,910 $10,781 $ 6,822 ===================================================

Cullen/Frost did not have any restructured loans for the years ended December 31, 2001-1997. Interest income that would have been recorded in 2001 on non-performing assets, had such assets performed in accordance with their original contract terms, was $2.4 million on non-accrual loans and $181 thousand on foreclosed assets. During 2001, the amount of interest income actually recorded on non-accrual loans was $913 thousand. There were no foreign loans 90 days past due as of December 31, 2001. Loans to a customer whose financial condition has deteriorated are considered for non-accrual status whether or not the loan is 90 days or more past due. All non-consumer loans 90 days or more past due are classified as non-accrual unless the loan is well secured and in the process of collection. When a loan is placed on non-accrual status, interest income is not recognized until collected, and any previously accrued but uncollected interest is reversed. A loan is considered as restructured if it has been modified as to original terms, resulting in a reduction or deferral of principal and/or interest as a concession to the debtor that the creditor would not otherwise consider. Classification of an asset in the non-performing category does not preclude ultimate collection of loan principal or interest. Potential problem loans consist of loans that are performing in accordance with contractual terms but for which management has serious concerns about the ability of an obligor to continue to comply with repayment terms because of the obligor's potential operating or financial difficulties. At December 31, 2001, Cullen/Frost had $4.2 million in loans of this type which had not been included in either of the non-accrual or 90 days past due loan categories. Subsequent to December 31, 2001, the Corporation has placed $2.5 million of these loans 30 on non-performing status. Management monitors such loans closely and reviews their performance on a regular basis. ALLOWANCE FOR POSSIBLE LOAN LOSSES ---------------------------------- The allowance for possible loan losses was $72.9 million or 1.61 percent of period-end loans at December 31, 2001, compared to $63.3 million or 1.40 percent of period-end loans at year-end 2000. The allowance for possible loan losses as a percentage of non-accrual loans was 219.5 percent at December 31, 2001, compared with 379.7 percent at December 31, 2000. Cullen/Frost recorded a $40.0 million provision for possible loan losses during 2001, compared to $14.1 million and $12.4 million recorded during 2000 and 1999, respectively. The increase in the provision for possible loan losses was due to the two previously discussed SNC loans and reflected the increased uncertainty in the economy since the terrorist acts of September 11, 2001 combined with the economic downturn already in progress at that time. The allowance for loan losses is maintained at a level considered appropriate by management, based on estimated probable losses in the loan portfolio. The allowance consists of three elements: (i) allowances established for potential losses on specific loans, (ii) allowances based on historical loan loss experience, for similar loans with similar loan characteristics, and trends, and (iii) unallocated allowances, not allocated to loans or a group of loans, but instead based on general economic conditions and other internal and external risk factors in the Corporation's individual markets. The specific allowances are based on a regular analysis and evaluation of criticized loans. The quality of loans are determined based on an internal credit risk grading process that evaluates: the obligor's ability to repay, the underlying collateral, if any, and the economic environment and industry in which the obligor operates. This analysis is performed at the relationship manager level for all commercial loans. Obligors whose calculated grade is below a predetermined grade are viewed as criticized. Once criticized, a loan is analyzed (at least quarterly) by a special assets officer to determine if a specific allowance is needed. Specific allocations are based on an obligor's inability or unwillingness to repay, collateral deficiencies and risk grade, and/or the state of the borrower's industry. If a specific allowance is not assigned to a criticized loan, and it is not determined impaired, it is included in the historical allowance portion of the process for loans with similar characteristics. Historical allowances are determined statistically using a loss analysis that examines loss experience of the portfolio in total, by specific loan types and the related internal grading of loans charged-off. This loss analysis is periodically updated based on actual experience. This analysis is performed on several groups of loans including unfunded loan commitments. Thereby, several historical allowance pools result. Specifically, historical allowance pools exist for commercial real estate loans, commercial and industrial loans, consumer loans and 1-4 family residential mortgages. Unallocated allowances based on general economic conditions and other internal and external risk factors are determined by evaluating the experience, ability and effectiveness of the bank's lending management and staff, effectiveness of lending policies and procedures and internal controls, changes in asset quality, changes in loan portfolio volume, composition and concentrations of credit, impact of competition on loan structuring and pricing, effectiveness of the internal loan review, impact of environmental risks on portfolio risks, and impact of rising interest rates on portfolio risk. Quarterly, senior management evaluates the degree of risk that each one of these components has on the quality of the loan portfolio. Each component is determined to have either a high, moderate or low degree of risk. The results are then input into a "general allocation matrix" to determine the unallocated general allowance. While the loss analysis for the historical allowance is performed annually, the Corporation may revise the general allocation factors whenever necessary in order to address improving or deteriorating credit quality trends or events; or recognize specific risks associated with a given loan concentration or pool classification. In addition, an audit committee of non-management directors reviews the adequacy of the allowance for possible loan losses quarterly. 31 Cullen/Frost recorded net charge-offs of $30.4 million for the year ended December 31, 2001, compared to net charge-offs of $9.2 million and $8.8 million in 2000 and 1999, respectively. Charge-offs are loan balances that have been written off against the reserve for loan losses once the loan is determined to be uncollectible. As a percentage of average loans, net charge-offs were .67 percent for 2001 compared to .21 percent last year. The Corporation's gross charge-offs in 2001 consisted primarily of commercial and industrial loans, which increased $25.1 million to $32.1 million, and consumer loans, which decreased $1.3 million to $4.3 million. The increase in commercial and industrial loan charge-offs is associated with two large SNC non-accrual loans (previously discussed in the Non-Performing Assets section on page 30). The Corporation's gross charge-offs in 2000 consisted primarily of commercial and industrial loans, which increased $1.7 million to $7.0 million, and consumer loans, which decreased $1.8 million to $5.6 million. The decrease in consumer charge-offs for 2001 and 2000 is related to lower indirect lending charge-offs, a product that the company stopped originating in 2000.

Year Ended December 31 ------------------------------------------------------------------ ALLOWANCE FOR POSSIBLE LOAN LOSSES 2001 2000 1999 1998 1997 ------------------------------------------------------------------------------------------------------ Average loans outstanding during year, net of unearned discount..................... $4,546,596 $4,352,868 $3,934,406 $3,437,510 $2,917,371 ================================================================== Balance of allowance for possible loan losses at beginning of year......................... $ 63,265 $ 58,345 $ 53,616 $ 48,073 $ 42,821 Provision for possible loan losses....................... 40,031 14,103 12,427 10,393 9,174 Loan loss reserve of acquired institutions................. 1,066 1,250 2,105 Charge-offs: Real estate.................. (336) (465) (357) (397) (650) Commercial and industrial.... (32,074) (6,999) (5,349) (3,980) (2,028) Consumer..................... (4,340) (5,625) (7,420) (8,081) (7,209) Other, including foreign*.... (30) (73) (7) (90) (40) ------------------------------------------------------------------ Total charge-offs......... (36,780) (13,162) (13,133) (12,548) (9,927) ------------------------------------------------------------------ Recoveries: Real estate.................. 917 388 582 1,674 956 Commercial and industrial.... 3,658 1,549 1,799 2,176 965 Consumer..................... 1,779 2,030 1,919 2,528 1,853 Other, including foreign*.... 11 12 69 70 126 ------------------------------------------------------------------ Total recoveries.......... 6,365 3,979 4,369 6,448 3,900 ------------------------------------------------------------------ Net charge-offs................ (30,415) (9,183) (8,764) (6,100) (6,027) ------------------------------------------------------------------ Balance of allowance for possible loan losses at end of year... $ 72,881 $ 63,265 $ 58,345 $ 53,616 $ 48,073 ================================================================== Net charge-offs as a percentage of average loans outstanding during year, net of unearned discount..................... .67% .21% .22% .18% .21% Allowance for possible loan losses as a percentage of year-end loans, net of unearned discount..................... 1.61 1.40 1.40 1.47 1.54

* There were no foreign charge-offs in 2001-1997. 32 Cullen/Frost has certain lending policies and procedures in place that are designed to maximize loan income within an acceptable level of risk. These policies and procedures, some of which are described below, are reviewed regularly by senior management. A reporting system supplements this review process by providing management and the board of directors with frequent reports related to loan production, loan quality, concentrations of credit, loan delinquencies and non-performing and potential problem loans. 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 their business. Once it is determined that the borrower's management possesses sound ethics and solid business acumen, current and projected cash flows are examined to determine the ability to repay their obligations as agreed. Underwriting standards are designed to promote relationship banking rather than transactional banking. While some short-term loans may be made on an unsecured basis, most are secured by the assets being financed with appropriate collateral margins. The diversity of the Corporation's commercial real estate portfolio allows it to reduce the impact of a decline in a single market or industry. Management monitors and evaluates commercial real estate loans based on collateral, geography and risk grade criteria. As a general rule, single purpose projects are avoided unless other underwriting factors are present to help mitigate the risk. The Corporation also utilizes the knowledge of third-party experts to provide insight and guidance about the economic conditions and dynamics of the markets served by the Corporation. In addition, management closely tracks the level of owner-occupied commercial real estate loans versus non-owner occupied loans. At December 31, 2001, 49 percent of the Corporation's commercial real estate loans were secured by owner-occupied properties. These loans are viewed primarily as cash flow loans and secondarily as loans secured by real estate. Consequently, these loans must withstand the analysis of a commercial loan and the underwriting process of a commercial real estate loan. Loans secured by non-owner occupied commercial real estate are made to developers and builders who have a relationship with Cullen/Frost and who have a proven record of success. These loans are underwritten through the use of feasibility studies, independent appraisal reviews, sensitivity analysis of absorption and lease rates and financial analysis of the developers and property owners. Sources of repayment for these types of loans may be pre-committed permanent loans from approved long-term lenders, sales of developed property or an interim mini-perm 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, general economic conditions and the availability of long-term financing. A computer-based credit scoring analysis is used to supplement the consumer loan underwriting process. To monitor and manage consumer loan risk, policies and procedures are developed and modified, as needed, jointly by line and staff personnel. This activity, coupled with relatively small loan amounts that are spread across many individual borrowers, minimizes the risk. Additionally, trend and outlook reports are provided to senior management on a frequent basis to aid in planning. Underwriting standards for home equity loans are heavily influenced by statutory requirements, which include but are not limited to, maximum loan-to-value percentage, collection remedies, the number of such loans a borrower can have at one time and documentation requirements. 33 Cullen/Frost has an independent Loan Review Division that reviews and validates the credit risk program on a periodic basis. Results of these reviews are presented to senior management and the board of directors. Loan Review's function complements and reinforces the risk identification and assessment decisions made by lenders and credit personnel, as well as the Corporation's policies and procedures. Loans identified as losses by management, internal loan review and/or bank examiners are charged-off. Furthermore, consumer loan accounts are charged-off automatically based on regulatory requirements. An allowance for possible loan losses is maintained in an amount which, in management's judgment, provides an adequate reserve to absorb probable credit losses related to specifically identified loans as well as loan losses inherent in the remainder of the loan portfolio that have been incurred as of the balance sheet date.

December 31 ------------------------------------------------------------------------------------------------- 2001 2000 1999 1998 ---------------------- ---------------------- ---------------------- ---------------------- ALLOWANCE Allowance Allowance As a Allowance As a FOR AS A For As A For Percentage For Percentage POSSIBLE PERCENTAGE Possible Percentage Possible Of Possible Of ALLOCATION OF ALLOWANCE LOAN OF TOTAL Loan Of Total Loan Total Loan Total FOR POSSIBLE LOAN LOSSES LOSSES LOANS Losses Loans Losses Loans Losses Loans ----------------------------------------------------------------------------------------------------------------------------- Commercial and industrial............... $30,831 .68% $25,031 .55% $22,404 .54% $15,085 .41% Real estate............... 10,427 .23 11,389 .25 9,485 .23 10,021 .28 Consumer.................. 9,909 .22 10,846 .24 12,621 .30 17,130 .47 Purchasing or carrying securities............... 1 85 Financial institutions.... 118 98 36 Other, including foreign.................. 423 .01 279 .01 215 .01 246 .01 Unallocated............... 21,291 .47 15,602 .35 13,521 .32 11,013 .30 ------------------------------------------------------------------------------------------------- Total.................. $72,881 1.61% $63,265 1.40% $58,345 1.40% $53,616 1.47% =================================================================================================

December 31 ---------------------- 1997 ---------------------- Allowance As a For Percentage Possible Of ALLOCATION OF ALLOWANCE Loan Total FOR POSSIBLE LOAN LOSSES Losses Loans -------------------------- ---------------------- Commercial and industrial............... $14,346 .46% Real estate............... 9,460 .31 Consumer.................. 17,486 .56 Purchasing or carrying securities............... 88 Financial institutions.... 60 Other, including foreign.................. 371 .01 Unallocated............... 6,262 .20 ---------------------- Total.................. $48,073 1.54% ======================

Allocation of a portion of the allowance does not preclude its availability to absorb losses in other categories. 34 SECURITIES ---------- Total securities, including securities available for sale, were $2.2 billion at year-end 2001 compared to $1.7 billion a year ago, and consist primarily of obligations of U.S. Government agencies. Securities available for sale totaled $2.1 billion at December 31, 2001, compared to $1.6 billion at year-end 2000. Available for sale securities are stated at fair value, with unrealized gains and losses, net of tax, reported as a separate component of shareholders' equity. Securities held to maturity totaled $51 million at December 31, 2001 compared to $71 million at December 31, 2000. Securities classified as held to maturity are carried at amortized cost. Debt securities are classified as held to maturity when Cullen/Frost has the positive intent and ability to hold the securities to maturity. The remaining securities are classified as trading and are carried at fair value. Trading securities were $118 thousand at December 31, 2001 compared to $2.5 million at December 31, 2000. Trading securities held primarily for sale in the near term are valued at their fair values, with unrealized gains and losses included immediately in other income. The average yield of the securities portfolio for the year ended December 31, 2001 was 6.33 percent compared with 6.84 percent for 2000. See page 79 "Maturity Distribution and Securities Portfolio Yields" for additional information on end of period securities. Total securities including trading, available for sale and held to maturity are summarized below:

December 31 --------------------------------------------------------------------------- 2001 2000 1999 ----------------------- ----------------------- ----------------------- PERIOD-END PERCENTAGE Period-End Percentage Period-End Percentage SECURITIES BALANCE OF TOTAL Balance Of Total Balance Of Total ----------------------------------------------------------------------------------------------------------- U.S. Treasury................. $ 14,362 .7% $ 107,567 6.5% $ 118,130 7.2% U.S. Government agencies and corporations................ 1,936,200 89.8 1,358,818 81.4 1,324,440 81.3 States and political subdivisions................ 177,090 8.2 165,675 9.9 153,319 9.4 Other......................... 28,944 1.3 36,424 2.2 34,022 2.1 --------------------------------------------------------------------------- Total.................... $2,156,596 100.0% $1,668,484 100.0% $1,629,911 100.0% =========================================================================== Average yield earned during the year (taxable-equivalent basis)...................... 6.33% 6.84% 6.38%

35 DEPOSITS -------- Total average demand deposits increased 15.3 percent from 2000. Most of the increase came in commercial and individual accounts, which increased $247.3 million or 15.1 percent. Approximately 62 percent of the increase in commercial and individual deposit levels is related to a large mortgage originator and servicing customer for which Cullen/Frost is the depository and clearing bank. The remaining portion of the increase is attributable to broad based growth and was not impacted by a banking acquisition. Cullen/Frost continues to maintain good relationships with correspondent banks in the markets it serves. These relationships along with market conditions are the primary reason for the increase of $35 million or 15.4 percent in correspondent bank deposit levels from a year ago. Reflective of Cullen/Frost's commitment to relationships and full-service business banking is the high level of average demand deposits as a percentage of total deposits. Average demand deposits for 2001 were 33.4 percent of total deposits compared to 31.3 percent for 2000.

2001 2000 1999 -------------------- -------------------- -------------------- AVERAGE PERCENT Average Percent Average Percent DEMAND DEPOSITS BALANCE CHANGE Balance Change Balance Change ---------------------------------------------------------------------------------------------------- Commercial and individual....... $1,883,931 +15.1% $1,636,633 + 6.8% $1,533,160 +10.5% Correspondent banks............. 262,840 +15.4 227,807 + 2.8 221,530 +13.3 Public funds.................... 39,919 +22.0 32,732 -12.9 37,567 -13.7 ---------- ---------- ---------- Total...................... $2,186,690 +15.3 $1,897,172 + 5.9 $1,792,257 +10.2 ========== ========== ==========

Total average time deposits increased $210.2 million or 5.1 percent from a year ago. The largest increase of $122.4 million or 7.2 percent was in money market deposit accounts. During 2000, Cullen/Frost simplified its retail deposit products and offered a new money market index account. The money market index account requires the maintenance of certain balances in a checking account and offers a higher-yielding money fund with rates based on an external index. The money market index account had $545 million in average deposits for 2001 compared with $162 million for 2000. In addition, public funds increased $55.7 million or 22.2 percent with jumbo certificate of deposits representing the largest category of public funds and accounting for $35.9 million of the increase. These increases were offset by a decline in consumer time accounts under $100,000 of $18.1 million or 3.2 percent.

2001 2000 1999 --------------------------- --------------------------- --------------------------- AVERAGE PERCENT Average Percent Average Percent TIME DEPOSITS BALANCE CHANGE COST Balance Change Cost Balance Change Cost -------------------------------------------------------------------------------------------------------------- Savings and Interest-on-Checking.. $ 966,429 + .5% .37% $ 961,315 + 1.4% .66% $ 948,487 + 5.2% .69% Money market deposit accounts........... 1,825,991 + 7.2 2.63 1,703,602 + 4.1 4.49 1,636,915 +17.9 3.69 Time accounts of $100,000 or more... 718,456 + 6.7 4.57 673,421 + 3.8 5.52 648,820 - 1.2 4.44 Time accounts under $100,000........... 547,543 - 3.2 4.43 565,601 - 6.0 4.83 601,520 - 4.4 4.15 Public funds......... 306,248 +22.2 3.26 250,559 +13.5 4.58 220,845 -12.2 3.61 ---------- ---------- ---------- Total........... $4,364,667 + 5.1 2.72 $4,154,498 + 2.4 3.82 $4,056,587 + 6.0 3.18 ========== ========== ==========

36 The table below provides average deposits and related growth by geographic market primarily excluding correspondent bank deposits.

December 31 ------------------------- Percent (in millions) 2001 Change 2000 --------------------------------------------------------------------------------------- San Antonio................................................. $2,727 10.9% $2,459 Houston..................................................... 1,188 10.5 1,075 Fort Worth/Dallas........................................... 1,026 3.7 989 Austin...................................................... 779 7.4 725 Corpus Christi.............................................. 488 3.0 474 Rio Grande Valley........................................... 82 10.0 75 ------ ------ $6,290 $5,797 ====== ======

The following table summarizes the certificates of deposit in amounts of $100,000 or more as of December 31, 2001 by time remaining until maturity.

December 31 --------------------- 2001 REMAINING MATURITY OF PRIVATE --------------------- CERTIFICATES OF DEPOSIT PERCENTAGE OF $100,000 OR MORE AMOUNT OF TOTAL ----------------------------------------------------------------------------------- Three months or less........................................ $379,660 56.6% After three, within six months.............................. 169,644 25.3 After six, within twelve months............................. 113,527 16.9 After twelve months......................................... 8,219 1.2 --------------------- Total.................................................. $671,050 100.0% ===================== Percentage of total private time deposits................... 16.5%

Other time deposits of $100,000 or more were $172.3 million at December 31, 2001. Of this amount 67.2 percent matures within three months, 27.1 percent matures between three and six months and the remainder matures between six months and one year. Mexico has been considered a part of the natural trade territory of the banking offices of Cullen/Frost for over 90 years. Thus, dollar-denominated foreign deposits from Mexican sources have traditionally been a significant source of funding. The Corporation's average foreign deposits increased 1.2 percent from 2000.

