100 West Houston Street

San Antonio, Texas 78205

 

 

NOTICE OF ANNUAL MEETING OF SHAREHOLDERS

 

 

To the Shareholders of

CULLEN/FROST BANKERS, INC.:

 

The Annual Meeting of Shareholders of Cullen/Frost Bankers, Inc. (“Cullen/Frost”) will be held in the Commanders Room at The Frost National Bank, 100 West Houston Street, San Antonio, Texas, on Thursday, April 26, 2007, at 11:00 a.m., San Antonio time, for the following purposes:

 

 

You must be a shareholder of record at the close of business on March 9, 2007 to vote at the Annual Meeting. In order to hold the meeting, holders of a majority of the outstanding shares must be present either in person or by proxy.

 

Your vote is important, so please promptly complete and return the enclosed proxy card in the postage prepaid envelope provided.

 

All shareholders are cordially invited to attend the Annual Meeting.

 

By Order of the Board of Directors,

 

STAN McCORMICK

Corporate Secretary

 

Dated: March 26, 2007

 

TABLE OF CONTENTS

 

 

100 West Houston Street

San Antonio, Texas 78205

 

 

PROXY STATEMENT FOR THE ANNUAL MEETING OF SHAREHOLDERS

To Be Held on April 26, 2007

 

 

INTRODUCTION

 

The Board of Directors of Cullen/Frost Bankers, Inc. (“Cullen/Frost” or the “Company”) is soliciting proxies to be used at the Annual Meeting of Shareholders and any adjournment or postponement thereof. The meeting will be held in the Commanders Room at The Frost National Bank, 100 West Houston Street, San Antonio, Texas, on Thursday, April 26, 2007 at 11:00 a.m., San Antonio time. This Proxy Statement and the accompanying proxy card will be mailed to shareholders beginning on or about March 26, 2007.

 

Record Date and Voting Rights

 

The close of business on March 9, 2007 has been fixed as the record date for the determination of shareholders entitled to vote at the Annual Meeting. The only class of securities of Cullen/Frost outstanding and entitled to vote at the Annual Meeting is Common Stock, par value $0.01 per share. On March 9, 2007, there were outstanding 59,963,652 shares of Common Stock, with each share entitled to one vote.

 

Proxies

 

All shares of Cullen/Frost Common Stock represented by properly executed proxies, if timely returned and not subsequently revoked, will be voted at the Annual Meeting in the manner directed in the proxy. If a properly executed proxy does not provide directions, it will be voted for all proposals listed on the proxy and in the discretion of the persons named as proxies with respect to any other business that may properly come before the meeting.

 

A shareholder may revoke a proxy at any time before it is voted by delivering a written revocation notice to the Corporate Secretary of Cullen/Frost Bankers, Inc., 100 West Houston Street, San Antonio, Texas 78205. A shareholder who attends the Annual Meeting may, if desired, vote by ballot at the meeting, and such vote will revoke any proxy previously given.

 

Quorum and Voting Requirements

 

A quorum of shareholders is required to hold a valid meeting. If the holders of at least a majority of the issued and outstanding shares of Company Common Stock are present at the Annual Meeting in person or represented by proxy, a quorum will exist. Shares for which votes are withheld, as well as abstentions and broker non-votes, are counted as “present” for establishing a quorum.

 

Directors are elected by a plurality of the votes cast at the Annual Meeting. Accordingly, the nominees receiving the highest number of votes will be elected. In the election of Directors, votes may be cast “for” or “withhold authority” with respect to any or all nominees. Votes that are “withheld” will be excluded entirely from the vote and will have no effect on the outcome of the vote.

 

The approval of the Cullen/Frost Bankers, Inc. 2007 Outside Directors Incentive Plan requires the affirmative vote of the holders of at least a majority of the shares of Cullen/Frost’s Common Stock having voting power and present in person or represented by proxy at the annual meeting; provided, that, the total votes cast on this proposal represent over 50% of the outstanding shares of Cullen/Frost’s Common Stock. For purposes of this vote, a vote to abstain (or a direction to a broker or other nominee to abstain) will be counted as present in person or represented by proxy and entitled to vote at the annual meeting, and therefore, will have the effect of a negative vote. A broker non-vote, as described below, is not counted as a vote cast, and therefore, could prevent the total votes cast on this proposal from representing over 50% of the outstanding shares of Common Stock, but will not otherwise have an effect on this vote.

