UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
x QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended June 30, 2011
OR
o TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from to
Commission file number 000-09439
INTERNATIONAL BANCSHARES CORPORATION
(Exact name of registrant as specified in its charter)
Texas
74-2157138
(State or other jurisdiction of incorporation or organization)
(I.R.S. Employer Identification No.)
1200 San Bernardo Avenue, Laredo, Texas 78042-1359
(Address of principal executive offices)
(Zip Code)
(956) 722-7611
(Registrant’s telephone number, including area code)
None
(Former name, former address and former fiscal year, if changed since last report)
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No o
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Website, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes x No o
Indicate by check mark if the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.
Large accelerated filer x
Accelerated filer o
Non-accelerated filer o (Do not check if a smaller reporting company)
Smaller reporting company o
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes o No x
Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date
Class
Shares Issued and Outstanding
Common Stock, $1.00 par value
67,522,606 shares outstanding at August 1, 2011
PART I - FINANCIAL INFORMATION
Item 1. Financial Statements
INTERNATIONAL BANCSHARES CORPORATION AND SUBSIDIARIES
Consolidated Statements of Condition (Unaudited)
(Dollars in Thousands)
June 30,
December 31,
2011
2010
Assets
Cash and due from banks
$
221,922
197,814
Total cash and cash equivalents
Investment securities:
Held-to-maturity (Market value of $2,450 on June 30, 2011 and $2,450 on December 31, 2010)
2,450
Available-for-sale (Amortized cost of $4,933,681 on June 30, 2011 and $5,041,847 on December 31, 2010)
5,067,648
5,086,457
Total investment securities
5,070,098
5,088,907
Loans, net of unearned discounts
5,256,183
5,410,003
Less allowance for probable loan losses
(78,481
)
(84,482
Net loans
5,177,702
5,325,521
Bank premises and equipment, net
460,933
468,950
Accrued interest receivable
33,969
35,660
Other investments
358,552
360,955
Identified intangible assets, net
14,705
17,309
Goodwill, net
282,532
Other assets
199,930
165,821
Total assets
11,820,343
11,943,469
1
Consolidated Statements of Condition, continued (Unaudited)
Liabilities and Shareholders’ Equity
Liabilities:
Deposits:
Demand — non-interest bearing
1,746,356
1,639,076
Savings and interest bearing demand
2,672,263
2,522,842
Time
3,368,266
3,437,640
Total deposits
7,786,885
7,599,558
Securities sold under repurchase agreements
1,423,589
1,433,270
Other borrowed funds
755,901
1,026,780
Junior subordinated deferrable interest debentures
190,726
201,117
Other liabilities
101,179
223,527
Total liabilities
10,258,280
10,484,252
Commitments, Contingent Liabilities and Other Tax Matters (Note 10)
Shareholders’ equity:
Series A Cumulative perpetual preferred shares, $.01 par value, $1,000 per share liquidation value. Authorized 25,000,000 shares; issued 216,000 shares on June 30, 2011, net of discount of $6,712 and issued 216,000 shares on December 31, 2010, net of discount of $7,932
209,288
208,068
Common shares of $1.00 par value. Authorized 275,000,000 shares; issued 95,717,948 shares on June 30, 2011 and 95,711,285 shares on December 31, 2010
95,718
95,711
Surplus
162,575
162,276
Retained earnings
1,261,403
1,214,743
Accumulated other comprehensive income (including $(7,285) and $(6,870) of comprehensive loss related to other-than-temporary impairment for non-credit related issues)
86,388
28,777
1,815,372
1,709,575
Less cost of shares in treasury, 28,195,342 shares on June 30, 2011 and 28,016,059 shares on December 31, 2010
(253,309
(250,358
Total shareholders’ equity
1,562,063
1,459,217
Total liabilities and shareholders’ equity
See accompanying notes to consolidated financial statements.
2
Consolidated Statements of Income (Unaudited)
(Dollars in Thousands, except per share data)
Three Months Ended June 30,
Six Months Ended June 30,
Interest income:
Loans, including fees
74,574
78,766
149,254
159,380
Taxable
29,208
32,348
59,463
69,681
Tax-exempt
2,386
1,783
4,514
3,416
Other interest income
1,676
183
1,751
425
Total interest income
107,844
113,080
214,982
232,902
Interest expense:
Savings deposits
2,232
2,410
4,494
4,891
Time deposits
8,145
12,822
16,915
25,875
10,613
11,235
21,199
22,287
Other borrowings
445
129
1,095
440
Junior subordinated interest deferrable debentures
2,998
3,047
6,035
6,077
Total interest expense
24,433
29,643
49,738
59,570
Net interest income
83,411
83,437
165,244
173,332
(Credit) provision for probable loan losses
(1,917
1,429
2,163
8,658
Net interest income after (credit) provision for probable loan losses
85,328
82,008
163,081
164,674
Non-interest income:
Service charges on deposit accounts
23,918
24,954
48,700
49,234
Other service charges, commissions and fees
Banking
14,412
12,167
27,438
23,787
Non-banking
1,177
1,855
2,669
3,523
Gain on investment securities transactions, net
1,445
2,573
2,861
30,837
Other investments, net
4,220
4,116
9,576
7,473
Other income
2,692
3,735
4,986
6,144
Total non-interest income
47,864
49,400
96,230
120,998
3
Consolidated Statements of Income, continued (Unaudited)
Non-interest expense:
Employee compensation and benefits
32,620
32,498
64,655
64,162
Occupancy
9,015
8,724
17,616
17,242
Depreciation of bank premises and equipment
7,931
8,969
16,258
17,981
Professional fees
3,689
3,781
7,575
7,763
Deposit insurance assessments
2,592
2,668
5,049
5,212
Net expense, other real estate owned
8,150
905
9,264
1,885
Amortization of identified intangible assets
1,323
1,324
2,626
2,625
Advertising
1,840
2,453
3,627
5,067
Litigation expense
—
21,803
Impairment charges (Total other-than-temporary impairment charges, $(254), net of $(420), $17, net of ($241), $1,055, net of $640, and $4,045, net of $(3,416) included in other comprehensive income)
166
258
415
7,461
Other
16,616
17,884
32,322
33,842
Total non-interest expense
83,942
79,464
159,407
185,043
Income before income taxes
49,250
51,944
99,904
100,629
Provision for income taxes
16,626
17,936
33,759
34,575
Net income
32,624
34,008
66,145
66,054
Preferred Stock Dividends
3,315
3,277
6,620
6,545
Net income available to common shareholders
29,309
30,731
59,525
59,509
Basic earnings per common share:
Weighted average number of shares outstanding:
67,628,223
68,063,899
67,664,567
68,083,089
.43
.45
.88
.87
Fully diluted earnings per common share:
67,689,784
68,163,864
67,734,494
68,184,767
4
Consolidated Statements of Comprehensive Income (Unaudited)
Other comprehensive income, net of tax
Net unrealized holding gains on securities available for sale arising during period (tax effects of $29,866, $9,567, $31,877 and $9,746)
55,465
17,766
59,201
18,099
Reclassification adjustment for gains on securities available for sale included in net income (tax effects of $(505), $(901), $(1,001) and $(10,793))
(940
(1,672
(1,860
(20,044
Reclassification adjustment for impairment charges on available for sale securities included in net income (tax effects of $58, $90, $145 and $2,611)
108
168
270
4,850
Comprehensive income
87,257
50,270
123,756
68,959
5
Consolidated Statements of Cash Flows (Unaudited)
Operating activities:
Adjustments to reconcile net income to net cash provided by operating activities:
Provision for probable loan losses
Accretion of time deposit discounts
(7
Gain on sale of bank premises and equipment
(332
(192
Accretion of investment securities discounts
(870
(793
Amortization of investment securities premiums
10,223
4,940
Investment securities transactions, net
(2,861
(30,837
Impairment charges on available-for-sale investment securities
Amortization of junior subordinated debenture discounts
9
18
Stock based compensation expense
195
297
Earnings from affiliates and other investments
(8,980
(6,490
Deferred tax benefit
(2,283
(10,374
Decrease in accrued interest receivable
1,691
2,599
Net decrease (increase) in other assets
7,149
5,867
Net increase in other liabilities
2,942
28,448
Net cash provided by operating activities
94,483
96,255
Investing activities:
Proceeds from maturities of securities
500
600
Proceeds from sales and calls of available for sale securities
774,856
1,051,172
Purchases of available for sale securities
(1,331,496
(1,238,690
Principal collected on mortgage-backed securities
497,445
458,264
Net decrease in loans
104,376
89,232
Purchases of other investments
(2,173
(1,014
Distributions of other investments
13,556
43,912
Purchases of bank premises and equipment
(9,018
(8,553
Proceeds from sale of bank premises and equipment
1,109
1,678
Net cash provided by investing activities
49,155
396,601
6
Consolidated Statements of Cash Flows, continued (Unaudited)
Financing activities:
Net increase in non-interest bearing demand deposits
107,280
44,561
Net increase in savings and interest bearing demand deposits
149,421
121,767
Net (decrease) increase in time deposits
(69,367
135,544
Net (decrease) increase in securities sold under repurchase agreements
(9,681
Net decrease in other borrowed funds
(270,879
(804,125
Repayment of long-term debt
(5,200
Purchase of treasury stock
(2,951
(2,663
Proceeds from stock transactions
110
Payments of dividends on common stock
(12,863
(11,578
Payments of dividends on preferred stock
(5,400
Net cash used in financing activities
(119,530
(473,193
Increase in cash and cash equivalents
24,108
19,663
Cash and cash equivalents at beginning of period
224,638
Cash and cash equivalents at end of period
244,301
Supplemental cash flow information:
Interest paid
52,494
60,729
Income taxes paid
42,773
45,552
Accrued dividends, preferred shares
1,350
Sales of available-for-sale securities not yet settled
15,271
Net transfer from loans to other real estate owned
41,280
25,724
Purchases of available-for-sale securities not yet settled
28,269
Accrued partial redemption of trust preferred securities, IB Capital Trust I
5,200
7
Notes to Consolidated Financial Statements
(Unaudited)
Note 1 - Basis of Presentation
The accounting and reporting policies of International Bancshares Corporation (“Corporation”) and Subsidiaries (the Corporation and Subsidiaries collectively referred to herein as the “Company”) conform to accounting principles generally accepted in the United States of America and to general practices within the banking industry. The consolidated financial statements include the accounts of the Corporation and its wholly-owned subsidiaries, International Bank of Commerce, Laredo (“IBC”), Commerce Bank, International Bank of Commerce, Zapata, International Bank of Commerce, Brownsville and the Corporation’s wholly-owned non-bank subsidiaries, IBC Subsidiary Corporation, IBC Life Insurance Company, IBC Trading Company, IBC Capital Corporation and Premier Tierra Holdings, Inc. All significant inter-company balances and transactions have been eliminated in consolidation. The consolidated financial statements are unaudited, but include all adjustments, which, in the opinion of management, are necessary for a fair presentation of the results of the periods presented. All such adjustments were of a normal and recurring nature. It is suggested that these financial statements be read in conjunction with the financial statements and the notes thereto in the Company’s latest Annual Report on Form 10-K. The consolidated statement of condition at December 31, 2010 has been derived from the audited financial statements at that date but does not include all of the information and footnotes required by accounting principles generally accepted in the United States of America for complete financial statements. Certain reclassifications have been made to make prior periods comparable.