FOREIGN DEPOSITS 2001 2000 1999 -------------------------------------------------------------------------------------------- Average balance............................................. $737,680 $729,111 $691,356 Percentage of total average deposits........................ 11.3% 12.1% 11.8%

SHORT-TERM BORROWINGS --------------------- The Corporation's primary source of short-term borrowings is Federal funds purchased from correspondent banks and securities sold under repurchase agreements in the natural trade territory of Frost Bank, as well as from upstream banks. The net purchase position, experienced for the last four years, is primarily the result of continued growth in earning assets over core deposit growth. Core deposits are deposits that have traditionally been stable, including all deposits other than time deposits of $100,000 or more and foreign deposits. The reduction in this position during 2001 resulted from the Corporation's use of funds acquired from the issuance of $150 million of Bank Notes in August by Frost Bank. The weighted-average interest rate on Federal funds purchased at December 31, 2001 and 2000 was 1.49 percent and 6.31 percent, respectively. 37 Generally, the interest rates on securities sold under repurchase agreements are a percentage of the Federal funds rate.

2001 2000 1999 ------------------- ------------------- ------------------- AVERAGE AVERAGE Average Average Average Average FEDERAL FUNDS BALANCE RATE Balance Rate Balance Rate -------------------------------------------------------------------------------------------------- Federal funds sold and securities purchased under repurchase agreements..................... $ 253,112 3.81% $ 130,800 6.50% $ 81,363 5.22% Federal funds purchased and securities sold under repurchase agreements.......... (351,319) 3.38 (326,448) 5.48 (285,470) 4.38 --------- --------- --------- Net funds position............. $ (98,207) $(195,648) $(204,107) ========= ========= =========

Year Ended December 31 FEDERAL FUNDS PURCHASED AND SECURITIES ------------------------------ SOLD UNDER REPURCHASE AGREEMENTS 2001 2000 1999 -------------------------------------------------------------------------------------------- Balance at year end......................................... $305,384 $363,111 $333,459 Maximum month-end balance................................... 400,358 486,356 474,013

In addition, Cullen/Frost had average borrowings from the Federal Home Loan Bank of $31.4 million, $32.1 million and $12.1 million for 2001, 2000 and 1999, respectively. See Note I on page 56 for further discussion. CAPITAL AND LIQUIDITY -------------------------------------------------------------------------------- At December 31, 2001, shareholders' equity was $594.9 million, which was an increase of 3.8 percent from $573.0 million at December 31, 2000. In addition to net income of $80.9 million, activity in 2001 included $43.3 million of dividends paid and $10.4 million paid for repurchasing shares of the Corporation's common stock. The unrealized loss on securities available for sale and additional minimum pension liability, net of deferred taxes, was $14.0 million as of December 31, 2001 compared to an unrealized loss of $4.0 million as of December 31, 2000, which had the effect of decreasing capital by $10.0 million. Currently, under regulatory requirements, the unrealized gain or loss on securities available for sale does not reduce regulatory capital and is not included in the calculation of risk-based capital and leverage ratios. Cullen/Frost paid a quarterly dividend of $.195 per common share during the first quarter of 2001. During the second quarter of 2001 the Corporation raised its cash dividend 10.3 percent to .215 for the second, third, and fourth quarters of 2001. The Corporation paid a quarterly dividend of $.175 per common share during the first quarter of 2000 increasing to $.195 per common share during the second, third, and fourth quarters of 2000. The dividend payout ratio was 53.5 percent for 2001 compared to 36.3 percent for 2000. In addition, the Corporation announced in 2001 that its board of directors had authorized the repurchase of up to 2.6 million shares of its common stock over a two-year period from time to time at various prices in the open market or through private transactions. As of December 31, 2001, 398 thousand shares worth $10.4 million had been repurchased under this program. The Federal Reserve Board utilizes capital guidelines designed to measure Tier 1 and Total Capital and take into consideration the risk inherent in both on-balance sheet and off-balance sheet items. For Cullen/ Frost's capital ratios at December 31, 2001 and 2000, see Note L "Capital" on page 58. Liquidity measures the ability to meet current and future cash flow needs as they become due. Cullen/ Frost seeks to ensure that these needs are met at a reasonable cost by maintaining a level of liquid funds through asset/liability management. Asset liquidity is provided by liquid assets which are readily marketable or pledgeable or which will mature in the near future. Liquid assets include cash, short-term time deposits in banks, securities available for sale, maturities and cash flow from securities held to maturity, and Federal funds sold and securities purchased under resale agreements. 38 Liability liquidity is provided by access to funding sources which include core deposits and correspondent banks in Cullen/Frost's natural trade area that maintain accounts with and sell Federal funds to Frost Bank, as well as Federal funds purchased and securities sold under repurchase agreements from upstream banks. The liquidity position of Cullen/Frost is continuously monitored and adjustments are made to the balance between sources and uses of funds as deemed appropriate. INTEREST RATE SWAPS/FLOOR -------------------------------------------------------------------------------- Cullen/Frost uses interest rate swaps and floors to hedge its interest rate risk. The Corporation had 43 fair value type commercial loan/lease interest rate swaps with a notional amount of $119 million at December 31, 2001 and 34 commercial loan/lease interest rate swaps with a notional amount of $211 million at December 31, 2000. In 2001 and 2000, each swap was a hedge against a specific commercial fixed-rate loan/lease or against a specific pool of commercial floating-rate loans with lives ranging from approximately one month to ten years. For 2001 and 2000, the scheduled reductions of the interest rate swaps' notional amount generally matched the expected amortization of the underlying loan/lease or pool of loans. In 2000, the Corporation entered into an interest rate floor three-year agreement with a notional amount totaling $1 billion. The interest rate floor was a hedge of interest rate exposure associated with commercial loan accounts in an environment of falling rates. The floor agreement was sold during the first quarter of 2001. Under new accounting rules (see "Accounting Changes" on page 49) adopted on January 1, 2001, the interest rate floor did not qualify for hedge accounting treatment and in management's opinion would have introduced excessive volatility into earnings. For a discussion on the gain from the sale see Note S on page 69. In 2001 Cullen/Frost entered into a fair value type interest rate swap agreement related to the $150 million fixed rate subordinated debt issued in 2001. The swap agreement has an effective notional amount of $150 million over a period of five years. In 2001, the Corporation's derivative financial instruments used in hedging activities were all designated as fair value type hedges, which were required to meet specific criteria. For fair value type hedges, the changes in fair values of both the hedging derivative and the hedged item were recorded in current earnings as other income or other expense and were immaterial in 2001. When a fair value type hedge no longer qualifies for hedge accounting, previous adjustments to the carrying value of the hedged item are reversed immediately to current earnings and the hedge is reclassified to a trading position recorded at fair value. Interest rate swap and floor contracts involve the risk of dealing with counterparties and their ability to meet contractual terms. Each counterparty to a swap transaction is approved by Cullen/Frost's Asset/ Liability Management Committee ("ALCO" or the "Committee") and has a credit rating that is investment grade. The net amount payable or receivable under interest rate swaps/floors is accrued as an adjustment to interest income and was not material in 2001, 2000 or 1999. Effective January 1, 2001, Cullen/Frost has adopted SFAS No. 133 "Accounting for Derivative Instruments and Hedging Activities" (See "Accounting Changes" on page 49.) MARKET RISK DISCLOSURE -- INTEREST RATE SENSITIVITY -------------------------------------------------------------------------------- Market risk is the potential loss arising from adverse changes in the fair value of a financial instrument due to the changes in market rates and prices. In the ordinary course of business, Cullen/Frost's market risk is primarily that of interest rate risk. The Corporation's interest rate sensitivity and liquidity are monitored on an ongoing basis by the ALCO committee. The Committee seeks to avoid fluctuating net interest margins and to maximize net interest income within acceptable levels of risks through periods of changing interest rates. A variety of measures are used to provide for a comprehensive view of the magnitude of interest rate risk, the distribution of risk, level of risk over time and exposure to changes in certain interest rate relationships. Cullen/Frost utilizes an earnings simulation model as the primary quantitative tool in measuring the amount of interest rate risk associated with changing market rates. The model quantifies the effects of various interest rate scenarios on the projected net interest income and net income over the ensuing 12-month period. 39 The model was used to measure the impact on net interest income relative to a base case scenario, of rates increasing ratably 200 basis points or decreasing ratably 50 basis points (due to the already low level of short term rates) over the next 12 months. These simulations incorporate assumptions regarding balance sheet growth and mix, pricing and the repricing and maturity characteristics of the existing and projected balance sheet. The impact of interest rate swaps is included in the model. Other interest rate-related risks such as prepayment, basis and option risk are also considered. The resulting model simulations show that a 200 basis point increase in rates will result in a positive variance in net interest income of 4.2 percent relative to the base case over the next 12 months; while a decrease of 50 basis points will result in a negative variance in net interest income of 0.6 percent. This compares to last year's estimate when a 200 basis points increase in rates resulted in a positive variance in net interest income of 0.9 percent relative to the base case over the next 12 months, while a decrease of 200 basis points resulted in a negative variance in net interest income of 1.8 percent. The Corporation's trading portfolio is immaterial, and, as such, separate quantitative disclosure is not presented. The Committee continuously monitors and manages the balance between interest rate-sensitive assets and liabilities. The objective is to manage the impact of fluctuating market rates on net interest income within acceptable levels. In order to meet this objective, management may lengthen or shorten the duration of assets or liabilities or enter into derivative contracts to mitigate potential market risk. PARENT CORPORATION -------------------------------------------------------------------------------- Historically, a large portion of the parent Corporation's income, which provides funds for the payment of dividends to shareholders and for other corporate purposes, has been derived from Cullen/Frost's investments in subsidiaries. The amount of dividends received from Frost Bank is based upon its earnings and capital position. See Note K "Dividends" on page 57. Management fees are not assessed. NON-BANKING SUBSIDIARIES -------------------------------------------------------------------------------- The New Galveston Company is a second-tier wholly-owned financial holding company subsidiary, which holds all shares of each banking and non-banking subsidiary. Cullen/Frost has four principal non-banking subsidiaries. Frost Securities, Inc., an investment banking subsidiary based in Dallas, Texas offers a full range of services including financial advisory services, mergers and acquisitions support, equity research, institutional equity sales and trading. The firm provides institutional investors with in-depth research coverage in energy and communications technology. Main Plaza Corporation occasionally makes loans to qualified borrowers. Such loans are typically funded with borrowings against Cullen/Frost's current cash or borrowings against credit lines. Daltex General Agency, Inc., a managing general insurance agency, provides vendor's single interest insurance for Cullen/Frost subsidiary banks. Cullen/Frost Capital Trust I is a Delaware statutory trust. The sole purpose of the trust was to issue Capital Securities and lend the proceeds back to the Corporation on a long term basis. This structure allowed the Corporation to obtain Tier 1 regulatory capital on a tax advantaged basis. The subsidiary is consolidated and the capital is recorded in the liability section of the balance sheet. SUBSEQUENT EVENTS -------------------------------------------------------------------------------- Frost Bank has signed a definitive agreement to acquire the Harlingen branch of JPMorgan Chase Bank. This acquisition allows the Corporation to expand its presence in the Rio Grande Valley, which began when it acquired Valley Bancshares and its bank in McAllen, Valley National Bank in 1995. A second McAllen location was opened in 1997. Frost Bank will assume approximately $20 million in deposits associated with the Harlingen branch. Completion of the acquisition is expected to occur during the second quarter, following regulatory approval, at which time the Harlingen location will become a Frost Bank financial center. 40 CRITICAL ACCOUNTING POLICIES -------------------------------------------------------------------------------- The Securities and Exchange Commission ("SEC") recently issued guidance for the disclosure of "critical accounting policies". The SEC defines "critical accounting policies" as those that are most important to the portrayal of a company's financial condition and results, and require management's most difficult, subjective or complex judgments, often as a result of the need to make estimates about the effect of matters that are inherently uncertain. Cullen/Frost follows financial accounting and reporting policies that are in accordance with accounting principles generally accepted in the United States of America ("GAAP"). The more significant of these policies are summarized in Note A, Summary of Accounting Policies, on page 47. Not all these significant accounting policies require management to make difficult, subjective or complex judgments. However, the policies noted below could be deemed to meet the SEC's definition of critical accounting policies. Management considers the policies related to the allowance for possible loan losses as the most critical to the financial statement presentation. The total allowance for possible loan losses includes activity related to allowances calculated in accordance with Statement of Financial Accounting Standards ("SFAS") No. 114, "Accounting by Creditors for Impairment of a Loan" and activity related to other loan loss allowances determined in accordance with SFAS No. 5, "Accounting for Contingencies." The allowance for possible loan losses is established through a provision for possible loan losses charged to current operations. The amount maintained in the allowance reflects management's continuing assessment of the potential losses inherent in the portfolio based on evaluations of industry concentrations, specific credit risks, loan loss experience, current loan portfolio quality, present economic, political and regulatory conditions and unidentified losses inherent in the current loan portfolio. Certain non-homogeneous loans are accounted for under the provisions of SFAS No. 114. This standard requires an allowance to be established as a component of the allowance for loan losses for certain loans when it is probable that all amounts due pursuant to the contractual terms of the loan will not be collected. In these situations a reserve is recorded when the carrying amount of the loan exceeds the discounted cash flows using the loan's initial effective interest rate or the fair value of the collateral for certain collateral dependent loans. Income on impaired loans is recognized based on the collectability of the principal amount. See "Allowance for Possible Loan Losses" beginning on page 31 for further discussion of the risk factors considered by management. 41 MANAGEMENT'S RESPONSIBILITY FOR FINANCIAL REPORTING --------------------------------------------------- The management of Cullen/Frost Bankers, Inc. is responsible for the preparation of the financial statements, related financial data and other information in this annual report. The consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States and include amounts based on management's estimates and judgment where appropriate. Financial information appearing throughout this annual report is consistent with the financial statements. In meeting its responsibility both for the integrity and fairness of these financial statements and information, management depends on the accounting systems and related internal accounting controls that are designed to provide reasonable assurances that transactions are authorized and recorded in accordance with established procedures, that assets are safeguarded and that proper and reliable records are maintained. The concept of reasonable assurance is based on the recognition that the cost of a system of internal controls should not exceed the related benefits. As an integral part of the system of internal controls, Cullen/ Frost maintains an internal audit staff, which monitors compliance with and evaluates the effectiveness of the system of internal controls and coordinates audit coverage with the independent auditors. The Audit Committee of Cullen/Frost's Board of Directors, which is composed entirely of directors independent of management, meets regularly with management, regulatory examiners, internal auditors, the asset review staff and independent auditors to discuss financial reporting matters, internal controls, regulatory reports, internal auditing and the nature, scope and results of the audit efforts. Internal Audit and Asset Review report directly to the Audit Committee. The banking regulators, internal auditors and independent auditors have direct access to the Audit Committee. The consolidated financial statements have been audited by Ernst & Young LLP, independent auditors, who render an independent opinion on management's financial statements. Their appointment was recommended by the Audit Committee and approved by the Board of Directors and this approval was ratified by the shareholders. The audit by the independent auditors provides an additional assessment of the degree to which Cullen/Frost's management meets its responsibility for financial reporting. Their opinion on the financial statements is based on auditing procedures, which include their consideration of internal controls and performance of selected tests of transactions and records, as they deem appropriate. These auditing procedures are designed to provide an additional reasonable level of assurance that the financial statements are fairly presented in conformity with generally accepted accounting principles in all material respects. /s/ DICK EVANS /s/ PHILLIP D. GREEN Dick Evans Phillip D. Green Chairman and Chief Group Executive Vice President Executive Officer and Chief Financial Officer ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK --------------------------------------------------------------------- The information required by this Item is set forth in the section entitled "Market Risk Disclosure -- Interest Rate Sensitivity" included under Item 7 of this document on page 39, and is incorporated herein by reference. 42 ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA -------------------------------------------------------------------------------- CONSOLIDATED STATEMENTS OF OPERATIONS (dollars in thousands, except per share amounts)

Year Ended December 31 ------------------------------ 2001 2000 1999 -------------------------------------------------------------------------------------------- INTEREST INCOME: Loans, including fees................................... $343,928 $394,073 $329,610 Securities: Taxable............................................ 99,323 101,874 106,893 Tax-exempt......................................... 7,610 7,374 6,668 ------------------------------ TOTAL SECURITIES............................... 106,933 109,248 113,561 Time deposits........................................... 331 505 164 Federal funds sold and securities purchased under resale agreements............................................ 9,784 8,505 4,245 ------------------------------ TOTAL INTEREST INCOME.......................... 460,976 512,331 447,580 INTEREST EXPENSE: Deposits................................................ 118,699 158,858 128,819 Federal funds purchased and securities sold under repurchase agreements................................. 12,054 17,889 12,500 Guaranteed preferred beneficial interests in the Corporation's subordinated debentures................. 8,475 8,475 8,475 Long-term notes payable and other borrowings............ 5,531 4,346 808 ------------------------------ TOTAL INTEREST EXPENSE......................... 144,759 189,568 150,602 ------------------------------ NET INTEREST INCOME............................ 316,217 322,763 296,978 Provision for possible loan losses.......................... 40,031 14,103 12,427 ------------------------------ NET INTEREST INCOME AFTER PROVISION FOR POSSIBLE LOAN LOSSES......................... 276,186 308,660 284,551 NON-INTEREST INCOME: Trust fees.............................................. 48,784 49,266 46,411 Service charges on deposit accounts..................... 70,534 60,627 58,787 Insurance commissions................................... 17,423 10,331 3,902 Other service charges, collection and exchange charges, commissions and fees.................................. 24,999 20,143 13,779 Net gain(loss) on securities transactions............... 78 4 (86) Other................................................... 31,073 30,494 28,470 ------------------------------ TOTAL NON-INTEREST INCOME...................... 192,891 170,865 151,263 NON-INTEREST EXPENSE: Salaries and wages...................................... 144,787 138,643 122,104 Pension and other employee benefits..................... 35,477 29,163 26,096 Net occupancy........................................... 29,649 27,905 27,149 Furniture and equipment................................. 23,919 21,495 19,958 Intangible amortization................................. 15,127 15,625 15,000 Restructuring charges................................... 19,865 Other................................................... 83,782 80,449 76,886 ------------------------------ TOTAL NON-INTEREST EXPENSE..................... 352,606 313,280 287,193 ------------------------------ INCOME BEFORE INCOME TAXES AND CUMULATIVE EFFECT OF ACCOUNTING CHANGE.................. 116,471 166,245 148,621 Income taxes................................................ 38,565 57,428 50,979 ------------------------------ Income before cumulative effect of accounting change........ 77,906 108,817 97,642 Cumulative effect of change in accounting for derivative, net of tax................................................ 3,010 ------------------------------ NET INCOME..................................... $ 80,916 $108,817 $ 97,642 ============================== Basic per share: Income before cumulative effect of accounting change.... $ 1.51 $ 2.09 $ 1.83 Cumulative effect of change in accounting, net of taxes................................................. .06 ------------------------------ NET INCOME..................................... $ 1.57 $ 2.09 $ 1.83 ============================== Diluted per share: Income before cumulative effect of accounting change.... $ 1.46 $ 2.03 $ 1.78 Cumulative effect of change in accounting, net of taxes................................................. .06 ------------------------------ NET INCOME..................................... $ 1.52 $ 2.03 $ 1.78 ============================== Dividends per share......................................... $ .84 $ .76 $ .675

See notes to consolidated financial statements. 43 CONSOLIDATED BALANCE SHEETS (dollars in thousands, except per share amounts)