 

With respect to the other matters to be voted on at the annual meeting, including the ratification of Ernst & Young LLP to act as our independent auditors for the 2007 fiscal year, the affirmative vote of the holders of at least a majority of the shares of Cullen/Frost’s Common Stock having voting power and present in person or represented by proxy at the annual meeting will be the act of the shareholders. In voting for these other matters, shares may be voted “for” or “against” or “abstain”. An abstention will have the effect of a vote against these other matters.

 

Under the rules of the National Association of Securities Dealers, Inc., member brokers generally may not vote shares held by them in street name for customers, a so-called “broker non-vote,” unless they are permitted to do so under the rules of any national securities exchange of which they are a member. Under the rules of the New York Stock Exchange, Inc. (“NYSE”), a member broker that holds shares in street name for customers has authority to vote on “routine” items if it has transmitted proxy-soliciting materials to the beneficial owner but has not received instructions from that owner. The election of Directors and the proposal to ratify the selection of Ernst & Young LLP to act as Cullen/Frost’s independent auditors are both “routine” items and the NYSE rules permit member brokers that do not receive instructions to vote on these items. However, the approval of the Cullen/Frost Bankers, Inc. 2007 Outside Directors Incentive Plan is a “non-routine” item and member brokers may not vote on this item unless they receive voting instructions.

 

Expenses of Solicitation

 

Cullen/Frost will pay the expenses of the solicitation of proxies for the Annual Meeting. In addition to the solicitation of proxies by mail, Directors, officers, and employees of Cullen/Frost may solicit proxies by telephone, facsimile, in person or by other means of communication. Cullen/Frost also has retained Georgeson Shareholder Communications Inc. (“Georgeson”) to assist with the solicitation of proxies. Directors, officers, and employees of Cullen/Frost will receive no additional compensation for the solicitation of proxies, and Georgeson will receive a fee not to exceed $7,000.00, plus reimbursement for out-of-pocket expenses. Cullen/Frost has requested that brokers, nominees, fiduciaries, and other custodians forward proxy-soliciting material to the beneficial owners of Cullen/Frost Common Stock. Cullen/Frost will reimburse these persons for out-of-pocket expenses they incur in connection with its request.

ELECTION OF DIRECTORS
(Item 1 On Proxy Card)

 

The Company’s Bylaws provide for a classified Board of Directors. Directors are assigned to one of three classes, and all classes are as equal in number as possible. The term of office of Class I will expire at the 2009 Annual Meeting. The term of office of Class II will expire at the 2010 Annual Meeting, and the term of office of Class III will expire at the 2008 Annual Meeting.

 

The following four Directors currently assigned to Class II have been nominated to serve for a new three-year term: Mr. Richard W. Evans, Jr., Ms. Karen E. Jennings, Mr. Richard M. Kleberg, III and Mr. Horace Wilkins, Jr. In addition, one Director from Class II, Mr. T.C. Frost, has been nominated to serve in Class III until the 2008 Annual Meeting of Shareholders. If any nominee is unable to serve, the individuals named as proxies on the enclosed proxy card will vote the shares to elect the remaining nominees and any substitute nominee or nominees designated by the Board.

 

The tables below provide information on each nominee, as well as each Director whose term continues after the meeting.

 

Nominees for Three-Year Term Expiring in 2010 (Class II):

 

 

Directors Continuing in Office Term Expiring in 2009 (Class I):

 

Directors Continuing in Office Term Expiring in 2008 (Class III):

 

 

 

 

 

Meetings and Attendance

 

The Board of Directors had seven meetings in 2006. Each of the Company’s current Directors attended at least 75 percent of the meetings of the Board and the Committees of the Board on which he or she served during 2006 except Carlos Alvarez who attended 67 percent.

 

The Board of Directors has a policy which encourages all Directors to attend the Annual Meeting of Shareholders and in 2006 eleven out of thirteen Directors attended the Annual Meeting.

 

Committees of the Board

 

The Board of Directors has five Committees, each of which is described in the chart below.

 

 

The Board has adopted written charters for the Audit Committee, the Compensation and Benefits Committee and the Corporate Governance and Nominating Committee. All of these charters are available at

 

As described in more detail below under “Certain Corporate Governance Matters — Director Independence,” the Board has determined that each member of the Audit Committee, the Compensation and Benefits Committee and the Corporate Governance and Nominating Committee is independent within the meaning of the rules of the NYSE. The Board has also determined that each member of the Audit Committee is independent within the meaning of the rules of the Securities and Exchange Commission (the “SEC”). In addition, the Board has determined that each member of the Audit Committee is “financially literate” and that at least one member of the Audit Committee has “accounting or related financial management expertise,” in each case within the meaning of the NYSE’s rules. The Board has also determined that Mr. Ruben M. Escobedo is an “audit committee financial expert” within the meaning of the SEC’s rules.

