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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
☒
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 2019
OR
☐
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from to
Commission file number 000-09439
INTERNATIONAL BANCSHARES CORPORATION
(Exact name of registrant as specified in its charter)
Texas
74-2157138
(State or other jurisdiction of
(I.R.S. Employer Identification No.)
incorporation or organization)
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)
Securities registered pursuant to Section 12(b) of the Act:
Title of each class:
Trading Symbol
Name of each exchange on which registered:
Common Stock, $1.00 par value
IBOC
NASDAQ
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 ⌧ No ◻
Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted 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 such files). Yes ⌧ No ◻
Indicate by check mark if the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company, in Rule 12b-2 of the Exchange Act.
Large accelerated filer ⌧
Accelerated filer ◻
Non-accelerated filer ◻
Smaller reporting company ☐
Emerging growth company ☐
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act.
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ☐ No ⌧
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
65,195,349 shares outstanding at November 1, 2019
PART I - FINANCIAL INFORMATION
Item 1. Financial Statements
INTERNATIONAL BANCSHARES CORPORATION AND SUBSIDIARIES
Consolidated Statements of Condition (Unaudited)
(Dollars in Thousands)
September 30,
December 31,
2019
2018
Assets
Cash and cash equivalents
$
286,519
316,797
Investment securities:
Held to maturity debt securities (Market value of $2,400 on September 30, 2019 and 1,200 on December 31, 2018)
2,400
1,200
Available for sale debt securities (Amortized cost of $3,187,248 on September 30, 2019 and $3,481,165 on December 31, 2018)
3,192,872
3,411,350
Equity securities with readily determinable fair values
6,172
5,937
Total investment securities
3,201,444
3,418,487
Loans
6,895,142
6,561,289
Less allowance for probable loan losses
(59,860)
(61,384)
Net loans
6,835,282
6,499,905
Bank premises and equipment, net
507,945
506,899
Accrued interest receivable
35,359
36,803
Other investments
307,010
337,507
Cash surrender value of life insurance policies
287,871
282,646
Goodwill
282,532
Other assets
222,073
190,376
Total assets
11,966,035
11,871,952
1
Consolidated Statements of Condition, continued (Unaudited)
Liabilities and Shareholders’ Equity
Liabilities:
Deposits:
Demand—non-interest bearing
3,575,930
3,454,840
Savings and interest bearing demand
3,254,762
3,268,237
Time
1,981,369
1,973,468
Total deposits
8,812,061
8,696,545
Securities sold under repurchase agreements
289,334
229,989
Other borrowed funds
456,556
705,665
Junior subordinated deferrable interest debentures
134,642
160,416
Other liabilities
205,518
139,755
Total liabilities
9,898,111
9,932,370
Shareholders’ equity:
Common shares of $1.00 par value. Authorized 275,000,000 shares; issued 96,191,692 shares on September 30, 2019 and 96,104,029 shares on December 31, 2018
96,192
96,104
Surplus
147,456
145,283
Retained earnings
2,148,835
2,064,134
Accumulated other comprehensive income (loss)
4,563
(54,634)
2,397,046
2,250,887
Less cost of shares in treasury, 31,014,374 shares on September 30, 2019 and 30,494,143 on December 31, 2018
(329,122)
(311,305)
Total shareholders’ equity
2,067,924
1,939,582
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
Nine Months Ended
Interest income:
Loans, including fees
104,688
95,828
313,057
275,744
Taxable
18,040
20,213
56,942
62,121
Tax-exempt
1,019
1,981
4,045
6,263
Other interest income
372
352
998
719
Total interest income
124,119
118,374
375,042
344,847
Interest expense:
Savings deposits
4,023
3,353
12,515
8,872
Time deposits
5,680
3,493
15,102
9,172
640
468
1,820
1,839
Other borrowings
3,144
4,358
10,151
13,426
1,414
1,828
5,045
5,119
Total interest expense
14,901
13,500
44,633
38,428
Net interest income
109,218
104,874
330,409
306,419
Provision for probable loan losses
5,278
4,280
15,363
3,212
Net interest income after provision for probable loan losses
103,940
100,594
315,046
303,207
Non-interest income:
Service charges on deposit accounts
18,723
18,391
53,593
53,658
Other service charges, commissions and fees
Banking
14,708
13,100
37,348
35,374
Non-banking
2,015
1,885
5,762
5,273
Investment securities transactions, net
(2)
(141)
(12)
Other investments, net
2,440
5,625
4,685
16,192
Other income
4,813
3,643
11,866
13,425
Total non-interest income
42,697
42,503
113,242
123,781
3
Consolidated Statements of Income, continued (Unaudited)
Non-interest expense:
Employee compensation and benefits
37,038
35,360
110,693
104,670
Occupancy
7,294
6,839
20,251
20,077
Depreciation of bank premises and equipment
7,127
6,460
21,140
19,097
Professional fees
4,744
4,063
12,081
10,010
Deposit insurance assessments
829
928
2,471
2,902
Net expense, other real estate owned
1,578
911
3,776
3,289
Advertising
1,987
2,020
6,150
5,667
Software and software maintenance
4,691
4,481
14,191
12,943
Other
15,778
17,005
42,877
48,922
Total non-interest expense
81,066
78,067
233,630
227,577
Income before income taxes
65,571
65,030
194,658
199,411
Provision for income taxes
14,127
13,935
41,288
42,009
Net income
51,444
51,095
153,370
157,402
Basic earnings per common share:
Weighted average number of shares outstanding
