CULLEN/FROST BANKERS, INC. (CFR) FY 2021 MD&A

ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Forward-Looking Statements and Factors that Could Affect Future Results

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”), including statements regarding the potential effects of the ongoing COVID-19 pandemic on our business, financial condition, liquidity and results of operations, notwithstanding that such statements are not specifically identified as such. In addition, certain statements may be contained in our future filings with the SEC, in press releases, and in oral and written statements made by us or with our approval that are not statements of historical fact and constitute forward-looking statements within the meaning of the Act. Examples of forward-looking statements include, but are not limited to: (i) projections of revenues, expenses, income or loss, earnings or loss per share, the payment or nonpayment of dividends, capital structure and other financial items; (ii) statements of plans, objectives and expectations of Cullen/Frost or its management or Board of Directors, including those relating to products, services or operations; (iii) statements of future economic performance; and (iv) statements of assumptions underlying such statements. Words such as “believes”, “anticipates”, “expects”, “intends”, “targeted”, “continue”, “remain”, “will”, “should”, “may” and other 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:

•Local, regional, national and international economic conditions and the impact they may have on us and our customers and our assessment of that impact.

•Volatility and disruption in national and international financial and commodity markets.

•Government intervention in the U.S. financial system.

•Changes in the mix of loan geographies, sectors and types or the level of non-performing assets and charge-offs.

•Changes in estimates of future reserve requirements based upon the periodic review thereof under relevant regulatory and accounting requirements.

•The effects of and changes in trade and monetary and fiscal policies and laws, including the interest rate policies of the Federal Reserve Board.

•Inflation, interest rate, securities market and monetary fluctuations.

•The effect of changes in laws and regulations (including laws and regulations concerning taxes, banking, securities and insurance) and their application with which we and our subsidiaries must comply.

•The soundness of other financial institutions.

•Political instability.

•Impairment of our goodwill or other intangible assets.

•Acts of God or of war or terrorism.

•The potential impact of climate change.

•The timely development and acceptance of new products and services and perceived overall value of these products and services by users.

•Changes in consumer spending, borrowings and savings habits.

•Changes in the financial performance and/or condition of our borrowers.

•Technological changes.

•The cost and effects of cyber incidents or other failures, interruptions or security breaches of our systems or those of our customers or third-party providers.

•Acquisitions and integration of acquired businesses.

•Our ability to increase market share and control expenses.

•Our ability to attract and retain qualified employees.

•Changes in the competitive environment in our markets and among banking organizations and other financial service providers.

•The effect of changes in accounting policies and practices, as may be adopted by the regulatory agencies, as well as the Public Company Accounting Oversight Board, the Financial Accounting Standards Board and other accounting standard setters.

•Changes in the reliability of our vendors, internal control systems or information systems.

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•Changes in our liquidity position.

•Changes in our organization, compensation and benefit plans.

•The impact of the ongoing COVID-19 pandemic and any other pandemic, epidemic or health-related crisis.

•The costs and effects of legal and regulatory developments, the resolution of legal proceedings or regulatory or other governmental inquiries, the results of regulatory examinations or reviews and the ability to obtain required regulatory approvals.

•Greater than expected costs or difficulties related to the integration of new products and lines of business.

•Our success at managing the risks involved in the foregoing items.

Further, statements about the potential effects of the ongoing COVID-19 pandemic on our business, financial condition, liquidity and results of operations may constitute forward-looking statements and are subject to the risk that the actual effects may differ, possibly materially, from what is reflected in those forward-looking statements due to factors and future developments that are uncertain, unpredictable and in many cases beyond our control, including the scope and duration of the pandemic, actions taken by governmental authorities in response to the pandemic, and the direct and indirect impact of the pandemic on our customers, clients, third parties and us.

Forward-looking statements speak only as of the date on which such statements are made. We do not undertake any 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.

COVID-19 Effects, Actions and Recent Developments

Overview. During 2020 and to a lesser extent in 2021, our business has been, and continues to be, impacted by the ongoing outbreak of COVID-19. In March 2020, COVID-19 was declared a pandemic by the World Health Organization and a national emergency by the President of the United States. Efforts to limit the spread of COVID-19 have included quarantines/shelter-in-place orders, the closure or limiting capacity of businesses, travel restrictions, supply chain limitations and prohibitions on public gatherings, among other things, throughout many parts of the United States and, in particular, the markets in which we operate. As the current pandemic is ongoing and dynamic in nature, there are many uncertainties related to COVID-19 including, among other things, its severity; the duration of the outbreak; the impact to our customers, employees and vendors; the impact to the financial services and banking industry; and the impact to the economy as a whole as well as the effect of actions taken, or that may yet be taken, or inaction by governmental authorities to contain the outbreak or to mitigate its impact (both economic and health-related). COVID-19 has negatively affected, and is expected to continue to negatively affect, our business, financial position and operating results. In light of the uncertainties and continuing developments discussed herein, the ultimate adverse impact of COVID-19 cannot be reliably estimated at this time, but it has been and is expected to continue to be material. The longer-term potential impact on our business could depend to a large extent on future developments and actions taken by authorities and other entities to contain COVID-19 and its economic impact. Furthermore, the sustainability of the economic recovery observed in 2021 remains unclear and significant volatility could continue for a prolonged period as the potential exists for additional variants of COVID-19, including the recent Omicron variant, to impede the global economic recovery and exacerbate geographic differences in the spread of, and response to, COVID-19.

Impact on our Operations. In 2020, the State of Texas and many other jurisdictions declared health emergencies. The resulting closures and/or limited operations of non-essential businesses and related economic disruption impacted our operations as well as the operations of our customers. Financial services were identified as a Critical Infrastructure Sector by the Department of Homeland Security. Accordingly, our business remained open and we implemented our Business Continuity and Health Emergency Response plans to address the issues arising as a result of COVID-19 and to facilitate the continued delivery of essential services while maintaining a high level of safety for our customers as well as our employees. Nonetheless, as the COVID-19 pandemic continues to be on-going, there continues to be uncertainties related to its magnitude, duration and persistent effects. This is particularly the case with the emergence, contagiousness and threat of new and different strains of the virus as well as the availability, acceptance and effectiveness of vaccines. As such, the COVID-19 pandemic could still, among other things, greatly affect our routine and essential operations due to staff absenteeism, particularly among key personnel; result in limited access to or closures of our branch facilities and other physical offices; exacerbate operational, technical or security-related risks arising from a remote workforce; and result in adverse government or regulatory agency orders. Additionally, we are experiencing an increasingly competitive labor market due to an on-going labor shortage which has impacted and could continue to impact our ability to staff open positions and/or retain existing employees and has resulted in and could continue to result in an increase in our staffing costs. The business and operations of our third-party service providers, many of whom perform critical services for our business, could also

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be significantly impacted by many of these same issues, which in turn could impact us. As a result, we continue to be unable to fully assess or predict the extent of the effects of COVID-19 on our operations as the ultimate impact will depend on factors that are currently unknown and/or beyond our control.

Impact on our Financial Position and Results of Operations. Our financial position and results of operations are particularly susceptible to the ability of our loan customers to meet loan obligations, the availability of our workforce, the availability of our vendors and the decline in the value of assets held by us. While its effects continue to be on-going, during 2020 and to a lesser extent in 2021, the COVID-19 pandemic resulted in a significant decrease in commercial activity throughout the State of Texas as well as nationally. This decrease in commercial activity caused and, in light of new and different strains of the virus, may yet further cause our customers (including affected businesses and individuals), vendors and counterparties to be unable to meet existing payment or other obligations to us. The national public health crisis arising from the COVID-19 pandemic (and public expectations about it), combined with other factors, including, but not limited to, inflation, labor shortages, supply chain disruption and further oil price volatility, could, despite improvements in 2021, again destabilize the financial markets and geographies in which we operate. The resulting economic pressure on consumers and uncertainty regarding the sustainability of any economic improvements could further impact the creditworthiness of potential and current borrowers. Borrower loan defaults that adversely affect our earnings correlate with deteriorating economic conditions, which, in turn, are likely to impact our borrowers' creditworthiness and our ability to make loans. See further information related to the risk exposure of our loan portfolio under the sections captioned “Loans” and “Allowance for Credit Losses” elsewhere in this discussion.

In addition, the economic pressures and uncertainties arising from the COVID-19 pandemic have resulted in and may continue to result in specific changes in consumer and business spending and borrowing and saving habits, affecting the demand for loans and other products and services we offer. Consumers affected by COVID-19 may continue to demonstrate changed behavior even after the crisis is over. For example, consumers may decrease discretionary spending on a permanent or long-term basis and certain industries may take longer to recover (particularly those that rely on travel or large gatherings) as consumers may be hesitant to return to full social interaction. We lend to customers operating in such industries including energy, hotels/lodging, restaurants, entertainment and commercial real estate, among others, that have been significantly impacted by COVID-19 and we are continuing to monitor these customers closely. Additionally, the temporary closures of bank branches in 2020 and the safety precautions implemented at re-opened branches could result in consumers becoming more comfortable with technology and devaluing face-to-face interaction. Our business is relationship driven and such changes could necessitate changes to our business practices to accommodate changing consumer behaviors.

Legislative and Regulatory Actions. Actions taken by the federal government and the Federal Reserve and other bank regulatory agencies to mitigate the economic effects of COVID-19 have impacted our financial position and results of operations. These actions are further discussed below.

During 2020, in an effort to provide monetary stimulus to counteract the economic disruption caused by COVID-19, the Federal Reserve:

•Expanded reverse repo operations, adding liquidity to the banking system.

•Restarted quantitative easing.

•Lowered the interest rate at the discount window by 1.5% to 0.25%.

•Reduced reserve requirement ratios to zero percent.

•Encouraged banks to use their capital and liquidity buffers to lend.

•Introduced and expanded several new temporary programs to help preserve market liquidity.

In 2020, the U.S. government enacted certain fiscal stimulus measures in several phases to counteract the economic disruption caused by the COVID-19. The Phase 1 legislation, the Coronavirus Preparedness and Response Supplemental Appropriations Act, was enacted on March 6, 2020 and, among other things, authorized funding for research and development of vaccines and allocated money to state and local governments to aid containment and response measures. The Phase 2 legislation, the Families First Coronavirus Response Act, was enacted on March 18, 2020 and provided for paid sick/medical leave, established no-cost coverage for coronavirus testing, expanded unemployment benefits, expanded food assistance, and provided additional funding to states for the ongoing economic consequences of the pandemic, among other provisions. The Phase 3 legislation, the Coronavirus Aid, Relief, and Economic Security Act (the “CARES Act”), was enacted on March 27, 2020. Among other provisions, the CARES Act (i) authorized the Secretary of the Treasury to make loans, loan guarantees and other investments,

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up to $500 billion, for assistance to eligible businesses, States and municipalities with limited, targeted relief for passenger air carriers, cargo air carriers, and businesses critical to maintaining national security, (ii) created a $349 billion loan program called the Paycheck Protection Program (the “PPP”) for loans to small businesses for, among other things, payroll, group health care benefit costs and qualifying mortgage, rent and utility payments, (iii) provided certain credits against the 2020 personal income tax for eligible individuals and their dependents, (iv) expanded eligibility for unemployment insurance and provides eligible recipients with an additional $600 per week on top of the unemployment amount determined by each State and (v) expanded tele-health services in Medicare. The Phase 3.5 legislation, the Paycheck Protection Program and Healthcare Enhancement Act of 2020 (the “PPPHE Act”), was enacted on April 24, 2020. Among other things, the PPPHE Act provided an additional $310 billion of funding for the PPP. The Paycheck Protection Program Flexibility Act of 2020” (the “PPPF Act”) was enacted in June 2020 to modify certain provisions of the PPP including, among other things, establishing a minimum maturity of five years for all loans made after the enactment of the PPPF Act and permitted an extension of the maturity of existing loans to five years if the borrower and lender agree.

In December 2020, the Bipartisan-Bicameral Omnibus COVID Relief Deal, included as a component of appropriations legislation, was enacted to provide economic stimulus to individuals and businesses in further response to the economic distress caused by the COVID-19 pandemic. Among other things, the legislation (i) authorized payments of $600 for individuals making up to $75,000 per year, (ii) extended the timeframe for enhanced unemployment benefits and (iii) authorized approximately $325 billion for small business relief, including approximately $284 billion for a second round of PPP loans and a new simplified forgiveness procedure for PPP loans of $150,000 or less.

During the first quarter of 2021, President Biden signed a number of executive orders relating to stimulus and relief measures. These orders included, among other things, (i) an extension, through March 31, 2021, of the moratorium on evictions and foreclosures, (ii) an extension, through September 30, 2021, of the deferral of federal student loan payments and interest and (iii) an extension, through June 30, 2021, of certain mortgage forbearance programs and guidelines.

On March 11 2021, the American Rescue Plan Act of 2021 (the “ARP Act”) was enacted, implementing a $1.9 trillion package of stimulus and relief proposals. Among other things, the ARP Act provided (i) additional funding for the PPP program and an expansion of the program for the benefit of certain nonprofits, (ii) funding for the Small Business Administration (“SBA”) to make targeted grants for restaurants and similar establishments, (iii) direct cash payments of up to $1,400 to individuals, subject to income provisions, (iv) an increase in the maximum annual Child Tax Credit, subject to income limitation provisions, (v) $300 a week in expanded unemployment insurance lasting through September 6, 2021 and made $10,200 in unemployment benefits tax free for households, subject to income limitation provisions, (vi) tax relief making any student loan forgiveness incurred between December 31, 2020, and January 1, 2026 non-taxable income, and (vii) funding to support state and local governments; K-12 schools and higher education; the Centers for Disease Control; public transit; rental assistance; child care; and airline industry workers.