December 31 ----------------------- 2001 2000 ------------------------------------------------------------------------------------- ASSETS Cash and due from banks..................................... $ 994,622 $ 820,459 Time deposits............................................... 6,530 3,574 Securities held to maturity (market value: 2001-$52,749; 2000-$72,104)............................................. 51,231 71,153 Securities available for sale............................... 2,105,247 1,594,860 Trading account securities.................................. 118 2,471 Federal funds sold and securities purchased under resale agreements................................................ 129,550 215,050 Loans, net of unearned discount of $5,005 in 2001 and $7,349 in 2000................................................... 4,518,608 4,534,645 Less: Allowance for possible loan losses.................. (72,881) (63,265) ----------------------- Net loans.............................................. 4,445,727 4,471,380 Premises and equipment...................................... 148,871 149,893 Accrued interest and other assets........................... 487,688 331,532 ----------------------- TOTAL ASSETS......................................... $8,369,584 $7,660,372 ======================= LIABILITIES Demand deposits (non-interest bearing): Commercial and individual................................. $2,317,926 $1,817,761 Correspondent banks....................................... 298,055 245,734 Public funds.............................................. 53,848 55,129 ----------------------- Total demand deposits................................ 2,669,829 2,118,624 Time deposits (interest bearing): Savings and Interest-on-Checking.......................... 1,063,923 1,012,790 Money market deposit accounts............................. 1,804,796 1,774,656 Time accounts............................................. 1,202,246 1,275,289 Public funds.............................................. 357,213 318,331 ----------------------- Total time deposits.................................. 4,428,178 4,381,066 ----------------------- Total deposits....................................... 7,098,007 6,499,690 Federal funds purchased and securities sold under repurchase agreements................................................ 305,384 363,111 Accrued interest and other liabilities...................... 120,499 122,316 Subordinated notes payable and other long-term debt......... 152,152 3,661 Guaranteed preferred beneficial interest in the Corporation's junior subordinated deferrable interest debentures, net........................................... 98,623 98,568 ----------------------- TOTAL LIABILITIES.................................... 7,774,665 7,087,346 SHAREHOLDERS' EQUITY Common stock, par value $.01 per share...................... 536 536 Shares authorized: 90,000,000 Shares issued: 53,561,616 Surplus..................................................... 191,856 187,673 Retained earnings........................................... 478,432 448,006 Accumulated other comprehensive loss, net of tax............ (14,005) (4,023) Treasury stock at cost (2,206,381 and 2,131,534 shares in 2001 and 2000, respectively).............................. (61,900) (59,166) ----------------------- TOTAL SHAREHOLDERS' EQUITY........................... 594,919 573,026 ----------------------- TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY........... $8,369,584 $7,660,372 =======================

See notes to consolidated financial statements. 44 CONSOLIDATED STATEMENTS OF CASH FLOWS (dollars in thousands)

Year Ended December 31 --------------------------------------- 2001 2000 1999 ----------------------------------------------------------------------------------------------- OPERATING ACTIVITIES Net income............................................ $ 80,916 $ 108,817 $ 97,642 Adjustments to reconcile net income to net cash provided by operating activities: Provision for possible loan losses............... 40,031 14,103 12,427 Credit for deferred taxes........................ (7,505) (1,785) (6,083) Accretion of discounts on loans.................. 2,355 (1,038) (547) Accretion of securities' discounts............... (5,004) (5,183) (2,306) Amortization of securities' premiums............. 2,800 1,470 4,738 Increase (decrease) in trading account securities..................................... 2,353 (2,470) 708 Net realized (gain) loss on securities transactions................................... (78) (4) 86 Net gain on sale of assets....................... (2,018) (2,661) (4,052) Depreciation and amortization.................... 35,530 34,037 32,657 Decrease (increase) in interest receivable....... 8,916 (6,795) (1,951) (Decrease) increase in interest payable.......... (2,433) 4,703 3,566 Originations of loans held-for-sale.............. (26,114) (52,313) (69,587) Proceeds from sales of loans held-for-sale....... 39,570 61,913 75,054 Tax benefit from exercise of employee stock options........................................ 3,475 1,926 1,698 Net change in other assets and liabilities....... (75,158) (25,061) (5,716) --------------------------------------- NET CASH PROVIDED BY OPERATING ACTIVITIES........ 97,636 129,659 138,334 INVESTING ACTIVITIES Proceeds from maturities of securities held to maturity............................................ 19,824 13,988 26,471 Purchases of investment securities held to maturity... (95) (123) Proceeds from sales of securities available for sale................................................ 5,478,619 3,020,345 1,696,657 Proceeds from maturities of securities available for sale................................................ 680,894 438,641 929,644 Purchases of securities available for sale............ (6,674,787) (3,448,612) (2,172,113) Purchase of bank owned life insurance................. (100,000) Net increase in loan portfolio........................ (27,773) (385,845) (421,478) Net increase in premises and equipment................ (17,479) (25,213) (15,640) Proceeds from sales of repossessed properties......... 1,959 1,548 2,653 Net cash and cash equivalents paid for acquisitions... (4,954) (724) (23,788) --------------------------------------- NET CASH (USED) PROVIDED BY INVESTING ACTIVITIES..................................... (643,697) (385,967) 22,283 FINANCING ACTIVITIES Net increase in demand deposits, IOC accounts, savings accounts and public funds........................... 671,360 505,463 77,501 Net (decrease)increase in certificates of deposit..... (73,043) 40,395 (195,031) Net (decrease)increase in short-term borrowings....... (57,727) 29,652 27,895 Net proceeds from issuance of subordinated notes...... 148,646 Proceeds from employee stock purchase plan and options............................................. 2,164 4,489 3,616 Purchase of treasury stock............................ (10,424) (47,162) (24,318) Dividends paid........................................ (43,296) (39,554) (36,013) --------------------------------------- NET CASH PROVIDED (USED) BY FINANCING ACTIVITIES..................................... 637,680 493,283 (146,350) --------------------------------------- INCREASE IN CASH AND CASH EQUIVALENTS............ 91,619 236,975 14,267 Cash and cash equivalents at beginning of year........ 1,039,083 802,108 787,841 --------------------------------------- CASH AND CASH EQUIVALENTS AT END OF YEAR......... $ 1,130,702 $ 1,039,083 $ 802,108 =======================================

See notes to consolidated financial statements. 45 CONSOLIDATED STATEMENT OF CHANGES IN SHAREHOLDERS' EQUITY (dollars in thousands)

Accumulated Other Comprehensive Common Retained Income (Loss) Treasury Stock Surplus Earnings Net of Tax Stock Total -------------------------------------------------------------------------------------------------------- BALANCE AT JANUARY 1, 1999.......... $267 $183,151 $321,754 $ 7,747 $ -- $512,919 Net Income for 1999............... 97,642 97,642 Unrealized loss on securities available for sale of $46,913, net of tax and reclassification adjustment for after-tax losses included in net income of $56... (46,857) (46,857) -------- Total comprehensive income................... 50,785 -------- Transactions from employee stock purchase plan and options....... 1 856 (1,816) 3,315 2,356 Tax benefit related to exercise of stock options................... 1,698 1,698 Purchase of treasury stock........ (24,318) (24,318) Issuance of restricted stock...... (23) 1,283 1,260 Restricted stock plan deferred compensation, net............... 624 624 Cash dividend..................... (36,013) (36,013) Two-for-one stock split........... 268 (268) ------------------------------------------------------------------ BALANCE AT DECEMBER 31, 1999........ 536 185,437 382,168 (39,110) (19,720) 509,311 Net Income for 2000............... 108,817 108,817 Unrealized gain on securities available for sale of $36,826, net of tax and reclassification adjustment for after-tax losses included in net income of $3.... 36,829 36,829 Additional minimum pension liability, net of tax........... (1,742) (1,742) -------- Total comprehensive income................... 143,904 -------- Transactions from employee stock purchase plan and options....... 28 (3,532) 6,208 2,704 Tax benefit related to exercise of stock options................... 1,926 1,926 Purchase of treasury stock........ (47,162) (47,162) Issuance of restricted stock...... 282 (5) 1,508 1,785 Restricted stock plan deferred compensation, net............... 112 112 Cash dividend..................... (39,554) (39,554) ------------------------------------------------------------------ BALANCE AT DECEMBER 31, 2000........ 536 187,673 448,006 (4,023) (59,166) 573,026 Net Income for 2001............... 80,916 80,916 Unrealized loss on securities available for sale of $4,672, net of tax and reclassification adjustment for after-tax gains included in net income of $51... (4,723) (4,723) Additional minimum pension liability, net of tax........... (5,259) (5,259) -------- Total comprehensive income................... 70,934 -------- Transactions from employee stock purchase plan and options....... (6,234) 5,193 (1,041) Tax benefit related to exercise of stock options................... 3,475 3,475 Purchase of treasury stock........ (10,424) (10,424) Issuance of restricted stock...... 708 2,497 3,205 Restricted stock plan deferred compensation, net............... (960) (960) Cash dividend..................... (43,296) (43,296) ------------------------------------------------------------------ BALANCE AT DECEMBER 31, 2001........ $536 $191,856 $478,432 $(14,005) $(61,900) $594,919 ==================================================================

See notes to consolidated financial statements. 46 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS NOTE A -- SUMMARY OF ACCOUNTING POLICIES ---------------------------------------- Cullen/Frost Bankers, Inc. ("Cullen/Frost" or the "Corporation") is a financial holding company that provides, through its subsidiaries a broad array of products and services throughout 11 Texas markets. In addition to general commercial banking, other products and services offered include trust and investment management, investment banking, insurance brokerage, leasing, asset-based lending, treasury management and item processing. The accounting and reporting policies followed by Cullen/Frost are in accordance with accounting principles generally accepted in the United States and conform to general practices within the banking industry. The more significant accounting and reporting policies are summarized below. BASIS OF PRESENTATION -- The consolidated financial statements include the accounts of Cullen/Frost and its wholly-owned subsidiaries. Condensed parent company financial statements reflect investments in subsidiaries using the equity method of accounting. All significant intercompany balances and transactions have been eliminated in consolidation. Certain reclassifications have been made to make prior years comparable. USE OF ESTIMATES -- The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the amounts reported in the consolidated financial statements and accompanying notes. Actual results could differ from those estimates. See the Allowance for Possible Loan Losses section for an important use of estimates. SECURITIES -- Securities are classified as held to maturity and carried at amortized cost when Cullen/Frost has the intent and ability to hold the securities until maturity. Securities held for resale in anticipation of short-term market movements are classified as trading and are carried at market value with both net realized and unrealized gains and losses included in other income during the period. Securities to be held for indefinite periods of time are classified as available for sale and stated at fair value, with the unrealized gains and losses, net of tax, reported as a separate component of shareholders' equity. When a security is sold, its adjusted carrying value is used to compute the gain or loss on the sale. Declines in value other than temporary declines are adjusted against the security with a charge to operations. LOANS -- Interest on loans is accrued and accreted to operations based on the principal amount outstanding. Interest on certain consumer loans is recognized over their respective terms using a method that approximates the interest method. Loan origination fees and certain direct costs of originated loans are amortized as an adjustment to the yield over the term of the loan in accordance with SFAS No. 91, "Accounting for Nonrefundable Fees and Costs Associated with Originating or Acquiring Loans and Initial Direct Costs of Leases". In addition, unearned discounts are also amortized. Loan commitment fees for commitment periods greater than one year are deferred and amortized into fee income on a straight-line basis over the commitment period. At December 31, 2001, net unamortized deferred costs were approximately $1.6 million. Generally, loans are placed on non-accrual status if principal or interest payments become 90 days past due and/or management deems the collectability of the principal and/or interest to be in question, as well as when required by regulatory provisions. Once interest accruals are discontinued, accrued but uncollected interest is charged to current year operations. Subsequent receipts on non-accrual loans are recorded as a reduction of principal, and interest income is recorded only once principal recovery is reasonably assured. Loans that are determined to be uncollectible are charged to the allowance for possible loan losses. Management continually reviews the collectability of loans. ALLOWANCE FOR POSSIBLE LOAN LOSSES -- Management considers this to be an important estimate. The amount maintained in the allowance for possible loan losses reflects management's continuing assessment of the potential losses inherent in the portfolio based on evaluations of industry concentrations, specific credit risks, loan loss experience, current loan portfolio quality, present economic, political and regulatory conditions and unidentified losses inherent in the current loan portfolio. Determination of the allowance for possible loan 47 losses is inherently subjective, as it requires significant estimates. The allowance consists of three elements: (i) allowances established for potential losses on specific loans, (ii) allowances based on historical loan loss experience, for similar loans with similar loan characteristics, and trends, and (iii) unallocated allowances, not allocated to loans or a group of loans, but instead based on general economic conditions and other internal and external risk factors in the Corporation's individual markets. The allowance for possible loan losses is established through a provision for possible loan losses charged to current operations based on factors previously mentioned. The allowance for possible loan losses incorporates the results of measuring impaired loans in accordance with Statement of Financial Accounting Standards ("SFAS") No. 114, "Accounting by Creditors for Impairment of a Loan" and activity related to other loan loss allowances determined in accordance with SFAS No. 5, "Accounting for Contingencies." Certain loans that are not similar in nature or kind are accounted for under the provisions of SFAS No. 114. This standard requires an allowance to be established as a component of the allowance for loan losses for certain loans when it is probable that all amounts due pursuant to the contractual terms of the loan will not be collected and the recorded investment in the loan exceeds the fair value. The allowance for possible loan losses related to loans that are impaired as defined by SFAS No. 114 is generally based on the fair value of the collateral for certain collateral dependent loans or discounted cash flows using the loan's initial effective interest rate. Income on impaired loans, which are non-accrual loans greater than or equal to $250 thousand, is recognized based on the collectability of the principal amount. FORECLOSED ASSETS -- Foreclosed assets consist of property that has been formally repossessed. Collateral obtained through foreclosure is recorded at the lower of fair value less estimated selling costs or the book value of the loan prior to foreclosure. Write-downs are provided for subsequent declines in value and are recorded in other non-interest expense. PREMISES AND EQUIPMENT -- Premises and equipment are stated at cost, less accumulated depreciation and amortization. Depreciation and amortization are generally computed on a straight-line basis over the estimated useful lives of the assets. Leasehold improvements are generally amortized over the lesser of the term of the respective leases or the estimated useful lives of the improvements. INTANGIBLE ASSETS -- The excess of cost over fair value of net assets of businesses acquired (goodwill) is amortized on a straight-line and accelerated basis (as appropriate) over periods generally not exceeding twenty-five years. Core deposit and other intangibles are amortized on an accelerated basis over their estimated lives ranging from five to ten years. Intangible assets are included in other assets. All such intangible assets are evaluated, when events or circumstances change, as to the recoverability of their carrying value. If circumstances indicate that the carrying value of the assets may not be recoverable, an impairment charge would be recorded. At December 31, 2001, intangible assets were $124 million, net of accumulated amortization of $105 million. Effective January 1, 2002, Cullen/Frost adopted SFAS No. 142, "Goodwill and Other Intangible Assets," which changes the way goodwill and certain other intangible assets are recognized and accounted for in the Consolidated Financial Statements. See "Accounting Changes" on page 49 for further discussion of the impact of this new accounting pronouncement on the Corporation's financial statements. FEDERAL INCOME TAXES -- Cullen/Frost files a consolidated federal income tax return that includes the taxable income of all of its subsidiaries. Deferred tax assets and liabilities are recognized for the expected future tax consequences of temporary differences between the financial reporting bases and the tax bases of assets and liabilities. Deferred tax assets are the expected future tax benefits of deductible temporary differences and operating loss and tax credit carryforwards. Deferred tax assets are reduced by a valuation allowance if there is a likelihood of more than 50 percent that some portion or all of the deferred tax asset will not be realized. Deferred tax liabilities are recognized for the temporary differences that will result in taxable amounts in future years. Both deferred tax assets and liabilities are measured using the enacted tax rate that is expected to apply to taxable income in the periods in which the deferred tax asset or liability is expected to be realized or settled. STOCK OPTIONS AND RESTRICTED STOCK -- Cullen/Frost accounts for its stock options based on the "intrinsic value method" provided in Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to 48 Employees," ("APB No. 25") and related Interpretations. Under APB No. 25, because the exercise price of Cullen/Frost's employee stock options equals the market price of the underlying stock on the date of grant, no compensation expense is recognized on option plans. Compensation expense for restricted stock awards is based on the market price on the date of grant and is recognized over the vesting period of the award. SECURITIES PURCHASED UNDER AGREEMENTS TO RESELL AND SECURITIES SOLD UNDER AGREEMENTS TO REPURCHASE -- Securities purchased under agreements to resell and securities sold under agreements to repurchase are generally treated as collateralized financing transactions and are recorded at the amounts at which the securities were acquired or sold plus accrued interest. The fair value of collateral either received from or provided to a third party is continually monitored and additional collateral obtained or requested to be returned to the Corporation as deemed appropriate. The counterparty to a Securities Sold Under Agreement to Repurchase contract has an absolute and binding obligation to return the pledged securities at the contract's maturity in exchange for the predetermined amount of cash plus accrued interest. Similarly, the counterparty to a Securities Purchased Under Agreement to Resell contract has an absolute and binding obligation to receive the pledged securities at the contract's maturity in exchange for the predetermined amount of cash plus accrued interest. The securities involved in these transactions are generally U.S. Treasury or Federal Agency issues. FINANCIAL DERIVATIVES -- The Corporation enters into derivative contracts to hedge interest rate exposure by modifying the interest rate characteristics of related balance sheet instruments. To qualify for hedge accounting, derivatives must be highly effective at reducing the risk associated with the exposure being hedged and must be designated as a hedge at the inception of the derivative contract. Derivative contracts are carried on the balance sheet at fair value in other assets and other liabilities. Derivatives used for hedging purposes at year-end 2001 consisted entirely of interest rate swaps used to hedge changes in the fair value of assets and liabilities due to changes in interest rates. As a result of changes in interest rates, hedged assets and liabilities will appreciate or depreciate in market value. The effect of this unrealized appreciation or depreciation will generally be offset by income or loss on the fair value of the derivative instruments that are associated with the hedged assets and liabilities. When a fair value type hedge no longer qualifies for hedge accounting, previous adjustments to the carrying value of the hedged item are reversed immediately to current earnings and the hedge is reclassified to a trading position recorded at fair value. Prior to the adoption of SFAS No. 133 the fair value of these derivative instruments were not recorded on the balance sheet and unrealized gains or losses were deferred. ACCOUNTING CHANGES -- The following is a brief discussion of pronouncements issued by the Financial Accounting Standards Board ("FASB") that are pending adoption or have been recently adopted by Cullen/Frost. On January 1, 2001, the Corporation adopted SFAS No. 133, "Accounting for Derivative Instruments and Hedging Activities", and at that time, designated anew the derivative instruments used for risk management into hedging relationships in accordance with the requirements of the new standard. SFAS No. 133 requires the recognition of all derivatives on the balance sheet at fair value. See the accounting policy for Financial Derivatives above and Note S on page 69 for further discussion. In September 2000, the FASB issued SFAS No. 140, "Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities" (SFAS No. 140). SFAS No. 140 replaces SFAS No. 125. The guidance in SFAS No. 140, while not changing most of the guidance originally issued in SFAS No. 125, revises the standards for accounting for securitizations and other transfers of financial assets and collateral and requires certain additional disclosures related to transferred assets. Certain provisions of the statement related to the recognition, reclassification and disclosure of collateral, as well as the disclosure of securitization transactions, became effective for Cullen/Frost for 2000 year-end reporting. Other provisions related to the transfer and servicing of financial assets and the extinguishing of liabilities were effective for transactions occurring after March 31, 2001. The application of the new rules did not have a material impact on the Corporation's results of operations, financial position or liquidity. 49 In July 2001, the FASB issued SFAS No. 141, "Business Combinations", and SFAS No. 142, "Goodwill and Other Intangible Assets." These Statements make significant changes to the accounting for business combinations, goodwill, and intangible assets. SFAS No. 141, which replaces APB Opinion No. 16, eliminates the pooling-of-interests method of accounting for business combinations initiated after June 30, 2001. In addition, it establishes criteria for recognition of indefinite lived intangible assets separately from goodwill. SFAS No. 141 is effective for purchase business combinations completed after June 30, 2001. SFAS No. 141 will impact future acquisitions by the Corporation, but had no impact on 2001 results of operations, financial position or liquidity. With the adoption of SFAS No. 142 goodwill and indefinite lived intangible assets are no longer amortized. Instead they are reviewed for impairment at least annually or when certain indicators are encountered to determine if they should be written down with a charge to earnings. At December 31, 2001 the Corporation did not have indefinite lived intangible assets other than goodwill. Intangible assets, such as core deposit intangibles, with a determinable useful life will continue to be amortized over their respective useful lives. The Corporation has adopted the Statement effective on January 1, 2002. The non-amortization provisions are effective immediately for goodwill and intangible assets acquired after June 30, 2001 and prior to the adoption. Application of the non-amortization provisions of the Statement is expected to result in additional net income of approximately $6.9 million or approximately $.13 per diluted common share in 2002. The Statement requires a transitional impairment test be applied to all goodwill and other indefinite-lived intangible assets within the first six months after adoption. The impairment test involves identifying separate reporting units based on the reporting structure of the Corporation, then assigning all assets and liabilities, including goodwill, to these units. Goodwill is assigned based on the reporting unit benefiting from the factors that gave rise to the goodwill. Each reporting unit is then tested for goodwill impairment by comparing the fair value of the unit with its book value, including goodwill. If the fair value of the reporting unit is greater than its book value, no goodwill impairment exits. However, if the book value of the reporting unit is greater than its determined fair value, goodwill impairment may exist and further testing is required to determine the amount, if any, of the actual impairment loss. Any impairment loss determined with this transitional test would be reported as a change in accounting principle. The Corporation has completed a preliminary transitional impairment test of goodwill and based on current information does not expect to record an impairment loss as a result of this test. In October 2001 the FASB issued SFAS No. 144, "Accounting for the Impairment of Long-Lived Assets". This Statement addresses financial accounting and reporting for the impairment or disposal of long-lived assets. SFAS No. 144 replaces SFAS No. 121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed of", as well as the provisions of APB Opinion No. 30, "Reporting Results of Operations -- Reporting the Effects of Disposal of a Segment of a Business", for the disposal of segments of a business. The Statement requires that those long-lived assets be measured at the lower of carrying amount or fair value less cost to sell, whether reported in continuing operations or in discontinued operations. This statement is effective for fiscal years beginning after December 15, 2001 and is not expected to have a material effect on the Corporation. NOTE B -- ACQUISITIONS --------------------- The transactions listed below have been or will be accounted for as purchase transactions with the total cash consideration funded through internal sources, including funds provided by the issuance of the $100 million Trust Preferred Capital Securities, see Note I "Borrowed Funds" on page 56. The purchase price has been allocated to the underlying assets and liabilities based on estimated fair values at the date of acquisition. Results of operations are included from the date of acquisition. 2002 PENDING ACQUISITION BRANCH OF JPMORGAN CHASE BANK -- HARLINGEN The Frost National Bank ("Frost Bank") has signed a definitive agreement to acquire the location and certain deposits of the Harlingen branch of JPMorgan Chase Bank. This acquisition allows the Corporation to 50 expand its presence in the Rio Grande Valley, which began when it acquired Valley Bancshares and its bank in McAllen, Valley National Bank in 1995. A second McAllen location was opened in 1997. Frost Bank will assume approximately $20 million in deposits associated with the Harlingen branch. Completion of the acquisition is expected to occur during the second quarter, following regulatory approval, at which time the Harlingen location will become a Frost Bank financial center. This acquisition is not expected to have a material impact on Cullen/Frost's 2002 net income. 2001 ACQUISITION AIS INSURANCE AGENCY -- FORT WORTH On August 1, 2001, Frost Insurance Agency ("FIA") completed its acquisition of AIS Insurance & Risk Management, an independent insurance agency based in Fort Worth, Texas. AIS offered a broad range of commercial insurance for small to mid-size businesses, including property and casualty, employee benefits (health, life and retirement plans), business succession planning and risk management services. In accordance with SFAS No. 142, which is discussed in Note A, no amortization has been recorded on goodwill associated with this acquisition. This acquisition did not have a material impact on Cullen/Frost's 2001 net income. 2000 ACQUISITIONS NIEMAN HANKS PURYEAR PARTNERS AND NIEMAN HANKS PURYEAR BENEFITS -- AUSTIN On July 1, 2000, FIA acquired Nieman Hanks Puryear Partners and Nieman Hanks Puryear Benefits ("Nieman Hanks"), an Austin, Texas based independent insurance agency. Nieman Hanks offered property and casualty insurance, professional and umbrella liability insurance, homeowners and auto insurance, group health, life and disability policies and 401(k) retirement plans and executive planning. This acquisition did not have a material impact on Cullen/Frost's 2000 net income. WAYLAND HANCOCK INSURANCE AGENCY, INC. -- HOUSTON On April 1, 2000, FIA acquired Wayland Hancock Insurance Agency, Inc. ("Wayland Hancock"), a Houston, Texas based independent insurance agency. Wayland Hancock offered a full range of property and casualty, life and health insurance products, as well as retirement and financial planning, to individuals and businesses. This acquisition did not have a material impact on Cullen/Frost's 2000 net income. 1999 ACQUISITIONS COMMERCE FINANCIAL CORP. -- FORT WORTH On May 20, 1999, Cullen/Frost paid approximately $42.3 million to acquire Commerce Financial Corporation and its four-location subsidiary, Bank of Commerce, in Fort Worth, Texas. The Corporation acquired loans of approximately $76 million and deposits of approximately $164 million. This acquisition did not have a material impact on Cullen/Frost's 1999 net income. PROFESSIONAL INSURANCE AGENTS, INC. -- VICTORIA On May 1, 1999, FIA acquired Professional Insurance Agents, Inc. ("PIA"), a mid-sized independent insurance agency based in Victoria, Texas, with additional locations in San Antonio, New Braunfels and Refugio. PIA offered corporate and personal property and casualty insurance as well as group health and life insurance products to individuals and businesses. This acquisition did not have a material impact on Cullen/Frost's 1999 net income. KELLER STATE BANK -- TARRANT COUNTY On January 15, 1999, Frost Bank paid approximately $18.7 million to acquire Keller State Bank which had three locations in Tarrant County, Texas. The Corporation acquired loans of approximately $38 million and deposits of approximately $62 million. This acquisition did not have a material impact on Cullen/Frost's 1999 net income. 51 INVESTMENT BANKING SUBSIDIARY On August 2, 1999 Cullen/Frost began operations of its investment banking subsidiary in Dallas, Texas. Frost Securities, Inc. offers a full range of services including financial advisory services, mergers and acquisitions, equity research, and institutional equity sales and trading. The firm provides institutional investors with in-depth research coverage in energy and communications technology. NOTE C -- CASH AND DUE FROM BANKS --------------------------------- Frost Bank is required to maintain cash or non-interest bearing reserves with the Federal Reserve Bank that are equal to specified percentages of deposits. The average amounts of reserve and contractual balances were $73.0 million for 2001 and $73.4 million for 2000. NOTE D -- SECURITIES -------------------- A summary of the amortized cost and estimated fair value of securities is presented below.