65,449,159
66,136,091
65,571,124
66,114,482
0.79
.77
2.34
2.38
Fully diluted earnings per common share:
65,636,116
66,423,209
65,777,552
66,739,899
0.78
2.33
2.36
See accompanying notes to consolidated financial statements
4
Consolidated Statements of Comprehensive Income (Unaudited)
Other comprehensive income, net of tax:
Net unrealized holding gains (losses) on securities available for sale arising during period (net of tax effects of $2,343, $(4,193), $15,733, and $(17,787))
8,813
(15,772)
59,188
(66,912)
Reclassification adjustment for losses on securities available for sale included in net income (net of tax effects of $0, $30, $3 and $30)
111
9
8,815
(15,661)
59,197
(66,801)
Comprehensive income
60,259
35,434
212,567
90,601
5
Consolidated Statements of Shareholders’ Equity
Three Months ended September 30, 2019 and 2018
(in Thousands, except per share amounts)
Number
of
Common
Retained
Comprehensive
Treasury
Shares
Stock
Earnings
Income (Loss)
Total
Balance at June 30, 2019
96,151
146,614
2,133,239
(4,252)
(311,433)
2,060,319
Net Income
—
Dividends:
Payable ($.55 per share)
(35,848)
Purchase of treasury (516,973 shares)
(17,689)
Exercise of stock options
41
602
643
Stock compensation expense recognized in earnings
240
Net change in unrealized gains and losses on available for sale securities, net of reclassification adjustments
Balance at September 30, 2019
Balance at June 30, 2018
96,066
173,057
1,982,464
(79,537)
(292,320)
1,879,730
Payable ($.42 per share)
(27,783)
17
323
340
285
Repurchase of outstanding warrant
(29,005)
Cumulative adjustment for adoption of new accounting standards
(170)
170
(15,817)
Balance at September 30, 2018
96,083
144,660
2,005,606
(95,184)
1,858,845
6
Nine Months ended September 30, 2019 and 2018
Balance at December 31, 2018
Cash ($1.05 per share)
(68,669)
Purchase of treasury (3,258 shares)
(17,817)
88
1,429
1,517
744
Balance at December 31, 2017
96,019
171,816
1,891,805
(28,397)
(292,263)
1,838,980
Cash ($.75 per share)
(49,598)
Purchase of treasury (1,298 shares)
(57)
64
1,094
1,158
755
5,997
(5,997)
(60,790)
7
Consolidated Statements of Cash Flows (Unaudited)
Operating activities:
Adjustments to reconcile net income to net cash provided by operating activities:
Specific reserve, other real estate owned
154
3,033
Gain on sale of bank premises and equipment
(207)
(293)
Gain on sale of other real estate owned
(1,246)
(1,317)
Accretion of investment securities discounts
(311)
(209)
Amortization of investment securities premiums
13,678
15,620
12
141
Unrealized (gain) loss on equity securities with readily determinable fair values
(235)
312
Stock based compensation expense
Earnings from affiliates and other investments
(2,869)
(12,247)
Deferred tax expense
330
1,373
Decrease in accrued interest receivable
1,444
65
Increase in other assets
(17,430)
(48,747)
Net increase in other liabilities
27,250
40,533
Net cash provided by operating activities
211,187
178,730
Investing activities:
Proceeds from maturities of securities
1,075
Proceeds from sales and calls of available for sale securities
92,980
37,675
Proceeds from sales of equity securities with readily determinable fair values
21,607
Purchases of available for sale securities
(380,095)
(47,346)
Principal collected on mortgage backed securities
566,455
529,956
Net increase in loans
(372,121)
(168,823)
Purchases of other investments
(33,940)
(34,914)
Distributions from other investments
52,693
2,894
Purchases of bank premises and equipment
(23,809)
(16,256)
Proceeds from sales of bank premises and equipment
1,830
1,413
Proceeds from sales of other real estate owned
3,685
3,633
Net cash (used in) provided by investing activities
(92,322)
330,914
8
Consolidated Statements of Cash Flows, continued (Unaudited)
Financing activities:
Net increase in non-interest bearing demand deposits
121,090
188,518
Net decrease in savings and interest bearing demand deposits
(13,475)
(13,938)
Net increase (decrease) in time deposits
7,901
(73,871)
Net increase (decrease) in securities sold under repurchase agreements
59,345
(20,002)
Net decrease in other borrowed funds
(249,109)
(520,325)
Redemption of long-term debt
(25,774)
Repurchase of outstanding common stock warrant
Purchase of treasury stock
Proceeds from stock transactions
Payments of cash dividends - common
(32,821)
(21,815)
Net cash used in financing activities
(149,143)
(489,337)
(Decrease) increase in cash and cash equivalents
(30,278)
20,307
Cash and cash equivalents at beginning of period
265,357
Cash and cash equivalents at end of period
285,664
Supplemental cash flow information:
Interest paid
43,262
37,051
Income taxes paid
38,591
39,715
Non-cash investing and financing activities:
Net transfers from loans to other real estate owned
21,381
31,609
Dividends declared, not yet paid on common stock
35,848
27,784
Establishment of lease liability and right-of-use asset
6,171
Notes to Consolidated Financial Statements
(Unaudited)
As used in this report, the words “Company,” “we,” “us” and “our” refer to International Bancshares Corporation, a Texas corporation, its five wholly-owned subsidiary banks, and other subsidiaries. The information that follows may contain forward-looking statements, which are qualified as indicated under “Cautionary Notice Regarding Forward-Looking Statements” in Item 2 (Management’s Discussion and Analysis of Financial Condition and Results of Operations) of this report. Our website address is www.ibc.com.