On March 27, 2021, the COVID-19 Bankruptcy Relief Extension Act of 2021 was enacted, extending the bankruptcy relief provisions enacted in the CARES Act of 2020 bill until March 27, 2022. These provisions provide financially distressed small businesses and individuals greater access to bankruptcy relief. We are continuing to monitor the potential development of additional legislation and further actions taken by the U.S. government.

The above mentioned significant fiscal stimulus and monetary policy actions of the U.S. government and Federal Reserve have been contributing factors to an inflationary surge during most of 2021. As a result, in December 2021, the Federal Reserve released projections related to the target range for the federal funds rate that imply, while there can be no such assurance that any increases in the federal funds rate will occur, three 25 basis point increases in the federal funds rate in 2022, followed by three in 2023 and two in 2024 as further discussed in the section captioned “Net Interest Income” elsewhere in this discussion.

Banks and bank holding companies have been particularly impacted by the COVID-19 pandemic as a result of disruption and volatility in the global capital markets. We are closely monitoring the potential for new laws and regulations impacting lending and funding practices as well as capital and liquidity standards. Such changes could require us to maintain significantly more capital, with common equity as a more predominant component, or manage the composition of our assets and liabilities to comply with formulaic liquidity requirements.

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Application of Critical Accounting Policies and Accounting Estimates

We follow accounting and reporting policies that conform, in all material respects, to accounting principles generally accepted in the United States and to general practices within the financial services industry. The preparation of financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. While we base estimates on historical experience, current information and other factors deemed to be relevant, actual results could differ from those estimates.

We consider accounting estimates to be critical to reported financial results if (i) the accounting estimate requires management to make assumptions about matters that are highly uncertain and (ii) different estimates that management reasonably could have used for the accounting estimate in the current period, or changes in the accounting estimate that are reasonably likely to occur from period to period, could have a material impact on our financial statements.

Accounting policies related to the allowance for credit losses on financial instruments including loans and off-balance-sheet credit exposures are considered to be critical as these policies involve considerable subjective judgment and estimation by management. As discussed in Note 1 - Summary of Significant Accounting Policies, our policies related to allowances for credit losses changed on January 1, 2020 in connection with the adoption of a new accounting standard update as codified in Accounting Standards Codification (“ASC”) Topic 326 (“ASC 326”) Financial Instruments - Credit Losses. In the case of loans, the allowance for credit losses is a contra-asset valuation account, calculated in accordance with ASC 326, that is deducted from the amortized cost basis of loans to present the net amount expected to be collected.

In the case of off-balance-sheet credit exposures, the allowance for credit losses is a liability account, calculated in accordance with ASC 326, reported as a component of accrued interest payable and other liabilities in our consolidated balance sheets. The amount of each allowance account represents management's best estimate of current expected credit losses on these financial instruments considering available information, from internal and external sources, relevant to assessing exposure to credit loss over the contractual term of the instrument. Relevant available information includes historical credit loss experience, current conditions and reasonable and supportable forecasts. While historical credit loss experience provides the basis for the estimation of expected credit losses, adjustments to historical loss information may be made for differences in current portfolio-specific risk characteristics, environmental conditions or other relevant factors. While management utilizes its best judgment and information available, the ultimate adequacy of our allowance accounts is dependent upon a variety of factors beyond our control, including the performance of our portfolios, the economy, changes in interest rates and the view of the regulatory authorities toward classification of assets. See the section captioned “Allowance for Credit Losses” elsewhere in this discussion as well as Note 1 - Summary of Significant Accounting Policies and Note 3 - Loans in the notes to consolidated financial statements included in Item 8. Financial Statements and Supplementary Data elsewhere in this report for further details of the risk factors considered by management in estimating the necessary level of the allowance for credit losses.

Overview

The following discussion and analysis presents the more significant factors that affected our financial condition as of December 31, 2021 and 2020 and results of operations for each of the years then ended. Refer to Management’s Discussion and Analysis of Financial Condition and Results of Operations included in our Annual Report on Form 10-K filed with the SEC on February 5, 2021 (the “2020 Form 10-K”) for a discussion and analysis of the more significant factors that affected periods prior to 2020.

Certain reclassifications have been made to make prior periods comparable. This discussion and analysis should be read in conjunction with our consolidated financial statements, notes thereto and other financial information appearing elsewhere in this report. From time to time, we have acquired various small businesses through our insurance subsidiary. None of these acquisitions had a significant impact on our financial statements. We account for acquisitions using the acquisition method, and as such, the results of operations of acquired companies are included from the date of acquisition.

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, thus making tax-exempt yields comparable to taxable asset yields. Taxable equivalent adjustments were based upon a 21% income tax rate.

Dollar amounts in tables are stated in thousands, except for per share amounts.

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Results of Operations

Net income available to common shareholders totaled $435.9 million, or $6.76 diluted per common share, in 2021 compared to $323.6 million, or $5.10 diluted per common share, in 2020 and $435.5 million, or $6.84 diluted per common share, in 2019.

Selected income statement data, returns on average assets and average equity and dividends per share for the comparable periods were as follows:

Net income available to common shareholders increased $112.3 million for 2021 compared to 2020. The increase was primarily the result of a $241.2 million decrease in credit loss expense and an $8.9 million increase in net interest income partly offset by a $78.7 million decrease in non-interest income, a $33.1 million increase in non-interest expense and a $26.3 million increase in income tax expense. Credit loss expense during 2020 was impacted by both our adoption of a new credit loss accounting standard and the adverse events impacting our loan portfolio, including those arising from the COVID-19 pandemic and the significant volatility in oil prices. Non-interest income during 2020 was impacted by a $109.0 million net gain on securities transactions during the first quarter. Net income available to common shareholders during 2020 was also impacted by the reclassification of $5.5 million of issuance costs associated with our Series A preferred stock to retained earnings upon redemption of the Series A preferred stock.

Details of the changes in the various components of net income are further discussed below.

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Net Interest Income

Net interest income is the difference between interest income on earning assets, such as loans and securities, and interest expense on liabilities, such as deposits and borrowings, which are used to fund those assets. Net interest income is our largest source of revenue, representing 71.8% of total revenue during 2021. Net interest margin is the ratio of taxable-equivalent net interest income to average earning assets for the period. The level of interest rates and the volume and mix of earning assets and interest-bearing liabilities impact net interest income and net interest margin.

The Federal Reserve influences the general market rates of interest, including the deposit and loan rates offered by many financial institutions. Our loan portfolio is significantly affected by changes in the prime interest rate. The prime rate began 2019 at 5.50% and decreased 50 basis points during the third quarter of 2019 (25 basis points in each of August and September) and 25 basis points in October 2019 to end the year at 4.75%. During 2020, the prime rate decreased 150 basis points in March to 3.25% where it remained through December 31, 2021. Our loan portfolio is also significantly impacted, by changes in the London Interbank Offered Rate (“LIBOR”). At December 31, 2021, the one-month and three-month U.S. dollar LIBOR rates were 0.10% and 0.21%, respectively, while at December 31, 2020, the one-month and three-month U.S. dollar LIBOR rates were 0.14% and 0.24% respectively, and at December 31, 2019, the one-month and three-month U.S. dollar LIBOR rates were 1.76% and 1.90% respectively. We discontinued originating LIBOR-based loans effective December 31, 2021 and will negotiate loans using our preferred replacement index, the American Interbank Offered Rate (“AMERIBOR”), a benchmark developed by the American Financial Exchange, the Secured Overnight Financing Rate (“SOFR”) or (“BSBY”), a benchmark developed by Bloomberg Index Services. For our currently outstanding LIBOR-based loans, the timing and manner in which each customer’s contract transitions to AMERIBOR, SOFR or BSBY will vary on a case-by-case basis. We expect to complete all transitions by the first quarter of 2023.

The target range for the federal funds rate, which is the cost of immediately available overnight funds, began 2019 at 2.25% to 2.50% and decreased 50 basis points during the third quarter of 2019 (25 basis points in each of August and September) and 25 basis points in October 2019 to end the year at 1.50% to 1.75%. During 2020, the target range for the federal funds rate decreased 150 basis points in March to zero to 0.25% where it remained through December 31, 2021. The decrease in the target range for the federal funds rate in March 2020 was largely an emergency measure by the Federal Reserve aimed at blunting the economic impact of COVID-19. In December 2021, the Federal Reserve released projections whereby the midpoint of the projected appropriate target range for the federal funds rate would rise to 0.9% by the end of 2022, to 1.6% by the end of 2023 and to 2.1% by the end of 2024. While there can be no such assurance that any increases in the federal funds rate will occur, these projections imply three 25 basis point increases in the federal funds rate in 2022, followed by three in 2023 and two in 2024.

We are primarily funded by core deposits, with non-interest-bearing demand deposits historically being a significant source of funds. This lower-cost funding base is expected to have a positive impact on our net interest income and net interest margin in a rising interest rate environment. See Item 7A. Quantitative and Qualitative Disclosures About Market Risk elsewhere in this report for information about our sensitivity to interest rates. Further analysis of the components of our net interest margin is presented below.

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The following table presents an analysis of net interest income and net interest spread for the periods indicated, including average outstanding balances for each major category of interest-earning assets and interest-bearing liabilities, the interest earned or paid on such amounts, and the average rate earned or paid on such assets or liabilities, respectively. The table also sets forth the net interest margin on average total interest-earning assets for the same periods. For these computations: (i) average balances are presented on a daily average basis, (ii) information is shown on a taxable-equivalent basis assuming a 21% tax rate, (iii) average loans include loans on non-accrual status, and (iv) average securities include unrealized gains and losses on securities available for sale, while yields are based on average amortized cost.

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The following table presents the changes in taxable-equivalent net interest income and identifies the changes due to differences in the average volume of earning assets and interest-bearing liabilities and the changes due to changes in the average interest rate on those assets and liabilities. The changes in net interest income due to changes in both average volume and average interest rate have been allocated to the average volume change or the average interest rate change in proportion to the absolute amounts of the change in each. The comparisons between years includes an additional change factor that shows the effect of the difference in the number of days (due to leap year in 2020) in each period for assets and liabilities that accrue interest based upon the actual number of days in the period, as further discussed below.

Taxable-equivalent net interest income for 2021 increased $6.4 million, or 0.6%, compared to 2020. Taxable-equivalent net interest income for 2021 included 365 days compared to 366 days for 2020 as a result of the leap year. The additional day added approximately $1.8 million to taxable-equivalent net interest income during 2020. Excluding the impact of the additional day results in an effective increase in taxable-equivalent net interest income of approximately $8.2 million during 2021. The taxable-equivalent net interest margin decreased 56 basis points from 3.09% during 2020 to 2.53% during 2021.

The increase in taxable-equivalent net interest income during 2021 was primarily related to decreases in the average costs of interest-bearing deposit liabilities and other borrowed funds combined with increases in the average volumes of interest-bearing deposits (primarily amounts held by us in an interest-bearing account at the Federal Reserve) and taxable securities and an increase in the average taxable-equivalent yield on loans. The positive impact of these items was partly offset by decreases in the average volumes of loans and tax-exempt securities and increases in the average volumes of interest-bearing deposit liabilities and repurchase agreements combined with decreases in the average yields on taxable and tax-exempt securities and interest-bearing deposits (primarily amounts held by us in an interest-bearing account at the Federal Reserve). The decrease in taxable-equivalent net interest margin during 2021 was primarily related to an increase in the relative proportion of average interest-bearing deposits (primarily amounts held by us in an interest-bearing account at the Federal Reserve) to average total interest-earning assets combined with the aforementioned decreases in market interest rates. Interest-bearing deposits made up approximately 31.3% of average interest-earning assets during 2021 compared to approximately 15.0% in 2020.

The average volume of interest-earning assets for 2021 increased $7.9 billion, or 22.5%, compared to 2020. The increase in the average volume of interest-earning assets during 2021 included a $8.2 billion increase in average interest-bearing deposits (primarily amounts held by us in an interest-bearing account at the Federal Reserve) and a $372.2 million increase in average taxable securities partly offset by a $394.8 million decrease in average loans (of

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which approximately $306.7 million related to PPP loans, as further discussed below), a $178.6 million decrease in average tax-exempt securities, a $64.0 million decrease in average federal funds sold and a $14.3 million decrease in average resell agreements.

The average yield on interest-earning assets decreased 64 basis points from 3.22% during 2020 to 2.58% during 2021 while the average rate paid on interest-bearing liabilities decreased 13 basis points from 0.23% in 2020 to 0.10% in 2021. The average taxable-equivalent yields on interest-earning assets and the average rate paid on interest-bearing liabilities were primarily impacted by the aforementioned changes in market interest rates and changes in the volume and relative mix of interest-earning assets and interest-bearing liabilities.

The average taxable-equivalent yield on loans increased 6 basis points from 3.99% during 2020 to 4.05% during 2021. The average taxable-equivalent yield on loans during 2021 was positively impacted by higher average yields on PPP loans but negatively impacted by lower average market interest rates compared to 2020. The average volume of loans decreased $394.8 million, or 2.3%, in 2021 compared to 2020. The decrease in average loans was primarily due to an increase in the average volume of PPP loans forgiven by the SBA during 2021 compared to 2020. Loans made up approximately 38.8% of average interest-earning assets during 2021 compared to 48.7% during 2020.