 

Director Nomination Process

 

The Corporate Governance and Nominating Committee is responsible for identifying individuals qualified to become members of the Board of Directors and for recommending to the Board the nominees to stand for election as Directors.

 

In identifying Director candidates, the Corporate Governance and Nominating Committee may seek input from Cullen/Frost’s management and from current members of the Board. In addition, it may use the services of an outside consultant, although it has not done so in the past. The Corporate Governance and Nominating Committee will consider candidates recommended by shareholders. Shareholders who wish to recommend candidates may do so by writing to the Corporate Governance and Nominating Committee of Cullen/Frost Bankers, Inc., c/o Corporate Secretary, 100 West Houston Street, San Antonio, Texas 78205. Recommendations may be submitted at any time. The written recommendation must include the name of the candidate, the number of shares of Cullen/Frost Common Stock owned by the candidate and the information regarding the candidate that would be included in a proxy statement for the election of Directors pursuant to paragraphs (a), (e) and (f) of Item 401 of Regulation S-K adopted by the SEC.

 

In evaluating Director candidates, the Corporate Governance and Nominating Committee initially considers the Board’s need for additional or replacement Directors. It also considers the criteria approved by the Board and set forth in Cullen/Frost’s Corporate Governance Guidelines, which include, among other things, the candidate’s personal qualities (in light of the Company’s core values and mission statement), accomplishments and reputation in the business community, the fit of the candidate’s skills and personality with those of other Directors and candidates and the ability of the candidate to commit adequate time to Board and committee matters. The objective is to build a Board that is effective, collegial and responsive to the needs of Cullen/Frost. In addition, considerable emphasis is given to Cullen/Frost’s mission statement and core values, statutory and regulatory requirements, the Board’s goal of having a substantial majority of independent directors, and the Board’s retirement policy.

 

The Corporate Governance and Nominating Committee evaluates all Director candidates in the same manner, including candidates recommended by shareholders. In considering whether candidates satisfy the criteria described above, the committee will initially utilize the information it receives with the recommendation or otherwise possesses. If it determines, in consultation with other Board members, including the Chairman, that more information is needed, it may, among other things, conduct interviews.

 

Director Compensation

 

2006 Director Compensation Table

 

 

 

 

Cullen/Frost employees receive no fees for their services as members of the Board of Directors or any of its committees. Non-employee Directors receive an annual retainer fee of $16,000 and $2,000 for each Board meeting attended. In addition, non-employee Directors receive $1,000 for attending each meeting of a committee of the Board to which they have been appointed, except that the Chairman of the Audit Committee receives $1,500 for each meeting of the Audit Committee attended and all Committee Chairmen receive an annual retainer fee of $5,000. Non-employee Directors are also eligible to receive stock options each year under Cullen/Frost’s 1997 Director Stock Plan. In April 2006, each non-employee Director received options to purchase 2,000 shares of the Company’s Common Stock. A total of 20,000 stock options were granted to non-employee Directors in 2006. The options have a term of six years from the date of the grant, are exercisable immediately from the date of the grant and have an exercise price of $56.90, which is equal to the closing price of the Company’s Common Stock on the date of the grant.

 

In addition, the Board of Directors also serves as the Board of Directors for The Frost National Bank, a subsidiary of Cullen/Frost, and non-employee Directors receive fees for serving in this capacity. In particular, non-employee Directors receive $2,000 for each meeting of such Board attended and $1,000 for attending each meeting of a committee of such Board to which they have been appointed.

 

Other Directorships

 

The following are directorships held by nominees and Directors in public companies other than Cullen/Frost, or in registered investment companies:

 

 

Miscellaneous Information

 

There are no arrangements or understandings between any nominee or Director of Cullen/Frost and any other person regarding such nominee’s or Director’s selection as such, except that Mr. Robert S. McClane’s retirement agreement with Cullen/Frost provides that, until he reaches age 70, subject to the sole discretion of the Board of Directors, he will be considered as a candidate for reelection to the Board. In addition, pursuant to such retirement agreement, Mr. McClane is entitled to office space and secretarial services and support until he reaches age 70. The only family relationships among the Directors or executive officers of Cullen/Frost that are first cousin or closer are those of Messrs. T.C. Frost and Patrick B. Frost, who are father and son.