The Company operates as one segment. The operating information used by the Company’s chief executive officer for purposes of assessing performance and making operating decisions about the Company is the consolidated statements presented in this report. The Company has four active operating subsidiaries, namely, the bank subsidiaries, otherwise known as International Bank of Commerce, Laredo, Commerce Bank, International Bank of Commerce, Zapata and International Bank of Commerce, Brownsville.
The Company has evaluated all events or transactions that occurred through the date the Company issued these financial statements. During this period, the Company did not have any material recognizable or non-recognizable subsequent events.
Note 2 — Fair Value Measurements
Fair value is defined as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date; it also establishes a fair value hierarchy that prioritizes the inputs used in valuation methodologies into the following three levels:
· Level 1 Inputs — Unadjusted quoted prices in active markets for identical assets or liabilities.
· Level 2 Inputs — Observable inputs other than Level 1 prices, such as quoted prices for similar assets or liabilities; quoted prices in markets that are not active; or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the assets or liabilities.
· Level 3 Inputs — Unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the assets or liabilities. Level 3 assets and liabilities include financial instruments whose value is determined using pricing models, discounted cash flow methodologies, or other valuation techniques, as well as instruments for which the determination of fair value requires significant management judgment or estimation.
A description of the valuation methodologies used for instruments measured at fair value, as well as the general classification of such instruments pursuant to the valuation hierarchy is set forth below.
The following table represents assets and liabilities reported on the consolidated balance sheets at their fair value on a recurring basis as of June 30, 2011 by level within the fair value measurement hierarchy:
8
Fair Value Measurements at Reporting Date Using
(in thousands)
Assets/Liabilities Measured at Fair Value
Quoted Prices in Active Markets for Identical Assets
Significant Other Observable Inputs
Significant Unobservable Inputs
June 30, 2011
(Level 1)
(Level 2)
(Level 3)
Measured on a recurring basis:
Assets:
U.S. Treasury securities
Available-for-sale
828
Residential mortgage-backed securities
4,843,601
4,801,913
41,688
States and political subdivisions
208,458
14,761
The following table represents assets and liabilities reported on the consolidated balance sheets at their fair value on a recurring basis as of December 31, 2010 by level within the fair value measurement hierarchy:
December 31, 2010
1,327
4,924,468
4,878,440
46,028
145,997
14,665
Investment securities available-for-sale are classified within level 2 and level 3 of the valuation hierarchy, with the exception of certain equity investments that are classified within level 1. For investments classified as level 2 in the fair value hierarchy, the Company obtains fair value measurements for investment securities from an independent pricing service. The fair value measurements consider observable data that may include dealer quotes, market spreads, cash flows, the U.S. Treasury yield curve, live trading levels, trade execution data, market consensus prepayment speeds, credit information and the bond’s terms and conditions, among other things. Investment securities classified as level 3 are non-agency mortgage-backed securities. The non-agency mortgage-backed securities held by the Company are traded in in-active markets and markets that have experienced significant decreases in volume and level of activity, as exhibited by few recent transactions, a significant decline or absence of new issuances, price quotations that are not based on comparable securities transactions and wide bid-ask spreads among other factors. As a result of the inability to use quoted market prices to determine fair value for these securities, the Company determined that fair value, as determined by level 3 inputs in the fair value hierarchy, is more appropriate for financial reporting and more consistent with the expected performance of the investments. For the investments classified within level 3 of the fair value hierarchy, the Company used a discounted cash flow model to determine fair value. Inputs in the model included both historical performance and expected future performance based on information currently available. Assumptions used in the discounted cash flow model included estimates on future principal prepayment rates, default and loss severity rates. The Company estimates that future principal prepayment rates will range from 4 — 5% and used a 13% discount rate. Default rates used in the model were 10 — 11% for the first year and 7% thereafter, and loss severity rates started at 60% for the first year and are declined by 10% for the following three years, and remains at 20% thereafter.
The following table presents a reconciliation of activity for such mortgage-backed securities on a net basis (dollars in thousands):
Balance at December 31, 2010
Principal paydowns, net of discount amortization
(3,285
Total unrealized gains (losses) included in:
Other comprehensive income
(640
(415
Balance at June 30, 2011
Certain assets and liabilities are measured at fair value on a nonrecurring basis. They are not measured at fair value on an ongoing basis but are subject to fair value adjustments in certain circumstances (for example, when there is evidence of impairment).
The following table represents assets measured at fair value on a non-recurring basis as of and for the period ended June 30, 2011 by level within the fair value measurement hierarchy:
Quoted
Assets/Liabilities
Prices in
Measured at Fair
Active
Significant
Value
Markets for
Six months
Identical
Observable
Unobservable
Provision
ended
Inputs
During
Period
Measured on a non-recurring basis:
Impaired loans
25,855
814
Other real estate owned
31,042
7,633
10
The following table represents assets measured at fair value on a non-recurring basis as of and for the year ended December 31, 2010 by level within the fair value measurement hierarchy:
Year ended
24,034
(114
52,319
719
The Company’s assets measured at fair value on a non-recurring basis are limited to impaired loans and other real estate owned. Impaired loans are classified within level 3 of the valuation hierarchy. The fair value of impaired loans is derived in accordance with FASB ASC Topic 310, “Receivables”. The fair value of impaired loans is based on the fair value of the collateral, as determined through an external appraisal process, discounted based on internal criteria. Impaired loans are primarily comprised of collateral-dependent commercial loans. Impaired loans are remeasured and reported at fair value through a specific valuation allowance allocation of the allowance for probable loan losses based upon the fair value of the underlying collateral.
Other real estate owned is comprised of real estate acquired by foreclosure and deeds in lieu of foreclosure. Other real estate owned is carried at the lower of the recorded investment in the property or its fair value less estimated costs to sell such property (as determined by independent appraisal) within level 3 of the fair value hierarchy. Prior to foreclosure, the value of the underlying loan is written down to the fair value of the real estate to be acquired by a charge to the allowance for probable loan losses, if necessary. The fair value is reviewed periodically and subsequent write downs are made accordingly. Other real estate owned is included in other assets on the consolidated financial statements. For the six months ended June 30, 2011 and the twelve months ended December 31, 2010, the Company recorded $1,251,000 and $23,999,000 in charges to the allowance for probable loan losses in connection with other real estate owned. For the six months ended June 30, 2011 and the twelve months ended December 31, 2010, the Company recorded $7,633,000 and $719,000 in write downs in fair value in connection with other real estate owned.
The fair value estimates, methods, and assumptions for the Company’s financial instruments at June 30, 2011 and December 31, 2010 are outlined below.
Cash and Due From Banks and Federal Funds Sold
For these short-term instruments, the carrying amount is a reasonable estimate of fair value.
Time Deposits with Banks
The carrying amounts of time deposits with banks approximate fair value.
Investment securities held-to-maturity
The carrying amounts of investments held-to-maturity approximate fair value.
11
Investment Securities
For investment securities, which include U. S. Treasury securities, obligations of other U. S. government agencies, obligations of states and political subdivisions and mortgage pass through and related securities, fair values are based on quoted market prices or dealer quotes. Fair values are based on the value of one unit without regard to any premium or discount that may result from concentrations of ownership of a financial instrument, probable tax ramifications, or estimated transaction costs. See disclosures of fair value of investment securities in Note 6.
Loans
Fair values are estimated for portfolios of loans with similar financial characteristics. Loans are segregated by type such as commercial, real estate and consumer loans as outlined by regulatory reporting guidelines. Each category is segmented into fixed and variable interest rate terms and by performing and non-performing categories.
For variable rate performing loans, the carrying amount approximates the fair value. For fixed rate performing loans, except residential mortgage loans, the fair value is calculated by discounting scheduled cash flows through the estimated maturity using estimated market discount rates that reflect the credit and interest rate risk inherent in the loan. For performing residential mortgage loans, fair value is estimated by discounting contractual cash flows adjusted for prepayment estimates using discount rates based on secondary market sources or the primary origination market. At June 30, 2011, and December 31, 2010, the carrying amount of fixed rate performing loans was $1,342,693,000 and $1,337,827,000 respectively, and the estimated fair value was $1,266,119,000 and $1,226,413,000, respectively.
Accrued Interest
The carrying amounts of accrued interest approximate fair value.
Deposits
The fair value of deposits with no stated maturity, such as non-interest bearing demand deposit accounts, savings accounts and interest bearing demand deposit accounts, was equal to the amount payable on demand as of June 30, 2011 and December 31, 2010. The fair value of time deposits is based on the discounted value of contractual cash flows. The discount rate is based on currently offered rates. At June 30, 2011 and December 31, 2010, the carrying amount of time deposits was $3,368,266,000 and $3,437,640,000, respectively, and the estimated fair value was $3,379,746,000 and $3,449,980,000, respectively.
Securities Sold Under Repurchase Agreements
Securities sold under repurchase agreements include both short and long-term maturities. Due to the contractual terms of the short-term instruments, the carrying amounts approximated fair value at June 30, 2011 and December 31, 2010. The fair value of the long-term instruments is based on established market spreads. At June 30, 2011 and December 31, 2010, the carrying amount of long-term repurchase agreements was $1,000,000,000 and the estimated fair value was $1,127,908,000 and $1,123,774,000, respectively.
Junior Subordinated Deferrable Interest Debentures
The Company currently has fixed and floating rate junior subordinated deferrable interest debentures outstanding. Due to the contractual terms of the floating rate junior subordinated deferrable interest debentures, the carrying amounts approximated fair value at June 30, 2011 and December 31, 2010. The fair value of the fixed rate junior subordinated deferrable interest debentures is based on established market spreads to the debentures. At June 30, 2011 and December 31, 2010, the carrying amount of fixed rate junior subordinated deferrable interest debentures was $128,868,000 and $139,259,000, respectively, and the estimated fair value was $70,259,000 and $74,103,000, respectively.