In April 2020, we began originating loans to qualified small businesses under the PPP administered by the SBA under the provisions of the CARES Act. In 2020, we funded $3.3 billion of PPP loans of which approximately $3.2 billion were funded during the second quarter of 2020. As of December 31, 2021, approximately $3.2 billion of these 2020 originated PPP loans have been forgiven by the SBA or repaid by the customer. During 2021, we funded an additional $1.4 billion of PPP loans, most of which was during the first quarter. As of December 31, 2021, approximately $1.0 billion of these 2021 originated PPP loans have been forgiven by the SBA or repaid by the customer. During 2021 and 2020, we recognized $97.3 million and $59.5 million, respectively, in PPP loan related deferred processing fees (net of amortization of related deferred origination costs) as a yield adjustment and this amount is included in interest income on loans. As a result of the inclusion of these net fees in interest income, the average yields on PPP loans were 6.26% and 3.78% during 2021 and 2020, respectively, compared to the stated interest rate of 1.0% on these loans. The increase in the average yield on PPP Loans was impacted by a decrease in the average expected lives of the PPP loans funded in 2021 compared to 2020. Furthermore, the average fee percentage for 2021 originations was higher due to a smaller average loan size relative to 2020. In return for processing and booking a PPP loan, the SBA paid lenders a processing fee tiered by the size of the loan (5% for loans of not more than $350 thousand; 3% for loans of more than $350 thousand and less than $2 million; and 1% for loans of at least $2 million). For PPP loans funded through December 31, 2021, we expect to recognize additional PPP loan related deferred processing fees (net of deferred origination costs) totaling approximately $2.8 million as a yield adjustment over the remaining expected lives of these loans. We expect to recognize all of this amount in 2022.

The average taxable-equivalent yield on securities was 3.29% during 2021, decreasing 17 basis points compared to 3.46% during 2020 and was negatively impacted by a decrease in the relative proportion of higher-yielding tax-exempt securities to total securities. The average yield on taxable securities was 1.97% during 2021 compared to 2.27% during 2020, decreasing 30 basis points, while the average yield on tax exempt securities was 4.06% during 2021 compared to 4.08% during 2020, decreasing 2 basis points. Tax exempt securities made up approximately 64.2% of total average securities during 2021, compared to 66.6% during 2020. The average volume of total securities increased $193.6 million, or 1.5%, during 2021 compared to 2020. Securities made up approximately 29.8% of average interest-earning assets in 2021 compared to 36.0% in 2020. The decrease was primarily related to an increase in the relative proportion of interest-earning assets invested in interest-bearing deposits (primarily amounts held by us in an interest-bearing account at the Federal Reserve).

Average interest-bearing deposits (primarily amounts held by us in an interest-bearing account at the Federal Reserve), during 2021 increased $8.2 billion, or 155.2%, compared to 2020. Interest-bearing deposits made up approximately 31.3% of average interest-earning assets during 2021 compared to approximately 15.0% in 2020. The increase in the average volume of interest-bearing deposits (primarily amounts held by us in an interest-bearing account at the Federal Reserve) during 2021 was primarily due to an increase in the average volume of customer deposits and, to a lesser extent, repurchase agreements. The average yield on interest-bearing deposits was 0.13% during 2021 and 0.24% during 2020. The average yields on interest-bearing deposits during 2021 and 2020 were negatively impacted by a decrease in the interest rate paid on excess reserves held at the Federal Reserve to 0.10% during March 2020, although this rate ultimately increased 5 basis points to 0.15% in June 2021.

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Average federal funds sold and resell agreements during 2021 decreased $64.0 million, or 81.2%, and $14.3 million, or 68.4%, respectively compared to 2020. Federal funds sold and resell agreements were not a significant component of interest-earning assets during the comparable periods. The average yields on federal funds sold and resell agreements were 0.21% and 0.24%, respectively, during 2021 compared to 0.92% and 0.82%, respectively, during 2020. The average yields on federal funds sold and resell agreements were negatively impacted by lower average market interest rates during 2021 compared to 2020.

The average rate paid on interest-bearing liabilities was 0.10% during 2021, decreasing 13 basis points from 0.23% during 2020. Average deposits increased $7.0 billion, or 22.4%, in 2021 compared to 2020. Average interest-bearing deposits increased $3.9 billion in 2021 compared to 2020, while average non-interest-bearing deposits increased $3.1 billion in 2021 compared to 2020. The ratio of average interest-bearing deposits to total average deposits was 56.7% in 2021 compared to 56.9% in 2020. The average cost of deposits is primarily impacted by changes in market interest rates as well as changes in the volume and relative mix of interest-bearing deposits. The average rate paid on interest-bearing deposits and total deposits was 0.07% and 0.04% in 2021 compared to 0.18% and 0.10% in 2020. The average cost of deposits during 2021 and 2020 was impacted by decreases in the interest rates we pay on most of our interest-bearing deposit products as a result of the aforementioned decreases in market interest rates.

In April 2020, we borrowed an aggregate $1.3 billion from the Federal Home Loan Bank (“FHLB”) to provide additional liquidity in light of economic uncertainty and our significant PPP lending volume. These advances were subsequently paid-off in May 2020 as we determined additional liquidity resources were not necessary.

Our taxable-equivalent net interest spread, which represents the difference between the average rate earned on earning assets and the average rate paid on interest-bearing liabilities, was 2.48% in 2021 compared to 2.99% in 2020. 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 of the effects of changing interest rates on net interest income is set forth in Item 7A. Quantitative and Qualitative Disclosures About Market Risk elsewhere in this report.

Our hedging policies permit the use of various derivative financial instruments, including interest rate swaps, swaptions, caps and floors, to manage exposure to changes in interest rates. Details of our derivatives and hedging activities are set forth in Note 15 - Derivative Financial Instruments in the accompanying notes to consolidated financial statements elsewhere in this report. Information regarding the impact of fluctuations in interest rates on our derivative financial instruments is set forth in Item 7A. Quantitative and Qualitative Disclosures About Market Risk elsewhere in this report.

Credit Loss Expense

Credit loss expense is determined by management as the amount to be added to the allowance for credit loss accounts for various types of financial instruments including loans, securities and off-balance-sheet credit exposure after net charge-offs have been deducted to bring the allowance to a level which, in management’s best estimate, is necessary to absorb expected credit losses over the lives of the respective financial instruments.

The components of credit loss expense were as follows.

Credit loss expense in 2019 was calculated under the prior incurred loss accounting methodology. Furthermore, credit loss expense related to off-balance-sheet credit exposures was reported as a component of other non-interest expense prior to 2020. Such amounts have been reclassified to credit loss expense to make prior periods comparable to the current presentation. See the section captioned “Allowance for Credit Losses” elsewhere in this discussion for further analysis of credit loss expense related to loans and off-balance-sheet credit exposures.

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Non-Interest Income

Total non-interest income for 2021 decreased $78.7 million, or 16.9%, compared to 2020. Excluding $69 thousand and $109.0 million in net gains on securities transactions during 2021 and 2020, respectively, total non-interest income increased $30.2 million, or 8.5%, during 2021. Changes in the various components of non-interest income are discussed in more detail below.

Trust and Investment Management Fees. Trust and investment management fee income for 2021 increased $19.7 million, or 15.3%, compared to 2020. Investment management fees are the most significant component of trust and investment management fees, making up approximately 82.3% and 83.6% of total trust and investment management fees in 2021 and 2020, respectively. The increase in trust and investment management fees during 2021 was primarily due to increases in investment management fees (up $14.6 million, or 13.5%), oil and gas fees (up $3.1 million), estate fees (up $1.5 million) and custody fees (up $580 thousand). Investment management fees and other custodial account fees are generally based on the market value of assets within an account and are thus impacted by volatility in the equity and bond markets. The increases in investment management fees and custody fees during 2021 were primarily related to higher average equity valuations as well as increases in the number of accounts. Oil and gas fees during 2021 were impacted by increases in oil and gas prices. The increase in estate fees was primarily related to an increase in the aggregate value of estates settled.

At December 31, 2021, trust assets, including both managed assets and custody assets, were primarily composed of equity securities (46.9% of trust assets), fixed income securities (31.1% of trust assets), alternative investments (6.6% of assets) and cash equivalents (9.9% of trust assets). The estimated fair value of trust assets was $43.3 billion (including managed assets of $19.1 billion and custody assets of $24.2 billion) at December 31, 2021 compared to $38.6 billion (including managed assets of $16.9 billion and custody assets of $21.7 billion) at December 31, 2020.

Service Charges on Deposit Accounts. Service charges on deposit accounts for 2021 increased $2.4 million, or 3.0%, compared to 2020. The increase was primarily related to an increase in commercial service charges (up $3.7 million) partly offset by a decrease in overdraft charges on consumer accounts (down $1.8 million). Commercial service charges during 2021 were impacted by an increase in the volume of billable services relative to 2020. Overdraft/insufficient funds charges totaled $30.7 million ($23.9 million consumer and $6.8 million commercial) during 2021 compared to $32.3 million ($25.8 million consumer and $6.5 million commercial) during 2020. The decreases in consumer overdraft/insufficient funds charges during 2021 was primarily related to a decrease in the volume of fee assessed overdrafts relative to 2020. Furthermore, in April 2021, we implemented a new overdraft grace feature for certain consumer demand deposit accounts whereby no fees will be assessed on overdrafts of $100 or less, subject to certain qualifying conditions such as a minimum direct deposit. This new feature reduced overdraft charges on consumer accounts by approximately $3.2 million during 2021. The impact on future quarters will depend on future overdraft volumes.

Insurance Commissions and Fees. Insurance commissions and fees for 2021 increased $1.2 million, or 2.5%, compared to 2020. The increase was related to increases in contingent income (up $829 thousand) and commission income (up $406 thousand). Contingent income totaled $4.5 million in 2021 and $3.7 million in 2020. Contingent income primarily consists of amounts received from various property and casualty insurance carriers related to the loss performance of insurance policies previously placed. These performance related contingent payments are seasonal in nature and are mostly received during the first quarter of each year. This performance related contingent income totaled $3.2 million in 2021 and $2.5 million in 2020. The increase in performance related contingent income during 2021 was related to growth within the portfolio combined with improvement in the loss performance of insurance policies previously placed. During the first quarter of 2021, a severe weather event in Texas resulted in a significant increase in property and casualty claims and losses. This deterioration in loss performance is expected to impact the determination of performance related contingent payments we receive in 2022; however, such impact is not determinable at this time. Contingent income also includes amounts received from various benefit plan insurance companies related to the volume of business generated and/or the subsequent retention of such business. This benefit plan related contingent income totaled $1.3 million in 2021 and $1.2 million in 2020.

The increase in commission income was primarily related to increases in commercial lines property and casualty commissions and life insurance commissions partly offset by a decrease in benefit plan commissions. The increase in commercial lines property and casualty commissions were related to increased market rates while the increase in life insurance commissions and decrease in benefit plan commissions were related to fluctuations in business volumes.

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Interchange and Card Transaction Fees. Interchange fees, or “swipe” fees, are charges that merchants pay to us and other card-issuing banks for processing electronic payment transactions. Interchange and card transaction fees consist of income from check card usage, point of sale income from PIN-based debit card transactions and ATM service fees. Interchange and card transaction fees are reported net of related network costs.

Net revenues from interchange and card transaction fees for 2021 increased $4.0 million, or 29.6%, compared to 2020 primarily due to increased transaction volumes as well as the impact of new card products partly offset by an increase in network costs. Transaction volumes during 2020 were impacted by the onset of the COVID-19 pandemic. A comparison of gross and net interchange and card transaction fees for the reported periods is presented in the table below.

Federal Reserve rules applicable to financial institutions that have assets of $10 billion or more provide that the maximum permissible interchange fee for an electronic debit transaction is the sum of 21 cents per transaction and 5 basis points multiplied by the value of the transaction. An upward adjustment of no more than 1 cent to an issuer's debit card interchange fee is allowed if the card issuer develops and implements policies and procedures reasonably designed to achieve certain fraud-prevention standards. The Federal Reserve also has rules governing routing and exclusivity that require issuers to offer two unaffiliated networks for routing transactions on each debit or prepaid product.

Other Charges, Commissions and Fees. Other charges, commissions and fees for 2021 increased $2.0 million, or 5.8%, compared to 2020. The increase was primarily related to increases in income from the sale of mutual funds (up $3.0 million), merchant services rebates (up $978 thousand), funds transfer service charges (up $761 thousand) and income from the sale of annuities (up $571 thousand). These items were partly offset by a decrease in income from the placement of money market accounts (down $1.7 million), which was impacted by lower average market rates, and a decrease in fees on unused commitments (down $1.7 million), among other things.

Net Gain/Loss on Securities Transactions. During 2021, we sold certain available-for-sale securities with amortized costs totaling $2.0 billion and realized a net gain of $69 thousand. These sales were primarily related to securities purchased during 2021 and subsequently sold in connection with our tax planning strategies related to the Texas franchise tax. The gross proceeds from the sales of these securities outside of Texas are included in total revenues/receipts from all sources reported for Texas franchise tax purposes, which results in a reduction in the overall percentage of revenues/receipts apportioned to Texas and subjected to taxation under the Texas franchise tax.

During 2020, we sold certain available-for-sale securities with amortized costs totaling $1.0 billion and realized a net gain of $109.0 million. These sales included $483.1 million of residential mortgage-backed securities on which we realized a net gain of $1.9 million. The proceeds from these sales were reinvested into other residential mortgage-backed securities that had lower pre-payment rates. The sales also included $519.1 million of 30-year U.S Treasury securities on which we realized a net gain of $107.1 million. These U.S. Treasury securities were purchased during the fourth quarter of 2019 to hedge, in effect, against falling interest rates. Prior to their sale, these securities had significant unrealized holding gains as a result of decreases in market interest rates during the first quarter of 2020. We elected to sell these securities to provide liquidity and realize the gains.