 

Cullen/Frost believes that it has operated over the years with sound corporate governance practices that exemplify its commitment to integrity and to protect both the interests of its shareholders and the other constituencies that it serves. These practices include a substantially independent Board of Directors, periodic meetings of non-management Directors and a sound and comprehensive code of conduct, which obligates Directors and all employees to adhere to the highest legal and ethical business practices. A review of some of Cullen/Frost’s corporate governance measures is set forth below.

 

The Board of Directors believes that a substantial majority of its members should be independent within the meaning of the NYSE’s rules. To this end, the Board reviews annually the relevant facts and circumstances regarding relationships between Directors and Cullen/Frost. The purpose of the Board’s review is to determine whether any Director has a material relationship with Cullen/Frost (either directly or as a partner, shareholder or officer of an organization that has a relationship with Cullen/Frost).

 

In connection with the Board’s latest review, the Board determined that the following Directors, which compose 77% of the Board, are independent within the meaning of the NYSE’s rules: Mr. R. Denny Alexander, Mr. Carlos Alvarez, Mr. Royce S. Caldwell, Mr. Crawford H. Edwards, Mr. Ruben M. Escobedo, Ms. Karen E. Jennings, Mr. Richard M. Kleberg, III, Mr. Robert S. McClane, Ms. Ida Clement Steen and Mr. Horace Wilkins, Jr. Mr. T.C. Frost, Mr. Richard W. Evans, Jr. and Mr. Patrick B. Frost are not independent because they are executive officers of Cullen/Frost.

 

In making its independence determinations, the Board considers the NYSE’s rules, as well as the standards set forth below. The Board adopted these standards pursuant to the NYSE’s rules to assist in making independence determinations. For purposes of the standards, the term “Cullen/Frost Entity” means, collectively, Cullen/Frost and each of its subsidiaries.

 

Credit Relationships.  A proposed or outstanding relationship that consists of an extension of credit by a Cullen/Frost Entity to a Director or a person or entity that is affiliated, associated or related to a Director should not be deemed to be a material relationship if it satisfies each of the following criteria:

 

 

Non-Credit Banking or Financial Products or Services Relationships.  A proposed or outstanding relationship in which a Director or a person or Entity that is affiliated, associated or related to a Director procures non-credit banking or financial products or services from a Cullen/Frost Entity should not be deemed to be a material relationship if it (i) has been or will be offered in the ordinary course of the Cullen/Frost Entity’s business and (ii) has been or will be offered on terms and under circumstances that were or are substantially similar to those prevailing at the time for comparable non-credit banking or financial products or services provided by the Cullen/Frost Entity to other unrelated persons or entities.

 

Property or Services Relationships.  A proposed or outstanding relationship in which a Director or a person or Entity that is affiliated, associated or related to a Director provides property or services to a Cullen/Frost Entity should not be deemed to be a material relationship if the property or services (i) have been or will be procured in the ordinary course of the Cullen/Frost Entity’s business and (ii) have been or will be procured on terms and under circumstances that were or are substantially similar to those that the Cullen/Frost Entity would expect in procuring comparable property or services from other unrelated persons or entities.

 

Cullen/Frost’s non-management Directors meet in executive sessions without members of management present at each regularly scheduled meeting of the Board. The Chair of the Board’s Corporate Governance and Nominating Committee, who is currently Mr. Royce S. Caldwell, presides at the executive sessions.

 

The Board of Directors has established a mechanism for shareholders or other interested parties to communicate with the non-management Directors as a group and the presiding non-management Director. All such communications,which can be anonymous or confidential, should be addressed to the Board of Directors of Cullen/Frost Bankers, Inc., c/o Corporate Counsel, 100 West Houston Street, San Antonio, Texas 78205.

 

In addition, the Board of Directors has established a mechanism for shareholders or other interested parties that have concerns or complaints regarding accounting, internal accounting controls or auditing matters to communicate them to the Audit Committee. Such concerns or complaints, which can be anonymous or confidential, should be addressed to the Audit Committee of Cullen/Frost Bankers, Inc., c/o Corporate Counsel, 100 West Houston Street, San Antonio, Texas 78205.

 

For shareholders or other interested parties desiring to communicate with the non-management Directors, the presiding non-management Director or the Audit Committee by e-mail, telephone, or U.S. mail, please see the information set forth on Cullen/Frost’s website at www.frostbank.com. Alternatively, any shareholder or other interested party may communicate in writing by contacting the Corporate Secretary, Stan McCormick, at 100 West Houston Street, San Antonio, Texas 78205. These Communication can be anonymous or confidential.