12
Other Borrowed Funds
The company currently has short and long-term borrowings issued from the Federal Home Loan Bank (“FHLB”). Due to the contractual terms of the short-term borrowings, the carrying amounts approximated fair value at June 30, 2011 and December 31, 2010. The fair value of the long-term borrowings is based on established market spreads for similar types of borrowings. At June 30, 2011 and December 31, 2010, the carrying amount of the long-term FHLB borrowings was $6,726,000 and $6,780,000, respectively, and the estimated fair value was $6,726,000 and $6,780,000, respectively.
Commitments to Extend Credit and Letters of Credit
Commitments to extend credit and fund letters of credit are principally at current interest rates, and, therefore, the carrying amount approximates fair value.
Limitations
Fair value estimates are made at a point in time, based on relevant market information and information about the financial instrument. These estimates do not reflect any premium or discount that could result from offering for sale at one time the Company’s entire holdings of a particular financial instrument. Because no market exists for a significant portion of the Company’s financial instruments, fair value estimates are based on judgments regarding future expected loss experience, current economic conditions, risk characteristics of various financial instruments and other factors. These estimates are subjective in nature and involve uncertainties and matters of significant judgment and therefore cannot be determined with precision. Changes in assumptions could significantly affect the estimates.
Fair value estimates are based on existing on-and off-statement of condition financial instruments without attempting to estimate the value of anticipated future business and the value of assets and liabilities that are not considered financial instruments. Other significant assets and liabilities that are not considered financial assets or liabilities include the bank premises and equipment and core deposit value. In addition, the tax ramifications related to the effect of fair value estimates have not been considered in the above estimates.
Note 3— Loans
A summary of net loans, by loan type at June 30, 2011 and December 31, 2010 is as follows:
Commercial, financial and agricultural
2,658,034
2,615,878
Real estate — mortgage
943,978
948,982
Real estate — construction
1,297,647
1,473,471
Consumer
108,113
126,047
Foreign
248,411
245,625
Total loans
13
Note 4 - Allowance for Probable Loan Losses
The allowance for probable loan losses consists of the aggregate loan loss allowances of the subsidiaries that hold loans. The allowances are established through charges to operations in the form of provisions for probable loan losses. Loan losses or recoveries are charged or credited directly to the allowances. The allowance for probable loan losses of each subsidiary is maintained at a level considered appropriate by management, based on estimated probable losses in the loan portfolio. The allowance for probable loan losses is derived from the following elements: (i) allowances established on specific loans, which are based on a review of the individual characteristics of each loan, including the customer’s ability to repay the loan, the underlying collateral values, and the industry the customer operates in (ii) allowances based on actual historical loss experience for similar types of loans in the Company’s loan portfolio and (iii) allowances based on general economic conditions, changes in the mix of loans, Company resources, border risk and credit quality indicators, among other things. All segments of the loan portfolio continue to be impacted by the prolonged economic downturn. Loans secured by real estate could be impacted negatively by the continued economic environment and resulting decrease in collateral values. Consumer loans may be impacted by continued and prolonged unemployment rates.
The Company’s management continually reviews the allowance for loan loss of the subsidiaries using the amounts determined from the allowances established on specific loans, allowance established on quantitative historical percentages, allowance based on qualitative data, and the loans charged off and recoveries to establish an appropriate amount to maintain in the Company’s allowance for loan loss. If the basis of the Company’s assumptions change, the allowance for loan loss would either decrease or increase and the Company would increase or decrease the provision for loan loss charged to operations accordingly. While the calculation of the allowance for probable loan losses utilizes management’s best judgment and all information available, the adequacy of the allowance is dependent on a variety of factors beyond the Company’s control, including, among other things, the performance of the entire loan portfolio, the economy, changes in interest rates and the view of regulatory authorities towards loan classifications.
The specific loan loss provision is determined using the following methods. On a weekly basis, loan past due reports are reviewed by the servicing loan officer to determine if a loan has any potential problem and if a loan should be placed on the Company’s internal classified report. Additionally, the Company’s credit department reviews the majority of the Company’s loans regardless of whether they are past due and segregates any loans with potential problems for further review. The credit department will discuss the potential problem loans with the servicing loan officers to determine any relevant issues that were not discovered in the evaluation. Also, any analysis on loans that is provided through examinations by regulatory authorities is considered in the review process. After the above analysis is completed, the Company will determine if a loan should be placed on an internal classified report because of issues related to the analysis of the credit, credit documents, collateral and/or payment history.
A summary of the transactions in the allowance for probable loan losses by loan class is as follows:
Domestic
Commercial
Commercial real estate: other construction & land development
Commercial real estate: farmland & commercial
Commercial real estate: multifamily
Residential: first lien
Residential: junior lien
Total
Balance at December 31,
22,046
26,695
16,340
53
10,059
2,611
6,241
437
84,482
Losses charge to allowance
(6,818
(1,218
(645
(659
(566
(570
(13
(10,490
Recoveries credited to allowance
1,671
74
194
264
118
2,326
Net losses charged to allowance
(5,147
(1,144
(451
(655
(302
(452
(12
(8,164
(Credit) provision charged to operations
3,728
(5,475
5,439
801
(3,294
3,224
(3,411
1,150
Balance at June 30,
20,627
20,076
21,328
854
6,110
5,533
2,378
1,575
78,481
14
95,393
Losses charged to allowance
(14,298
615
(13,683
Provision charged to operations
90,368
The allowance for probable loan losses is a reserve established through a provision for probable loan losses charged to expense, which represents management’s best estimate of probable loan losses when evaluating loans (i) individually or (ii) collectively. The Company’s provision for probable loan losses decreased from December 31, 2010 to June 30, 2011 mainly due to a decrease in the Company’s charge-off experience over the last year and a decrease in the loan portfolio. While the Texas and Oklahoma economies are performing better and appear to be recovering faster than other parts of the country, Texas and Oklahoma are not completely immune to the problems associated with the U.S. economy.
The table below provides additional information on the balance of loans individually or collectively evaluated for impairment and their related allowance, by loan class as of June 30, 2011 and December 31, 2010:
Loans individually evaluated for impairment
Loans collectively evaluated for impairment
Recorded Investment
Allowance
23,365
7,937
799,557
12,690
32,674
371
1,264,973
19,705
31,340
4,334
1,691,043
16,994
112,289
1,799
534,678
1,519
405,982
1,100
107,013
248,410
92,238
12,642
5,163,945
65,839
15
Loans collectively evaluated
for impairment
23,426
8,138
807,098
13,908
77,207
592
1,396,264
26,103
21,844
3,441
1,666,719
12,899
473
96,318
2,015
531,440
199
415,328
29
126,018
245,618
125,200
12,171
5,284,803
72,311
The table below provides additional information on loans accounted for on a non-accrual basis by loan class at June 30, 2011 and December 31, 2010:
22,565
22,614
26,582
10,086
5,486
1,707
57
27
Total non-accrual loans
61,465
108,030
Impaired loans are those loans where it is probable that all amounts due according to contractual terms of the loan agreement will not be collected. The Company has identified these loans through its normal loan review procedures. Impaired loans are measured based on (1) the present value of expected future cash flows discounted at the loan’s effective interest rate; (2) the loan’s observable market price; or (3) the fair value of the collateral if the loan is collateral dependent. Substantially all of the Company’s impaired loans are measured at the fair value of the collateral. In limited cases, the Company may use other methods to determine the level of impairment of a loan if such loan is not collateral dependent.
16
The following tables detail key information regarding the Company’s impaired loans by loan class at June 30, 2011 and December 31, 2010:
Unpaid Principal Balance
Related Allowance
Average Recorded Investment
Interest Recognized
Loans with Related Allowance
22,942
22,948
20
8,136
8,147
8,177
22,468
22,489
413
Total impaired loans with related allowance
53,546
53,578
52,324
433
Loans with No Related Allowance
423
916
458
24,538
24,595
20,433
8,872
10,336
1,366
454
1,937
1,816
1,520
1,521
48
1,105
1,281
Total impaired loans with no related allowance
38,692
40,850
27,332
62
17
23,062
23,071
23,096
42
10,603
10,645
10,622
17,841
17,878
18,475
860
51,506
51,594
52,193
902
364
980
993
30
66,604
66,755
68,608
4,003
5,606
5,594
2,143
2,297
226
228
46
49
19
73,694
76,236
78,288
32
The impaired loans included in the tables above were primarily comprised of collateral dependent commercial loans, which have not been fully charged off. A portion of the impaired loans have adequate collateral and credit enhancements not requiring a related allowance for loan loss. The level of impaired loans is reflective of the economic weakness that has been created by the financial crisis and the subsequent economic downturn. Management is confident the Company’s loss exposure regarding these credits will be significantly reduced due to the Company’s long-standing practices that emphasize secured lending with strong collateral positions and guarantor support. Management is likewise confident the allowance for probable loan losses is adequate. The Company has no direct exposure to sub-prime loans in its loan portfolio, but the sub-prime crisis has affected the credit markets on a national level, and as a result, the Company has experienced an increasing amount of impaired loans; however, management’s decision to place loans in this category does not necessarily mean that the Company will experience significant losses from these loans or significant increases in impaired loans from these levels.
Management of the Company recognizes the risks associated with these impaired loans. However, management’s decision to place loans in this category does not necessarily mean that losses will occur. In the current environment, troubled loan management can be protracted because of the legal and process problems that delay the collection of an otherwise collectable loan. Additionally, management believes that the collateral related to these impaired loans and/or the secondary support from guarantors mitigates the potential for losses from impaired loans. It is also important to note that even though the economic conditions in Texas and Oklahoma are weakened, we believe these markets are improving and better positioned to recover than many other areas of the country.
The subsidiaries charge off that portion of any loan which management considers to represent a loss as well as that portion of any other loan which is classified as a “loss” by bank examiners. Commercial and industrial or real estate loans are generally considered by management to represent a loss, in whole or part, when an exposure beyond any collateral coverage is apparent and when no further collection of the loss portion is anticipated based on the borrower’s financial condition and general economic conditions in the borrower’s industry. Generally, unsecured consumer loans are charged-off when 90 days past due.
While management of the Company considers that it is generally able to identify borrowers with financial problems reasonably early and to monitor credit extended to such borrowers carefully, there is no precise method of predicting loan losses. The determination that a loan is likely to be uncollectible and that it should be wholly or partially charged-off as a loss is an exercise of judgment. Similarly, the determination of the adequacy of the allowance for probable loan losses can be made only on a subjective basis. It is the judgment of the Company’s management that the allowance for probable loan losses at June 30, 2011 was adequate to absorb probable losses from loans in the portfolio at that date.