DECEMBER 31, 2001 December 31, 2000 ------------------------------------------------- ------------------------------------------------- AMORTIZED UNREALIZED UNREALIZED ESTIMATED Amortized Unrealized Unrealized Estimated (in thousands) COST GAINS LOSSES FAIR VALUE Cost Gains Losses Fair Value --------------------------------------------------------------------------------------------------------------------------------- Securities Held to Maturity: U.S. Government agencies and corporations...... $ 48,491 $ 1,351 $ 6 $ 49,836 $ 68,430 $ 772 $ 69,202 States and political subdivisions.......... 2,615 173 2,788 2,598 177 2,775 Other................... 125 125 125 2 127 ----------------------------------------------------------------------------------------------------- Total................. $ 51,231 $ 1,524 $ 6 $ 52,749 $ 71,153 $ 951 $ 72,104 ===================================================================================================== Securities Available for Sale: U.S. Treasury........... $ 14,302 $ 61 $ 1 $ 14,362 $ 107,433 $ 134 $ 107,567 U.S. Government agencies and corporations...... 1,897,326 9,852 19,469 1,887,709 1,291,925 2,316 $6,324 1,287,917 State and political subdivisions.......... 175,694 1,524 2,743 174,475 162,712 365 163,077 Other................... 28,701 28,701 36,299 36,299 ----------------------------------------------------------------------------------------------------- Total................. $2,116,023 $11,437 $22,213 $2,105,247 $1,598,369 $2,815 $6,324 $1,594,860 =====================================================================================================

The amortized cost and estimated fair value of securities at December 31, 2001 are presented below by contractual maturity. Actual maturities will differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without prepayment penalties.

DECEMBER 31, 2001 -------------------------------------------------------------- SECURITIES HELD TO MATURITY SECURITIES AVAILABLE FOR SALE ---------------------------- ------------------------------ AMORTIZED ESTIMATED AMORTIZED ESTIMATED (in thousands) COST FAIR VALUE COST FAIR VALUE ------------------------------------------------------------------------------------------------------------ Due in one year or less..................... $ 180 $ 181 $ 120,250 $ 120,650 Due after one year through five years....... 865 885 33,089 34,186 Due after five years through ten years...... 1,695 1,847 76,803 76,564 Due after ten years......................... 98,937 97,071 -------------------------------------------------------------- 2,740 2,913 329,079 328,471 Mortgage-backed securities and collateralized mortgage obligations....... 48,491 49,836 1,786,944 1,776,776 -------------------------------------------------------------- Total.................................. $51,231 $52,749 $2,116,023 $2,105,247 ==============================================================

Proceeds from sales of securities available for sale during 2001 were $5.5 billion with gross gains of $173 thousand and gross losses of $95 thousand realized on those sales. During 2000, gross gains of $487 thousand and gross losses of $483 thousand were realized on $3.0 billion in proceeds from these sales. 52 Proceeds from sales of securities available for sale during 1999 were $1.7 billion. During 1999, gross gains of $625 thousand and gross losses of $711 thousand were realized on those sales. The carrying value of securities pledged to secure public funds, trust deposits, securities sold under repurchase agreements and for other purposes, as required or permitted by law, amounted to $1.0 billion at December 31, 2001 and $1.1 billion at December 31, 2000. NOTE E -- LOANS AND ALLOWANCE FOR POSSIBLE LOAN LOSSES ------------------------------------------------------ A summary of loans outstanding follows:

December 31 ----------------------- (IN THOUSANDS) 2001 2000 ------------------------------------------------------------------------------------- Real estate: Construction: Commercial........................................ $ 373,431 $ 342,944 Consumer.......................................... 44,623 44,078 Land: Commercial........................................ 128,782 148,777 Consumer.......................................... 7,040 9,282 Commercial real estate mortgage........................ 994,485 1,011,105 1-4 Family residential................................. 244,897 310,946 Consumer real estate........................................ 278,849 267,790 Commercial and industrial................................... 1,985,447 1,873,809 Consumer: Indirect............................................... 65,217 136,921 Other.................................................. 345,899 341,546 Other....................................................... 54,943 54,796 Unearned discount........................................... (5,005) (7,349) ----------------------- Total loans............................................ $4,518,608 $4,534,645 =======================

In the normal course of business, in order to meet the financial needs of its customers, Cullen/Frost is a party to financial instruments with off-balance sheet risk. These include commitments to extend credit and standby letters of credit which commit the Corporation to make payments on behalf of customers when certain specified future events occur. Both arrangements have credit risk essentially the same as that involved in extending loans to customers and are subject to the Corporation's normal credit policies. Collateral is obtained based on management's credit assessment of the customer. Commitments to extend credit and standby letters of credit amounted to $2.3 billion and $123.5 million, respectively, at December 31, 2001, and $2.1 billion and $105.8 million respectively, at December 31, 2000. Commercial and industrial loan commitments represent approximately 75 percent and 69 percent of the total loan commitments outstanding at December 31, 2001 and 2000. The majority of Cullen/Frost's real estate loans are secured by real estate in San Antonio, Houston and Fort Worth. In the normal course of business, Cullen/Frost's subsidiary bank makes loans to directors and officers of both Cullen/Frost and its subsidiaries. These loans are made on substantially the same terms, including interest rates and collateral, as those prevailing at the time for comparable transactions with other unaffiliated persons. Loans made to directors and executive officers of Cullen/Frost and its significant subsidiaries, including loans made to their associates, amounted to $15.4 million and $11.8 million at December 31, 2001 and 2000, respectively. During 2001, additions to these loans amounted to $15.0 million, repayments totaled $8.9 million and other changes totaled $2.5 million. These other changes consisted primarily of changes in related-party status. Standby letters of credit extended to directors and executive officers of Cullen/Frost and 53 its significant subsidiaries and their associates amounted to $127 thousand and $267 thousand at December 31, 2001 and 2000, respectively. A summary of the changes in the allowance for possible loan losses follows:

Year Ended December 31 ------------------------------ (in thousands) 2001 2000 1999 -------------------------------------------------------------------------------------------- Balance at the beginning of the year........................ $ 63,265 $ 58,345 $ 53,616 Provision for possible loan losses.......................... 40,031 14,103 12,427 Loan loss reserve of acquired institutions.................. 1,066 Net charge-offs: Losses charged to the allowance........................ (36,780) (13,162) (13,133) Recoveries............................................. 6,365 3,979 4,369 ------------------------------ Net charge-offs................................... (30,415) (9,183) (8,764) ------------------------------ Balance at the end of the year.............................. $ 72,881 $ 63,265 $ 58,345 ==============================

A loan within the scope of SFAS No. 114 is considered impaired when, based on current information and events, it is probable that Cullen/Frost will be unable to collect all amounts due according to the contractual terms of the loan agreement, including scheduled principal and interest payments. All impaired loans are included in non-performing assets. At December 31, 2001, the majority of the impaired loans were commercial loans and collectability was measured based on the fair value of the collateral. Interest payments on impaired loans are typically applied to principal unless collectability of the principal amount is reasonably assured, in which case interest is recognized on a cash basis. Subsequent to classification as an impaired loan, there was no interest income recognized in 1999 through 2001 on these loans. The total allowance for possible loan losses includes activity related to allowances calculated in accordance with SFAS No. 114 and activity related to other loan loss allowances determined in accordance with SFAS No. 5. The average recorded investment in impaired loans was $24.1 million, $8.3 million, and $6.2 million for the years ended December 31, 2001, 2000, and 1999, respectively. The following is a summary of loans considered to be impaired:

December 31 ----------------- (in thousands) 2001 2000 ------------------------------------------------------------------------------- Impaired loans with no allocated allowance.................. $11,655 $ 1,048 Impaired loans with an allocated allowance.................. 18,082 10,872 ----------------- Total recorded investment in impaired loans................. $29,737 $11,920 ================= Allocated allowance......................................... $ 6,103 $ 5,708

NOTE F -- NON-PERFORMING ASSETS ------------------------------- A summary of non-performing assets follows:

December 31 ----------------- (In Thousands) 2001 2000 ------------------------------------------------------------------------------- Non-accrual loans........................................... $33,196 $16,662 Foreclosed assets........................................... 4,234 2,271 ----------------- $37,430 $18,933 =================

Cullen/Frost recognized interest income on non-accrual loans of approximately $913 thousand, $565 thousand and $1.1 million in 2001, 2000 and 1999, respectively. Had these loans performed according to their original contract terms, Cullen/Frost would have recognized additional interest income of approximately $2.4 million in 2001, $1.9 million in 2000 and $1.3 million in 1999. Cullen/Frost did not have any restructured loans for the years ended December 31, 2001 and 2000. 54 NOTE G -- PREMISES AND EQUIPMENT ---------------------------------------- A summary of premises and equipment follows:

December 31 ----------------------------------------------------------------------- 2001 2000 ---------------------------------- ---------------------------------- ACCUMULATED Accumulated DEPRECIATION NET Depreciation Net AND CARRYING And Carrying (in thousands) COST AMORTIZATION VALUE Cost Amortization Value ---------------------------------------------------------------------------------------------------- Land....................... $ 49,421 $ 49,421 $ 49,483 $ 49,483 Buildings.................. 84,790 $ 35,768 49,022 80,956 $ 33,545 47,411 Furniture and equipment.... 123,436 97,746 25,690 123,721 95,586 28,135 Leasehold improvements..... 50,129 27,964 22,165 43,985 25,335 18,650 Construction in progress... 2,573 2,573 6,214 6,214 ----------------------------------------------------------------------- Total premises and equipment........... $310,349 $161,478 $148,871 $304,359 $154,466 $149,893 =======================================================================

Depreciation of premises and equipment of $14.4 million, $14.1 million, and $14.2 million was included in non-interest expense for the years ended December 31, 2001, 2000 and 1999, respectively. The useful lives applied in depreciating buildings ranged from 7 to 39 years, leasehold improvements ranged from 5 to 15 years, and furniture and equipment ranged from 2 to 12 years. NOTE H -- DEPOSITS ----------------- A summary of deposits outstanding by category follows:

December 31 ----------------------- (in thousands) 2001 2000 ------------------------------------------------------------------------------------- Demand deposits............................................. $2,669,829 $2,118,624 Savings and Interest-on-Checking............................ 1,063,923 1,012,790 Money market deposit accounts............................... 1,804,796 1,774,656 Time accounts of $100,000 or more........................... 672,242 720,831 Time accounts under $100,000................................ 530,004 554,458 Public funds................................................ 357,213 318,331 ----------------------- Total deposits......................................... $7,098,007 $6,499,690 =======================

Deposits from non-United States sources totaled $712 million and $748 million at December 31, 2001 and 2000, respectively. Deposits from directors and executive officers of Cullen/Frost and its significant subsidiaries, including deposits from their associates were less than one percent of total deposits at December 31, 2001. At December 31, 2001, Cullen/Frost's aggregate amount of maturities of public and private time accounts are as follows:

(in thousands) Maturities ------------------------------------------------------------------------ 2002........................................................ $1,511,976 2003........................................................ 46,883 2004........................................................ 339 2005........................................................ 50 2006........................................................ 14 Subsequent to 2006.......................................... 197 ---------- Total.................................................. $1,559,459 ==========

55 NOTE I -- BORROWED FUNDS ----------------------- Advances from the Federal Home Loan Bank ("FHLB") totaled $27.6 million, and $32.6 million at December 31, 2001 and 2000, respectively. These advances, which are included in other liabilities, fall under provisions of a credit facility designed to enable Frost Bank to fund long-term loans. The advances mature between January 2002 and July 2018, bear interest at the FHLB's floating rate (average 4.68 percent at December 31, 2001), and are collateralized by a blanket floating lien on all first mortgage loans, the FHLB capital stock owned by Frost Bank, and any funds on deposit with the FHLB. Maturities for the FHLB advances are as follows:

FHLB Repayment (in thousands) Obligations ------------------------------------------------------------------------- 2002........................................................ $21,409 2003........................................................ 4,621 2004........................................................ 314 2005........................................................ 295 2006........................................................ 292 Subsequent to 2006.......................................... 678 ----------- Total.................................................. $27,609 ===========