Other Non-Interest Income. Other non-interest income for 2021 increased $816 thousand, or 1.7%, compared to 2020. The increase in other non-interest income during 2021 was primarily related to an increase in gains on the sale/exchange of assets (up $11.0 million) and increases in income from customer derivative and foreign exchange transactions (up $2.9 million and $1.2 million, respectively). These items were partly offset by decreases in sundry and other miscellaneous income (down $4.6 million), public finance underwriting fees (down $2.9 million) and earnings on the cash surrender value of life insurance (down $1.3 million). Additionally, other non-interest income during 2020 included approximately $6.0 million in gains realized on the sale of certain non-hedge related, short-term put options on U.S. Treasury securities with an aggregate notional amount of $500 million. The put options were not exercised and expired in March 2020.

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Gains on the sale/exchange of assets in 2021 included $9.7 million related to an exchange of a branch facility and $1.8 million related to the sale of certain parking lots in downtown San Antonio while gains on the sale/exchange of assets in 2020 included $758 thousand related to the sale of a branch facility. The increases in income from customer derivative and trading activities and income from customer foreign currency transactions were primarily related to increases in business volumes. Sundry and other miscellaneous income during 2021 included $3.4 million in card related incentives/rebates and $519 thousand in recoveries of prior write-offs, among other things, while sundry and other miscellaneous income during 2020 included $5.3 million in card related incentives/rebates, $2.8 million in recoveries of prior write-offs and $512 thousand related to settlements, among other things. The decrease in public finance underwriting fees was primarily due to a decrease in business volume. The decrease in earnings on the cash surrender value of life insurance was due to lower yields on the investments within the bank-owned life insurance portfolio.

Non-Interest Expense

Total non-interest expense for 2021 increased $33.1 million, or 3.9%, compared to 2020. Changes in the various components of non-interest expense are discussed below.

Salaries and Wages. Salaries and wages increased $8.2 million, or 2.1%, in 2021 compared to 2020. The increase was primarily related to an increase in incentive compensation and, to a lesser extent, a decrease in salary costs deferred in connection with loan originations and an increase in commissions. The impact of these items was partly offset by a decrease in salaries, due to a decrease in the number of employees, and a decrease in stock-based compensation. Salaries and wages for 2020 also included $5.2 million related to severance costs.

Employee Benefits. Employee benefits expense for 2021 increased $6.4 million, or 8.4%, compared to 2020. The increase was primarily related to an increase in certain discretionary benefit plan expenses and, to a lesser extent, increases in medical benefits expense and payroll taxes partly offset by decreases in expenses related to our defined benefit retirement and restoration plans, among other things.

Our defined benefit retirement and restoration plans were frozen in 2001 which has helped to reduce the volatility in retirement plan expense. We nonetheless still have funding obligations related to these plans and could recognize additional expense related to these plans in future years, which would be dependent on the return earned on plan assets, the level of interest rates and employee turnover. See Note 12 - Defined Benefit Plans for additional information related to our net periodic pension benefit/cost.

Net Occupancy. Net occupancy expense for 2021 increased $4.4 million, or 4.3%, compared to 2020. The increase was primarily related to increases in depreciation on leasehold improvements (up $1.9 million), repairs and maintenance/service contracts expense (up $1.8 million) and building depreciation (up $675 thousand), among other things, partly offset by a decrease in lease expense (down $581 thousand), among other things. The increases in the aforementioned components of net occupancy expense during the comparable periods were impacted, in part, by our expansion within the Houston market area.

Technology, Furniture and Equipment. Technology, furniture and equipment expense for 2021 increased $7.5 million, or 7.1%, compared to 2020. The increase was primarily related to increases in cloud services expense (up $5.9 million) and depreciation of furniture and equipment (up $2.5 million) partly offset by a decrease in software maintenance (down $1.1 million).

Deposit Insurance. Deposit insurance expense totaled $12.2 million in 2021 compared to $10.5 million in 2020. The increase was primarily related to an increase in total assets partly offset by a decrease in the assessment rate.

Other Non-Interest Expense. Other non-interest expense for 2021 increased $5.1 million, or 3.1%, compared to 2020. The increase included increases in donations expense (up $8.0 million); sundry and other miscellaneous expenses (up $6.4 million); and fraud losses (up $1.9 million), among other things. Donations expense during 2021 was impacted by $8.8 million in contributions to the Frost Charitable Foundation. Sundry and other miscellaneous expense in 2021 included $4.7 million related to the write-off of certain assets while sundry and other miscellaneous expense in 2020 included $958 thousand related to the closure of certain branch locations in our Houston market area and $454 thousand related to the write-off of certain other assets. The aforementioned items were partly offset by decreases in outside computer service expense (down $4.3 million); professional services expense (down $2.5 million); travel, meals and entertainment expense (down $2.2 million); amortization of deferred costs associated with loan commitments (down $1.1 million); and losses on the sale/write-down of foreclosed and other assets (down $1.1 million); among other things.

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Results of Segment Operations

We are managed under a matrix organizational structure whereby our two primary operating segments, Banking and Frost Wealth Advisors, overlap a regional reporting structure. A third operating segment, Non-Banks, is for the most part the parent holding company, as well as certain other insignificant non-bank subsidiaries of the parent that, for the most part, have little or no activity. A description of each business and the methodologies used to measure financial performance is described in Note 18 - Operating Segments in the accompanying notes to consolidated financial statements elsewhere in this report. Net income (loss) by operating segment is presented below:

Banking

Net income for 2021 increased $92.8 million, or 28.8%, compared to 2020. The increase was primarily the result of a $241.2 million decrease in credit loss expense, an $8.4 million increase in net interest income partly offset by a $100.5 million decrease in non-interest income, a $35.2 million increase in non-interest expense and a $21.1 million increase in income tax expense.

Net interest income for 2021 increased $8.4 million, or 0.9%, compared to 2020. The increase was primarily related to decreases in the average costs of interest-bearing deposit liabilities and other borrowed funds combined with increases in the average volumes of interest-bearing deposits (primarily amounts held by us in an interest-bearing account at the Federal Reserve) and taxable securities and an increase in the average taxable-equivalent yield on loans. The positive impact of these items was partly offset by decreases in the average volumes of loans and tax-exempt securities and increases in the average volumes of interest-bearing deposit liabilities and repurchase agreements combined with decreases in the average yields on taxable and tax-exempt securities and interest-bearing deposits (primarily amounts held by us in an interest-bearing account at the Federal Reserve). Net interest income during 2020 was also positively impacted by the additional day as a result of the leap year. See the analysis of net interest income included in the section captioned “Net Interest Income” elsewhere in this discussion.

Credit loss expense for 2021 totaled $54 thousand compared to $241.2 million in 2020. Credit loss expense in 2020 was impacted by our adoption of a new credit loss accounting standard and the expected credit losses resulting from a deterioration in forecasted economic conditions and the current and uncertain future impacts associated with the COVID-19 pandemic and recent volatility in oil prices. See the sections captioned “Credit Loss Expense” and “Allowance for Credit Losses” elsewhere in this discussion for further analysis of credit loss expense related to loans and off-balance-sheet commitments.

Non-interest income for 2021 decreased $100.5 million, or 31.3%, compared to 2020. Excluding $69 thousand and $109.0 million in net gains on securities transactions in 2021 and 2020, respectively, total non-interest income for the Banking segment increased $8.4 million, or 4.0%, during 2021. This increase was primarily related to increases in interchange and card transaction fees, service charges on deposit accounts and insurance commissions and fees. The increase in interchange and card transaction fees was due to increased transaction volumes as well as the impact of new card products partly offset by increases in network costs. The increase in service charges on deposit accounts was primarily related to an increase in commercial service charges partly offset by a decrease in overdraft charges on consumer accounts. The increase in insurance commissions and fees was the result of increases in contingent income and commission income, which is further discussed below in relation to Frost Insurance Agency. See the analysis of these categories of non-interest income included in the section captioned “Non-Interest Income” included elsewhere in this discussion.

Non-interest expense for 2021 increased $35.2 million, or 4.9%, compared to 2020. The increase was primarily due to increases in salaries and wages; other non-interest expense; employee benefit expense; technology, furniture and equipment expense; net occupancy expense and deposit insurance expense. The increase in salaries and wages was primarily related to an increase in incentive compensation and, to a lesser extent, a decrease in salary costs deferred in connection with loan originations and an increase in commissions. The impact of these items was partly offset by a decrease in salaries, due to a decrease in the number of employees, and a decrease in stock-based compensation. The increase in other non-interest expense was primarily due to increases in donations; sundry and other miscellaneous expenses; and fraud losses, among other things, partly offset by decreases in outside computer service expense; professional services expense; travel, meals and entertainment expense; amortization of deferred costs associated with loan commitments; and losses on the sale/write-down of foreclosed and other assets; among other things. The increase in employee benefits expense was primarily related to an increase in certain discretionary benefit plan expenses and, to a lesser extent, increases in medical benefits expense and payroll taxes partly offset by decreases in expenses related to our defined benefit retirement and restoration plans, among other things. The

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increase in technology, furniture and equipment expense was primarily related to increases in cloud services expense and depreciation of furniture and equipment partly offset by a decrease in software maintenance. The increase in net occupancy expense was primarily related to increases in depreciation on leasehold improvements, repairs and maintenance/service contracts expense and building depreciation, among other things, partly offset by a decrease in lease expense, among other things. The increase in deposit insurance expense was primarily related to an increase in total assets partly offset by a decrease in the assessment rate. See the analysis of these categories of non-interest expense included in the section captioned “Non-Interest Expense” included elsewhere in this discussion.

Income tax expense for 2021 increased $21.1 million, or 103.9%, compared to 2020. See the section captioned “Income Taxes” elsewhere in this discussion.

Frost Insurance Agency, which is included in the Banking operating segment, had gross commission revenues of $52.5 million during 2021 compared to $51.1 million during 2020. The increase in gross commission revenues was the result of increases in contingent income and commission income. The increase in contingent income was related to growth within the portfolio combined with improvement in the loss performance of insurance policies previously placed. The increase in commission income was primarily related to increases in commercial lines property and casualty commissions, related to increased market rates, and an increase in life insurance commissions, related to fluctuations in business volumes, partly offset by a decrease in benefit plan commissions, related to fluctuations in business volumes. See the analysis of insurance commissions and fees included in the section captioned “Non-Interest Income” included elsewhere in this discussion.

Frost Wealth Advisors

Net income for 2021 increased $17.5 million, or 90.9%, compared to 2020. The increase was primarily due to a $22.2 million increase in non-interest income and a $658 thousand decrease in non-interest expense partly offset by a $4.7 million increase in income tax expense and a $647 thousand decrease in net interest income.

Net interest income for 2021 decreased $647 thousand, or 23.3%, compared to 2020. This decrease was primarily due to a decrease in the average funds transfer price allocated to the funds provided by Frost Wealth Advisors. The decrease in the average funds transfer price was primarily due to a decrease in market interest rates. See the analysis of net interest income included in the section captioned “Net Interest Income” included elsewhere in this discussion.

Non-interest income for 2021 increased $22.2 million, or 15.3%, compared to 2020. The increase was primarily related to an increase in trust and investment management fees and, to a lesser extent, an increase in other charges, commissions and fees. Trust and investment management fee income is the most significant income component for Frost Wealth Advisors. Investment management fees are the most significant component of trust and investment management fees, making up approximately 82.3% and 83.6% of total trust and investment management fees for 2021 and 2020, respectively. The increase in trust and investment management fees was primarily due to increases in investment management fees, oil and gas fees, estate fees and custody fees. The increases in investment management fees and custody fees were primarily related to higher average equity valuations as well as increases in the number of accounts. Oil and gas fees during 2021 were impacted by an increases in oil and gas prices. The increase in estate fees was primarily related to an increase in the aggregate value of estates settled. The increase in other charges, commissions and fees was primarily related to increases in income from the sale of mutual funds and income from the sale of annuities partly offset by a decrease in income from the placement of money market accounts, which was impacted by lower average market rates. See the analysis of trust and investment management fees and other charges, commissions and fees included in the section captioned “Non-Interest Income” included elsewhere in this discussion.

Non-interest expense for 2021 decreased $658 thousand, or 0.5%, compared to 2020. The decrease was primarily due to decreases in other non-interest expense and net occupancy expense partly offset by an increase in technology, furniture and equipment expense. The decrease in other non-interest expense was primarily related to decreases in outside computer service expense; travel, meals and entertainment expense; and professional service expense; among other things; partly offset by increases in subscriptions expense and platform fees expense. The decrease in net occupancy expense was primarily related to a decrease in lease expense. The increase in technology, furniture and equipment expense was primarily related to an increase in cloud services expense.

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Non-Banks

The Non-Banks operating segment had a net loss of $9.0 million for 2021 compared to a net loss of $10.6 million in 2020. The decreased net loss was primarily due to decreases in other non-interest expense and net interest expense. The decrease in other non-interest expense was primarily due to decreases in professional services expense and travel, meals and entertainment expense. The decrease in net interest expense was primarily related to a decrease in the average rates paid on our long-term borrowings. Net interest expense was also positively impacted by the redemption, during the fourth quarter of 2021, of $13.4 million of junior subordinated deferrable interest debentures issued to WNB Capital Trust I.