The following table presents information regarding the aging of past due loans by loan class at June 30, 2011 and December 31, 2010:
30 — 59 Days
60 — 89 Days
90 Days or Greater
90 Days or greater & still accruing
Total Past due
Current
Total Portfolio
3,452
1,162
1,202
692
5,816
817,106
822,922
1,139
372
25,668
5,266
27,179
1,270,468
6,517
1,348
17,973
9,364
25,838
1,696,545
1,722,383
76
516
112,213
112,729
7,818
2,260
5,764
4,417
15,842
520,635
536,477
1,272
562
368
321
2,202
405,299
407,501
2,369
502
1,230
1,207
4,101
104,012
1,657
444
483
2,584
245,827
Total past due loans
24,300
6,650
53,128
21,750
84,078
5,172,105
3,734
861
23,239
1,029
27,834
802,690
830,524
2,685
2,896
50,618
11,507
56,199
1,417,272
3,077
817
6,600
1,585
10,494
1,678,069
1,688,563
73
185
731
96,060
96,791
4,884
3,436
5,136
3,472
13,456
519,999
533,455
703
272
457
277
1,432
414,095
415,527
1,518
587
1,505
1,477
3,610
122,437
196
380
501
1,077
244,548
16,870
9,434
88,529
19,848
114,833
5,295,170
The Company’s internal classified report is segregated into the following categories: (i) “Special Review Credits,” (ii) “Watch List - Pass Credits,” or (iii) “Watch List - Substandard Credits.” The loans placed in the “Special Review Credits” category reflect the Company’s opinion that the loans reflect potential weakness which requires monitoring on a more frequent basis. The “Special Review Credits” are reviewed and discussed on a regular basis with the credit department and the lending staff to determine if a change in category is warranted. The loans placed in the “Watch List - Pass Credits” category reflect the Company’s opinion that the credit contains weaknesses which represent a greater degree of risk, which warrant “extra attention.” The “Watch List — Pass Credits” are reviewed and discussed on a regular basis with the credit department and the lending staff to determine if a change in category is warranted. The loans placed in the “Watch List — Substandard Credits” classification are considered to be potentially inadequately protected by the current sound worth and debt service capacity of the borrower or of any pledged collateral. These credit obligations, even if apparently protected by collateral value, have shown defined weaknesses related to adverse financial, managerial, economic, market or political conditions which may jeopardize repayment of principal and interest. Furthermore, there is the possibility that some future loss could be sustained by the Company if such weaknesses are not corrected. For loans that are classified as impaired, management evaluates these credits under Statement of Financial Accounting Standards No. 114, “Accounting by Creditors for Impairment of a Loan,” now included as part of ASC Topic 310-10, “Receivables,” criteria and, if deemed necessary, a specific reserve is allocated to the credit. The specific reserve allocated under ASC 310-10, is based on (i) the present value of expected future cash flows discounted at the loan’s effective interest rate; (ii) the loan’s observable market price; or (iii) the fair value of the collateral if the loan is collateral dependent. Substantially all of the Company’s loans evaluated as impaired under ASC 310-10 are measured using the fair value of collateral method. In limited cases, the Company may use other methods to determine the specific reserve of a loan under ASC 310-10 if such loan is not collateral dependent.
The allowance based on historical loss experience on the Company’s remaining loan portfolio, which includes the “Special Review Credits,” “Watch List - Pass Credits,” and “Watch List - Substandard Credits” is determined by segregating the remaining loan portfolio into certain categories such as commercial loans, installment loans, international loans, loan concentrations and overdrafts. Installment loans are then further segregated by number of days past due. A historical loss percentage, adjusted for (i) management’s evaluation of changes in lending policies and procedures, (ii) current economic conditions in the market area served by the Company, (iii) other risk factors, (iv) the effectiveness of the internal loan review function, (v) changes in loan portfolios, and (vi) the composition and concentration of credit volume is applied to each category. Each category is then added together to determine the allowance allocated under ASC Topic 450-20.
A summary of the loan portfolio by credit quality indicator by loan class at June 30, 2011 and December 31, 2010 is as follows:
Pass
Special Review
Watch List - Pass
Watch List - Substandard
Watch List - Impaired
733,204
5,807
6,839
53,707
999,131
79,988
42,215
143,639
1,492,529
98,524
36,639
63,351
88,792
23,497
530,461
636
61
3,520
405,942
40
106,969
44
247,913
497
4,604,941
208,452
85,754
264,798
21
741,006
14,015
7,187
44,890
1,100,430
117,058
53,770
125,006
1,521,243
42,353
29,936
73,187
94,973
1,345
526,504
2,237
1,747
952
415,021
307
125,973
234,979
10,108
531
4,760,129
187,119
92,640
244,915
Note 5 — Stock Options
On April 1, 2005, the Board of Directors adopted the 2005 International Bancshares Corporation Stock Option Plan (the “2005 Plan”). Effective May 19, 2008, the 2005 Plan was amended to increase the number of shares available for stock option grants under the 2005 Plan by 300,000 shares. The 2005 Plan replaced the 1996 International Bancshares Corporation Key Contributor Stock Option Plan (the “1996 Plan”). Under the 2005 Plan, both qualified incentive stock options (“ISOs”) and non-qualified stock options (“NQSOs”) may be granted. Options granted may be exercisable for a period of up to 10 years from the date of grant, excluding ISOs granted to 10% shareholders, which may be exercisable for a period of up to only five years. As of June 30, 2011, 210,322 shares were available for future grants under the 2005 Plan.
A summary of option activity under the stock option plans for the six months ended June 30, 2011 is as follows:
Number of options
Weighted average exercise price
Weighted average remaining contractual term (years)
Aggregate intrinsic value ($)
Options outstanding at December 31, 2010
764,982
20.65
Plus: Options granted
1,500
18.44
Less:
Options exercised
7,092
17.95
Options expired
81,218
19.93
Options forfeited
25,221
18.86
Options outstanding at June 30, 2011
652,951
20.86
3.77
1,333
Options fully vested and exercisable at June 30, 2011
323,472
24.73
2.82
Stock-based compensation expense included in the consolidated statements of income for the three and six months ended June 30, 2011 was approximately $93,000 and $195,000, respectively. Stock-based compensation expense included in the consolidated statements of income for the three and six months ended June 30, 2010 was approximately $145,000 and $297,000, respectively. As of June 30, 2011, there was approximately $480,000 of total unrecognized stock-based compensation cost related to non-vested options granted under the Company plans that will be recognized over a weighted average period of 1.3 years.
22
Note 6 - Investment Securities
The Company classifies debt and equity securities into one of three categories: held-to maturity, available-for-sale, or trading. Such securities are reassessed for appropriate classification at each reporting date. Securities classified as “held-to-maturity” are carried at amortized cost for financial statement reporting, while securities classified as “available-for-sale” and “trading” are carried at their fair value. Unrealized holding gains and losses are included in net income for those securities classified as “trading”, while unrealized holding gains and losses related to those securities classified as “available-for-sale” are excluded from net income and reported net of tax as other comprehensive income (loss) and accumulated other comprehensive income (loss) until realized, or in the case of losses, when deemed other than temporary.
The amortized cost and estimated fair value by type of investment security at June 30, 2011 are as follows:
Held to Maturity
Amortized cost
Gross unrealized gains
Gross unrealized losses
Estimated fair value
Carrying value
Other securities
Available for Sale
Carrying value (1)
4,716,507
138,394
(11,300
Obligations of states and political subdivisions
202,521
6,938
(1,001
Equity securities
13,825
949
4,933,681
146,281
(12,314
(1) Included in the carrying value of residential mortgage-backed securities are $3,031,788 of mortgage-backed securities issued by Ginnie Mae, $1,770,125 of mortgage-backed securities issued by Fannie Mae and Freddie Mac and $41,688 issued by non-government entities
The amortized cost and estimated fair value by type of investment security at December 31, 2010 are as follows:
4,876,573
77,741
(29,846
150,122
(4,761
864
(24
5,041,847
79,241
(34,631
(1) Included in the carrying value of residential mortgage-backed securities are $2,326,378 of mortgage-backed securities issued by Ginnie Mae, $2,552,062 of mortgage-backed securities issued by Fannie Mae and Freddie Mac and $46,028 issued by non-government entities
23
The amortized cost and estimated fair value of investment securities at June 30, 2011, by contractual maturity, are shown below. Expected maturities will differ from contractual maturities because borrowers may have the right to prepay obligations with or without prepayment penalties.
Amortized Cost
Due in one year or less
1,225
Due after one year through five years
233
236
Due after five years through ten years
4,828
4,880
Due after ten years
197,460
203,342
Residential mortgage-backed securities are securities issued by Freddie Mac, Fannie Mae, Ginnie Mae or non-government entities. Investments in residential mortgage-backed securities issued by Ginnie Mae are fully guaranteed by the U.S. Government. Investments in mortgage-backed securities issued by Freddie Mac and Fannie Mae are not fully guaranteed by the U.S. Government, however, the Company believes that the quality of the bonds is similar to other AAA rated bonds with limited credit risk, particularly given the placement of Fannie Mae and Freddie Mac into conservatorship by the federal government in early September 2008.
The amortized cost and fair value of available for sale investment securities pledged to qualify for fiduciary powers, to secure public monies as required by law, repurchase agreements and short-term fixed borrowings was $2,641,895,000 and $2,727,905,000 at June 30, 2011.
Proceeds from the sale of securities available-for-sale were $422,177,000 and $774,856,000 for the three and six months ended June 30, 2011, which included $420,149,000 and $770,244,000 of mortgage-backed securities. Gross gains of $1,458,000 and $2,893,000 and gross losses of $(13,000) and $(32,000) were realized on the sales for the three and six months ended June 30, 2011, respectively. Proceeds from the sale of securities available-for-sale were $105,502,000 and $1,051,172,000 for the three and six months ended June 30, 2010, which included $99,058,000 and $1,042,678,000 of mortgage-backed securities. Gross gains of $2,576,000 and $30,843,000 and gross losses of $(3,000) and $(6,000) were realized on the sales for the three and six months ended June 30, 2010, respectively.