 

The Board of Directors has adopted Corporate Governance Guidelines, which reaffirm Cullen/Frost’s commitment to having strong corporate governance practices. The Guidelines set forth, among other things, the policies of the Board with respect to Board composition, selection of Directors, retirement of Directors, Director orientation and continuing training, executive sessions of non-management Directors, Director compensation and Director responsibilities. The Guidelines are available on Cullen/Frost’s website at www.frostbank.com or in print, to any shareholder making a request by contacting the Corporate Secretary, Stan McCormick, at 100 West Houston Street, San Antonio, Texas 78205.

 

The Board of Directors has adopted a Code of Business Conduct and Ethics to promote the highest legal and ethical business practices by Cullen/Frost. The Code applies to Directors and Cullen/Frost employees, including Cullen/Frost’s Chief Executive Officer, Chief Financial Officer and principal accounting officer. The Code addresses, among other things, honest and ethical conduct, accurate and timely financial reporting, compliance with applicable laws, accountability for adherence to the Code and prompt internal reporting of violations of the Code. The code prohibits retaliation against any Director, officer or employee who in good faith reports a potential violation. The Code is available on Cullen/Frost’s website at www.frostbank.com or in print, to any shareholder making a request by contacting the Corporate Secretary, Stan McCormick at 100 West Houston Street, San Antonio, Texas 78205. As required by law, Cullen/Frost will disclose any amendments to or waivers from the Code that apply to its Chief Executive Officer, Chief Financial Officer and principal accounting officer by posting such information on its website at www.frostbank.com.

 

Charter.  The Committee’s charter is posted on the frostbank.com website.

 

Scope of authority.  The primary function of the Compensation and Benefits Committee (the Committee) is to assist the Board in fulfilling its oversight responsibility with respect to:

 

 

 

Delegation authority.  While the Committee approves the annual normal grant of stock options and restricted stock to officers, it delegates authority to the CEO to allocate a specified pool of stock options to address special needs as they arise.

 

Role of executive officers.  The CEO recommends to the Committee base salary, target bonus levels, actual bonus payouts and long-term incentive grants for Company officers. The Committee considers, discusses, modifies as appropriate, and takes action on such proposals.

 

Role of compensation consultants.  In 2006, the Committee directly retained Hewitt Associates LLC (Hewitt) as its independent compensation consultant. The Committee informed Hewitt in writing that it expected Hewitt to advise it if and when there were elements of management proposals to the Committee that Hewitt believed the Committee should not support, set expectations for Hewitt to be frank and upfront with the Committee at all times, and stated that Hewitt’s ongoing engagement would be determined by the Committee.

 

The mandate of the consultant is to serve the Company and work for the Committee in its review of executive and director compensation practices, including the competitiveness of pay levels, executive compensation design issues, market trends, and technical considerations. The nature and scope of services rendered by Hewitt on the Committee’s behalf is described below:

 

 

The Committee did not direct Hewitt to perform the above services in any particular manner or under any particular method. The Committee has the final authority to hire and terminate the consultant, and the Committee evaluates the consultant periodically.

 

Hewitt consultants attended Committee meetings in 2006 and assisted the Committee with the market data and an assessment of executive compensation levels, annual incentive plan design, CEO compensation and information with respect to the new proxy disclosure rules.

 

Compensation and Benefits Committee Interlocks and Insider Participation

 

Some of the members of the Compensation and Benefits Committee, and some of these persons’ associates, are current or past customers of one or more of the Company’s subsidiaries. Since January 1, 2006, transactions between these persons and such subsidiaries have occurred, including borrowings. In the opinion of management, all of the transactions have been in the ordinary course of business, have had substantially the same terms, including interest rates and collateral, as those prevailing at the time for comparable transactions with other persons and did not involve more than the normal risk of collectibility. Additional transactions may take place in the future.

 

The Compensation and Benefits Committee has reviewed and discussed the Compensation Discussion and Analysis with management. Based on our review and discussions, we have recommended to the Board of Directors that the Compensation Discussion and Analysis be included in the Company’s Annual Report on Form 10-K or proxy statement.

 

Royce S. Caldwell, Committee Chairman

Ruben M. Escobedo

Karen E. Jennings

 

Introduction

 

This discussion is included to provide the material information necessary to understand the objectives and policies of Cullen/Frost’s compensation program for the named executive officers:

 

 

Objectives of the Compensation Program

 

The Cullen/Frost Compensation Program is administered by the Compensation and Benefits Committee. The objectives of the program are to:

 

 

 

Design of the Total Compensation Program and Overview of Compensation Decisions Made in 2006

 

Pay Philosophy

 

In general, it is the Company’s compensation philosophy to target aggregate executive compensation at the 50th percentile of the external market. In addition to external competitiveness, the Committee evaluates the following factors when making compensation decisions for executive officers:

 

 

The Committee does not assign specific weighting to these factors when making compensation decisions.