Income Taxes

We recognized income tax expense of $46.5 million, for an effective tax rate of 9.5%, in 2021 compared to $20.2 million, for an effective tax rate of 5.7%, in 2020. The effective income tax rates differed from the U.S. statutory federal income tax rate of 21% during 2021 and 2020 primarily due to the effect of tax-exempt income from loans, securities and life insurance policies and the income tax effects associated with stock-based compensation, among other things, and their relative proportion to total pre-tax net income. The increase in the effective tax rate during 2021 was primarily related to an increase in pre-tax net income, partly off-set by the impact of higher discrete tax benefits associated with stock-based compensation. The effective tax rate during 2020 was also impacted by a one-time, discrete tax benefit associated with an asset contribution to a charitable trust. See Note 13 - Income Taxes in the accompanying notes to consolidated financial statements elsewhere in this report.

Sources and Uses of Funds

The following table illustrates, during the years presented, the mix of our funding sources and the assets in which those funds are invested as a percentage of our average total assets for the period indicated. Average assets totaled $46.0 billion in 2021 compared to $38.0 billion in 2020.

Deposits continue to be our primary source of funding. Average deposits increased $7.0 billion, or 22.4%, in 2021 compared to 2020. Non-interest-bearing deposits remain a significant source of funding, which has been a key factor in maintaining our relatively low cost of funds. Average non-interest-bearing deposits totaled 43.3% of total average deposits in 2021 compared to 43.1% in 2020. Though federal prohibitions on the payment of interest on demand deposits were repealed in 2011, we have not experienced any significant additional costs as a result. Should the market dictate, we may increase the interest rates we pay on some or all of our various interest-bearing deposit products. This could lead to a decrease in the relative proportion of non-interest-bearing deposits to total deposits.

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We primarily invest funds in loans, securities and interest-bearing deposits (primarily amounts held by us in an interest-bearing account at the Federal Reserve). Average loans decreased $394.8 million, or 2.3%, ($88.1 million, or 0.6% excluding PPP loans) in 2021 compared to 2020 while average securities increased $193.6 million, or 1.5%, in 2021 compared to 2020. Average interest-bearing deposits (primarily amounts held by us in an interest-bearing account at the Federal Reserve) increased $8.2 billion, or 155.2%, in 2021 compared to 2020, primarily as a result of deposit growth.

Loans

Overview. Details of our loan portfolio are presented in Note 3 - Loans in the accompanying notes to consolidated financial statements included elsewhere in this report. Year-end total loans decreased $1.1 billion, or 6.5%, during 2021 compared to 2020. As further discussed below, during the second quarter of 2020, we began originating loans to qualified small businesses under the PPP administered by the SBA under the provisions of the CARES Act. Excluding PPP loans, total loans would have otherwise increased $860.1 million, or 5.7%, from December 31, 2020. The majority of our loan portfolio is comprised of commercial and industrial loans, energy loans and real estate loans. Commercial and industrial loans made up 32.9% and 28.4% (33.7% and 32.9% excluding PPP loans) of total loans at December 31, 2021 and 2020 while energy loans made up 6.6% and 7.1% (6.8% and 8.2% excluding PPP loans) of total loans at both December 31, 2021 and 2020 and real estate loans made up 55.0% and 47.7% (56.5% and 55.5% excluding PPP loans) of total loans at December 31, 2021 and 2020. Energy loans include commercial and industrial loans, leases and real estate loans to borrowers in the energy industry. Real estate loans include both commercial and consumer balances. It is possible that the on-going effects of COVID-19 could continue to impact demand for our loan products.

Loan Origination/Risk Management. We have certain lending policies and procedures in place that are designed to maximize loan income within an acceptable level of risk. Management reviews and approves these policies and procedures on a regular basis. A reporting system supplements the review process by providing management with frequent reports related to loan production, loan quality, concentrations of credit, loan delinquencies and non-performing and potential problem loans. Diversification in the loan portfolio is a means of managing risk associated with fluctuations in economic conditions. We have begun to explore the credit and reputational risks associated with climate change and their potential impact on the foregoing and are also closely monitoring regulatory developments on climate risk. This includes, among other things, researching and developing a formalized approach to considering climate change related risks in our underwriting processes. This approach will be impacted, in part, by the accessibility and reliability of both customer climate risk data and climate risk data in general. One of the objectives of these efforts is to enable us to better understand the climate change related risks associated with our customers' business activities and to be able to monitor their response to those risks and their ultimate impact on our customers.

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

Our energy loan portfolio includes loans for production, energy services and other energy loans, which includes private clients, transportation and equipment providers, manufacturers, refiners and traders. The origination process for energy loans is similar to that of commercial and industrial loans. Because, however, of the average loan size, the significance of the portfolio and the specialized nature of the energy industry, our energy lending requires a highly prescriptive underwriting policy. Production loans are secured by proven, developed and producing reserves. Loan proceeds for these types of loans are typically used for the development and drilling of additional wells, the acquisition of additional production, and/or the acquisition of additional properties to be developed and drilled. Our customers in this sector are generally large, independent, private owner-producers or large corporate producers. These borrowers typically have large capital requirements for drilling and acquisitions, and as such, loans in this portfolio are generally greater than $10 million. Production loans are collateralized by the oil and gas interests of the

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borrower. Collateral values are determined by the risk-adjusted and limited discounted future net revenue of the reserves. Our valuations take into consideration geographic and reservoir differentials as well as cost structures associated with each borrower. Collateral value is calculated at least semi-annually using third-party engineer-prepared reserve studies. These reserve studies are conducted using a discount factor and base case assumptions for the current and future value of oil and gas. To qualify as collateral, typically reserves must be proven, developed and producing. For certain borrowers, collateral may include up to 20% proven, non-producing reserves. Loan commitments are limited to 65% of estimated reserve value. Cash flows must be sufficient to amortize the loan commitment within 120% of the half-life of the underlying reserves. Loan commitments generally must also be 100% covered by the risk-adjusted and limited discounted future net revenue of the reserves when stressed at 75% of our base case price assumptions. In addition, the ratio of the borrower's debt to earnings before interest, taxes, depreciation and amortization (“EBITDA”) should generally not exceed 350%. We generally require production borrowers to maintain an active hedging program to manage risk and to have at least 50% of their production hedged for two years.

Oil and gas service, transportation, and equipment providers are economically aligned due to their reliance on drilling and active oil and gas development. Income for these borrowers is highly dependent on the level of drilling activity and rig utilization, both of which are driven by the current and future outlook for the price of oil and gas. We mitigate the credit risk in this sector through conservative concentration limits and guidelines on the profile of eligible borrowers. Guidelines require that the companies have extensive experience through several industry cycles, and that they be supported by financially competent and committed guarantors who provide a significant secondary source of repayment. Borrowers in this sector are typically privately-owned, middle-market companies with annual sales of less than $100 million. The services provided by companies in this sector are highly diversified, and include down-hole testing and maintenance, providing and threading drilling pipe, hydraulic fracturing services or equipment, seismic testing and equipment and other direct or indirect providers to the oil and gas production sector.

Our private client portfolio primarily consists of loans to wealthy individuals and their related oil and gas exploration and production entities, where the oil and gas producing reserves are not considered to be the primary source of repayment. These borrowers and guarantors typically have significant sources of wealth including significant liquid assets and/or cash flow from other investments which can fully repay the loans. The credit structures of these loans are generally similar to those of energy production loans, described above, with respect to the valuation of the reserves taken as collateral and the repayment structures.

Although no balances were outstanding at December 31, 2021 and 2020, in prior years we have had a small portfolio of loans to refiners where our credit involvement with these customers was through purchases of shared national credit syndications. These borrowers refine crude oil into gasoline, diesel, jet fuel, asphalt and other petrochemicals and are not dependent on drilling or development. All of the borrowers in this portfolio are very large public companies that are important employers in several of our major markets. These borrowers, for the most part, have been long-term customers and we have a strong relationship with these companies and their executive management. There is no new customer origination process for this segment and any outstanding balances are expected to only reflect the needs of these existing relationships.

We also have a small portfolio of loans to energy trading companies that serve as intermediaries that buy and sell oil, gas, other petrochemicals, and ethanol. These companies are not dependent on drilling or development. As a general policy, we do not lend to energy traders; however, we have made an exception to this policy for certain customers based upon their underlying business models which minimize risk as commodities are bought only to fill existing orders (back-to-back trading). As such, the commodity price risk and sale risk are eliminated.

PPP loans, which we began originating in April 2020, are loans to qualified small businesses under the PPP administered by the SBA under the provisions of the CARES Act. Loans covered by the PPP may be eligible for loan forgiveness for certain costs incurred related to payroll, group health care benefit costs and qualifying mortgage, rent and utility payments. The remaining loan balance after forgiveness of any amounts is still fully guaranteed by the SBA. Terms of the PPP loans include the following (i) maximum amount limited to the lesser of $10 million or an amount calculated using a payroll-based formula, (ii) maximum loan term of five years, (iii) interest rate of 1.00%, (iv) no collateral or personal guarantees are required, (v) no payments are required until the date on which the forgiveness amount relating to the loan is remitted to the lender and (vi) loan forgiveness up to the full principal amount of the loan and any accrued interest, subject to certain requirements including that no more than 40% of the loan forgiveness amount may be attributable to non-payroll costs. In return for processing and booking a PPP loan, the SBA paid lenders a processing fee tiered by the size of the loan (5% for loans of not more

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than $350 thousand; 3% for loans of more than $350 thousand and less than $2 million; and 1% for loans of at least $2 million).

Commercial real estate loans are subject to underwriting standards and processes similar to commercial and industrial loans, in addition to those of real estate loans. These loans are viewed primarily as cash flow loans and secondarily as loans secured by real estate. Commercial real estate lending typically involves higher loan principal amounts and the repayment of these loans is generally largely dependent on the successful operation of the property securing the loan or the business conducted on the property securing the loan. Commercial real estate loans may be more adversely affected by conditions in the real estate markets or in the general economy. The properties securing our commercial real estate portfolio are diverse in terms of type and geographic location. This diversity helps reduce our exposure to adverse economic events that affect any single market or industry. Management monitors and evaluates commercial real estate loans based on collateral, geography and risk grade criteria. As a general rule, we avoid financing single-purpose projects unless other underwriting factors are present to help mitigate risk. We also utilize third-party experts to provide insight and guidance about economic conditions and trends affecting market areas we serve. In addition, management tracks the level of owner-occupied commercial real estate loans versus non-owner occupied loans. At December 31, 2021, approximately 48.4% of the outstanding principal balance of our commercial real estate loans were secured by owner-occupied properties.

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

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

We maintain an independent loan review department that reviews and validates the credit risk program on a periodic basis. Results of these reviews are presented to management and the appropriate committees of our board of directors. The loan review process complements and reinforces the risk identification and assessment decisions made by lenders and credit personnel, as well as our policies and procedures.

Commercial and Industrial. Commercial and industrial loans increased $409.6 million, or 8.3%, during 2021 compared to 2020. Our commercial and industrial loans are a diverse group of loans to small, medium and large businesses. The purpose of these loans varies from supporting seasonal working capital needs to term financing of equipment. While some short-term loans may be made on an unsecured basis, most are secured by the assets being financed with collateral margins that are consistent with our loan policy guidelines. The commercial and industrial loan portfolio also includes the commercial lease and purchased shared national credits.

Energy. Energy loans include loans to entities and individuals that are engaged in various energy-related activities including (i) the development and production of oil or natural gas, (ii) providing oil and gas field servicing, (iii) providing energy-related transportation services (iv) providing equipment to support oil and gas drilling (v) refining petrochemicals, or (vi) trading oil, gas and related commodities. Energy loans decreased $157.4 million, or 12.7%, during 2021 compared to 2020. The average loan size, the significance of the portfolio and the specialized nature of the energy industry requires a highly prescriptive underwriting policy. Exceptions to this policy are rarely granted. Due to the large borrowing requirements of this customer base, the energy loan portfolio includes participations and purchased shared national credits.

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Paycheck Protection Program. PPP loans include loans to businesses and other entities that would otherwise be reported as commercial and industrial loans and, to a lesser extent, energy loans, originated under the guidelines discussed above. We funded approximately $1.4 billion and $3.3 billion of SBA-approved PPP loans during 2021 and 2020, respectively. During 2021 and 2020, we recognized approximately $97.3 million and $59.5 million in PPP loan related deferred processing fees (net of amortization of related deferred origination costs), respectively, as yield adjustments and these amounts are included in interest income on loans. As a result of the inclusion of these net fees in interest income, the average yields on PPP loans were 6.26% during 2021 and 3.78% during 2020, compared to the stated interest rate of 1.0% on these loans. We expect to recognize additional PPP loan related deferred processing fees (net of deferred origination costs) totaling approximately $2.8 million as a yield adjustment during 2022.

Industry Concentrations. As of December 31, 2021 and 2020, there were no concentrations of loans related to any single industry, as segregated by Standard Industrial Classification code (“SIC code”), in excess of 10% of total loans. The largest industry concentrations at such dates were related to the energy industry, which totaled 6.6% of total loans, or 6.8% excluding PPP loans, as of December 31, 2021 and 7.1% of total loans, or 8.2% excluding PPP loans, as of December 31, 2020. The SIC code system is a federally designed standard industrial numbering system used by us to categorize loans by the borrower’s type of business. The following table summarizes the industry concentrations of our loan portfolio, as segregated by SIC code, stated as a percentage of year-end total loans as of December 31, 2021 and 2020.