Gross unrealized losses on investment securities and the fair value of the related securities, aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position at June 30, 2011, were as follows:
Less than 12 months
12 months or more
Fair Value
Unrealized Losses
Available for sale:
777
(6
(11,294
42,465
17,727
(834
(167
18,229
Other equity securities
18,504
(840
42,252
(11,474
60,756
24
Gross unrealized losses on investment securities and the fair value of the related securities, aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position, at December 31, 2010 were as follows:
1,166,720
(19,192
(10,654
1,212,748
97,701
(4,666
355
(95
98,056
4,988
63
5,051
1,269,409
(23,870
46,446
(10,761
1,315,855
The unrealized losses on investments in residential mortgage-backed securities are primarily caused by changes in market interest rates. Residential mortgage-backed securities are primarily securities issued by Freddie Mac, Fannie Mae and Ginnie Mae. Investments in mortgage-backed securities issued by Ginnie Mae are fully guaranteed by the U.S. Government. Investments in mortgage-backed securities issued by Freddie Mac and Fannie Mae are not fully guaranteed by the U.S. Government; however, the Company believes the quality of the bonds is similar to other AAA rated bonds with limited credit risk, particularly given the placement of Fannie Mae and Freddie Mac into conservatorship by the federal government in early September 2008. The decrease in fair value on residential mortgage-backed securities issued by Freddie Mac, Fannie Mae and Ginnie Mae is due to market interest rates. The Company has no intent to sell and will more than likely not be required to sell before a market price recovery or maturity of the securities; therefore, it is the conclusion of the Company that the investments in residential mortgage-backed securities issued by Freddie Mac, Fannie Mae and Ginnie Mae are not considered other-than-temporarily impaired. In addition, the Company has a small investment in non-agency residential mortgage-backed securities that have strong credit backgrounds and include additional credit enhancements to protect the Company from losses arising from high foreclosure rates. These securities have additional market volatility beyond economically induced interest rate events. It is the conclusion of the Company that the investments in non-agency residential mortgage-backed securities are other-than-temporarily impaired due to both credit and other than credit issues. Impairment charges of $166,000 ($107,900, after tax) and $415,000 ($269,750, after tax) were recorded for the three and six months ended June 30, 2011. Impairment charges of $258,000 ($167,700, after tax) and $7,461,000 ($4,849,650, after tax) were recorded for the three and six months ended June 30, 2010. The impairment charge represents the credit related impairment on the securities.
The unrealized losses on investments in other securities are caused by fluctuations in market interest rates. The underlying cash obligations of the securities are guaranteed by the entity underwriting the debt instrument. It is the belief of the Company that the entity issuing the debt will honor its interest payment schedule, as well as the full debt at maturity. The securities are purchased by the Company for their economic value. The decrease in fair value is primarily due to market interest rates and not other factors, and because the Company has no intent to sell and will more than likely not be required to sell before a market price recovery or maturity of the securities, it is the conclusion of the Company that the investments are not considered other-than-temporarily impaired.
The following table presents a reconciliation of credit-related impairment charges on available-for-sale investments recognized in earnings for the three months ended June 30, 2011 (Dollars in Thousands):
Balance at March 31, 2011
8,665
Impairment charges recognized during period
8,831
The following table presents a reconciliation of credit-related impairment charges on available-for-sale investments recognized in earnings for the six months ended June 30, 2011 (Dollars in Thousands):
8,416
25
The following table presents a reconciliation of credit-related impairment charges on available-for-sale investments recognized in earnings for the three months ended June 30, 2010 (Dollars in Thousands):
Balance at March 31, 2010
7,203
Balance at June 30, 2010
The following table presents a reconciliation of credit-related impairment charges on available-for-sale investments recognized in earnings for the six months ended June 30, 2010 (Dollars in Thousands):
Balance at December 31, 2009
Note 7 — Other Borrowed Funds
Other borrowed funds include Federal Home Loan Bank borrowings, which are short-term and long-term borrowings issued by the FHLB of Dallas at the market price offered at the time of funding. These borrowings are secured by residential mortgage-backed investment securities and a portion of the Company’s loan portfolio. At June 30, 2011, other borrowed funds totaled $755,901,000, a decrease of 26.4% from $1,026,780,000 at December 31, 2010. The decrease in other borrowed funds can be attributed to the use of funds generated from the sale of mortgage-backed securities to facilitate a re-positioning of the Company’s investment portfolio.
Note 8 — Junior Subordinated Interest Deferrable Debentures
The Company has formed eight statutory business trusts under the laws of the State of Delaware, for the purpose of issuing trust preferred securities. The eight statutory business trusts formed by the Company (the “Trusts”) have each issued Capital and Common Securities and invested the proceeds thereof in an equivalent amount of junior subordinated debentures (the “Debentures”) issued by the Company. As of June 30, 2011 and December 31, 2010, the principal amount of debentures outstanding totaled $190,726,000 and $201,117,000, respectively. As a result of the participation in the TARP Capital Purchase Program, the Company may not, without the consent of the Treasury Department, redeem any of the Debentures until the earlier to occur of December 23, 2011, or the date on which the Company has redeemed all of the Series A Preferred Stock issued under the Capital Purchase Program or the date on which the Treasury has transferred all of the Series A Preferred Stock to third parties not affiliated with the Treasury. On March 14, 2011, upon the request of the Company, the Treasury consented to the repurchase by the Company of the $10.4 million in trust preferred securities of Trust I, as well as related costs for a total payment of approximately $11 million, provided that the aggregate amount of the Company’s (i) semi-annual cash dividend, (ii) common stock repurchases and (iii) trust preferred securities redemptions for a given semi-annual period may not exceed the originally permitted semi-annual cash dividend aggregate amount of $.33 per share. One half of the Trust I securities were redeemed on June 8, 2011 and the remaining one half of the Trust I securities were redeemed on July 1, 2011.
The Debentures are subordinated and junior in right of payment to all present and future senior indebtedness (as defined in the respective indentures) of the Company, and are pari passu with one another. The interest rate payable on, and the payment terms of the Debentures are the same as the distribution rate and payment terms of the respective issues of Capital and Common Securities issued by the Trusts. The Company has fully and unconditionally guaranteed the obligations of each of the Trusts with respect to the Capital and Common Securities. The Company has the right, unless an Event of Default (as defined in the Indentures) has occurred and is continuing, to defer payment of interest on the Debentures for up to ten consecutive semi-annual periods on Trust I and for up to twenty consecutive quarterly periods on Trusts VI, VII, VIII, IX, X, XI and XII. If interest payments on any of the Debentures are deferred, distributions on both the Capital and Common Securities related to that Debenture would also be deferred. The redemption prior to maturity of any of the Debentures may require the prior approval of the Federal Reserve and/or other regulatory bodies.
26
For financial reporting purposes, the Trusts are treated as investments of the Company and not consolidated in the consolidated financial statements. Although the Capital Securities issued by each of the Trusts are not included as a component of shareholders’ equity on the consolidated statement of condition, the Capital Securities are treated as capital for regulatory purposes. Specifically, under applicable regulatory guidelines, the Capital Securities issued by the Trusts qualify as Tier 1 capital up to a maximum of 25% of Tier 1 capital on an aggregate basis. Any amount that exceeds the 25% threshold would qualify as Tier 2 capital. At June 30, 2011 and December 31, 2010, the total $190,726,000 and $201,117,000 of the Capital Securities outstanding qualified as Tier 1 capital.
The following table illustrates key information about each of the Capital and Common Securities and their interest rate at June 30, 2011:
Repricing Frequency
Interest Rate
Interest Rate Index
Maturity Date
Optional Redemption Date
(In Thousands)
Trust VI
25,774
Quarterly
3.71
%
LIBOR + 3.45
November 2032
November 2011
Trust VII
10,310
3.52
LIBOR + 3.25
April 2033
October 2011
Trust VIII
3.33
LIBOR + 3.05
October 2033
Trust IX
41,238
Fixed
7.10
%(1)
October 2036
Trust X
34,021
6.66
February 2037
February 2012
Trust XI
32,990
6.82
July 2037
July 2012
Trust XII
20,619
6.85
September 2037
September 2012
(1) Trust IX, X, XI and XII accrue interest at a fixed rate for the first five years, then floating at LIBOR + 1.62%, 1.65%, 1.62% and 1.45% thereafter, respectively.
Note 9 — Preferred Stock, Common Stock and Dividends
The Company has outstanding 216,000 shares of Series A cumulative perpetual preferred stock, issued to the US Treasury under the Company’s participation in the Troubled Asset Relief Program Capital Purchase Program (the “TARP Capital Purchase Program”). The Series A shares have a par value of $.01 per share (the “Senior Preferred Stock”), and a liquidation preference of $1,000 per share, for a total price of $216,000,000. The Senior Preferred Stock will pay dividends at a rate of 5% per year for the first five years and 9% per year thereafter. The Senior Preferred Stock has no maturity date and ranks senior to the Company’s common stock with respect to the payment of dividends and distributions and amounts payable upon liquidation, dissolution and winding up of the Company. In conjunction with the purchase of the Senior Preferred Stock, the US Treasury received a warrant (the “Warrant”) to purchase 1,326,238 shares of the Company’s common stock (the “Warrant Shares”) at $24.43 per share, which would represent an aggregate common stock investment in the Company on exercise of the warrant in full equal to 15% of the Senior Preferred Stock investment. The term of the Warrant is ten years and was immediately exercisable. Both the Senior Preferred Stock and Warrant are included as components of Tier 1 capital. As of June 30, 2011, none of the Warrants had been exercised. The Company paid dividends on the Senior Preferred Stock on February 15 and May 16, 2011, in the amount of $2,700,000 each and will pay a dividend on the Senior Preferred Stock on August 15, 2011, in the amount of $2,700,000.
Upon issuance, the fair value of the Series A shares and the associated warrants were computed as if the instruments were issued on a stand-alone basis. The fair value of the Series A shares were estimated based on discounted cash flows, resulting in a stand-alone fair value of approximately $130.9 million. The Company used the Black-Sholes-Merton option pricing model to estimate the fair value of the warrants, resulting in a stand-alone fair value of approximately $8.0 million. The fair values of both were then used to record the Series A shares and Warrants on a relative fair value basis, with the warrants being recorded in Surplus as permanent equity and the Series A shares being recorded at a discount of approximately $12.4 million. Accretion of the discount associated with the preferred stock is recognized as an increase to preferred stock dividends in determining net income available to common shareholders. The discount is being amortized over a five year period from the respective issuance date using the effective-yield method and totaled $615,000 and $1,220,000 for the three and six months ended June 30, 2011 and $577,000 and $1,145,000 for the three and six months ended June 30, 2010, respectively.
The Company paid cash dividends to the common shareholders of $.19 per share on April 18, 2011 to all holders of record on March 28, 2011. Cash dividends to common shareholders were paid on April 19, and October 18, 2010 to all holders of record on April 1, 2010 and September 30, 2010, respectively.
The Company terminated its stock repurchase program on December 19, 2008, in connection with participating in the TARP Capital Purchase Program, which program prohibited stock repurchases, except for repurchases made in connection with the administration of an employee benefit plan in the ordinary course of business and consistent with past practices. On April 7, 2009, the Company obtained consent from the Treasury to repurchase shares of the Company’s common stock; provided, however, that in no event will the aggregate amount of cash dividends and common stock repurchases for a given semi-annual period exceed the aggregate amount that would be used to pay the originally permitted semi-annual cash dividend of $.33 per share. The Company also received consent from the Treasury to pay quarterly dividends. The Company will determine on an ongoing basis the best use of the funds and whether a more frequent dividend program and expanded repurchase program are warranted and beneficial to its shareholders. Following receipt of the Treasury Department’s consent, the Board of Directors established a formal stock repurchase program that authorized the repurchase of up to $40 million of common stock within the following twelve months and on March 10, 2011, the Board of Directors extended the repurchase program and again authorized the repurchase of up to $40 million of common stock during the twelve month period expiring on April 10, 2012, which repurchase cap the Board is inclined to increase over time, subject to the limitations imposed by the Treasury Department’s consent. Stock repurchases may be made from time to time, on the open market or through private transactions. Shares repurchased in this program will be held in treasury for reissue for various corporate purposes, including employee stock option plans. As of August 1, 2011, a total of 7,501,455 shares had been repurchased under all programs at a cost of $232,336,000.