The following table represents balances as they relate to securities sold under repurchase agreements:

December 31 ------------------- (in thousands) 2001 2000 --------------------------------------------------------------------------------- Balance at year end......................................... $282,134 $293,261 Fair value of underlying securities at year end............. 328,435 320,011 Maximum month-end balance................................... 286,658 313,896 For the year: Average daily balance.................................. 265,814 241,161

Frost Bank issued $150 million of its 6 7/8 percent Subordinated Bank Notes (the "Bank Notes") due 2011, during August of 2001. The Bank Notes pay interest semiannually and are not redeemable prior to maturity. The Bank Notes qualify as Tier 2 capital for both Frost Bank and the Corporation and are reported as debt on the balance sheet, net of deferred issuance cost. The Bank Notes were offered only to accredited investors in denominations of $250 thousand or more under the Office of the Comptroller of the Currency's abbreviated registration procedures set forth in Section 16.6 of 12 C.F.R. Part 16. Frost Bank intends to use the proceeds from the sale of these Bank Notes for general corporate purposes. Cullen/Frost Capital Trust I, a Delaware statutory business trust (the "Issuer Trust") and wholly-owned subsidiary of the Corporation, issued on February 6, 1997, $100 million of its 8.42 percent Capital Securities, Series A (the "Capital Securities"), which represent beneficial interests in the Issuer Trust, in an offering exempt from registration under the Securities Act of 1933 pursuant to Rule 144A. The Capital Securities will mature on February 1, 2027 and are redeemable in whole or in part at the option of the Corporation at any time after February 1, 2007 with the approval of the Federal Reserve and in whole at any time upon the occurrence of certain events affecting their tax or regulatory capital treatment. The Issuer Trust used the proceeds of the offering of the Capital Securities to purchase Junior Subordinated Debentures of the Corporation which constitute its only assets and which have terms substantially similar to the Capital Securities. Payments of distributions on the Capital Securities and payments on liquidation or redemption of the Capital Securities are guaranteed by the Corporation on a limited basis pursuant to a Guarantee. The Corporation has also entered into an Agreement as to Expenses and Liabilities with the Issuer Trust pursuant to which it has agreed on a subordinated basis to pay any costs, expenses or liabilities of the Issuer Trust other than those arising under the Capital Securities. The obligations of the Corporation under the Junior Subordinated Debentures, the related Indenture, the trust agreement establishing the Issuer Trust, the 56 Guarantee and the Agreement as to Expenses and Liabilities, in the aggregate, constitute a full and unconditional guarantee by the Corporation of the Issuer Trust's obligations under the Capital Securities. The Corporation used the majority of the proceeds from the sale of the Junior Subordinated Debentures for acquisitions and the repurchase of the Corporation's common stock. The Capital Securities are included in the Tier 1 capital of the Corporation for regulatory capital purposes and are reported as debt on the balance sheet, net of deferred issuance costs. The Corporation records distributions payable on the Capital Securities as interest expense. The Corporation has the right to defer payments of interest on the Junior Subordinated Debentures at any time or from time to time for a period of up to ten consecutive semi-annual periods with respect to each deferral period. Under the terms of the Junior Subordinated Debentures, in the event that under certain circumstances there is an event of default under the Junior Subordinated Debentures or the Corporation has elected to defer interest on the Junior Subordinated Debentures, the Corporation may not, with certain exceptions, declare or pay any dividends or distributions on its capital stock or purchase or acquire any of its capital stock. On March 13, 1997, the Corporation and the Issuer Trust filed a Registration Statement on Form S-4 with the Securities and Exchange Commission to register under the Securities Act of 1933 the exchange of up to $100 million aggregate Liquidation Amount of "new" 8.42 percent Capital Securities, Series A for the then outstanding Capital Securities. On April 25, 1997, the Corporation exchanged all of the outstanding Capital Securities for registered Capital Securities. The "new" Capital Securities have the same terms as the "old" Capital Securities. This exchange enhanced the transferability of the Capital Securities and had no impact on redemption of the Capital Securities, the Junior Subordinated Debentures issued by the Company, the Company's Guarantee of the Capital Securities, or other matters described above. NOTE J -- COMMON STOCK AND EARNINGS PER SHARE --------------------------------------------- A reconciliation of earnings per share for 2001, 2000 and 1999 follows:

December 31 ---------------------------- (in thousands, except per share amounts) 2001 2000 1999 ------------------------------------------------------------------------------------------ Numerators for both basic and diluted earnings per share, net income................................................ $80,916 $108,817 $97,642 ============================ Denominators: Denominators for basic earnings per share, average outstanding common shares................................. 51,530 52,123 53,368 Dilutive effect of stock options based on the average price for the year.............................................. 1,818 1,534 1,378 ---------------------------- Denominator for diluted earnings per share.................. 53,348 53,657 54,746 ============================ Earnings per share: Basic....................................................... $ 1.57 $ 2.09 $ 1.83 Diluted..................................................... 1.52 2.03 1.78

NOTE K -- DIVIDENDS ------------------- 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. The amount of dividends Frost Bank may declare is subject to regulations. Without prior regulatory approval, Frost Bank had approximately $110.9 million available for the payment of dividends to Cullen/Frost at December 31, 2001. 57 NOTE L -- CAPITAL ----------------- At December 31, 2001 and 2000, Cullen/Frost's subsidiary bank was considered "well capitalized" as defined by the Federal Deposit Insurance Corporation Improvement Act of 1991, the highest regulatory rating, and Cullen/Frost's capital ratios were in excess of "well capitalized" levels. A financial institution is deemed to be well capitalized if the institution has a Tier 1 risk-based capital ratio of 6.0 percent or greater, a total risk-based capital ratio of 10.0 percent or greater, and a Tier 1 leverage ratio of 5.0 percent or greater and the institution is not subject to regulatory actions such as an order, written agreement, capital directive or prompt corrective action directive to meet and maintain a specific capital level for any capital measure. Cullen/Frost and its subsidiary bank currently exceed all minimum capital requirements. Management is not aware of any conditions or events that would have changed the Corporation's regulatory capital rating since December 31, 2001. The table below reflects various measures of regulatory capital at year-end 2001 and 2000 for Cullen/Frost.

DECEMBER 31, 2001 December 31, 2000 ------------------ ------------------ (in thousands) AMOUNT RATIO Amount Ratio ----------------------------------------------------------------------------------------------- Risk-Based Tier 1 Capital................................... $ 583,273 10.14% $ 549,261 10.08% Well Capitalized requirement..................... 345,049 6.00 326,850 6.00 Total Capital.................................... $ 803,872 13.98% $ 612,527 11.24% Well Capitalized requirement..................... 575,081 10.00 544,751 10.00 Risk-adjusted assets, net of goodwill............ $5,750,813 $5,447,508 Leverage ratio........................................ 7.21% 7.54% Well capitalized requirement.......................... 5.00 5.00 Average equity as a percentage of average assets...... 7.84 7.46

Cullen/Frost's Tier 1 Capital consists of shareholders equity before unrealized gains and losses related to securities available for sale plus the Capital Securities discussed in Note I, less intangible assets. Total Capital is comprised of Tier 1 Capital plus the Bank Notes discussed in Note I and the permissible portion of the allowance for possible loan losses. Risk-adjusted assets are calculated based on regulatory requirements and include total assets and certain off balance sheet items (primarily loan commitments), less intangible assets. The Tier 1 and Total Capital ratios are calculated by dividing the respective capital amounts by the risk-adjusted assets. The leverage ratio is calculated by dividing Tier 1 Capital by average total assets (excluding intangible assets) for the period. Cullen/Frost is subject to the regulatory capital requirements administered by the Federal Reserve Bank. Regulators can initiate certain mandatory actions if the Corporation fails to meet the minimum requirements, which could have a direct material effect on the Corporation's financial statements. 58 NOTE M -- LEASES AND RENTAL AGREEMENTS -------------------------------------------------------------------------------- Rental expense for all leases amounted to $15.7 million, $15.1 million and $14.3 million for the years ended December 31, 2001, 2000 and 1999, respectively. In June 1987, Frost Bank consummated the sale of its office tower and leased back a portion of the premises under a 13-year primary lease term with options allowing for occupancy up to 50 years. Frost Bank also sold its adjacent parking garage facility and leased back space in that structure under a 12-year primary lease term with options allowing for occupancy up to 50 years. Both leases allow for purchase of the related asset under specific terms. Frost Bank has agreed to purchase both the office tower and the adjacent parking garage facility. The purchase of the properties is expected to occur in the second quarter of 2002, with the purchase price of the office tower and adjacent parking garage being approximately $25.7 million and $15.0 million, respectively. A summary of the total future minimum rental commitments due under non-cancelable equipment leases and long-term agreements on premises (excluding the office tower and adjacent parking garage facility)at December 31, 2001 follows:

Total (In thousands) Commitments ------------------------------------------------------------------------- 2002........................................................ $15,160 2003........................................................ 12,477 2004........................................................ 9,149 2005........................................................ 7,653 2006........................................................ 6,552 Subsequent to 2006.......................................... 20,708 ------- Total future minimum rental commitments................ $71,699 =======

It is expected that certain leases will be renewed, or equipment replaced with new leased equipment, as these leases expire. Aggregate future minimum rentals to be received under non-cancelable subleases greater than one year at December 31, 2001, were $1.1 million. 59 NOTE N -- EMPLOYEE BENEFIT PLANS ------------------------------- RETIREMENT PLANS -- Defined Benefit Plan -- Cullen/Frost has a non-contributory defined benefit plan that covers substantially all employees who have completed at least one year of service and have attained the age of 21. Defined benefits are provided based on an employee's final average compensation, age at retirement and years of service. Cullen/Frost's funding policy is to contribute quarterly an amount necessary to satisfy the Employee Retirement Income Security Act ("ERISA") funding standards. An eligible employee's right to receive benefits under the plan becomes fully vested upon the earlier of the date on which such employee has completed five years of service or the date on which such employee attains 65 years of age. Retirement benefits under the plan are paid to vested employees upon their (i) normal retirement at age 65 or later or (ii) early retirement at or after age 55, but before age 65. This plan was frozen as of December 31, 2001 and replaced with a deferred profit sharing plan. In accordance with SFAS No. 88, "Employers' Accounting for Settlements and Curtailments of Defined Benefit Pension Plans and for Termination Benefits", $6.3 million in expenses, which were previously being amortized over the service years, were recognized as restructuring charges (see Note V on page 73) during 2001 as a result of this curtailment. Restoration Plan -- Cullen/Frost's Restoration of Retirement Income Plan (providing benefits in excess of the limits under Section 415 of the Internal Revenue Code of 1986, as amended) for eligible employees is designed to comply with the requirements of ERISA. The entire cost of the plan is supported by Cullen/Frost contributions. The Corporation recognized $335 thousand as restructuring charges (see Note V on page 73) during 2001 as a result of the curtailment of this plan as of December 31, 2001. The above plans, as amended, provide for the payment of monthly retirement income pursuant to a formula based on an eligible employee's highest three consecutive years of final average compensation during the last ten consecutive years of employment. The freezing of the plan provides that future salary increases will not be considered. Deferred Profit Sharing Plan -- On January 1, 2002, the Corporation adopted a deferred profit sharing plan, which is a contributory retirement plan. Contributions will be made to individual eligible employee accounts based upon the Corporation's fiscal year profitability. Employee assets will be self-directed into a menu of investment options. The assets will be subject to vesting requirements and withdrawal restrictions. During the fourth quarter of 2001, Cullen/Frost offered a voluntary early retirement program ("ERW") to employees with eligibility determined by age plus years of service. Of the 280 eligible employees, 131, or four percent of the staff, chose to accept this offer. As a result of the ERW, the Corporation recognized $6.0 million in special termination benefit costs related to the Defined Benefit Plan. The ERW also resulted in the creation of a post-retirement medical liability of $1.4 million as of December 31, 2001. Both of these costs were part of the restructuring charges (See Note V on page 73). 60 The following table summarizes benefit obligation and plan asset activity for the plans.

(in thousands) 2001 2000 --------------------------------------------------------------------------------- CHANGE IN BENEFIT OBLIGATION: Benefit obligation at beginning of year................... $ 80,990 $ 64,593 Service cost.............................................. 5,437 3,884 Interest cost............................................. 6,009 4,788 Special terminations benefit (ERW impact)................. 6,034 Curtailment............................................... (17,638) Actuarial loss............................................ 9,322 9,458 Benefits paid............................................. (2,708) (1,733) ------------------- Benefit obligation at end of year......................... 87,446 80,990 CHANGE IN PLAN ASSETS: Fair value of plan assets at beginning of year............ 52,320 51,294 Actual return on plan assets.............................. (750) (1,344) Employer contributions.................................... 7,493 4,103 Benefits paid............................................. (2,708) (1,733) ------------------- Fair value of plan assets at end of year.................. 56,355 52,320 Funded status of the plan................................. 31,091 28,670 Unrecognized net actuarial loss........................... (10,771) (14,118) Unrecognized prior service cost........................... (7,657) Unrecognized net transition asset......................... 263 ------------------- Accrued benefit cost...................................... $ 20,320 $ 7,158 =================== AMOUNTS RECOGNIZED IN THE CONSOLIDATED BALANCE SHEET: Accrued benefit liability................................. $ 31,091 $ 10,279 Intangible asset.......................................... (441) Accumulated other comprehensive income.................... (10,771) (2,680) ------------------- Net amount recognized..................................... $ 20,320 $ 7,158 =================== WEIGHTED-AVERAGE ASSUMPTIONS AS OF DECEMBER 31 Discount rate............................................. 7.25% 7.50% Expected return on plan assets............................ 9.00 9.00 Expected rate of compensation increase.................... 5.00 5.00

Net pension cost included the following components:

(in thousands) 2001 2000 1999 ----------------------------------------------------------------------------------------- Service cost for benefits earned during the year............ $ 5,437 $ 3,884 $ 3,987 Expected return on plan assets, net of expenses............. (4,965) (4,608) (4,245) Interest cost on projected benefit obligation............... 6,009 4,788 4,387 Net amortization and deferral............................... 1,545 946 1,096 --------------------------- Net pension cost....................................... $ 8,026 $ 5,010 $ 5,225 Prior service cost (curtailment expense).................... 6,595 Special termination benefit (ERW expense)................... 6,034 --------------------------- Total pension cost..................................... $20,655 $ 5,010 $ 5,225 ===========================

The prior service cost and special termination benefit were recorded as part of the fourth quarter 2001 restructuring charges. (See Note V on page 73) 61 Cullen/Frost has a supplemental executive retirement plan ("SERP") for a key executive. The plan provides for target retirement benefits, as a percentage of pay, beginning at age 55. The target percentage is 45 percent of pay at age 55, increasing to 60 percent at age 60 and later. Benefits under the SERP are reduced, dollar-for-dollar, by benefits received under the Retirement and Restoration Plans, described above, and any social security benefits. SAVINGS PLANS -- Cullen/Frost maintains a 401(k) stock purchase plan (the "401(k) Plan"). The 401(k) Plan permits each participant to make before- or after-tax contributions up to 16 percent of eligible compensation and subject to dollar limits from Internal Revenue Service regulations. Cullen/Frost matches 100 percent of the employees contributions to the 401(k) Plan based on the amount of each participant's contributions up to a maximum of six percent of eligible compensation. Eligible employees must complete 90 days of service in order to enroll and vest in the Corporation's matching contributions immediately. Cullen/Frost's gross expenses related to the 401(k) Plan were $5.9 million, $5.5 million and $4.8 million for 2001, 2000 and 1999, respectively. The Corporation's matching contribution is initially invested in Cullen/Frost stock. However, employees may immediately reallocate the Corporation's matching portion, as well as invest their individual contribution, to any of a variety of investment vehicles offered within the 401(k) Plan. The 1991 Thrift Incentive Stock Purchase Plan ("1991 Stock Purchase Plan") was adopted to offer those employees whose participation in the 401(k) Plan is limited an alternative means of receiving comparable benefits. Cullen/Frost's expenses related to the 1991 Stock Purchase Plan were $118 thousand, $105 thousand and $123 thousand for 2001, 2000 and 1999, respectively. EXECUTIVE STOCK PLANS -- Cullen/Frost has two active executive stock plans and one outside director stock plan; the 1992 Stock Plan, the 2001 Stock Plan and the 1997 Director Stock Plan ("1997 Plan"). The 2001 Stock Plan has an aggregate of 4,830,790 shares of common stock authorized for award. The 2001 Stock Plan has replaced all other previously approved executive stock plans. The 2001 Stock Plan allows Cullen/Frost to grant restricted stock, incentive stock options, nonqualified stock options, stock appreciation rights, or any combination thereof to certain key employees of the Corporation. When the shareholders approved the 2001 Stock Plan, all remaining shares authorized for grant under the superceded 1992 Cullen/Frost Stock Plan were transferred to the new plan. The 1997 Plan allows Cullen/Frost to grant nonqualified stock options to outside directors. The options may be awarded in such number, and upon such terms, and at any time and from time to time as determined by Cullen/Frost's Compensation and Benefits Committee ("Committee") of the Board of Directors. Each award from all plans is evidenced by an award agreement that specifies the option price, the duration of the option, the number of shares to which the option pertains, and such other provisions as the Committee determines. The option price for each grant is at least equal to the fair market value of a share on the date of grant. Options granted expire at such time as the Committee determines at the date of grant and in no event does the exercise period exceed a maximum of ten years. 62 The following table summarizes option transactions in each of the last three years for plans active as of December 31, 2001. During 2001, the 1983 Nonqualified Stock Option Plan and the 1988 Nonqualified Stock Option Plan expired. Stock option exercises under the 1988 Plan were 161,852, 19,072 and 77,578 for 2001, 2000 and 1999 respectively. Under the 1983 Plan, option exercises were 2,860, 17,412 and zero for 2001, 2000 and 1999 respectively.