 

When reviewing the components of the compensation program, the Committee, together with the head of Human Resources, works to ensure the total package is competitive with the external marketplace and remains balanced from an internal equity standpoint. However, it is the total package that should be competitive, and not necessarily the individual elements.

 

The Committee does not maintain a stated policy with regard to cash versus non-cash compensation. However, the allocation of cash and non-cash compensation for each of the named executive officers is reviewed annually.

 

In general, the Committee does not take into account amounts realizable from prior compensation when making future pay decisions. However, prior compensation amounts and values as of their grant dates are contemplated, particularly when establishing long-term incentive award grants. Beginning in 2007 the Committee will annually review a total compensation tally sheet for Mr. Evans.

 

Benchmarking and Peer Companies

 

Under the direction of the Committee, the Company conducts annual benchmarking of base pay, annual incentive pay, and long-term incentive pay. The competitiveness of other forms of pay is reviewed on a periodic basis.

 

External market data is provided by independent external consultant, Hewitt. For 2006, market data was collected from multiple published survey sources representing national financial institutions of a similar asset size

to the Company. Additionally, market data was collected from public filings for the following 29 companies comprising the Lehman Brothers Small-Cap Bank Index (excluding Frost):

 

 

Elements of the Compensation Program

 

To ensure achievement of the program objectives, compensation is provided to the executive officers in the following elements:

 

 

The purpose, design, determination of amounts, and 2006 pay decisions are described below.

 

Base Pay

 

Base pay is an important element of executive compensation because it provides executives with a base level of monthly income. As discussed in the Pay Philosophy section, internal and external equity, performance, experience, and other factors are considered when establishing base salaries. The Committee does not assign specific weighting to these factors when making compensation decisions. Base salary changes are generally approved in October of each year and are effective January 1st of the following year. No specific weighting is targeted for base salaries as a percentage of total compensation.

 

In 2006, the Committee increased salaries for Mr. Evans and the other executive officers. The increases were based on external market data, internal equity, and each individual’s performance as well as specific concerns over a heightened market for executive talent in the Texas banking market. As a result, base salaries approximated the 75th percentile of the external market. Base pay levels can be seen in the Summary Compensation Table.

 

Annual Incentive Pay

 

Annual Incentive Pay is provided to executive officers to recognize achievement of financial targets both on the overall corporate level and the individual level and is paid in accordance with the terms of the Management Bonus Plan. This reward is paid in the form of a cash bonus. Annually, a target bonus pool is generated if financial performance of the Company meets the budgeted net income for the year with the possibility of additional bonus dollars generated by exceptional performance. The Committee establishes the corporate and individual objectives as well as the target, which is expressed as a percentage of the executive’s base salary earnings for the year. There is not a stated cap on the plan. However, over the past eight years, the most we have paid to any named executive officer in excess of target was 140% of target.

 

For 2006, the Company had established the following individual targets as a percentage of 2006 base salary earnings for the named executives:

 

 

The individual targets are not formula driven. For all of the named executive officers with the exception of Mr. Evans, the targets are set at the discretion of senior management with approval of the Committee based on external market data provided by independent external consultants, internal equity considerations, and strategic objectives for corporate performance. These targets are reviewed annually at the fall meeting of the Committee and altered as deemed appropriate. Payout amounts for the named executive officers, with the exception of Mr. Evans, are made based on recommendations of senior management and approval of the Committee. Bonus amounts in excess of target may be paid at the discretion of senior management with the approval of the Committee. The Committee has the discretion to approve, disapprove or alter senior management’s recommendations.

 

For Mr. Evans, the Committee establishes a designated bonus pool annually. For 2007 the Committee approved a pool of 0.8% of fiscal year net income. To determine the payout amount, the Committee exercises downward discretion based on performance measures approved by the Committee. The Board must ratify the payout amount determined by the Committee for Mr. Evans.

 

Criteria for Incentive Payout for the named executive officers is summarized in the following table:

 

 

The 2006 bonuses were paid in February of 2007. Because actual performance met budgeted expectations, senior management recommended to the Committee that payouts be at 100% of target. The Committee approved this recommendation.