Large Credit Relationships. The market areas served by us include three of the top ten most populated cities in the United States. These market areas are also home to a significant number of Fortune 500 companies. As a result, we originate and maintain large credit relationships with numerous commercial customers in the ordinary course of business. We consider large credit relationships to be those with commitments equal to or in excess of $10.0 million, excluding treasury management lines exposure, prior to any portion being sold. Large relationships also include loan participations purchased if the credit relationship with the agent is equal to or in excess of $10.0 million. In addition to our normal policies and procedures related to the origination of large credits, one of our Regional Credit Committees must approve all new credit facilities which are part of large credit relationships and renewals of such credit facilities with exposures between $20.0 million and $30.0 million. Our Central Credit Committee must approve all new credit facilities which are part of large credit relationships and renewals of such credit facilities with exposures that exceed $30.0 million. The Regional and Central Credit Committees meet regularly to review large credit relationship activity and discuss the current pipeline, among other things.

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The following table provides additional information on our large credit relationships outstanding at year-end.

Purchased Shared National Credits (“SNCs”). Purchased SNCs are participations purchased from upstream financial organizations and tend to be larger in size than our originated portfolio. Our purchased SNC portfolio totaled $698.4 million at December 31, 2021 decreasing $89.7 million, or 11.4%, from $788.1 million at December 31, 2020. At December 31, 2021, 27.2% of outstanding purchased SNCs were related to the construction industry, 23.2% of outstanding purchased SNCs were related to the energy industry, 14.0% were related to the real estate management industry and 13.4% of outstanding purchased SNCs were related to the financial services industry. The remaining purchased SNCs were diversified throughout various other industries, with no other single industry exceeding 10% of the total purchased SNC portfolio. Additionally, almost all of the outstanding balance of purchased SNCs was included in the energy and commercial and industrial portfolios, with the remainder included in the real estate categories. SNC participations are originated in the normal course of business to meet the needs of our customers. As a matter of policy, we generally only participate in SNCs for companies headquartered in or which have significant operations within our market areas. In addition, we must have direct access to the company’s management, an existing banking relationship or the expectation of broadening the relationship with other banking products and services within the following 12 to 24 months. SNCs are reviewed at least quarterly for credit quality and business development successes.

The following table provides additional information about certain credits within our purchased SNCs portfolio as of year-end.

Real Estate Loans. Real estate loans increased $636.2 million, or 7.6%, during 2021 compared to 2020. Real estate loans include both commercial and consumer balances. Commercial real estate loans totaled $7.6 billion, or 84.3% of total real estate loans, at December 31, 2021 and $7.0 billion, or 84.1% of total real estate loans, at December 31, 2020. The majority of this portfolio consists of commercial real estate mortgages, which includes both permanent and intermediate term loans. Loans secured by owner-occupied properties make up a significant portion of our commercial real estate portfolio. 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 that of a real estate loan.

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The following tables summarize our commercial real estate loan portfolio, including commercial real estate loans reported as a component of our energy loan portfolio segment, as segregated by (i) the type of property securing the credit and (ii) the geographic region in which the loans were originated. Property type concentrations are stated as a percentage of year-end total commercial real estate loans as of December 31, 2021 and 2020:

Consumer Loans. The consumer loan portfolio at December 31, 2021 increased $51.7 million, or 2.8%, from December 31, 2020. As the following table illustrates, the consumer loan portfolio has two distinct segments, including consumer real estate and consumer and other.

Consumer real estate loans at December 31, 2021 increased $80.0 million, or 6.0%, from December 31, 2020. Combined, home equity loans and lines of credit made up 59.8% and 58.8% of the consumer real estate loan total at December 31, 2021 and 2020, respectively. We offer home equity loans up to 80% of the estimated value of the personal residence of the borrower, less the value of existing mortgages and home improvement loans. We have not generally originated 1-4 family mortgage loans since 2000; however, from time to time, we invested in such loans to meet the needs of our customers or for other regulatory compliance purposes. Nonetheless, we expect to begin regular production of 1-4 family mortgage loans for portfolio investment purposes in the second half of 2022. The

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consumer and other loan portfolio at December 31, 2021 decreased $28.3 million, or 5.6%, from December 31, 2020. This portfolio primarily consists of automobile loans, unsecured revolving credit products, personal loans secured by cash and cash equivalents, and other similar types of credit facilities.

Foreign Loans. We make U.S. dollar-denominated loans and commitments to borrowers in Mexico. The outstanding balance of these loans and the unfunded amounts available under these commitments were not significant at December 31, 2021 or 2020.

Maturities and Sensitivities of Loans to Changes in Interest Rates. The following table presents the maturity distribution of our loan portfolio at December 31, 2021. The table also presents the portion of loans that have fixed interest rates or variable interest rates that fluctuate over the life of the loans in accordance with changes in an interest rate index.

We generally structure commercial loans with shorter-term maturities in order to match our funding sources and to enable us to effectively manage the loan portfolio by providing the flexibility to respond to liquidity needs, changes in interest rates and changes in underwriting standards and loan structures, among other things. Due to the shorter-term nature of such loans, from time to time in the ordinary course of business and without any contractual obligation on our part, we will renew/extend maturing lines of credit or refinance existing loans at their maturity dates. Some loans may renew multiple times in a given year as a result of general customer practice and need. These renewals, extensions and refinancings are made in the ordinary course of business for customers that meet our normal level of credit standards. Such borrowers typically request renewals to support their on-going working capital needs to finance their operations. Such borrowers are not experiencing financial difficulties and generally could obtain similar financing from another financial institution. In connection with each renewal, extension or refinancing, we may require a principal reduction, adjust the rate of interest and/or modify the structure and other

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terms to reflect the current market pricing/structuring for such loans or to maintain competitiveness with other financial institutions. In such cases, we do not generally grant concessions, and, except for those reported in Note 3 - Loans, any such renewals, extensions or refinancings that occurred during the reported periods were not deemed to be troubled debt restructurings pursuant to applicable accounting guidance. Loans exceeding $1.0 million undergo a complete underwriting process at each renewal.

Accruing Past Due Loans. Accruing past due loans are presented in the following table. Also see Note 3 - Loans in the accompanying notes to consolidated financial statements included elsewhere in this report.

Accruing past due loans at December 31, 2021 increased $17.9 million compared to December 31, 2020. The increase was primarily due to increases in past due non-construction related commercial real estate loans (up $25.5 million) and past due PPP loans (up $23.7 million). PPP loans are fully guaranteed by the SBA and we expect to collect all amounts due related to these loans. Excluding PPP loans, accruing past due loans decreased $5.8 million as the aforementioned increase in past due non-construction related commercial real estate loans was entirely offset by decreases in past due commercial and industrial loans (down $13.4 million) and past due energy loans (down $12.2 million) and, to a lesser extent, decreases in past due consumer real estate loans (down $3.5 million), past due consumer and other loans (down $1.5 million) and past due construction loans (down $668 thousand).

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Non-Accrual Loans. Non-accrual loans are presented in the tables below. Also see Note 3 - Loans in the accompanying notes to consolidated financial statements included elsewhere in this report.

Non-accrual loans at December 31, 2021 decreased $7.7 million from December 31, 2020 primarily due to a decrease in non-accrual energy loans. The decrease was primarily related to principal payments and, to a lesser extent, loans returning to accrual status and charge-offs, partly offset by new loans placed on non-accrual status during 2021.

Generally, loans are placed on non-accrual status if principal or interest payments become 90 days past due and/or management deems the collectibility of the principal and/or interest to be in question, as well as when required by regulatory requirements. Once interest accruals are discontinued, accrued but uncollected interest is charged to current year operations. Subsequent receipts on non-accrual loans are recorded as a reduction of principal, and interest income is recorded only after principal recovery is reasonably assured. Classification of a loan as non-accrual does not preclude the ultimate collection of loan principal or interest. There were no non-accrual commercial and industrial loans in excess of $5.0 million at December 31, 2021. Non-accrual commercial and industrial loans included one credit relationship in excess of $5.0 million with an aggregate balance of $9.0 million at December 31, 2020. We recognized a charge-off totaling $861 thousand related to this relationship during 2021 while the remainder of the decrease was related to principal payments made by the borrower. Non-accrual energy loans included one credit relationship in excess of $5 million totaling $9.6 million at December 31, 2021. This credit relationship was previously reported as non-accrual with an aggregate balance of $20.1 million at December 31, 2020. The decrease in the aggregate balance of this credit relationship was related to principal payments made by the borrower. Non-accrual real estate loans primarily consist of land development, 1-4 family residential construction credit relationships and loans secured by office buildings and religious facilities. There were no non-accrual commercial real estate loans in excess of $5.0 million at December 31, 2021 or December 31, 2020.

The COVID-19 pandemic has contributed to an increased risk of delinquencies, defaults and foreclosures. As a result of the COVID-19 pandemic, a significant number and amount of our loans experienced ratings downgrades, credit deterioration and defaults. We have a significant amount of loans in certain industries that have been particularly impacted. These include energy, hotels/lodging, restaurants, entertainment and commercial real estate, among others. See additional information about the effects of and risks associated with the COVID-19 pandemic in the section captioned “Recent Developments Related to COVID-19” elsewhere in this discussion and Part I. Item 1A. Risk Factors elsewhere in this report.

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Allowance For Credit Losses

As discussed in Note 1 - Summary of Significant Accounting Policies in the accompanying notes to consolidated financial statements, our policies and procedures related to accounting for credit losses changed on January 1, 2020 in connection with the adoption of a new accounting standard update as codified in Accounting Standards Codification (“ASC”) Topic 326 (“ASC 326”) Financial Instruments - Credit Losses. In the case of off-balance-sheet credit exposures, the allowance for credit losses is a liability account, calculated in accordance with ASC 326, reported as a component of accrued interest payable and other liabilities in our consolidated balance sheets. The amount of each allowance account represents management's best estimate of current expected credit losses (“CECL”) on these financial instruments considering available information, from internal and external sources, relevant to assessing exposure to credit loss over the contractual term of the instrument. Relevant available information includes historical credit loss experience, current conditions and reasonable and supportable forecasts. While historical credit loss experience provides the basis for the estimation of expected credit losses, adjustments to historical loss information may be made for differences in current portfolio-specific risk characteristics, environmental conditions or other relevant factors. While management utilizes its best judgment and information available, the ultimate adequacy of our allowance accounts is dependent upon a variety of factors beyond our control, including the performance of our portfolios, the economy, changes in interest rates and the view of the regulatory authorities toward classification of assets. For additional information regarding our accounting policies related to credit losses, refer to Note 1 - Summary of Significant Accounting Policies and Note 3 - Loans in the accompanying notes to consolidated financial statements.

Allowance for Credit Losses - Loans. The table below provides an allocation of the year-end allowance for credit losses on loans by loan portfolio segment; however, allocation of a portion of the allowance to one segment does not preclude its availability to absorb losses in other segments.

The allowance allocated to commercial and industrial loans totaled $72.1 million, or 1.34% of total commercial and industrial loans, at December 31, 2021 decreasing $1.8 million, or 2.4%, compared to $73.8 million, or 1.49% of total commercial and industrial loans at December 31, 2020. Modeled expected credit losses decreased $18.7 million while qualitative factor (“Q-Factor”) and other qualitative adjustments related to commercial and industrial loans increased $11.7 million. Specific allocations for commercial and industrial loans that were evaluated for expected credit losses on an individual basis increased $5.2 million, or 98.0%, from $5.3 million at December 31, 2020 to $10.5 million at December 31, 2021. The increase in specific allocations for commercial and industrial loans

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was primarily related to several newly downgraded credit relationships with specific allocations totaling $9.2 million partly offset by reductions in allocations for certain other loans due to principal payments received and the recognition of charge-offs.

The allowance allocated to energy loans totaled $17.2 million, or 1.60% of total energy loans, at December 31, 2021 decreasing $22.3 million, or 56.5%, compared to $39.6 million, or 3.20% of total energy loans at December 31, 2020. Modeled expected credit losses related to energy loans decreased $2.5 million while Q-Factor and other qualitative adjustments related to energy loans decreased $15.8 million. Specific allocations for energy loans that were evaluated for expected credit losses on an individual basis totaled $5.5 million at December 31, 2021 decreasing $3.9 million, or 41.9%, compared to $9.4 million at December 31, 2020. The decrease in specific allocations for energy loans was primarily related to principal payments received and, to a lesser extent, the recognition of charge-offs.

The allowance allocated to commercial real estate loans totaled $144.9 million, or 1.91% of total commercial real estate loans, at December 31, 2021 increasing $10.0 million, or 7.4%, compared to $134.9 million, or 1.92% of total commercial real estate loans at December 31, 2020. Modeled expected credit losses related to commercial real estate loans decreased $108.5 million while Q-Factor and other qualitative adjustments related to commercial real estate loans increased $118.6 million. Specific allocations for commercial real estate loans that were evaluated for expected credit losses on an individual basis decreased from $513 thousand at December 31, 2020 to $400 thousand at December 31, 2021.

The allowance allocated to consumer real estate loans totaled $6.6 million, or 0.47% of total consumer real estate loans, at December 31, 2021 decreasing $1.3 million, or 16.9%, compared to $7.9 million, or 0.60% of total consumer real estate loans at December 31, 2020 primarily due to modeled expected credit losses which decreased $1.4 million.

The allowance allocated to consumer loans totaled $7.8 million, or 1.64% of total consumer loans, at December 31, 2021 increasing $874 thousand, or 12.6%, compared to $7.0 million, or 1.38% of total consumer loans at December 31, 2020. Modeled expected credit losses related to consumer loans decreased $548 thousand while Q-Factor and other qualitative adjustments related to consumer loans increased $1.4 million.

As more fully described in Note 3 - Loans in the accompanying consolidated financial statements, we measure expected credit losses over the life of each loan utilizing a combination of models which measure probability of default and loss given default, among other things. The measurement of expected credit losses is impacted by loan/borrower attributes and certain macroeconomic variables. Models are adjusted to reflect the current impact of certain macroeconomic variables as well as their expected changes over a reasonable and supportable forecast period.