1992 PLAN 2001 PLAN ----------------------------------- ----------------------------------- SHARES WEIGHTED SHARES WEIGHTED AVAILABLE OPTIONS AVERAGE AVAILABLE OPTIONS AVERAGE FOR GRANT OUTSTANDING PRICE FOR GRANT OUTSTANDING PRICE -------------------------------------------------------------------------------------------------- Balance, Dec. 31, 1998................. 1,557,420 3,184,066 $16.35 Authorized............. 3,000,000 Granted................ (1,519,000) 1,519,000 24.80 Exercised.............. (187,262) 11.27 Canceled............... 54,000 (54,000) 21.57 ------------------------------------------------------------------------- Balance Dec. 31, 1999................. 3,092,420 4,461,804 19.37 Granted................ (1,467,000) 1,467,000 33.24 Exercised.............. (205,608) 12.12 Canceled............... 25,400 (25,400) 25.09 ------------------------------------------------------------------------- Balance Dec. 31, 2000................. 1,650,820 5,697,796 23.18 Authorized............. 2,750,000 Transferred............ (1,650,820) 1,650,820 Granted................ (5,250) 5,250 33.26 (1,617,300) 1,617,300 $24.13 Exercised.............. (204,234) 16.91 Canceled............... 130,400 (130,400) 26.98 8,200 (8,200) 24.12 ------------------------------------------------------------------------- Balance Dec. 31, 2001................. N/A 5,368,412 $23.34 2,791,720 1,609,100 $24.13 ========================================================================= At Dec. 31, 2001 Per Share Price A $6.37-$ 9.07 E $24.12-$27.78 Range................ B 11.44- 15.13 F 37.27 C 22.44- 30.31 D 32.00- 37.06 Weighted-Average Remaining Contractual A 2.3 Years E 5.8 Years Life................. B 4.5 Years F 5.6 Years C 4.8 Years D 4.8 Years

1997 PLAN ---------------------------------- SHARES WEIGHTED AVAILABLE OPTIONS AVERAGE FOR GRANT OUTSTANDING PRICE ----------------------- ---------------------------------- Balance, Dec. 31, 1998................. 192,000 108,000 $25.44 Authorized............. Granted................ (76,000) 76,000 26.63 Exercised.............. Canceled............... ---------------------------------- Balance Dec. 31, 1999................. 116,000 184,000 25.93 Granted................ (72,000) 72,000 30.56 Exercised.............. (2,000) 22.56 Canceled............... ---------------------------------- Balance Dec. 31, 2000................. 44,000 254,000 27.27 Authorized............. 250,000 Transferred............ Granted................ (68,000) 68,000 36.25 Exercised.............. Canceled............... ---------------------------------- Balance Dec. 31, 2001................. 226,000 322,000 $29.16 ================================== At Dec. 31, 2001 Per Share Price Range................ $22.56-$30.56 G 36.25 H Weighted-Average Remaining Contractual Life................. 7.3 Years G 9.7 Years H

A Includes 655,662 options which are all exercisable with a weighted-average exercise price of $8.69. B Includes 846,000 options which are all exercisable with a weighted-average exercise price of $14.04. C Includes 2,440,500 options with a weighted-average exercise price of $24.66 of which 1,015,500 are exercisable with a weighted-average exercise price of $24.48. D Includes 1,426,250 options of which none are exercisable with a weighted-average exercise price of $33.32. E Includes 1,608,100 options of which none are exercisable with a weighted-average exercise price of $24.12. F Includes 1,000 options of which none are exercisable with a weighted-average exercise price of $37.27. G Includes 254,000 options which are all exercisable with a weighted-average exercise price of $27.27. H Includes 68,000 options which are all exercisable with a weighted-average exercise price of $36.25. 63 There were 2,839,162, 2,064,908 and 1,915,976 options exercisable for 2001, 2000, and 1999 with a weighted-average exercise price of $18.26, $13.66, and $12.19, respectively. Options awarded during 2001 through the 1997 Directors Plan have a six-year life with immediate vesting. Options awarded prior to 2001 through the 1997 Directors Plan have a ten-year life with immediate vesting. All other options awarded in 1999 through 2001 have a six-year life with a three-year cliff vesting period. Options awarded in 1998 have a ten-year life with a three-year cliff vesting period. In general, options awarded prior to 1998 had a ten-year life with a five-year vesting period. These plans, which were approved by shareholders, were established to enable Cullen/Frost to retain and motivate key employees. A committee of non-participating directors has sole authority to select the employees, establish the awards to be issued, and approve the terms and conditions of each award contract. Cullen/Frost has common stock reserved for future issuance upon the grant and exercise of options of 10,317,232 shares. In accounting for the impact of issuing stock options, Cullen/Frost applies the intrinsic value method set forth in Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees" and Related Interpretation as allowed by SFAS No. 123, "Accounting for Stock Based Compensation". SFAS No. 123 requires disclosure of pro forma net income and earnings per share information assuming that stock options granted in 1999, 2000 and 2001 have been accounted for in accordance with the fair value method described in SFAS No. 123. The fair value for these options was estimated at the date of grant using a Black-Scholes option pricing model. The Black-Scholes option valuation model was developed for use in estimating the fair value of traded options, which have characteristics that are different from Cullen/Frost's employee stock options. In addition, option valuation models require the input of highly subjective assumptions, which can significantly impact the estimated fair value. As such, in management's opinion, the existing models do not necessarily provide a reliable single measure of the fair value of stock options. The following weighted-average assumptions were used for 2001, 2000 and 1999, respectively: risk-free interest rates with a term of six years were 4.70 percent, 5.03 percent and 6.56 percent; dividend yield of 2.75 percent, 2.00 percent and 3.00 percent; volatility factors of the expected market price of Cullen/Frost's common stock of 32 percent, 29 percent and 24 percent; and weighted-average expected lives of the options of six years. The weighted-average grant-date fair value of options granted during 2001, 2000 and 1999 was $7.10, $9.33, and $6.02, respectively. For purposes of pro forma disclosures, the estimated fair value of the options is amortized to expense over the options' vesting period. Cullen/Frost's pro forma information as if compensation expense had been recognized in accordance with the fair value requirements SFAS No. 123 is summarized below:

(in thousands except for earnings per share amounts) 2001** 2000 1999 f-------------------------------------------------------------------------------------------- Proforma net income*........................................ $73,879 $104,051 $94,857 Proforma earnings per common share Basic.................................................. $ 1.43 $ 2.00 $ 1.78 Diluted................................................ 1.42 1.98 1.77

* Because SFAS No. 123 is applicable only to options granted subsequent to December 31, 1994, its proforma effect is not necessarily indicative of its impact on future years. ** Actual net income for 2001 was $80.9 million. 2001 basic and diluted earnings per share were $1.57 and $1.52, respectively. 64 Restricted shares are generally awarded under a three- to four-year cliff vesting period. The market value of restricted shares at the date of grant is expensed over the vesting period. The following table summarizes restricted stock transactions in each of the last three years.

1992 Plan 2001 Plan --------------------------------- --------------------------------- Weighted Deferred Weighted Deferred Shares Average Compensation Shares Average Compensation Granted Price Expense* Granted Price Expense* -------------------------------------------------------------------------------------------------------- 1999............................. 50,171 $25.12 $1,633,380 2000............................. 62,940 28.35 1,782,559 2001............................. 10,131 34.55 1,473,805 81,589 $35.00 $378,773

* Reflects the deferred compensation expense recorded in each year, which is spread over the vesting period of outstanding restricted stock. Total deferred compensation expense on all restricted stock during 2001 was $1.9 million. Cullen/Frost has change-in-control agreements with 23 of its executives. Under these agreements, each covered person could receive, upon the effectiveness of a change-in-control, two to three times (depending on the person) the executive's base compensation plus target bonus established for the year, and any unpaid base salary and pro rata target bonus for the year in which the termination occurs, including vacation pay. Additionally, the executive's insurance benefits will continue for two to three full years after the termination and all long-term incentive awards immediately vest. The Corporation has no material liability for post-retirement or post-employment benefits other than pensions. NOTE O -- INCOME TAXES ---------------------- The following is an analysis of the Corporation's income taxes included in the consolidated statements of operations for the years ended December 31, 2001, 2000, and 1999:

(in thousands) 2001 2000 1999 ----------------------------------------------------------------------------------------- Current income tax expense.................................. $46,070 $59,213 $57,062 Deferred income tax benefit................................. (7,505) (1,785) (6,083) --------------------------- Income tax expense as reported.............................. $38,565 $57,428 $50,979 =========================== Current income tax expense related to the cumulative effect of change in accounting for derivatives................... $ 1,620

65 The following is a reconciliation of the difference between income tax expense as reported and the amount computed by applying the statutory income tax rate to income before income taxes:

Year Ended December 31 ==============================

(in thousands) 2001 2000 1999 -------------------------------------------------------------------------------------------- Income before income taxes and cumulative effect of accounting change......................................... $116,471 $166,245 $148,621 Statutory rate.............................................. 35% 35% 35% ------------------------------ Income tax expense at the statutory rate.................... 40,765 58,186 52,017 Effect of tax-exempt interest............................... (3,080) (2,920) (2,927) Bank owned life insurance income............................ (1,200) Amortization of non-deductible goodwill..................... 2,112 2,126 1,910 Other....................................................... (32) 36 (21) ------------------------------ Income tax expense as reported.............................. $ 38,565 $ 57,428 $ 50,979 ============================== Tax (expense) benefits related to securities transactions... $ (27) $ (1) $ 30 ==============================

The tax effects of temporary differences that give rise to significant portions of deferred tax assets and liabilities at December 31, 2001, and 2000 are presented below:

(in thousands) 2001 2000 ------------------------------------------------------------------------------- Deferred tax assets: Allowance for possible loan losses..................... $25,508 $22,143 Building modification reserve.......................... 1,592 1,592 Gain on sale of assets................................. 1,050 1,050 Unrealized loss on securities available for sale....... 3,771 1,228 Additional minimum pension liability................... 3,770 938 Retirement plan........................................ 4,169 2,453 Other.................................................. 1,196 1,303 ----------------- Total gross deferred tax assets................... 41,056 30,707 Deferred tax liabilities: Prepaid expenses....................................... (656) (1,547) Intangible assets...................................... (2,736) (4,311) Leases................................................. (1,715) (1,161) Federal Home Loan Bank stock dividends................. (1,437) (1,117) Bank premises and equipment............................ (94) (424) Other.................................................. (854) (777) ----------------- Total gross deferred tax liabilities.............. (7,492) (9,337) ----------------- Net deferred tax asset............................ $33,564 $21,370 =================

At December 31, 2001 and 2000, no valuation allowance for deferred tax assets was necessary because they were supported by recoverable taxes paid in prior years. 66 NOTE P -- NON-INTEREST EXPENSE ------------------------------ Significant components of other non-interest expense for the years ended December 31, 2001, 2000, and 1999 are presented below:

Year Ended December 31 ----------------------------- (in thousands) 2001 2000 1999 ------------------------------------------------------------------------------------------- Outside computer service.................................... $ 9,670 $ 9,676 $ 9,537 Other professional expenses................................. 6,676 7,422 5,867 Stationery, printing and supplies........................... 6,158 6,056 6,676 Armored motor service....................................... 4,751 4,821 4,441 Postage and express......................................... 4,129 3,954 4,154 Other....................................................... 52,398 48,520 46,211 ----------------------------- Total.................................................. $83,782 $80,449 $76,886 =============================

Included in Other expense in the above table are advertising expenses of $4.0 million, $3.3 million, and $3.4 million for 2001, 2000, and 1999, respectively. Advertising costs are expensed as incurred. NOTE Q -- CASH FLOW DATA ------------------------ For purposes of reporting cash flow, cash and cash equivalents include the following:

December 31 ------------------------------------ (in thousands) 2001 2000 1999 ---------------------------------------------------------------------------------------------- Cash in vault and other cash items...................... $ 845,250 $ 664,329 $606,889 Due from banks.......................................... 149,372 156,130 153,723 Time deposits........................................... 6,530 3,574 6,546 Federal funds sold and securities purchased under resale agreements............................................ 129,550 215,050 34,950 ------------------------------------ Total.............................................. $1,130,702 $1,039,083 $802,108 ====================================

Generally, Federal funds are sold for one-day periods and securities purchased under resale agreements are held for less than thirty-five days. Supplemental cash flow information is as follows:

Year Ended December 31 -------------------------------- (in thousands) 2001 2000 1999 --------------------------------------------------------------------------------------------- Cash paid: Interest.............................................. $147,192 $184,864 $147,036 Income taxes.......................................... 49,621 54,165 57,549 Non-cash items: Loans originated to facilitate the sale of foreclosed assets.............................................. 413 278 Loan foreclosures..................................... 2,416 440 2,766

67 NOTE R -- FAIR VALUES OF FINANCIAL INSTRUMENTS -------------------------------------------------------------------------------- Fair Values of Financial Instruments -- SFAS No. 107, "Disclosures about Fair Value of Financial Instruments" requires disclosure of fair value information about financial instruments, whether or not recognized in the balance sheet, for which it is practicable to estimate that value. In cases where quoted market prices are not available, fair values are based on estimates using present value or other valuation techniques. Those techniques are significantly affected by the assumptions used, including the discount rate and estimates of future cash flows. SFAS No. 107 excludes certain financial instruments and all non-financial instruments from its disclosure requirements. This disclosure does not, and is not intended to, represent the fair value of Cullen/Frost. The following methods and assumptions were used in estimating its fair value of financial instruments: Cash and cash equivalents: The carrying amounts reported in the consolidated balance sheet, for cash and due from banks, time deposits, and Federal funds sold and securities purchased under resale agreements, approximates their fair value. Securities: Estimated fair values are based on quoted market prices, if available. If a quoted market price is not available, fair value is estimated using quoted market prices for similar instruments. Loans: For variable-rate loans that reprice frequently and with no significant change in credit risk, fair values are based on carrying values. The fair value for other loans is estimated using discounted cash flow analyses, using interest rates currently being offered for loans with similar terms to borrowers of similar credit quality. The carrying amount of accrued interest approximates its fair value. Interest rate swaps/floor asset/liability: The estimated fair value of the existing agreements are based on quoted market prices. Deposits: SFAS No. 107 defines the fair value of demand deposits as the amount payable on demand, and prohibits adjusting fair value for any deposit base intangible. The deposit base intangible is not considered in the fair value amounts. The carrying amounts for variable-rate money market accounts approximate their fair value. The fair value of fixed-term certificates of deposit are estimated using a discounted cash flow calculation that applies interest rates currently being offered on certificates to a schedule of aggregated expected monthly maturities. Short-term borrowings: The carrying amount reported in the consolidated balance sheet approximates the estimated fair value. Loan commitments, standby and commercial letters of credit: Cullen/Frost's lending commitments have variable interest rates and "escape" clauses if the customer's credit quality deteriorates. Therefore, the amounts committed approximate fair value. Guaranteed preferred beneficial interest in the Corporation's junior subordinated deferrable interest debentures: The fair value of the Trust Preferred Capital Securities is estimated based on the quoted market prices of the instruments. Subordinated notes payable: The fair value of the Subordinated Bank Notes is estimated based on the quoted market prices of the instruments. 68 The estimated fair values of Cullen/Frost's financial instruments are as follows:

December 31 ------------------------------------------------- 2001 2000 ----------------------- ----------------------- CARRYING ESTIMATED Carrying Estimated (in thousands) AMOUNT FAIR VALUE Amount Fair Value ------------------------------------------------------------------------------------------------ Financial assets: Cash and cash equivalents............... $1,130,702 $1,130,702 $1,039,083 $1,039,083 Securities.............................. 2,156,596 2,158,114 1,668,484 1,669,435 Loans................................... 4,518,608 4,556,505 4,534,645 4,523,856 Allowance for loan losses............... (72,881) (63,265) ------------------------------------------------- Net loans.......................... 4,445,727 4,556,505 4,471,380 4,523,856 Interest rate swap on loans............. (4,281) (4,281) Financial liabilities: Deposits................................ 7,098,007 7,101,531 6,499,690 6,504,433 Short-term borrowings................... 332,993 332,993 395,665 395,665 Guaranteed preferred beneficial interest in the Corporation's junior subordinated deferrable interest debentures, net....................... 98,623 92,253 98,568 90,660 Subordinated note payable............... 148,702 147,153 Interest rate swap on debt.............. 2,080 2,080 Off-balance sheet instruments: Interest rate swaps(pre-SFAS No. 133)... (2,015) Interest rate floor(pre-SFAS No. 133)... 495 5,139

NOTE S -- DERIVATIVE FINANCIAL INSTRUMENTS -------------------------------------------------------------------------------- Cullen/Frost uses interest rate swaps and floors to hedge its interest rate risk. The Corporation had 43 fair value type commercial loan/lease interest rate swaps with a notional amount of $119 million at December 31, 2001 and 34 commercial loan/lease interest rate swaps with a notional amount of $211 million at December 31, 2000. In 2001 and 2000, each swap was a hedge against a specific commercial fixed-rate loan/lease or against a specific pool of commercial floating-rate loans with lives ranging from approximately one month to ten years. For 2001 and 2000, the scheduled reductions of the interest rate swaps' notional amount generally matched the expected amortization of the underlying loan/lease or pool of loans. In 2000, the Corporation entered into an interest rate floor three-year agreement with a notional amount totaling $1 billion. The interest rate floor was a hedge of interest rate exposure associated with commercial loan accounts in an environment of falling rates. The floor agreement was sold during the first quarter of 2001. Under SFAS No. 133, adopted on January 1, 2001, the interest rate floor did not qualify for hedge accounting treatment and in management's opinion would have introduced excessive volatility into earnings. The Corporation recognized a gain of $5.7 million related to the sale of the floor agreement. Of the total gain $1.1 million was included in other non-interest income, with the remainder included, net of tax, as a $3.0 million cumulative effect of adopting SFAS No. 133. In 2001 Cullen/Frost entered into a fair value type interest rate swap agreement related to the $150 million fixed rate subordinated debt issued in 2001. The swap agreement has an effective notional amount of $150 million over a period of five years. In 2001, the Corporation's derivative financial instruments used in hedging activities were all designated as fair value type hedges, which were required to meet specific criteria. For fair value type hedges, the changes in fair values of both the hedging derivative and the hedged item were recorded in current earnings as other income or other expense and were immaterial in 2001. When a fair value type hedge no longer qualifies for hedge accounting, previous adjustments to the carrying value of the hedged item are reversed immediately to current earnings and the hedge is reclassified to a trading position recorded at fair value. 69 Interest rate swap and floor contracts involve the risk of dealing with counterparties and their ability to meet contractual terms. Each counterparty to a swap transaction is approved by Cullen/Frost's Asset/ Liability Management Committee and has a credit rating that is investment grade. The net amount payable or receivable under interest rate swaps/floors is accrued as an adjustment to interest income and was not material in 2001 or 2000. Cullen/Frost's credit exposure on interest rate swaps is limited to Cullen/Frost's net favorable value and interest payments of all swaps to each counterparty. In such cases collateral is required from the counterparties involved if the net value of the swaps exceeds a nominal amount considered to be immaterial. At December 31, 2001, the Corporation's credit exposure relating to interest rate swaps was immaterial. Activity in the notional amounts of end-user derivatives for each of the three years ended December 31, 2001, 2000 and 1999, is summarized as follows:

Amortizing Non-Amortizing Interest Rate Interest Rate Interest Rate Total (in millions) Swaps Swap Floors Derivatives ---------------------------------------------------------------------------------------------------------- Balance, January 1, 1999................. $ 75 $ 75 Additions........................... 239 239 Amortization and maturities......... (54) (54) Terminations........................ (1) (1) --------------------------------------------------------------- Balance, December 31, 1999............... 259 259 Additions........................... 24 $ 1,000 1,024 Amortization and maturities......... (72) (72) --------------------------------------------------------------- Balance, December 31, 2000............... 211 1,000 1,211 Additions........................... 33 $150 183 Amortization and maturities......... (120) (120) Terminations........................ (5) (1,000) (1,005) --------------------------------------------------------------- Balance, December 31, 2001............... $ 119 $150 $ 269 ===============================================================

The following table summarizes the weighted average receive and pay rates for the interest rate swaps at December 31, 2001.