 

In October 2006, the Committee reviewed the competitiveness of each named executives’ target incentive level and determined that they were at or slightly below the 50th percentile of the external market. No changes were made to targets for the named executives for 2007.

 

No specific weighting is targeted for annual incentive pay as a percentage of total compensation.

 

Long-Term Incentive Pay

 

Long-term incentives are awarded to the named executive officers in an effort to align management and shareholder interests, ensure future performance of the Company, enhance ownership opportunities, and to increase shareholder value. The Company maintains the 2005 Omnibus Incentive Plan (“Plan”) which was approved by shareholders and authorizes the granting of the following types of awards for executives:

 

 

As shown in the Summary Compensation Table, long-term incentives are primarily awarded in the form of stock options and restricted stock. It has generally been our practice to award these long-term incentives in a combined package of 50% stock options and 50% restricted stock, based on the estimated economic value of awards on the date of grant. We believe the weighting between stock options and restricted stock allows the Company to strike the desired balance between performance and retention and minimizes the impact to shareholder dilution.

 

Stock Options

 

Stock options are utilized to align management and shareholder interests and to reward executives with shareholder value creation. Stock options were granted at the fair market value of $57.88 on the date of grant, October 24, 2006. Fair market value is internally defined as the closing price on the date of grant. The options granted in 2006 vest 25% per year beginning on the first anniversary from the date of grant and have a life of ten years. The vesting schedule and life were strategically chosen to be competitive, enhance our retention efforts and help to manage shareholder dilution.

 

Restricted Stock

 

Shares of restricted stock are granted to the named executive officers to create an immediate link to shareholder interests, enhance ownership opportunities and to maintain a stable executive team. The awards granted in 2006 vest 100% four years from the date of the grant. This vesting schedule is both competitive and consistent with our traditional practice.

 

Stock Ownership Guidelines

 

The Company does not currently maintain a formal policy for executive stock ownership requirements. The Committee believes that the use of restricted stock for the named executives serves to reinforce stock ownership and aligns executive and shareholder interests.

 

Historically, award sizes have been developed by considering external market data, internal equity, performance, prior year awards, shareholder dilution, and accounting costs. In 2006, the Committee granted the same number of shares to named executives as in 2005. Because of the increase in the Company’s stock price from 2005 to 2006, this resulted in larger economic values to named executives and resulted in awards that were above the 50th percentile. The Committee determined that it was critical to continue to place a stronger emphasis on future financial performance and increasing shareholder value while offering a competitive total rewards package overall. The actual awards granted in 2006 can be seen in the Summary Compensation Table and the Grants of Plan-Based Awards Table.

 

Historically, the Committee has generally approved and granted long-term incentive awards to the named executive officers and any other designated employees at the October meeting or at the hire date of new designated employees, as applicable. The Company maintains no policy, whether official or unofficial, for timing the granting of stock options or other equity based awards in advance of the release of material nonpublic information. Our practice has been to grant on the date of the Fall Committee meeting.

 

Although the Committee believes a significant portion of named executives’ total compensation should be linked to the Company’s stock price, no specific weighting is targeted for long-term incentive pay as a percentage of total compensation.

 

Benefits

 

The following table provides a brief summary of benefits:

 

 

 

 

See the All Other Compensation Table for detail on benefits received by the named executive officers.

 

Perquisites

 

There are various perquisites offered to the named executive officers. Below is a brief summary of those perquisites and the reason they are used:

 

Physical Examinations — In order to ensure the continued health of our executive team, the named executive officers were given the opportunity to undergo a thorough physical examination with the physician of their choice with the cost underwritten by the Company.

 

Personal Financial Planning Services — To ensure the continued financial stability of our executive team, the named executive officers were given the opportunity to engage a financial advisor of their choice to provide Personal Financial Planning Services with the capped cost underwritten by the Company.

 

Home Security Services — To ensure the safety of our executive team, home security services are provided in certain instances.

 

Club Memberships — Club Memberships are provided to all the named executive officers to be used at their discretion for both personal and business purposes. This provides the named executive officers with the ongoing opportunity to network with other community leaders.

 

Use of Jet Aircraft — Through a provider in the fractional aircraft industry, the Company has acquired 200 hours per year of jet aircraft usage. These hours are used by Mr. Evans in connection with his extensive business travel requirements. This is provided to Mr. Evans to reduce travel time and related disruptions and to provide additional security, thereby increasing his availability, efficiency and productivity. Mr. Evans has been authorized to use a portion of these hours for non-business purposes, which should generally not exceed ten percent of the available hours annually. Mr. Evans did not exceed the authorized hours for non-business purposes during 2006.