In estimating expected credit losses as of December 31, 2021, we utilized the Moody’s Analytics December 2021 Consensus Scenario (the “December 2021 Consensus Scenario”) to forecast the macroeconomic variables used in our models. The December 2021 Consensus Scenario was based on the review of a variety of surveys of baseline forecasts of the U.S. economy. The December 2021 Consensus Scenario projections included, among other things, (i) U.S. Gross Domestic Product (“GDP”) annualized quarterly growth rate of 6.4% in the first quarter of 2022, followed by annualized quarterly growth rates in the range of 3.8% to 5.4% during the remainder of 2022 and an average annualized growth rate of 4.8% through the end of the forecast period in the fourth quarter of 2023; (ii) U.S. unemployment rate of 4.3% in the first quarter of 2022 improving to 3.7% by the end of the forecast period in the fourth quarter of 2023 with Texas unemployment rates slightly higher at those dates; and (iii) projected average 10 year Treasury rate of 1.59% in the first quarter of 2022, increasing to average projected rates of 1.75% during the remainder of 2022 and 2.10% in 2023. Furthermore, the December 2021 Consensus Scenario projects an average oil price in the range of approximately $62 to $66 per barrel through the end of the forecast period in the fourth quarter of 2023.

In estimating expected credit losses as of December 31, 2020, we utilized the Moody’s Analytics December 2020 BL Baseline Scenario (the “December BL Scenario”) to forecast the macroeconomic variables used in our models. The December BL Scenario was based on the review of a variety of surveys of baseline forecasts of the U.S. economy. The December BL Scenario projections included, among other things, (i) U.S. Gross Domestic Product (“GDP”) annualized quarterly growth rate of 4.6% for the fourth quarter of 2020 followed by projected annualized quarterly growth rates in the range of approximately 3.0% to 8.0% during 2021 and 6.0% to 7.5% through the end of the forecast period in the fourth quarter of 2022; (ii) a U.S. unemployment rate of 6.7% in the fourth quarter of 2020

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and an average projected rate of 7.0% in 2021 and 6.0% in 2022, with the fourth quarter of 2022 projected to be 5.4% (Texas unemployment rates were projected to be slightly less for those periods); and (iii) an average 10 year Treasury rate of 0.79% in the fourth quarter of 2020, increasing to an average projected rate of 1.05% in 2021 and 2.04% in 2022. The December BL Scenario also projected average oil prices of $40 per barrel in the fourth quarter of 2020, $45 per barrel on average for the year in 2021 and $55 per barrel on average for the year in 2022, with the fourth quarter of 2022 projected to be $59 per barrel.

The overall loan portfolio, excluding PPP loans which are fully guaranteed by the SBA, as of December 31, 2021 increased $860.1 million, or 5.7%, compared to December 31, 2020. This increase included a $556.1 million, or 7.9%, increase in commercial real estate loans, a $409.6 million, or 8.3%, increase in commercial and industrial loans and a $80.0 million, or 6.0%, increase in consumer real estate loans partly offset by a $157.4 million, or 12.7%, decrease in energy loans and a $28.3 million, or 5.6%, decrease in consumer and other loans. The weighted average risk grade for commercial and industrial loans decreased to 6.22 at December 31, 2021 compared to 6.45 at December 31, 2020. Commercial and industrial loans graded “watch” and “special mention” (risk grades 9 and 10) decreased $135.2 million during 2021 while classified commercial and industrial loans decreased $12.9 million. Classified loans consist of loans having a risk grade of 11, 12 or 13. The weighted-average risk grade for energy loans decreased to 6.06 at December 31, 2021 from 6.85 at December 31, 2020. The decrease in the weighted average risk grade was primarily related to a $141.6 million decrease in energy loans graded “watch” and “special mention” (risk grades 9 and 10) and a $56.1 million decrease in classified energy loans. Pass grade energy loans increased $40.2 million while the weighted-average risk grade of pass grade energy loans decreased slightly from 5.99 at December 31, 2020 to 5.78 at December 31, 2021. The weighted average risk grade for commercial real estate loans decreased from 7.32 at December 31, 2020 to 7.19 at December 31, 2021. Pass grade commercial real estate loans increased $679.2 million while commercial real estate loans graded as “watch” and “special mention” decreased $62.8 million and classified commercial real estate loans decreased $60.3 million.

As noted above our credit loss models utilized the economic forecasts in the Moody’s Consensus Scenario for December 2021 for our estimated expected credit losses as of December 31, 2021 and the Moody’s Baseline Scenario for December 2020 for our estimate of expected credit losses as of December 31, 2020. We qualitatively adjusted the model results based on these scenarios for various risk factors that are not considered within our modeling processes but are nonetheless relevant in assessing the expected credit losses within our loan pools. These Q-Factor and other qualitative adjustments are discussed below.

Q-Factor adjustments are based upon management judgment and current assessment as to the impact of risks related to changes in lending policies and procedures; economic and business conditions; loan portfolio attributes and credit concentrations; and external factors, among other things, that are not already captured within the modeling inputs, assumptions and other processes. Management assesses the potential impact of such items within a range of severely negative impact to positive impact and adjusts the modeled expected credit loss by an aggregate adjustment percentage based upon the assessment. As a result of this assessment as of December 31, 2021, modeled expected credit losses were adjusted upwards by a weighted-average Q-Factor adjustment of approximately 2.3%, up from approximately 1.2% at December 31, 2020. The weighted-average Q-Factor adjustment at December 31, 2021 was based on a limited negative expected impact on our commercial loan portfolios related to changes in lending policies procedures and underwriting standards and changes in loan portfolio concentrations; a negative expected impact associated with national, regional and local economic and business conditions and developments that affect the collectability of loans; a severely negative expected impact from other risk factors associated with our commercial real estate construction and land loan portfolios, particularly the risks related to expected extensions; and no impact to changes in loan portfolio attributes, changes in risk grades, changes in the volumes and severity of loan delinquencies and adverse classifications and potential deterioration of collateral values. The weighted-average Q-Factor adjustment at December 31, 2020 was based on a positive expected impact related to changes in lending policies, procedures and underwriting standards; a limited negative expected impact associated with changes in loan portfolio attributes and concentrations, changes in risk grades, changes in the volumes and severity of loan delinquencies and adverse classifications and potential deterioration of collateral values; and a severely negative expected impact from other risk factors associated with our commercial real estate construction and land loan portfolios, particularly the risks related to expected extensions.

In the first quarter of 2020, unprecedented economic conditions due to the COVID-19 pandemic and oil and gas price volatility resulted in significant spikes in the unemployment rate and the level of unemployment claims as well as severe declines in the level of the U.S. and Texas GDPs, among other things. In some cases, our expected credit loss models consider these economic variables on a three- to four-quarter lag basis. As of December 31, 2021, the

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significant spikes in several of these variables are no longer impacting our model results; however, as the economy has entered recovery, the models are now being impacted by exceptionally positive changes in certain variables which has resulted in lower estimates of expected credit losses. Notwithstanding the foregoing, management believes there are still significant headwinds impacting the recovery of the U.S. and Texas economies and certain categories of our loan portfolio. As a result, we have provided additional qualitative adjustments for certain categories of loans, as further described below.

As of December 31, 2020, we provided an additional qualitative adjustment for energy production loans. This adjustment was estimated based on borrowing base determinations for our energy production loans using current engineering valuations. We also performed an analysis of our customers' secondary sources of capital. As a result of the estimated borrowing base deficiencies for the identified credits, we provided an additional qualitative adjustment of approximately $21.1 million for energy production loans at December 31, 2020. Using a similar methodology, we determined that a similar qualitative adjustment was not necessary as of December 31, 2021 as there were no longer any significant borrowing base deficiencies within the energy production portfolio as a result of higher market prices for oil and gas and lower line balances on production loans. Nonetheless, as of December 31, 2021, we provided an additional qualitative adjustment for energy loans totaling $5.2 million to address the risk associated with relationship exposure concentrations within the energy loan portfolio, as further discussed below.

Our Commercial Real Estate Oversight Council, in its oversight and assessment of the credit quality of our commercial real estate loan portfolios, believes these portfolios continue to have an elevated level of risk notwithstanding recent economic stimulus efforts by federal and state governments. As of December 31, 2021, we provided additional qualitative adjustments totaling $127.2 million for various categories of our commercial real estate loan portfolio. This amount includes $67.3 million for non-owner-occupied commercial real estate loans, $40.5 million for owner-occupied commercial real estate loans and $19.4 million for commercial real estate construction loans. These additional qualitative adjustments are largely related to the on-going effects of the COVID-19 pandemic, as further discussed below, and to compensate for the effect of unusually large positive changes in certain economic variables used by our credit loss models. The COVID-19 pandemic has also been a catalyst for the evolution of various remote work options which could impact the long-term performance of some types of office properties within our commercial real estate portfolio. Furthermore, management believes that there are still significant headwinds impacting the recovery of the U.S. and Texas economies and certain categories of our loan portfolio. These additional qualitative adjustments also include $2.6 million to address the risk associated with relationship exposure concentrations within our commercial real estate loan portfolio, as further discussed below.

The COVID-19 pandemic has resulted in a significant decrease in commercial activity throughout the State of Texas as well as nationally. Efforts to limit the spread of COVID-19 led to the closure of non-essential businesses, travel restrictions, supply chain disruptions and prohibitions on public gatherings, among other things, throughout many parts of the United States and, in particular, the markets in which we operate. Nonetheless, by late 2020, the markets in which we operate had substantially reopened. We lend to customers operating in certain industries (detailed in the table below) that have been, and are expected to continue to be, more significantly impacted by the effects of the COVID-19 pandemic. We are continuing to monitor customers in these industries closely. In assessing these portfolios for an additional qualitative adjustment, we performed a comprehensive review of the financial condition and overall outlook of the borrowers within these portfolios. Based on this analysis, we determined that there continues to be an elevated level of risk associated with these industries. As a result, we provided an additional qualitative adjustment related to the effects of the COVID-19 pandemic totaling $45.2 million as of December 31, 2021, of which $40.5 million was allocated to commercial real estate loans and $4.7 million was allocated to commercial and industrial loans. These amounts are included in the totals detailed above. As of December 31, 2020, we provided a similar additional qualitative adjustment totaling $47.1 million, which, for the most part, was allocated to commercial real estate loans.

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These industries that management believes are particularly impacted by the effects of the COVID-19 pandemic are presented in the following table as of December 31, 2021 and 2020 and include amounts reported as both commercial and industrial loans and commercial real estate loans while PPP loans are excluded.

As of December 31, 2021, we provided an additional qualitative adjustment for our commercial and industrial loan portfolio totaling $13.7 million, of which $4.7 million was included in the $45.2 million additional qualitative adjustment for COVID-19 impacted industries discussed above. The adjustment also included $5.0 million to address the risk associated with relationship exposure concentrations within our commercial and industrial loan portfolio, as further discussed below. Lastly, the adjustment included $4.0 million to address the risk associated with the long-term sustainability of borrowers within our small business commercial and industrial loan portfolio. The majority of these borrowers have been bolstered by PPP funding from the SBA which has helped them to sustain their operations amid on-going pandemic-related shutdowns and other restrictions. Nonetheless, management believes there is an elevated level of risk associated with the long-term viability of many of these businesses when this government supplemented funding runs out. Furthermore, on March 27, 2021, the COVID-19 Bankruptcy Relief Extension Act of 2021 was enacted, extending the bankruptcy relief provisions enacted in the CARES Act of 2020 until March 27, 2022. These provisions provide financially distressed small businesses and individuals greater access to bankruptcy relief. In that regard, we also provided an additional qualitative adjustment for our consumer and other loan portfolio totaling $1.4 million in light of the level of unsecured loans within this portfolio and other risk factors.

As of December 31, 2021, we allocated $12.8 million to address the risk associated with relationship exposure concentrations within our loan portfolio. Of this amount, $5.2 million was allocated to energy loans, $5.0 million was allocated to commercial and industrial loans and $2.6 million was allocated to commercial real estate loans. Management has observed through industry research that the degree to which expected credit losses fluctuate is directly related to the degree to which a loan portfolio is concentrated or diversified. A highly concentrated loan portfolio is more likely to exhibit concentrated losses compared to a well diversified loan portfolio where segments are exposed to relatively uncorrelated factors. The variations in loan portfolio concentrations over time cause expected credit losses within our existing portfolio to differ from historical loss experience. Given that the allowance for credit losses on loans reflects expected credit losses within our loan portfolio and the fact that these expected credit losses are uncertain as to nature, timing and amount, management believes that segments with higher concentration risk are more likely to experience a high loss event. Due to the fact that a significant portion of our loan portfolio is concentrated in large credit relationships and because of large, concentrated credit losses in recent years, management made the aforementioned qualitative adjustments, which were based upon statistical analysis, to address the risk associated with the such a relationship deteriorating to a loss event.

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Additional information related to credit loss expense and net (charge-offs) recoveries is presented in the tables below. Also see Note 3 - Loans in the accompanying notes to consolidated financial statements included elsewhere in this report.