Weighted Average ------------------ December 31, 2001 Receive Pay (in millions) Notional Amount Rate Rate -------------------------------------------------------------------------------------------------- Interest Rate Swaps: Receive -- fixed swaps.............................. $150 6.88% 5.14% Pay -- fixed swaps.................................. 119 2.09 5.88 Combined rate....................................... 269 4.75 5.47

The fair value and any related carrying amounts of the interest rate swaps can be found in Note R on page 68. 70 NOTE T -- CONTINGENCIES -------------------------------------------------------------------------------- Certain subsidiaries of Cullen/Frost are defendants in various matters of litigation which have arisen in the normal course of conducting a commercial banking business. In the opinion of management, the disposition of such pending litigation will not have a material effect on Cullen/Frost's consolidated financial position. NOTE U -- OPERATING SEGMENTS -------------------------------------------------------------------------------- The Corporation has three reportable operating segments: Banking, the Financial Management Group and Frost Securities Inc. Banking includes both commercial and consumer banking services. Commercial banking services are provided to corporations and other business clients and include a wide array of lending and cash management products. Consumer banking services include direct lending and depository services. The Financial Management Group includes fee-based services within private trust, retirement services, and financial management services, including personal wealth management, insurance, and brokerage services. Frost Securities Inc., an investment banking subsidiary, began operations in August 1999. These business units were identified through the products and services that are offered within each unit. Prior period amounts have been reclassified to conform to the current year's presentation. The accounting policies of each reportable segment are the same as those of the Corporation described in Note A, except for the following items, which impact the Banking and Financial Management Group segments. The Corporation uses a match-funded transfer pricing process to assess operating segment performance. Expenses for consolidated back-office operations are allocated to operating segments based on estimated uses of those services. General overhead-type expenses such as executive administration, accounting and internal audit are allocated based on the direct expense level of the operating segment. Income tax expense for the individual segments is calculated essentially at the statutory rate. The Parent Company records the tax expense or benefit necessary to reconcile to the consolidated total. 71 The following table summarizes financial results by operating segment:

Financial Management Frost Restructuring Consolidated (in thousands) Banking Group Securities Non-Banks Charges Total --------------------------------------------------------------------------------------------------------------- 2001 NET INTEREST INCOME (EXPENSE)... $317,477 $ 7,010 $ 131 $ (8,401) $316,217 PROVISION FOR LOAN LOSSES....... 40,033 (2) N/A N/A 40,031 NON-INTEREST INCOME............. 123,551 59,091 10,368 (119) 192,891 NON-INTEREST EXPENSE............ 264,643 48,637 16,050 3,411 $ 19,865 352,606 ----------------------------------------------------------------------------- INCOME (LOSS) BEFORE INCOME TAXES......................... 136,352 17,466 (5,551) (11,931) (19,865) 116,471 INCOME TAX EXPENSE (CREDIT)..... 47,723 6,113 (1,901) (6,417) (6,953) 38,565 ----------------------------------------------------------------------------- OPERATING EARNINGS EXCLUDING CUMULATIVE EFFECT OF ACCOUNTING CHANGE............. 88,629 11,353 (3,650) (5,514) (12,912) 77,906 CUMULATIVE EFFECT ADJUSTMENT -- SFAS 133, NET OF TAX.......... 3,010 3,010 ----------------------------------------------------------------------------- NET INCOME (LOSS)............... $ 91,639 $11,353 $(3,650) $ (5,514) $(12,912) $ 80,916 ============================================================================= AVERAGE ASSETS (IN MILLIONS).... $ 7,773 $ 40* $ 5 $ N/M $ 7,837 =============================================================================================================== 2000 Net interest income (expense)... $321,170 $ 9,737 $ 191 $ (8,335) $322,763 Provision for loan losses....... 14,107 (4) N/A N/A 14,103 Non-interest income............. 106,525 58,131 6,215 (6) 170,865 Non-interest expense............ 251,107 43,006 11,513 7,654 313,280 ----------------------------------------------------------------------------- Income (loss) before income taxes......................... 162,481 24,866 (5,107) (15,995) 166,245 Income tax expense (credit)..... 56,868 8,702 (1,757) (6,385) 57,428 ----------------------------------------------------------------------------- Net income (loss)............... $105,613 $16,164 $(3,350) $ (9,610) $108,817 ============================================================================= Average assets (in millions).... $ 7,112 $ 33* $ 4 $ N/M $ 7,150 =============================================================================================================== 1999 Net interest income (expense)... $297,636 $ 8,077 $ 115 $ (8,850) $296,978 Provision for loan losses....... 12,426 1 N/A N/A 12,427 Non-interest income............. 96,249 53,808 953 253 151,263 Non-interest expense............ 237,725 38,404 4,741 6,323 287,193 ----------------------------------------------------------------------------- Earnings (loss) before income taxes......................... 143,734 23,480 (3,673) (14,920) 148,621 Income tax expense (credit)..... 50,307 8,218 (1,286) (6,260) 50,979 ----------------------------------------------------------------------------- Net income (loss)............... $ 93,427 $15,262 $(2,387) $ (8,660) $ 97,642 ============================================================================= Average assets (in millions).... $ 6,841 $ 34* $ 6 $ N/M $ 6,875 ===============================================================================================================

* Excludes off balance sheet managed and custody assets with total market value of $13.3 billion, $12.9 billion, and $12.8 billion at year-end 2001, 2000 and 1999, respectively. 72 NOTE V -- RESTRUCTURING CHARGES -------------------------------- During the fourth quarter of 2001, the Corporation recorded pre-tax restructuring charges totaling $19.9 million. Included in the restructuring charges were approximately $11.5 million related to costs associated with a voluntary early retirement program that was accepted by about four percent of the staff. The $11.5 million charge consisted of approximately $6.0 million related to the retirement plan, $1.4 million associated with future medical benefits with the remainder due to cash payments based on length of service. The restructuring charges also included $6.7 million due to the freezing of the Corporation's defined benefit pension plan as of December 31, 2001. This defined benefits plan (see Note N on page 60) was replaced with a deferred profit sharing plan. The remaining $1.7 million of the restructuring charges was related to severance and outplacement services for a two percent reduction in workforce, of which $469 thousand remained to be paid at December 31, 2001. 73 NOTE W -- CONDENSED PARENT CORPORATION FINANCIAL STATEMENTS ----------------------------------------------------------- Condensed financial information of the Parent Corporation as of December 31, 2001 and 2000 and for each of the three years in the period ended December 31, 2001 follows:

Year Ended December 31 ------------------------------ STATEMENTS OF OPERATIONS (in thousands) 2001 2000 1999 -------------------------------------------------------------------------------------------- INCOME: Dividends from second tier financial holding company subsidiary............................................ $75,283 $ 42,699 $81,444 Interest and other...................................... 1,612 3,552 3,851 ------------------------------ TOTAL INCOME....................................... 76,895 46,251 85,295 EXPENSES: Salaries and employee benefits.......................... 1,080 5,908 4,645 Interest expense........................................ 8,735 8,735 8,735 Other................................................... 2,388 1,884 1,534 ------------------------------ TOTAL EXPENSES..................................... 12,203 16,527 14,914 ------------------------------ INCOME BEFORE INCOME TAX CREDITS AND EQUITY IN UNDISTRIBUTED NET INCOME OF SUBSIDIARIES......... 64,692 29,724 70,381 Income tax credits.......................................... 4,371 5,377 4,394 Equity in undistributed net income of subsidiaries.......... 11,853 73,716 22,867 ------------------------------ NET INCOME......................................... $80,916 $108,817 $97,642 ==============================

December 31 -------------------- BALANCE SHEETS (in thousands) 2001 2000 ---------------------------------------------------------------------------------- ASSETS Cash........................................................ $ 380 $ 1,079 Securities purchased under resale agreements................ 39,030 25,059 Investment in second tier financial holding company subsidiary................................................ 671,185 667,057 Other....................................................... 2,717 3,799 -------------------- TOTAL ASSETS....................................... $713,312 $696,994 ==================== LIABILITIES Other....................................................... $ 16,677 $ 22,307 Guaranteed preferred beneficial interest in the Corporation's junior subordinated deferrable interest debentures................................................ 101,716 101,661 -------------------- TOTAL LIABILITIES.................................. 118,393 123,968 SHAREHOLDERS' EQUITY........................................ 594,919 573,026 -------------------- TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY......... $713,312 $696,994 ====================

Year Ended December 31 ---------------------------------- STATEMENTS OF CASH FLOWS (in thousands) 2001 2000 1999 ------------------------------------------------------------------------------------------------ OPERATING ACTIVITIES Net income.................................................. $ 80,916 $ 108,817 $ 97,642 Adjustments to reconcile net income to net cash provided by operating activities: Net income of subsidiaries.............................. (87,136) (116,415) (104,311) Dividends from subsidiaries............................. 75,283 42,699 81,444 Tax benefit from exercise of employee stock options..... 3,475 1,926 1,698 Net change in other liabilities and assets.............. (3,710) 2,446 1,328 ---------------------------------- NET CASH PROVIDED BY OPERATING ACTIVITIES.......... 68,828 39,473 77,801 INVESTING ACTIVITIES Capital contributions to subsidiaries....................... (4,000) (2,859) (50,521) Decrease in loans........................................... 52 ---------------------------------- NET CASH USED BY INVESTING ACTIVITIES.............. (4,000) (2,859) (50,469) FINANCING ACTIVITIES Purchase of treasury stock.................................. (10,424) (47,162) (24,318) Proceeds from employee stock purchase plan and options...... 2,164 4,489 3,616 Cash dividends.............................................. (43,296) (39,554) (36,013) ---------------------------------- NET CASH USED BY FINANCING ACTIVITIES.............. (51,556) (82,227) (56,715) ---------------------------------- INCREASE(DECREASE) IN CASH AND CASH EQUIVALENTS.... 13,272 (45,613) (29,383) Cash and cash equivalents at beginning of year.............. 26,138 71,751 101,134 ---------------------------------- CASH AND CASH EQUIVALENTS AT END OF YEAR........... $ 39,410 $ 26,138 $ 71,751 ==================================

74 Report of Ernst & Young LLP Independent Auditors SHAREHOLDERS AND BOARD OF DIRECTORS CULLEN/FROST BANKERS, INC. We have audited the accompanying consolidated balance sheets of Cullen/Frost Bankers, Inc. and Subsidiaries (the Corporation) as of December 31, 2001 and 2000, and the related consolidated statements of operations, changes in shareholders' equity, and cash flows for each of the three years in the period ended December 31, 2001. These financial statements are the responsibility of the Corporation's management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with auditing standards generally accepted in the United States. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of Cullen/Frost Bankers, Inc. and Subsidiaries at December 31, 2001 and 2000, and the consolidated results of their operations and their cash flows for each of the three years in the period ended December 31, 2001 in conformity with accounting principles generally accepted in the United States. ERNST & YOUNG LLP San Antonio, Texas January 22, 2002 75 CONSOLIDATED AVERAGE BALANCE SHEETS (dollars in thousands -- taxable-equivalent basis) The following unaudited schedule is presented for additional information and analysis.

Year Ended December 31 =============================================================== 2001 2000 ------------------------------ ------------------------------ INTEREST Interest AVERAGE INCOME/ YIELD/ Average Income/ Yield/ BALANCE EXPENSE COST Balance Expense Cost ====================================================================================================================== ASSETS: Time deposits........................................ $ 7,170 $ 331 4.61% $ 7,226 $ 505 6.99% Securities: U.S. Treasury.................................... 49,855 2,293 4.60 130,180 7,916 6.08 U.S. Government agencies and corporations........ 1,505,433 95,264 6.33 1,336,523 91,243 6.83 States and political subdivisions: Tax-exempt................................... 167,369 11,848 7.08 151,423 11,281 7.45 Taxable...................................... 2,947 192 6.52 3,399 226 6.65 Other............................................ 32,196 1,589 4.94 35,735 2,622 7.33 ---------- -------- ---------- -------- Total securities......................... 1,757,800 111,186 6.33 1,657,260 113,288 6.84 Federal funds sold and securities purchased under resale agreements.................................. 253,112 9,784 3.81 130,800 8,505 6.50 Loans, net of unearned discount...................... 4,546,596 344,413 7.58 4,352,868 394,527 9.06 ---------- -------- ---------- -------- TOTAL EARNING ASSETS AND AVERAGE RATE EARNED..... 6,564,678 465,714 7.09 6,148,154 516,825 8.41 Cash and due from banks.............................. 810,323 621,950 Allowance for possible loan losses................... (68,785) (59,281) Banking premises and equipment....................... 150,264 146,185 Accrued interest and other assets.................... 380,251 292,676 ---------- ---------- TOTAL ASSETS..................................... $7,836,731 $7,149,684 ========== ========== LIABILITIES: Demand deposits: Commercial and individual........................ $1,883,931 $1,636,633 Correspondent banks.............................. 262,840 227,807 Public funds..................................... 39,919 32,732 ---------- ---------- Total demand deposits........................ 2,186,690 1,897,172 Time deposits: Savings and Interest-on-Checking................. 966,429 3,605 .37 961,315 6,344 .66 Money market deposit accounts.................... 1,825,991 48,011 2.63 1,703,602 76,537 4.49 Time accounts.................................... 1,265,999 57,101 4.51 1,239,022 64,498 5.21 Public funds..................................... 306,248 9,982 3.26 250,559 11,479 4.58 ---------- -------- ---------- -------- Total time deposits...................... 4,364,667 118,699 2.72 4,154,498 158,858 3.82 ---------- ---------- Total deposits........................... 6,551,357 6,051,670 Federal funds purchased and securities sold under repurchase agreements.............................. 351,319 12,054 3.38 326,448 17,889 5.48 Guaranteed preferred beneficial interests in the Corporation's junior subordinated deferrable interest debentures, net........................... 98,596 8,475 8.60 98,542 8,475 8.60 Long-term notes payable.............................. 65,132 3,736 5.74 3,769 204 5.42 Other borrowings..................................... 31,411 1,795 5.71 63,243 4,142 6.55 ---------- -------- ---------- -------- TOTAL INTEREST-BEARING FUNDS AND AVERAGE RATE PAID........................................... 4,911,125 144,759 2.94 4,646,500 189,568 4.08 -------- ---- -------- ---- Accrued interest and other liabilities............... 124,906 72,887 ---------- ---------- TOTAL LIABILITIES................................ 7,222,721 6,616,559 SHAREHOLDERS' EQUITY................................. 614,010 533,125 ---------- ---------- TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY....... $7,836,731 $7,149,684 ========== ========== Net interest income.................................. $320,955 $327,257 ======== ======== Net interest spread.................................. 4.15% 4.33% ==== ==== Net interest income to total average earning assets............................................. 4.89% 5.32% ==== ====

The above information is shown on a taxable-equivalent basis assuming a 35 percent tax rate. Non-accrual loans are included in the average loan amounts outstanding for these computations. 76

Year Ended December 31 --------------------------------------------------------------------------------------------------------------------------------- 1999 1998 1997 1996 ------------------------------ ------------------------------ ------------------------------ ------------------------------ Interest Interest Interest Interest Average Income/ Yield/ Average Income/ Yield/ Average Income/ Yield/ Average Income/ Yield/ Balance Expense Cost Balance Expense Cost Balance Expense Cost Balance Expense Cost --------------------------------------------------------------------------------------------------------------------------------- $ 3,103 $ 164 5.27% 176,718 8,976 5.08 $ 262,098 $ 14,339 5.47% $ 301,133 $ 16,596 5.51% $ 282,692 $ 15,049 5.32% 1,478,519 95,491 6.46 1,557,489 99,971 6.42 1,374,202 90,688 6.60 1,439,744 95,838 6.66 141,224 10,377 7.35 66,278 4,963 7.49 36,888 2,850 7.73 29,863 2,340 7.84 3,585 229 6.38 2,229 138 6.19 3,185 239 7.50 1,783 118 6.62 38,803 2,203 5.68 42,025 2,579 6.14 11,317 686 6.06 6,723 389 5.79 ---------- -------- ---------- -------- ---------- -------- ---------- -------- 1,838,849 117,276 6.38 1,930,119 121,990 6.32 1,726,725 111,059 6.43 1,760,805 113,734 6.46 81,363 4,245 5.22 127,273 7,111 5.59 228,245 12,423 5.44 143,401 7,476 5.21 3,934,406 330,397 8.40 3,437,510 301,789 8.78 2,917,371 262,569 9.00 2,445,777 220,417 9.01 ---------- -------- ---------- -------- ---------- -------- ---------- -------- 5,857,721 452,082 7.72 5,494,902 430,890 7.84 4,872,341 386,051 7.92 4,349,983 341,627 7.85 619,917 577,489 527,924 508,934 (57,481) (51,230) (44,837) (39,814) 141,453 135,577 124,629 117,352 313,826 260,831 207,520 177,040 ---------- ---------- ---------- ---------- $6,875,436 $6,417,569 $5,687,577 $5,113,495 ========== ========== ========== ========== $1,533,160 $1,387,824 $1,143,828 $ 979,757 221,530 195,555 192,231 199,983 37,567 43,507 44,183 45,200 ---------- ---------- ---------- ---------- 1,792,257 1,626,886 1,380,242 1,224,940 948,487 6,557 .69 901,960 10,958 1.21 818,216 10,764 1.32 741,102 10,176 1.37 1,636,915 60,478 3.69 1,387,994 54,326 3.91 1,195,773 48,816 4.08 1,053,819 40,208 3.82 1,250,340 53,815 4.30 1,286,036 63,621 4.95 1,205,261 59,867 4.97 1,145,194 56,110 4.90 220,845 7,969 3.61 251,570 9,378 3.73 269,027 11,693 4.35 245,266 10,685 4.36 ---------- -------- ---------- -------- ---------- -------- ---------- -------- 4,056,587 128,819 3.18 3,827,560 138,283 3.61 3,488,277 131,140 3.76 3,185,381 117,179 3.68 ---------- ---------- ---------- ---------- 5,848,844 5,454,446 4,868,519 4,410,321 285,470 12,500 4.38 252,977 11,606 4.59 189,468 8,739 4.61 204,515 9,761 4.77 98,485 8,475 8.61 98,429 8,475 8.61 88,745 7,652 8.62 1,793 103 5.74 12,186 705 5.79 30,666 1,754 5.72 25,794 1,434 5.56 19,389 1,019 5.26 ---------- -------- ---------- -------- ---------- -------- ---------- -------- 4,454,521 150,602 3.38 4,209,632 160,118 3.80 3,792,284 148,965 3.93 3,409,285 127,959 3.75 -------- ---- -------- ---- -------- ---- -------- ---- 105,888 91,093 69,601 76,583 ---------- ---------- ---------- ---------- 6,352,666 5,927,611 5,242,127 4,710,808 522,770 489,958 445,450 402,687 ---------- ---------- ---------- ---------- $6,875,436 $6,417,569 $5,687,577 $5,113,495 ========== ========== ========== ========== $301,480 $270,772 $237,086 $213,668 ======== ======== ======== ======== 4.34% 4.04% 3.99% 4.10% ==== ==== ==== ==== 5.15% 4.93% 4.87% 4.91% ==== ==== ==== ====

77 FINANCIAL STATISTICS (dollars in thousands) The following unaudited schedules and statistics are presented for additional information and analysis. RATE/VOLUME ANALYSIS --------------------

2001/2000 2000/1999 -------------------------------- --------------------------------- INCREASE (DECREASE) Increase (Decrease) DUE TO CHANGE IN TOTAL Due to Change in Total ------------------- OR NET -------------------- or Net AVERAGE AVERAGE INCREASE Average Average Increase RATE BALANCE (DECREASE) Rate Balance (Decrease) --------------------------------------------------------------------------------------------------------- Changes in interest earned on: Time deposits.................... $ (170) $ (4) $ (174) $ 274 $ 67 $ 341 Securities: U.S. Treasury................. (1,592) (4,031) (5,623) (2,630) 1,570 (1,060) U.S. Government agencies and corporations................ (6,976) 10,997 4,021 (9,499) 5,251 (4,248) States and political subdivisions Tax-exempt.................. (581) 1,148 567 757 147 904 Taxable..................... (4) (30) (34) (12) 9 (3) Other......................... (793) (240) (1,033) (185) 604 419 Federal funds sold............... (4,425) 5,704 1,279 3,031 1,229 4,260 Loans............................ (67,058) 16,944 (50,114) 36,737 27,393 64,130 -------------------------------------------------------------------- Total.................... (81,599) 30,488 (51,111) 28,473 36,270 64,743 Changes in interest paid on: Savings, Interest-on-Checking.... 2,773 (34) 2,739 (88) 301 213 Money market deposits accounts... 33,688 (5,162) 28,526 (2,548) (13,511) (16,059) Time accounts and public funds... 12,504 (3,610) 8,894 (677) (13,516) (14,193) Federal funds purchased and securities sold under repurchase agreements......... 7,112 (1,277) 5,835 (1,959) (3,430) (5,389) Long-term notes payable and other borrowings.................... 465 (1,650) (1,185) (3,444) (94) (3,538) -------------------------------------------------------------------- Total.................... 56,542 (11,733) 44,809 (8,716) (30,250) (38,966) -------------------------------------------------------------------- Changes in net interest income..... $(25,057) $ 18,755 $ (6,302) $19,757 $ 6,020 $ 25,777 ====================================================================