28
Note 10 - Commitments and Contingent Liabilities and Other Tax Matters
The Company is involved in various legal proceedings that are in various stages of litigation. Some of these actions allege “lender liability” claims on a variety of theories and claim substantial actual and punitive damages. The Company has determined, based on discussions with its counsel that any material loss in such actions, individually or in the aggregate, is remote or the damages sought, even if fully recovered, would not be considered material to the consolidated financial position or results of operations of the Company. However, many of these matters are in various stages of proceedings and further developments could cause management to revise its assessment of these matters.
The Company is involved in a dispute related to certain tax matters that were inherited by the Company in its 2004 acquisition of LFIN. The dispute involves claims by the former controlling shareholders of LFIN related to approximately $14 million of tax refunds received by the Company based on deductions taken in 2003 by LFIN in connection with losses on loans acquired from a failed thrift and a dispute LFIN had with the FDIC regarding the tax benefits related to the failed thrift acquisition which originated in 1988. On March 5, 2010, judgment was entered on a jury verdict rendered against the Company in the U.S. District Court for the Western District of Oklahoma (the “Court”). Other than the tax refunds that are in dispute, the Company does not have any other disputes regarding tax refunds received by the Company in connection with the LFIN acquisition. An amended judgment was entered in the case on November 19, 2010, in the amount of approximately $24.25 million and it is final and appealable. During December 2010, the Company deposited $24.4 million with the Court in lieu of a supersedeas bond and the Company is currently appealing the judgment.
In October 2010, the Company was named as a defendant in two purported class-action lawsuits, including one filed in the United States District Court for the Southern District of Texas and one filed in the United States District Court for the Southern District of Florida where similar lawsuits against a number of other banks are currently pending in a multi-district proceeding known as “In re Checking Account Overdraft Litigation.” The lawsuits challenge the manner in which IBC assesses and collects overdraft fees on ATM and debit transactions and IBC’s policies related to posting order. The Texas lawsuit was dismissed without prejudice on January 12, 2011, when the parties stipulated to arbitrate the matter. The Florida case is in early stages, with no responsive pleadings or motions having been filed. No class has been certified in the case. At this state of the lawsuits, the Company cannot determine the probability of a material adverse result or reasonably estimate a range of potential exposures, if any. The Company intends to defend the action vigorously.
Note 11 — Capital Ratios
The Company had a Tier 1 capital to average total asset (leverage) ratio of 11.79% and 11.58%, risk-weighted Tier 1 capital ratio of 21.23% and 19.47% and risk-weighted total capital ratio of 22.48% and 20.72% at June 30, 2011 and December 31, 2010, respectively. The identified intangibles and goodwill of $297,237,000 as of June 30, 2011, recorded in connection with the acquisitions made by the Company, are deducted from the sum of core capital elements when determining the capital ratios of the Company. Under applicable regulatory guidelines, the Capital Securities issued by the Trusts qualify as Tier 1 capital up to a maximum of 25% of tier 1 capital on an aggregate basis. Any amount that exceeds the 25% threshold qualifies as Tier 2 capital. As of June 30, 2011, the total of $190,726,000 of the Capital Securities outstanding qualified as Tier 1 capital. The Company actively monitors the regulatory capital ratios to ensure that the Company’s bank subsidiaries are well capitalized under the regulatory framework.
In March 2005, the Federal Reserve Board issued a final rule that would continue to allow the inclusion of trust preferred securities in Tier 1 capital, but with stricter quantitative limits. Under the final rule, after a five-year transition period ending March 31, 2009, the aggregate amount of trust preferred securities and certain other capital elements would be limited to 25% of Tier 1 capital elements, net of goodwill, less any associated deferred tax liability. The amount of trust preferred securities and certain other elements in excess of the limit could be included in Supplementary Capital or Tier 2 capital, subject to restrictions. Tier 2 capital includes among other things, perpetual preferred stock, qualifying mandatory convertible debt securities, qualifying subordinated debt, and allowances for probable loan and lease losses, subject to limitations. Bank holding companies with significant international operations will be expected to limit trust preferred securities to 15% of Tier 1 capital elements, net of goodwill; however, they may include qualifying mandatory convertible preferred securities up to the 25% limit. On March 16, 2009, the Federal Reserve Board extended for two years the transition period. At the end of the transition period on March 31, 2011, all of the trust preferred securities issued by the Company qualified as Tier 1 capital. The Collins Amendment to the Dodd-Frank Act further restricts the use of trust preferred securities by excluding them from the regulatory capital of banking holding companies more broadly. However, for institutions with consolidated assets of less than $15 billion on December 31, 2009, such as the Company, the Collins Amendment will not apply to securities issued before May 19, 2010 and all the Company’s trust preferred securities were issued before such date. Pursuant to this grandfather provision, the Company will be able to continue to treat these securities as Tier 1 capital subject to existing Federal Reserve limitations through the life of the securities.
Item 2 - Management’s Discussion and Analysis of Financial Condition and Results of Operations
The following discussion should be read in conjunction with the Company’s consolidated financial statements, and notes thereto, for the year-ended December 31, 2010, included in the Company’s 2010 Form 10-K. Operating results for the three months ended June 30, 2011 are not necessarily indicative of the results for the year ending December 31, 2010, or any future period.
Special Cautionary Notice Regarding Forward Looking Information
Certain matters discussed in this report, excluding historical information, include forward-looking statements, within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended, and are subject to the safe harbor created by these sections. Although the Company believes such forward-looking statements are based on reasonable assumptions, no assurance can be given that every objective will be reached. The words “estimate,” “expect,” “intend,” “believe” and “project,” as well as other words or expressions of a similar meaning are intended to identify forward-looking statements. Readers are cautioned not to place undue reliance on forward-looking statements, which speak only as of the date of this report. Such statements are based on current expectations, are inherently uncertain, are subject to risks and should be viewed with caution. Actual results and experience may differ materially from the forward-looking statements as a result of many factors.
Risk factors that could cause actual results to differ materially from any results that are projected, forecasted, estimated or budgeted by the Company in forward-looking statements include, among others, the following possibilities:
· Local, regional, national and international economic business conditions and the impact they may have on the Company, the Company’s customers, and such customers’ ability to transact profitable business with the Company, including the ability of its borrowers to repay their loans according to their terms or a change in the value of the related collateral.
· Volatility and disruption in national and international financial markets.
· Government intervention in the U.S. financial system.
· The Company relies, in part, on external financing to fund the Company’s operations and the unavailability of such funds in the future could adversely impact the Company’s growth strategy and prospects.
· Changes in consumer spending, borrowings and savings habits.
· Changes in interest rates and market prices, which could reduce the Company’s net interest margins, asset valuations and expense expectations, including, without limitation, the repeal of the federal prohibitions on the payment of interest on demand deposits.
· Changes in the capital markets utilized by the Company and its subsidiaries, including changes in the interest rate environment that may reduce margins.
· Changes in state and/or federal laws and regulations to which the Company and its subsidiaries, as well as their customers, competitors and potential competitors, are subject, including, without limitation, the impact of the Consumer Financial Protection Bureau as a new regulator of financial institutions, changes in the accounting, tax and regulatory treatment of trust preferred securities, as well as changes in banking, tax, securities, insurance and employment, environmental and immigration laws and regulations and the risk of litigation that may follow.
· Changes in U.S. — Mexico trade, including, without limitation, reductions in border crossings and commerce resulting from the Homeland Security Programs called “US-VISIT,” which is derived from Section 110 of the Illegal Immigration Reform and Immigrant Responsibility Act of 1996.
· The loss of senior management or operating personnel.
· Increased competition from both within and outside the banking industry.
· The timing, impact and other uncertainties of the Company’s potential future acquisitions including the Company’s ability to identify suitable potential future acquisition candidates, the success or failure in the integration of their operations and the Company’s ability to maintain its current branch network and to enter new markets successfully and capitalize on growth opportunities.
· Changes in the Company’s ability to pay dividends on its Preferred Stock or Common Stock.
· Additions to the Company’s loan loss allowance as a result of changes in local, national or international conditions which adversely affect the Company’s customers, including, without limitation, lower real estate values or environmental liability risks associated with foreclosed properties.
· Greater than expected costs or difficulties related to the development and integration of new products and lines of business.
· Impairment of carrying value of goodwill could negatively impact our earnings and capital.
· Changes in the soundness of other financial institutions with which the Company interacts.
· Political instability in the United States or Mexico.
31
· Technological changes or system failure or breaches of our network security could subject us to increased operating costs as well as litigation and other liabilities.
· Acts of war or terrorism.
· Natural disasters.
· Reduced earnings resulting from the write down of the carrying value of securities held in our securities available-for-sale portfolio following a determination that the securities are other-than-temporarily impaired.
· 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 standards setters.
· The costs and effects of regulatory developments, including the resolution of regulatory or other governmental inquiries and the results of regulatory examinations or reviews.
· The effect of final rules amending Regulation E that prohibit financial institutions from charging consumer fees for paying overdrafts on ATM and one-time debit card transactions, unless the consumer consents or opts-in to the overdraft service for those types of transactions, as well as the effect of FDIC Overdraft Payment Supervisory Guidance and any other regulatory or legal developments that limit overdraft services.
· The reduction of income and possible increase in required capital levels related to the adoption of new legislation, including, without limitation, the Dodd-Frank Regulatory Reform Act and the implementing rules and regulations that will be adopted or effective in the future, including the Federal Reserve’s new interim final rule that would establish debit card interchange fee standards and prohibits network exclusivity arrangements and routing restrictions that is expected to negatively affect interchange revenue from debit card transactions as well as revenue from consumer services.
· The Company may be adversely affected by its continued participation in the CPP.
· The Company’s success at managing the risks involved in the foregoing items or a failure of circumvention of the Company’s internal controls and risk management policies and procedures.
Forward-looking statements speak only as of the date on which such statements are made. It is not possible to foresee or identify all such factors. The Company makes no commitment to update any forward-looking statement, or to disclose any facts, events or circumstances after the date hereof that may affect the accuracy of any forward-looking statement, unless required by law.