We recorded a net credit loss benefit related to loans totaling $6.1 million for 2021 compared to a net credit loss expense related to loans totaling $237.0 million in 2020 and $33.8 million in 2019. The net credit loss benefit related to loans during 2021 primarily reflects improvements in forecasted economic conditions and oil price trends relative to the prevailing conditions in 2020 as well as a decrease in net charge-offs. Credit loss expense related to loans during 2020 reflected the uncertain future impacts associated with the COVID-19 pandemic and the significant volatility in oil prices as well as the level of net charge-offs, the expected deterioration in credit quality and other changes within the loan portfolio. Credit loss expense during 2019 was calculated under our prior incurred loss methodology and primarily reflected the level of net charge-offs and specific valuation allowances as well as the impact of the overall growth in the loan portfolio since previous year-end. The ratio of the allowance for credit losses on loans to total loans was 1.52% (1.56% excluding PPP loans) at December 31, 2021 compared to 1.51% (1.75% excluding PPP loans) at December 31, 2020 and 0.90% at December 31, 2019. Management believes the recorded amount of the allowance for credit losses on loans is appropriate based upon management’s best estimate of current expected credit losses within the existing portfolio of loans. Should any of the factors considered by management in making this estimate change, our estimate of current expect credit losses could also change, which could affect the level of future credit loss expense related to loans.

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Allowance for Credit Losses - Off-Balance-Sheet Credit Exposures. The allowance for credit losses on off-balance-sheet credit exposures totaled $50.3 million and $44.2 million at December 31, 2021 and December 31, 2020, respectively. The level of the allowance for credit losses on off-balance-sheet credit exposures depends upon the volume of outstanding commitments, underlying risk grades, the expected utilization of available funds and forecasted economic conditions impacting our loan portfolio. Credit loss expense related to off-balance-sheet credit exposures totaled $6.2 million during 2021 compared to $4.3 million during 2020. The increase in credit loss expense primarily reflects an increase in overall off-balance-sheet credit exposures and the uncertain future impacts associated with COVID-19. Credit loss expense for off-balancee-sheet credit exposures in 2021 was also partly impacted by the down-grade of a large credit commitment within our SNC portfolio. No credit loss expense related to off-balance-sheet credit exposures was recognized during 2019 under our prior incurred loss methodology. Further information regarding our policies and methodology used to estimate the allowance for credit losses on off-balance-sheet credit exposures is presented in Note 8 - Off-Balance-Sheet Arrangements, Commitments, Guarantees and Contingencies in the accompanying notes to consolidated financial statements.

Securities

The following tables summarize the maturity distribution schedule with corresponding weighted-average yields of securities held to maturity and securities available for sale as of December 31, 2021. Weighted-average yields have been computed on a fully taxable-equivalent basis using a tax rate of 21%. Mortgage-backed securities are included in maturity categories based on their stated maturity date. Expected maturities may differ from contractual maturities because issuers may have the right to call or prepay obligations. Other securities classified as available for sale include stock in the Federal Reserve Bank and the Federal Home Loan Bank, which have no maturity date. These securities have been included in the total column only. Held-to-maturity securities are presented at amortized cost before any allowance for credit losses.

All mortgage-backed securities included in the above tables were issued by U.S. government agencies and corporations. At December 31, 2021, all of the securities in our municipal bond portfolio were issued by the State of Texas or political subdivisions or agencies within the State of Texas, of which approximately 77.9% are either guaranteed by the Texas Permanent School Fund, which has a “triple-A” insurer financial strength rating, or secured by U.S. Treasury securities via defeasance of the debt by the issuers.

The average taxable-equivalent yield on the securities portfolio based on a 21% tax rate was 3.29% in 2021 compared to 3.46% in 2020. Tax-exempt municipal securities totaled 64.2% of average securities in 2021 compared to 66.6% in 2020. The average yield on taxable securities was 1.97% in 2021 compared to 2.27% in 2020, while the average taxable-equivalent yield on tax-exempt securities was 4.06% in 2021 compared to 4.08% in 2020. See the section captioned “Net Interest Income” elsewhere in this discussion.

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Deposits

The table below presents the daily average balances of deposits by type and weighted-average rates paid thereon during the years presented:

Average deposits increased $7.0 billion, or 22.4%, in 2021 compared to 2020. The most significant volume growth during 2021 compared to 2020 was in non-interest bearing deposits; savings and interest checking; and money market deposits. The ratio of average interest-bearing deposits to total average deposits was 56.7% in 2021 compared to 56.9% in 2020. The average cost of interest-bearing deposits and total deposits was 0.07% and 0.04% during 2021 compared to 0.18% and 0.10% during 2020. The decrease in the average cost of interest-bearing deposits in 2021 as compared to 2020 was related to lower average interest rates paid on most of our interest-bearing deposit products as a result of lower average market interest rates.

Geographic Concentrations. The following table summarizes our average total deposit portfolio, as segregated by the geographic region from which the deposit accounts were originated. Certain accounts, such as correspondent bank deposits and deposits allocated to certain statewide operational units, are recorded at the statewide level.

Foreign Deposits. Mexico has historically been considered a part of the natural trade territory of our banking offices. Accordingly, U.S. dollar-denominated foreign deposits from sources within Mexico have traditionally been a significant source of funding. Average deposits from foreign sources, primarily Mexico, totaled $933.3 million in 2021 and $824.9 million in 2020.

Brokered Deposits. From time to time, we have obtained interest-bearing deposits through brokered transactions including participation in the Certificate of Deposit Account Registry Service (“CDARS”). Brokered deposits were not significant during the reported periods.

Capital and Liquidity

Capital. Shareholders’ equity totaled $4.4 billion at December 31, 2021 and $4.3 billion at December 31, 2020. In addition to net income of $443.1 million, other sources of capital during 2021 included $54.4 million in proceeds from stock option exercises and $12.8 million related to stock-based compensation. Additionally, we issued $1.7 million of common stock held in treasury to our 401(k) plan in connection with matching contributions. Uses of capital during 2021 included $195.9 million of dividends paid on preferred and common stock, an other comprehensive loss, net of tax, of $165.7 million and $3.9 million of treasury stock purchases.

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The accumulated other comprehensive income/loss component of shareholders’ equity totaled a net, after-tax, unrealized gain of $347.3 million at December 31, 2021 compared to a net, after-tax, unrealized gain $513.0 million at December 31, 2020. The decrease was primarily due to a $183.6 million net, after-tax, decrease in the net unrealized gain on securities available for sale and securities transferred to held to maturity, partly offset by $17.9 million related to a decrease in the net actuarial loss and reclassification adjustments related to our defined-benefit post retirement benefit plans.

Under the Basel III Capital Rules, we elected to opt-out of the requirement to include most components of accumulated other comprehensive income in regulatory capital. Accordingly, amounts reported as accumulated other comprehensive income/loss related to securities available for sale, effective cash flow hedges and defined benefit post-retirement benefit plans do not increase or reduce regulatory capital and are not included in the calculation of risk-based capital and leverage ratios. In connection with the adoption of ASC 326 on January 1, 2020, we also elected to exclude, for a transitional period, the effects of credit loss accounting under CECL in the calculation of our regulatory capital and regulatory capital ratios. Regulatory agencies for banks and bank holding companies utilize capital guidelines designed to measure capital and take into consideration the risk inherent in both on-balance sheet and off-balance sheet items. See Note 9 - Capital and Regulatory Matters in the accompanying notes to consolidated financial statements elsewhere in this report.

We paid quarterly dividends of $0.72, $0.72, $0.75 and $0.75 per common share during the first, second, third and fourth quarters of 2021, respectively, and quarterly dividends of $0.71, $0.71, $0.71 and $0.72 per common share during the first, second, third and fourth quarters of 2020, respectively. This equates to a dividend payout ratio of 43.3% in 2021 and 55.8% in 2020. The amount of dividend, if any, we may pay may be limited as more fully discussed in Note 9 - Capital and Regulatory Matters in the accompanying notes to consolidated financial statements elsewhere in this report.

Preferred Stock. On March 16, 2020, we redeemed all 6,000,000 shares of our 5.375% Non-Cumulative Perpetual Preferred Stock, Series A, (“Series A Preferred Stock”) at a redemption price of $25 per share, or an aggregate redemption of $150.0 million. On November 19, 2020 we issued 150,000 shares, or $150.0 million in aggregate liquidation preference, of our 4.450% Non-Cumulative Perpetual Preferred Stock, Series B, par value $0.01 and liquidation preference $1,000 per share (“Series B Preferred Stock”). Each share of Series B Preferred Stock issued and outstanding is represented by 40 depositary shares, each representing a 1/40th ownership interest in a share of the Series B Preferred Stock (equivalent to a liquidation preference of $25 per share). Additional details about our preferred stock are included in Note 9 - Capital and Regulatory Matters in the accompanying notes to consolidated financial statements elsewhere in this report.

Stock Repurchase Plans. From time to time, our board of directors has authorized stock repurchase plans. In general, stock repurchase plans allow us to proactively manage our capital position and return excess capital to shareholders. Shares purchased under such plans also provide us with shares of common stock necessary to satisfy obligations related to stock compensation awards. On January 26, 2022, our board of directors authorized a $100.0 million stock repurchase plan, allowing us to repurchase shares of our common stock over a one-year period from time to time at various prices in the open market or through private transactions. Under prior stock repurchase plans, we repurchased, 177,834 shares at a total cost of $13.7 million during 2020 and 699,031 shares at a total cost of $67.2 million during 2019. No shares were repurchased under a stock repurchase plan during 2021. See Part II, Item 5 - Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities, elsewhere in this report.

Liquidity. Liquidity measures the ability to meet current and future cash flow needs as they become due. The liquidity of a financial institution reflects its ability to meet loan requests, to accommodate possible outflows in deposits and to take advantage of interest rate market opportunities. The ability of a financial institution to meet its current financial obligations is a function of its balance sheet structure, its ability to liquidate assets and its access to alternative sources of funds. The objective of our liquidity management is to manage cash flow and liquidity reserves so that they are adequate to fund our operations and to meet obligations and other commitments on a timely basis and at a reasonable cost. We seek to achieve this objective and ensure that funding needs are met by maintaining an appropriate level of liquid funds through asset/liability management, which includes managing the mix and time to maturity of financial assets and financial liabilities on our balance sheet. Our liquidity position is enhanced by our ability to raise additional funds as needed in the wholesale markets.

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Asset liquidity is provided by liquid assets which are readily marketable or pledgeable or which will mature in the near future. Liquid assets include cash, interest-bearing deposits in banks, securities available for sale, maturities and cash flow from securities held to maturity, and federal funds sold and resell agreements. Liability liquidity is provided by access to funding sources which include core deposits and correspondent banks in our natural trade area that maintain accounts with and sell federal funds to Frost Bank, as well as federal funds purchased and repurchase agreements from upstream banks and deposits obtained through financial intermediaries.

Our liquidity position is continuously monitored and adjustments are made to the balance between sources and uses of funds as deemed appropriate. Liquidity risk management is an important element in our asset/liability management process. We regularly model liquidity stress scenarios to assess potential liquidity outflows or funding problems resulting from economic disruptions, volatility in the financial markets, unexpected credit events or other significant occurrences deemed problematic by management. These scenarios are incorporated into our contingency funding plan, which provides the basis for the identification of our liquidity needs. As of December 31, 2021, we had approximately $15.9 billion held in an interest-bearing account at the Federal Reserve. We also have the ability to borrow funds as a member of the Federal Home Loan Bank (“FHLB”). As of December 31, 2021, based upon available, pledgeable collateral, our total borrowing capacity with the FHLB was approximately $3.1 billion. Furthermore, at December 31, 2021, we had approximately $9.3 billion in securities that were unencumbered by a pledge and could be used to support additional borrowings through repurchase agreements or the Federal Reserve discount window, as needed. As of December 31, 2021, management is not aware of any events that are reasonably likely to have a material adverse effect on our liquidity, capital resources or operations. In addition, management is not aware of any regulatory recommendations regarding liquidity that would have a material adverse effect on us.

In the ordinary course of business we have entered into contractual obligations and have made other commitments to make future payments. Refer to the accompanying notes to consolidated financial statements elsewhere in this report for the expected timing of such payments as of December 31, 2021. These include payments related to (i) long-term borrowings (Note 7 - Borrowed Funds), (ii) operating leases (Note 4 - Premises and Equipment and Lease Commitments), (iii) time deposits with stated maturity dates (Note 6 - Deposits) and (iv) commitments to extend credit and standby letters of credit (Note 8 - Off-Balance-Sheet Arrangements, Commitments, Guarantees and Contingencies).

Since Cullen/Frost is a holding company and does not conduct operations, its primary sources of liquidity are dividends upstreamed from Frost Bank and borrowings from outside sources. Banking regulations may limit the amount of dividends that may be paid by Frost Bank. See Note 9 - Capital and Regulatory Matters in the accompanying notes to consolidated financial statements elsewhere in this report regarding such dividends. At December 31, 2021, Cullen/Frost had liquid assets, including cash and resell agreements, totaling $471.9 million.

Regulatory and Economic Policies

Our business and earnings are affected by general and local economic conditions and by the monetary and fiscal policies of the United States government, its agencies and various other governmental regulatory authorities, among other things. The Federal Reserve Board regulates the supply of money in order to influence general economic conditions. Among the instruments of monetary policy historically available to the Federal Reserve Board are (i) conducting open market operations in United States government obligations, (ii) changing the discount rate on financial institution borrowings, (iii) imposing or changing reserve requirements against financial institution deposits, and (iv) restricting certain borrowings and imposing or changing reserve requirements against certain borrowings by financial institutions and their affiliates. These methods are used in varying degrees and combinations to affect directly the availability of bank loans and deposits, as well as the interest rates charged on loans and paid on deposits. For that reason alone, the policies of the Federal Reserve Board have a material effect on our earnings.

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, we cannot accurately predict the nature, timing or extent of any effect such policies may have on our future business and earnings.

Accounting Standards Updates

See Note 20 - Accounting Standards Updates in the accompanying notes to consolidated financial statements elsewhere in this report for details of recently issued accounting pronouncements and their expected impact on our financial statements.

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