The allocation of the rate/volume variance has been made on a pro-rata basis assuming absolute values. The above information is shown on a taxable-equivalent basis assuming a 35 percent tax rate. LOAN MATURITY AND SENSITIVITY -----------------------------

DECEMBER 31, 2001 ----------------------------------------------- DUE IN AFTER ONE, AFTER ONE YEAR BUT WITHIN FIVE OR LESS FIVE YEARS YEARS TOTAL ----------------------------------------------------------------------------------------------- Real estate construction and land loans....... $ 307,180 $ 173,469 $ 73,227 $ 553,876 Other real estate loans....................... 141,549 471,546 660,238 1,273,333 All other loans............................... 1,113,024 951,654 194,398 2,259,076 ----------------------------------------------- Total.................................... $1,561,753 $1,596,669 $927,863 $4,086,285 =============================================== Loans with fixed interest rates............... $ 402,561 $ 582,909 $604,067 $1,589,537 Loans with floating interest rates............ 1,159,192 1,013,760 323,796 2,496,748 ----------------------------------------------- Total....................................... $1,561,753 $1,596,669 $927,863 $4,086,285 ===============================================

Due to the specific nature of the portfolios, loans secured by 1-4 family housing totaling $245 million, student loans totaling $103 million, certain commercial loans totaling $90 million and unearned income of $5 million are not included in the amounts in the table above. 78 MATURITY DISTRIBUTION AND SECURITIES PORTFOLIO YIELDS -----------------------------------------------------

December 31, 2001 -------------------------------------------------------------------------------------- Maturity -------------------------------------------------------------------------------------- Within 1 Year 1-5 Years 5-10 Years After 10 Years ------------------- ------------------ ------------------- --------------------- Weighted Weighted Weighted Weighted Average Average Average Average (in thousands) Amount Yield Amount Yield Amount Yield Amount Yield ---------------------------------------------------------------------------------------------------------------- Held to maturity: U.S. Government agencies and corporations...... $ 6,300 8.47% $ 42,191 6.86% States and political subdivisions.......... $ 180 7.23% $ 740 7.46% 1,695 7.69 Other................... 125 7.24 -------------------------------------------------------------------------------------- Total securities held to maturity.......... $ 180 7.23% $ 865 7.43% $ 7,995 8.31% $ 42,191 6.86% ====================================================================================== Available for sale: U.S. Treasury........... $ 9,237 1.94% $ 5,125 4.75% U.S. Government agencies and corporations...... 105,744 5.65 14,540 6.68 $ 87,459 5.70% $1,679,966 6.23% States and political subdivisions.......... 5,668 6.57 23,872 7.97 76,564 7.09 68,371 7.05 Other................... 28,701 4.51 -------------------------------------------------------------------------------------- Total securities available for sale.............. $120,649 5.41% $43,537 6.60% $164,023 6.35% $1,777,038 6.23% ======================================================================================

December 31, 2001 --------------------- Maturity --------------------- Total Carrying Amount --------------------- Weighted Average (in thousands) Amount Yield ------------------------ --------------------- Held to maturity: U.S. Government agencies and corporations...... $ 48,491 7.07% States and political subdivisions.......... 2,615 7.60 Other................... 125 7.24 --------------------- Total securities held to maturity.......... $ 51,231* 7.10% ===================== Available for sale: U.S. Treasury........... $ 14,362 2.94% U.S. Government agencies and corporations...... 1,887,709 6.18 States and political subdivisions.......... 174,475 7.18 Other................... 28,701 4.51 --------------------- Total securities available for sale.............. $2,105,247* 6.21% =====================

Weighted average yields have been computed on a fully taxable-equivalent basis assuming a tax rate of 35%. * Included in the totals are mortgage-backed securities and collateralized mortgage obligations of $1.8 billion which are included in maturity categories based on their stated maturity date. QUARTERLY RESULTS OF OPERATIONS ------------------------------- (Unaudited)

THREE MONTHS ENDED 2001 Three Months Ended 2000 ----------------------------------------- ----------------------------------------- (in thousands, except per share amounts) MAR 31 JUNE 30 SEPT 30 DEC 31 Mar 31 June 30 Sept 30 Dec 31 ------------------------------------------------------------------------------------------------------------------------------- Interest income..................... $127,176 $117,658 $113,067 $103,075 $118,759 $126,888 $131,492 $135,192 Interest expense.................... 46,557 38,460 33,827 25,915 41,207 46,906 49,528 51,927 Net interest income................. 80,619 79,198 79,240 77,160 77,552 79,982 81,964 83,265 Provision for possible loan losses... 15,031 1,000 20,000 4,000 2,682 2,867 3,436 5,118 Gain(loss) on securities transactions... 10 (12) 80 (8) 2 10 Non-interest income*................ 46,758 48,473 48,799 48,861 39,617 42,874 42,407 45,967 Non-interest expense................ 82,601 83,767 83,273 102,965 76,073 77,756 78,473 80,978 Income before income taxes and cumulative effect of accounting change............................ 29,745 42,904 24,766 19,056 38,414 42,233 42,462 43,136 Income taxes........................ 10,215 14,243 8,116 5,991 13,258 14,603 14,704 14,863 Income before cumulative effect of accounting change................. 19,530 28,661 16,650 13,065 25,156 27,630 27,758 28,273 Cumulative effect of accounting change............................ 3,010 Net income.......................... 22,540 28,661 16,650 13,065 25,156 27,630 27,758 28,273 Net income per diluted common share... .42 .54 .31 .25 .47 .52 .52 .53

* Includes gain (loss) on securities transactions. 79 CULLEN/FROST BANKERS, INC. AND SUBSIDIARIES -------------------------------------------------------------------------------- BANK SUBSIDIARY (in thousands) --------------------------------------------------------------------------------

DECEMBER 31, 2001 ------------------------------------ TOTAL TOTAL TOTAL ASSETS LOANS DEPOSITS ------------------------------------ Frost National Bank......................................... $8,359,416 $4,518,608 $7,095,429 San Antonio, Austin, Boerne, Corpus Christi, Dallas, Fair Oaks, Fort Worth, Galveston, Houston, McAllen, New Braunfels, and San Marcos Main Office: P. O. Box 1600, 100 West Houston Street San Antonio, Texas 78296 (210)220-4011

ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING ------------------------------------------------------------------- AND FINANCIAL DISCLOSURE ------------------------ None. PART III ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT -------------------------------------------------------------------------------- The information regarding directors and executive officers called for by Item 10 is incorporated herein by reference to Cullen/Frost's Proxy Statement for its Annual Meeting of Shareholders to be held May 22, 2002. The additional information regarding executive officers called for by Item 10 is included in Part I, Item 1 of this document under the heading "Executive Officers of the Registrant". ITEM 11. EXECUTIVE COMPENSATION -------------------------------------------------------------------------------- The information called for by Item 11 is incorporated herein by reference to Cullen/Frost's Proxy Statement for its Annual Meeting of Shareholders to be held May 22, 2002. ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT -------------------------------------------------------------------------------- The information called for by Item 12 is incorporated herein by reference to Cullen/Frost's Proxy Statement for its Annual Meeting of Shareholders to be held May 22, 2002. ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS -------------------------------------------------------------------------------- The information called for by Item 13 is incorporated herein by reference to Cullen/Frost's Proxy Statement for its Annual Meeting of Shareholders to be held May 22, 2002. 80 PART IV ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K -------------------------------------------------------------------------------- (a) The following documents are filed as part of this Annual Report on Form 10-K: 1. Financial Statements -- Reference is made to Part II, Item 8, of this Annual Report on Form 10-K. 2. The Financial Statement Schedules are omitted, as the required information is included in the annual report. 3. Exhibits -- The following exhibits are filed as a part of this Annual Report on Form 10-K:

EXHIBIT NUMBER ------- 3.1 -- Restated Articles of Incorporation, of Cullen/Frost Bankers, Inc.(11) 3.2 -- Amended By-Laws of Cullen/Frost Bankers, Inc.(7) 4.1 -- Shareholder Protection Rights Agreement dated as of February 1, 1999 between Cullen/Frost Bankers, Inc. and The Frost National Bank, as Rights Agent(10) 10.1 -- Restoration of Retirement Income Plan for Participants in the Retirement Plan for Employees of Cullen/Frost Bankers, Inc. and its Affiliates (as amended and restated)(9)* 10.2 -- 1983 Non-qualified Stock Option Plan, as amended(1) 10.3 -- 1988 Non-qualified Stock Option Plan(2) 10.4 -- The 401(k) Stock Purchase Plan for Employees of Cullen/Frost Bankers, Inc. and its Affiliates(3)* 10.5 -- 1991 Thrift Incentive Stock Purchase Plan for Employees of Cullen/Frost Bankers, Inc. and its Affiliates(4)* 10.6 -- Cullen/Frost Bankers, Inc. Restricted Stock Plan(5)* 10.7 -- Cullen/Frost Bankers, Inc. Supplemental Executive Retirement Plan(6)* 10.8 -- Cullen/Frost Bankers, Inc. 1997 Directors Stock Plan(8) 10.9 -- Cullen/Frost Bankers, Inc. 1992 Stock Plan, as amended(12) 10.10 -- Change-In-Control Agreements with 3 Executive Officers(11)* 10.11 -- Cullen/Frost Bankers, Inc. 2001 Stock Plan(12) 19.1 -- Annual Report on Form 11-K for the Year Ended December 31, 2001, for the 1991 Thrift Incentive Stock Purchase Plan (filed pursuant to Rule 15d-21 of the Securities and Exchange Act of 1934)(13) 19.2 -- Annual Report on Form 11-K for the Year Ended December 31, 2001, for the 401(k) Stock Purchase Plan (filed pursuant to Rule 15d-21 of the Securities and Exchange Act of 1934)(13) 21 -- Subsidiaries of Cullen/Frost Bankers, Inc. 23 -- Consent of Independent Auditors 24 -- Power of Attorney

* Management contract or compensatory plan or arrangement required to be filed as an exhibit pursuant to Item 601 of Regulation S-K. (b) Reports on Form 8-K -- No such reports were filed during the quarter ended December 31, 2001. 81 --------------- (1) Incorporated herein by reference to the designated Exhibits to Cullen/Frost's Report on Form S-8 filed September 5, 1989 (File No. 33-30776) (2) Incorporated herein by reference to the designated Exhibits to Cullen/Frost's Report on Form S-8 filed September 5, 1989 (File No. 33-30777) (3) Incorporated herein by reference to the designated Exhibits to Cullen/Frost's Report on Form S-8 filed October 31, 1990 (File No. 33-37500) (4) Incorporated herein by reference to the designated Exhibits to Cullen/Frost's Report on Form S-8 filed March 18, 1991 (File No. 33-39478) (5) Incorporated herein by reference to the designated Exhibits to Cullen/Frost's Report on Form S-8 filed October 20, 1992 (File No. 33-53492) (6) Incorporated herein by reference to the designated Exhibits to Cullen/Frost's Annual Report on Form 10-K for the Year Ended December 31, 1994 (File No. 0-7275) (7) Incorporated herein by reference to the designated Exhibits to Cullen/Frost's Annual Report on Form 10-K/A for the Year Ended December 31, 1995 (File No. 0-7275) (8) Incorporated herein by reference to the designated Exhibits to Cullen/Frost's Annual Report on Form 10-K for the Year Ended December 31, 1997 (File No. 0-7275) (9) Incorporated herein by reference to the designated Exhibits to Cullen/Frost's Annual Report on Form 10-K for the Year Ended December 31, 1998 (File No. 0-7275) (10) Incorporated herein by reference to the designated Exhibits to Cullen/Frost's Current Report on Form 8-A12B dated February 1, 1999 (File No. 0-7275) (11) Incorporated herein by reference to the designated Exhibits to Cullen/Frost's Annual Report on Form 10-K for the Year Ended December 31, 2000 (File No. 0-7275) (12) Incorporated herein by reference to the designated Exhibits to Cullen/Frost's Report on Form S-8 filed September 4, 2001 (File No. 33-68928) (13) To be filed as an amendment. 82 SIGNATURES PURSUANT TO THE REQUIREMENTS OF SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934, THE REGISTRANT HAS DULY CAUSED THIS REPORT TO BE SIGNED ON ITS BEHALF BY THE UNDERSIGNED, THEREUNTO DULY AUTHORIZED. Date: March 29, 2002 CULLEN/FROST BANKERS, INC. (Registrant) By: /s/ PHILLIP D. GREEN ---------------------------------- PHILLIP D. GREEN GROUP EXECUTIVE VICE PRESIDENT AND CHIEF FINANCIAL OFFICER PURSUANT TO THE REQUIREMENTS OF THE SECURITIES EXCHANGE ACT OF 1934, THIS REPORT HAS BEEN SIGNED BELOW BY THE FOLLOWING PERSONS ON BEHALF OF THE REGISTRANT AND IN THE CAPACITIES INDICATED ON MARCH 29, 2002.

SIGNATURES TITLE DATE ---------- ----- ---- T.C. FROST* Senior Chairman of the Board ----------------------------------------------------- and Director T.C. FROST RICHARD W. EVANS, JR.* Chairman of the Board and ----------------------------------------------------- Director (Principal Executive RICHARD W. EVANS, JR. Officer) R. DENNY ALEXANDER* Director ----------------------------------------------------- R. DENNY ALEXANDER CARLOS ALVAREZ* Director ----------------------------------------------------- CARLOS ALVAREZ ISAAC ARNOLD, JR.* Director ----------------------------------------------------- ISAAC ARNOLD, JR. ROYCE S. CALDWELL* Director ----------------------------------------------------- ROYCE S. CALDWELL BOB W. COLEMAN* Director ----------------------------------------------------- BOB W. COLEMAN HARRY H. CULLEN* Director ----------------------------------------------------- HARRY H. CULLEN EUGENE H. DAWSON, SR.* Director ----------------------------------------------------- EUGENE H. DAWSON, SR. RUBEN M. ESCOBEDO* Director ----------------------------------------------------- RUBEN M. ESCOBEDO

83 SIGNATURES -- (CONTINUED)

SIGNATURES TITLE DATE ---------- ----- ---- PATRICK B. FROST* Director ----------------------------------------------------- PATRICK B. FROST JOE R. FULTON* Director ----------------------------------------------------- JOE R. FULTON PRESTON M. GEREN III* Director ----------------------------------------------------- PRESTON M. GEREN III JAMES L. HAYNE* Director ----------------------------------------------------- JAMES L. HAYNE KAREN E. JENNINGS* Director ----------------------------------------------------- KAREN E. JENNINGS RICHARD M. KLEBERG, III* Director ----------------------------------------------------- RICHARD M. KLEBERG, III ROBERT S. MCCLANE* Director ----------------------------------------------------- ROBERT S. MCCLANE IDA CLEMENT STEEN* Director ----------------------------------------------------- IDA CLEMENT STEEN HORACE WILKINS, JR.* Director ----------------------------------------------------- HORACE WILKINS, JR. MARY BETH WILLIAMSON* Director ----------------------------------------------------- MARY BETH WILLIAMSON *By: /s/ PHILLIP D. GREEN Group Executive Vice March 29, 2002 President and Chief Financial ----------------------------------------------------- Officer PHILLIP D. GREEN (AS ATTORNEY-IN-FACT FOR THE PERSONS INDICATED)

84 EXHIBIT INDEX

EXHIBIT NUMBER ------- 3.1 -- Restated Articles of Incorporation, of Cullen/Frost Bankers, Inc.(11) 3.2 -- Amended By-Laws of Cullen/Frost Bankers, Inc.(7) 4.1 -- Shareholder Protection Rights Agreement dated as of February 1, 1999 between Cullen/Frost Bankers, Inc. and The Frost National Bank, as Rights Agent(10) 10.1 -- Restoration of Retirement Income Plan for Participants in the Retirement Plan for Employees of Cullen/Frost Bankers, Inc. and its Affiliates (as amended and restated)(9)* 10.2 -- 1983 Non-qualified Stock Option Plan, as amended(1) 10.3 -- 1988 Non-qualified Stock Option Plan(2) 10.4 -- The 401(k) Stock Purchase Plan for employees of Cullen/Frost Bankers, Inc. and its Affiliates(3)* 10.5 -- 1991 Thrift Incentive Stock Purchase Plan for Employees of Cullen/Frost Bankers, Inc. and its Affiliates(4)* 10.6 -- Cullen/Frost Bankers, Inc. Restricted Stock Plan(5)* 10.7 -- Cullen/Frost Bankers, Inc. Supplemental Executive Retirement Plan(6)* 10.8 -- Cullen/Frost Bankers, Inc. 1997 Directors Stock Plan(8) 10.9 -- Cullen/Frost Bankers, Inc. 1992 Stock Plan, as amended(12) 10.10 -- Change-In-Control Agreements with 3 Executive Officers(11)* 10.11 -- Cullen/Frost Bankers, Inc. 2001 Stock Plan(12) 19.1 -- Annual Report on Form 11-K for the Year Ended December 31, 2001, for the 1991 Thrift Incentive Stock Purchase Plan (filed pursuant to Rule 15d-21 of the Securities and Exchange Act of 1934)(13) 19.2 -- Annual Report on Form 11-K for the Year Ended December 31, 2001, for the 401(k) Stock Purchase Plan (filed pursuant to Rule 15d-21 of the Securities and Exchange Act of 1934)(13) 21 -- Subsidiaries of Cullen/Frost Bankers, Inc. 23 -- Consent of Independent Auditors 24 -- Power of Attorney

* Management contract or compensatory plan or arrangement required to be filed as an exhibit pursuant to Item 601 of Regulation S-K. --------------- (1) Incorporated herein by reference to the designated Exhibits to Cullen/Frost's Report on Form S-8 filed September 5, 1989 (File No. 33-30776) (2) Incorporated herein by reference to the designated Exhibits to Cullen/Frost's Report on Form S-8 filed September 5, 1989 (File No. 33-30777) (3) Incorporated herein by reference to the designated Exhibits to Cullen/Frost's Report on Form S-8 filed October 31, 1990 (File No. 33-37500) (4) Incorporated herein by reference to the designated Exhibits to Cullen/Frost's Report on Form S-8 filed March 18, 1991 (File No. 33-39478) (5) Incorporated herein by reference to the designated Exhibits to Cullen/Frost's Report on Form S-8 filed October 20, 1992 (File No. 33-53492) (6) Incorporated herein by reference to the designated Exhibits to Cullen/Frost's Annual Report on Form 10-K for the Year Ended December 31, 1994 (File No. 0-7275) 85 (7) Incorporated herein by reference to the designated Exhibits to Cullen/Frost's Annual Report on Form 10-K/A for the Year Ended December 31, 1995 (File No. 0-7275) (8) Incorporated herein by reference to the designated Exhibits to Cullen/Frost's Annual Report on Form 10-K for the Year Ended December 31, 1997 (File No. 0-7275) (9) Incorporated herein by reference to the designated Exhibits to Cullen/Frost's Annual Report on Form 10-K for the Year Ended December 31, 1998 (File No. 0-7275) (10) Incorporated herein by reference to the designated Exhibits to Cullen/Frost's Current Report on Form 8-A12B dated February 1, 1999 (File No. 0-7275) (11) Incorporated herein by reference to the designated Exhibits to Cullen/Frost's Annual Report on Form 10-K for the Year Ended December 31, 2000 (File No. 0-7275) (12) Incorporated herein by reference to the designated Exhibits to Cullen/Frost's Report on Form S-8 filed September 4, 2001 (File No. 33-68928) (13) To be filed as an amendment. 86