Overview
The Company, which is headquartered in Laredo, Texas, with 275 facilities and more than 440 ATMs, provides banking services for commercial, consumer and international customers of South, Central and Southeast Texas and the State of Oklahoma. The Company is one of the largest independent commercial bank holding companies headquartered in Texas. The Company, through its bank subsidiaries, is in the business of gathering funds from various sources and investing those funds in order to earn a return. The Company either directly or through a bank subsidiary owns two insurance agencies, a liquidating subsidiary, a broker/dealer and a fifty percent interest in an investment banking unit that owns a broker/dealer. The Company’s primary earnings come from the spread between the interest earned on interest-bearing assets and the interest paid on interest-bearing liabilities. In addition, the Company generates income from fees on products offered to commercial, consumer and international customers.
The Company is very active in facilitating trade along the United States border with Mexico. The Company does a large amount of business with customers domiciled in Mexico. Deposits from persons and entities domiciled in Mexico comprise a large and stable portion of the deposit base of the Company’s bank subsidiaries. The Company also serves the growing Hispanic population through the Company’s facilities located throughout South, Central and Southeast Texas and the State of Oklahoma.
Expense control is an essential element in the Company’s long-term profitability. As a result, the Company monitors the efficiency ratio, which is a measure of non-interest expense to net interest income plus non-interest income closely. As the Company adjusts to regulatory changes related to the adoption of the Dodd-Frank Regulatory Reform Act, the Company’s efficiency ratio may suffer because the additional regulatory compliance costs are expected to increase non-interest expense. The Company monitors this ratio over time to assess the Company’s efficiency relative to its peers. The Company uses this measure as one factor in determining if the Company is accomplishing its long-term goals of providing superior returns to the Company’s shareholders.
Results of Operations
Summary
Consolidated Statements of Condition Information
Percent Increase (Decrease)
(1.0
)%
(2.8
2.5
(26.4
(5.2
Shareholders’ equity
7.0
Consolidated Statements of Income Information
Percent
Increase
(Decrease)
Interest income
(4.6
(7.7
Interest expense
(17.6
(16.5
(4.7
(234.1
(75.0
Non-interest income
(3.1
(20.5
Non-interest expense
5.6
(13.9
Per common share (adjusted for stock dividends):
Basic
(4.4
1.1
Diluted
Net Income
Net income available to common shareholders for the second quarter of 2011 decreased by 4.6% and net income available to common shareholders for the six months ended June 30, 2011 remained at the same levels when compared to the same period in 2010. Net income during the first six months of 2011 was positively affected by a lower provision for probable loan losses of approximately $2.2 million, $1.4 million after tax, compared to approximately $8.7 million, $5.7 million, after tax, in the first six months of 2010. Net income for the first six months of 2010 was negatively affected by a dispute related to certain tax matters that were inherited by the Company in its 2004 acquisition of LFIN. The dispute involves claims by the former controlling shareholders of LFIN related to approximately $14 million of tax refunds received by the Company based on deductions taken in 2003 by LFIN in connection with losses on loans acquired from a failed thrift and a dispute LFIN had with the FDIC regarding the tax benefits related to the failed thrift acquisition which originated in 1988. On March 5, 2010, judgment was entered on a jury verdict rendered against the Company in the U.S. District Court for the Western District of Oklahoma. Other than the tax refunds that are in dispute, the Company does not have any other disputes regarding tax refunds received by the Company in connection with the LFIN acquisition. An amended judgment was entered in the case on November 19, 2010, in the amount of approximately $24.25 million and it is final and appealable. During December 2010, the Company deposited $24.4 million with the Court in lieu of a supersedeas bond and the Company is currently appealing the judgment. Net income for the six months ended June 30, 2010 was positively affected by gains on the sale of investment securities of $30.8 million, $20.0 million, after tax, to facilitate a re-positioning of the Company’s investment portfolio.
33
Net Interest Income
(in Thousands)
(5.3
(6.4
(9.7
(14.7
33.8
32.1
815.8
312.0
(7.4
(8.1
(36.5
(34.6
(5.5
(4.9
245.0
148.9
(1.6
(0.7
Net interest income is the spread between income on interest earning assets, such as loans and securities, and the interest expense on liabilities used to fund those assets, such as deposits, repurchase agreements and funds borrowed. As part of its strategy to manage interest rate risk, the Company strives to manage both assets and liabilities so that interest sensitivities match. One method of calculating interest rate sensitivity is through gap analysis. A gap is the difference between the amount of interest rate sensitive assets and interest rate sensitive liabilities that re-price or mature in a given time period. Positive gaps occur when interest rate sensitive assets exceed interest rate sensitive liabilities, and negative gaps occur when interest rate sensitive liabilities exceed interest rate sensitive assets. A positive gap position in a period of rising interest rates should have a positive effect on net interest income as assets will re-price faster than liabilities. Conversely, net interest income should contract somewhat in a period of falling interest rates. Management can quickly change the Company’s interest rate position at any given point in time as market conditions dictate. Additionally, interest rate changes do not affect all categories of assets and liabilities equally or at the same time. Analytical techniques employed by the Company to supplement gap analysis include simulation analysis to quantify interest rate risk exposure. The gap analysis prepared by management is reviewed by the Investment Committee of the Company twice a year (see table on page 38 for the June 30, 2011 gap analysis). Management currently believes that the Company is properly positioned for interest rate changes; however if management determines at any time that the Company is not properly positioned, it will strive to adjust the interest rate sensitive assets and liabilities in order to manage the effect of interest rate changes
34
Non-Interest Income
(4.2
(1.1
18.5
15.3
(24.2
(43.8
(90.7
28.1
(27.9
(18.8
Total non-interest income decreased 20.5% for the six months ended June 30, 2011 from the same period of 2010. The decrease can be attributed to the sale of investment securities to facilitate a re-positioning of the Company’s investment portfolio that occurred in the first quarter of 2010.
Non-Interest Expense
.4
.8
3.3
2.2
(11.6
(9.6
(2.4
800.6
391.5
(.1
(25.0
(28.4
(100.0
Impairment charges (Total other-than- temporary impairment charges, $(254), net of $(420), $17, net of ($241), $1,055, net of $640 and $4,045, net of $(3,416) included in other comprehensive income)
(35.7
(94.4
(7.1
(4.5
35
Non-interest expense decreased 13.9% for the six months ended June 30, 2011 compared to the same period of 2010. Non-interest expense for the first six months of 2011 was negatively impacted by a valuation allowance taken for a foreclosed real estate project, included in net expense, other real estate owned in the table above. After evaluation of the carrying value of the foreclosed real estate, the Company determined that certain properties required a valuation allowance. Non-interest expense for the six months ended June 30, 2010 was negatively impacted by a reserve for a dispute related to certain tax deductions that were inherited by the Company in its 2004 acquisition of LFIN. On March 31, 2010, the Company recorded an additional reserve of $21.8 million related to this matter, and this amount is included in litigation expense. The Company recorded other-than-temporary impairment charges of $415 and $7.5 million on non-agency mortgage-backed securities, representing the credit related impairment on the securities for the six months ended June 30, 2011 and 2010, respectively
Financial Condition
Allowance for Probable Loan Losses
The allowance for probable loan losses decreased 7.1% to $78,481,000 at June 30, 2011 from $84,482,000 at December 31, 2010. The provision for probable loan losses charged to expense decreased 75.0% to $2,163,000 for the six months ended June 30, 2011 from $8,658,000 for the same period in 2010. The allowance for probable loan losses was 1.5% of total loans at June 30, 2011 and 1.6% of total loans at December 31, 2010.
Mortgage-backed securities are securities primarily issued by the Federal Home Loan Mortgage Corporation (“Freddie Mac”), Federal National Mortgage Association (“Fannie Mae”), and the Government National Mortgage Association (“Ginnie Mae”). Investments in residential mortgage-backed securities issued by Ginnie Mae are fully guaranteed by the U.S. Government. Investments in residential mortgage-backed securities issued by Freddie Mac and Fannie Mae are not fully guaranteed by the U.S. Government, however, the Company believes that the quality of the bonds is similar to other AAA rated bonds with limited credit risk, particularly given the placement of Fannie Mae and Freddie Mac into conservatorship by the federal government in early September 2008.
Net loans decreased 2.8% to $5,177,702,000 at June 30, 2011, from $5,325,521,000 at December 31, 2010. The decrease in loans can be attributed to the lack of demand for loans that the Company is experiencing as the result of the negative economic conditions.
Deposits increased by 2.5% to $7,786,885,000 at June 30, 2011, from $7,599,558,000 at December 31, 2010. The increase in deposits is the result of the increased demand for deposits and the result of the increased availability of deposits in the banking market. Even though the Company increased its deposits, the Company is still experiencing a substantial amount of competition for deposits at higher than market rates. As a result, the Company has attempted to maintain certain deposit relationships but has allowed certain deposits to leave as the result of aggressive pricing.
Foreign Operations
On June 30, 2011, the Company had $11,820,343,000 of consolidated assets, of which approximately $248,411,000, or 2.1%, was related to loans outstanding to borrowers domiciled in foreign countries, compared to $245,625,000, or 2.1%, at December 31, 2010. Of the $248,411,000, 86.3% is directly or indirectly secured by U.S. assets, certificates of deposits and real estate; 13.5% is secured by foreign real estate; and 0.2% is unsecured.
Critical Accounting Policies
The Company has established various accounting policies which govern the application of accounting principles in the preparation of the Company’s consolidated financial statements. The significant accounting policies are described in the notes to the consolidated financial statements. Certain accounting policies involve significant subjective judgments and assumptions by management which have a material impact on the carrying value of certain assets and liabilities; management considers such accounting policies to be critical accounting policies.
36
The Company considers its Allowance for Probable Loan Losses as a policy critical to the sound operations of the subsidiaries that hold loans. The allowance for probable loan losses consists of the aggregate loan loss allowances of the subsidiaries. The allowances are established through charges to operations in the form of provisions for probable loan losses. Loan losses or recoveries are charged or credited directly to the allowances. The allowance for probable loan losses of each subsidiary is maintained at a level considered appropriate by management, based on estimated probable losses in the loan portfolio. The allowance is derived from the following elements: (i) allowances established on specific loans, which are based on a review of the individual characteristics of each loan, including the customer’s ability to repay the loan, the underlying collateral values, and the industry in which the customer operates (ii) allowances based on actual historical loss experience for similar types of loans in the Company’s loan portfolio and (iii) allowances based on general economic conditions, changes in the mix of loans, Company resources, border risk and credit quality indicators, among other things. See also discussion regarding the allowance for probable loan losses and provision for probable loan losses included in the results of operations and “Provision and Allowance for Probable Loan Losses” included in Notes 1 and 4 of the notes to Consolidated Financial Statements in the Company’s latest Annual Report on Form 10-K for further information regarding the Company’s provision and allowance for probable loan losses policy.