 

Life Insurance — Group Life Insurance is provided to the named executive officers with a death benefit being equal to three times base salary earnings for the most recent year not to exceed $1,250,000 for Mr. Evans, Mr. Green, Mr. Beck and Mr. Kardys. The death benefit for Mr. Frost is two times base salary earnings for the most recent year not to exceed $1,250,000. In addition, an Executive Insurance Policy is maintained for Mr. Evans with a death benefit of $1,000,000. Please see the All Other Compensation Table for more detail.

 

The perquisites received by certain named executive officers can be seen in the All Other Compensation Table.

 

Post-Termination Pay

 

The Company has change-in-control agreements with all the named executive officers as well as other key employees of The Frost National Bank. The main purposes of these agreements are to:

 

 

Under the agreements, the named executive could receive severance payments of three times base salary and target bonus if his position were terminated by the Company within two years following a change-in-control, if the termination is for reasons other than cause, death, disability or retirement. “Cause” is generally defined in the agreements as an executive’s (1) willful and continued failure to substantially perform his duties after delivery of a written demand for substantial performance; (2) willful engagement in conduct materially injurious to Cullen/Frost; or (3) conviction of a felony.

 

Change-in-control is considered in the agreements to be:

 

 

Further, the change-in-control agreements provide that the named executive officers could receive severance payments if they terminate their employment for good reason within two years following a change-in-control. “Good reason” is generally considered in the agreements as one or more of the following:

 

 

The change-in-control agreements also provide for a continuation of certain employee benefits and a tax gross-up payment in an amount necessary to make the executive whole for any excise taxes paid as a result of the severance payments.

 

Upon a change-in-control, all stock options would become immediately exercisable and all the vesting restrictions would lapse of all outstanding restricted shares.

 

The severance multiple for Mr. Kardys was increased during 2006 from two times to three times for internal equity purposes.

 

Under the existing change-in-control agreements, a change-in-control would have no impact on benefits available to named executive officers under the frozen retirement and retirement restoration plans.

 

For detailed estimated payments upon a change-in-control, please see the Change-in-Control Payments Table.

 

There are no other severance policies or employment contracts in place for the named executive officers. If any of the named executive officers were to have their employment with the Company severed, the Committee would make all post-termination pay determinations based on the individual situation(s).

 

Policy on 162(m)

 

Section 162(m) of the Internal Revenue Code generally limits the corporate tax deduction to $1,000,000 in a taxable year for compensation paid to each “covered employee” of the Company, which under Section 162(m), includes the Chief Executive Officer and the next four highest paid executive officers of the Company, unless the compensation is “performance based”.

 

In order to preserve the Company’s tax deduction, the Committee approved the Cullen/Frost Bankers, Inc. Deferred Compensation Plan for Covered Employees. This plan requires that certain components of the compensation of a “covered employee” that would exceed the amount deductible under Section 162(m) be deferred until the plan year after he or she ceases to be a “covered employee” or upon his or her death or disability. Currently, Mr. Evans is the only “covered employee” participating in the plan.

 

At the present time, we do not have nondeductible compensation.

 

Policy on Recovery of Awards

 

The Company currently has no written policy with respect to recovery of awards when financial statements are restated, but in the event of a restatement, the Company would recover any awards as required by applicable law.

 

Conclusion

 

The Company believes the 2006 Compensation Program was both competitive from an external standpoint and equitable from an internal standpoint. In addition, the Company is satisfied that its objectives were met by the program. The Company fully anticipates continuing to administer an executive compensation program that is conservative and remains consistent with its corporate philosophy.

 

2006 Compensation

 

Summary Compensation Table

 

The table below gives information on compensation for the CEO, the CFO and the other three most highly compensated executive officers of Cullen/Frost (collectively, the “named executive officers”).

 

 

 

 

 

 

 

 

Contributions to the Profit Sharing Plan were made March 24, 2006 and were based on 2005 earnings. Contributions to the Profit Sharing Restoration Plan were made March 27, 2006.

 

Grants of Plan-Based Awards

 

The following tables provide information concerning each grant of an award made to a named executive officer in 2006 under the Cullen/Frost Bankers, Inc. 2005 Omnibus Incentive Plan:

 

 

 

 

Holdings of Previously Awarded Equity

 

Outstanding Equity Awards at Fiscal Year-End

 

The following table sets forth outstanding equity awards held by each of the officers named in the Summary Compensation Table in 2006 as of December 29, 2006:

 

2006 Outstanding Equity Awards at Fiscal Year-End Table