Liquidity and Capital Resources
The maintenance of adequate liquidity provides the Company’s bank subsidiaries with the ability to meet potential depositor withdrawals, provide for customer credit needs, maintain adequate statutory reserve levels and take full advantage of high-yield investment opportunities as they arise. Liquidity is afforded by access to financial markets and by holding appropriate amounts of liquid assets. The Company’s bank subsidiaries derive their liquidity largely from deposits of individuals and business entities. Deposits from persons and entities domiciled in Mexico comprise a stable portion of the deposit base of the Company’s bank subsidiaries. Other important funding sources for the Company’s bank subsidiaries during 2011 and 2010 were borrowings from FHLB, securities sold under repurchase agreements and large certificates of deposit, requiring management to closely monitor its asset/liability mix in terms of both rate sensitivity and maturity distribution. Primary liquidity of the Company and its subsidiaries has been maintained by means of increased investment in shorter-term securities, certificates of deposit and repurchase agreements. As in the past, the Company will continue to monitor the volatility and cost of funds in an attempt to match maturities of rate-sensitive assets and liabilities and respond accordingly to anticipated fluctuations in interest rates over reasonable periods of time.
The Company maintains an adequate level of capital as a margin of safety for its depositors and shareholders. At June 30, 2011, shareholders’ equity was $1,562,063,000 compared to $1,459,217,000 at December 31, 2010, an increase of $102,846,000, or 7.0%. The increase is primarily due to the retention of earnings, offset by dividends paid to the preferred and common shareholders and an increase in accumulated other comprehensive income on the Company’s investment securities portfolio.
The Company had a leverage ratio of 11.79% and 11.58%, risk-weighted Tier 1 capital ratio of 21.23% and 19.47% and risk-weighted total capital ratio of 22.48% and 20.72% at June 30, 2011 and December 31, 2010, respectively. The identified intangibles and goodwill of $297,237,000 as of June 30, 2011, recorded in connection with the Company’s acquisitions, are deducted from the sum of core capital elements when determining the capital ratios of the Company.
As in the past, the Company will continue to monitor the volatility and cost of funds in an attempt to match maturities of rate-sensitive assets and liabilities, and respond accordingly to anticipate fluctuations in interest rates by adjusting the balance between sources and uses of funds as deemed appropriate. The net-interest rate sensitivity as of June 30, 2011 is illustrated in the table on the following page. This information reflects the balances of assets and liabilities for which rates are subject to change. A mix of assets and liabilities that are roughly equal in volume and re-pricing characteristics represents a matched interest rate sensitivity position. Any excess of assets or liabilities results in an interest rate sensitivity gap.
The Company undertakes an interest rate sensitivity analysis to monitor the potential risk on future earnings resulting from the impact of possible future changes in interest rates on currently existing net asset or net liability positions. However, this type of analysis is as of a point-in-time position, when in fact that position can quickly change as market conditions, customer needs, and management strategies change. Thus, interest rate changes do not affect all categories of asset and liabilities equally or at the same time. As indicated in the table, the Company is liability sensitive during the early time periods and asset sensitive in the longer periods. The Company’s Asset and Liability Committee semi-annually reviews the consolidated position along with simulation and duration models, and makes adjustments as needed to control the Company’s interest rate risk position. The Company uses modeling of future events as a primary tool for monitoring interest rate risk.
37
Interest Rate Sensitivity
Rate/Maturity
3 Months or Less
Over 3 Months to 1 Year
Over 1 Year to 5 Years
Over 5 Years
Rate sensitive assets
Investment securities
467,733
1,145,911
3,248,230
208,224
Loans, net of non-accruals
3,924,223
269,964
277,971
722,560
5,194,718
Total earning assets
4,391,956
1,415,875
3,526,201
930,784
10,264,816
Cumulative earning assets
5,807,831
9,334,032
Rate sensitive liabilities
1,375,084
1,628,657
364,053
472
Other interest bearing deposits
362,511
57,696
3,382
1,000,000
749,175
6,726
61,858
75,259
53,609
Total interest bearing liabilities
5,220,891
1,761,599
420,250
1,007,198
8,410,745
Cumulative sensitive liabilities
6,983,297
7,403,547
Repricing gap
(828,935
(345,737
3,105,157
(76,414
1,854,071
Cumulative repricing gap
(1,174,672
1,930,485
Ratio of interest-sensitive assets to liabilities
.84
.80
8.37
.92
1.22
Ratio of cumulative, interest- sensitive assets to liabilities
.83
1.26
Item 3. Quantitative and Qualitative Disclosures about Market Risk
During the first six months of 2011, there were no material changes in market risk exposures that affected the quantitative and qualitative disclosures regarding market risk presented under the caption “Liquidity and Capital Resources” located on pages 19 through 25 of the Company’s 2010 Annual Report as filed as an exhibit to the Company’s Form 10-K for the year ended December 31, 2010.
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Item 4. Controls and Procedures
Disclosure Controls and Procedures
The Company maintains disclosure controls and procedures designed to ensure that information required to be disclosed in reports filed under the Securities Exchange Act of 1934, as amended, is recorded, processed, summarized and reported within specified time periods. As of the end of the period covered by this Quarterly Report on Form 10-Q, the Company’s principal executive officer and principal financial officer evaluated, with the participation of the Company’s management, the effectiveness of the Company’s disclosure controls and procedures (as defined in Exchange Act rules 13a-15(e) and 15d-15(e)). Based on the evaluation, which disclosed no material weaknesses, the Company’s principal executive officer and principal financial officer concluded that the Company’s disclosure controls and procedures were effective as of the end of the period covered by this report.
Internal Control Over Financial Reporting
There were no changes in the Company’s internal control over financial reporting that occurred during the Company’s most recent fiscal quarter that have materially affected or are reasonably likely to materially affect the Company’s internal control over financial reporting.
PART II - OTHER INFORMATION
Item 1. Legal Proceedings
In October 2010, the Company was named as a defendant in a purported class-action lawsuit filed in the United States District Court for the Southern District of Florida where similar lawsuits against a number of other banks are currently pending in a multi-district proceeding known as “In re Checking Account Overdraft Litigation.” The lawsuit challenges the manner in which IBC assesses and collects overdraft fees on ATM and debit transactions and IBC’s policies related to posting order. The case is in early stages, with no responsive pleadings or motions having been filed. No class has been certified in the case. At this stage of the lawsuit, the Company cannot determine the probability of a material adverse result or reasonably estimate a range of potential exposures, if any. The Company intends to defend the action vigorously.
1A. Risk Factors
There were no material changes in the risk factors as previously disclosed in Item 1A to Part I of the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2010.
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Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
From time to time, the Company’s Board of Directors has authorized stock repurchase plans. The Company terminated its stock repurchase program on December 19, 2008, in connection with participating in the TARP Capital Purchase Program, which program prohibited stock repurchases, except for repurchases made in connection with the administration of an employee benefit plan in the ordinary course of business and consistent with past practices. On April 7, 2009 and March 14, 2011, the Company obtained consent from the Treasury and a modification to expand the original consent to include the redemption of trust preferred securities, respectively, which permit the Company to repurchase shares of the Company’s common stock; provided, however, that in no event will the aggregate amount of cash dividends, common stock repurchases and redemptions of trust preferred securities for a given semi-annual period exceed the aggregate amount that would be used to pay the originally permitted semi-annual cash dividend of $.33 per share. The Company also received consent from the Treasury to pay quarterly dividends. The Company will determine on an ongoing basis the best use of the funds and whether a more frequent dividend program and expanded repurchase program are warranted and beneficial to its shareholders. Following receipt of the Treasury Department’s original consent on April 7, 2009, the Board of Directors established a formal stock repurchase program that authorized the repurchase of up to $40 million of common stock within the following twelve months and on March 10, 2011, the Board of Directors extended the repurchase program and again authorized the repurchase of up to $40 million of common stock during the twelve month period expiring on April 9, 2012, which repurchase cap the Board is inclined to increase over time, subject to the limitations imposed by the Treasury Department’s original consent and modification. Stock repurchases may be made from time to time, on the open market or through private transactions. During the second quarter, the Company’s Board of Directors adopted a Rule 10b5-1 plan and intends to adopt additional Rule 10b5-1 trading plans that will allow the Company to purchase its shares of common stock during certain trading blackout periods when the Company ordinarily would not be in the market due to trading restrictions in its internal trading policy. Shares repurchased in this program will be held in treasury for reissue for various corporate purposes, including employee stock option plans. As of August 1, 2011, a total of 7,501,455 shares had been repurchased under all programs at a cost of $232,336,000. The Company is not obligated to repurchase shares under its stock purchase program or to enter into additional Rule 10b5-1 plans. The timing, actual number and value of shares purchased will depend on many factors, including the Company’s cash flow and the liquidity and price performance of its shares of common stock.
Except for repurchases in connection with the administration of an employee benefit plan in the ordinary course of business and consistent with past practices, common stock repurchases are only conducted under publicly announced repurchase programs approved by the Board of Directors. The following table includes information about common stock share repurchases for the quarter ended June 30, 2011.
Total Number of Shares Purchased
Average Price Paid Per Share
Shares Purchased as Part of a Publicly- Announced Program
Approximate Dollar Value of Shares Available for Repurchase (1)
April 1 – April 30, 2011
4,000
17.05
39,932,000
May 1 – May 31, 2011
143,137
16.60
37,555,000
June 1 – June 30, 2011
32,146
15.78
37,048,000
179,283
16.47
(1) The repurchase program was extended on March 10, 2011 and allows for the repurchase of up to an additional $40,000,000 of treasury stock through April 9, 2012.
Item 6. Exhibits
The following exhibits are filed as a part of this Report:
31(a) —Certification of Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
31(b) —Certification of Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
32(a) —Certification of Chief Executive Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
32(b) —Certification of Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
101++ — Interactive Data File
++ Attached as Exhibit 101 to this report are the following documents formatted in XBRL (Extensible Business Reporting Language): (i) the Condensed Consolidated Statement of Earnings for the three and six months ended June 30, 2011 and 2010, (ii) the Condensed Consolidated Balance Sheet as of June 30, 2011 and December 31, 2010, and (iii) the Condensed Consolidated Statement of Cash Flows for the six months ended June 30, 2011 and 2010. Users of this data are advised pursuant to Rule 406T of Regulation S-T that this interactive data file is deemed not filed or part of a registration statement or prospectus for purposes of sections 11 or 12 of the Securities Act of 1933, is deemed not filed for purposes of section 18 of the Securities and Exchange Act of 1934, and otherwise is not subject to liability under these sections.
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SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
Date:
August 8, 2011
/s/ Dennis E. Nixon
Dennis E. Nixon
President
/s/ Imelda Navarro
Imelda Navarro
Treasurer