Note 1 — Basis of Presentation
Our accounting and reporting policies conform to accounting principles generally accepted in the United States of America and to general practices within the banking industry. Our consolidated financial statements include the accounts of International Bancshares Corporation, and our wholly-owned bank subsidiaries, International Bank of Commerce, Laredo (“IBC”), Commerce Bank, International Bank of Commerce, Zapata, International Bank of Commerce, Brownsville, International Bank of Commerce, Oklahoma (the “Subsidiary Banks”) and our wholly-owned non-bank subsidiaries, IBC Trading Company, Premier Tierra Holdings, Inc., IBC Charitable and Community Development Corporation, and IBC Capital Corporation. Effective January 1, 2019, we dissolved one of our non-bank subsidiaries, IBC Subsidiary Corporation, a second-tier bank holding company incorporated in the State of Delaware. All significant inter-company balances and transactions have been eliminated in consolidation. Our 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. These financial statements should be read in conjunction with the financial statements and the notes thereto in our latest Annual Report on Form 10-K. Our consolidated statement of condition at December 31, 2018 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 (“US GAAP”) for complete financial statements. Certain reclassifications have been made to make prior periods comparable. Operating results for the three and nine months ended September 30, 2019 are not necessarily indicative of the results for the year ending December 31, 2019 or any future period.
We operate as one segment. The operating information used by our chief executive officer for purposes of assessing performance and making operating decisions is the consolidated statements presented in this report. We have five active operating subsidiaries, the Subsidiary Banks. We apply the provisions of Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”), FASB ASC 280, “Segment Reporting,” in determining our reportable segments and related disclosures.
We have evaluated all events or transactions that occurred through the date we issued these financial statements. During this period, we did not have any material recognizable or non-recognizable subsequent events.
On January 1, 2019, we adopted the provisions of ASU 2016-02, “Leases.” ASU 2016-02 amends existing standards for accounting for leases by lessees, with accounting for leases by lessors remaining mainly unchanged from current guidance. The update requires that lessees recognize a lease liability and a right of use asset for all leases (with the exception of short-term leases) at the commencement date of the lease and disclose key information about leasing arrangements. The update is to be applied on a modified retrospective basis for leases existing at, or entered into after, the beginning of the earliest comparative period presented in the consolidated financial statements. In January 2018, the FASB issued a proposal that provides an additional transition method that would allow entities to not apply the guidance in the update in the comparative periods presented in the consolidated financial statements, but instead recognize a cumulative-effect adjustment to the opening balance of retained earnings in the period of adoption. As part of our business model, we primarily own all property we occupy, with the exception of certain branches operating in grocery stores or shopping centers and certain ATM locations that were classified as operating leases under previous guidance.
10
The adoption of the standard did not have a significant impact on our consolidated financial statements. As of the date of adoption, we recorded a right of use asset and a lease liability of approximately $6.4 million. The right of use asset and lease liability are included in other assets and other liabilities, respectively, on our consolidated statement of condition. Amortization of the right of use asset for the three and nine months ended September 30, 2019 was approximately $267,000 and $726,000, respectively, and is included as a part of occupancy expense in our consolidated income statement.
In June 2016, the FASB issued Accounting Standards Update No. 2016-13 to ASC 326, “Financial Instruments – Credit Losses.” The update amends existing standards for accounting for credit losses for financial assets. The update requires that the expected credit losses on the financial instruments held as of the end of the period being reported be measured based on historical experience, current conditions, and reasonable and supportable forecasts. The update also expands the required disclosures related to significant estimates and judgements used in estimating credit losses, as well as the credit quality and underwriting standards of an organization’s financial assets. The update also amends the accounting for credit losses on available-for-sale debt securities and purchased financial assets with credit deterioration. The impact of the adoption of the standard is to be recorded as a cumulative-effect adjustment to retained earnings as of the beginning of the first reporting period in which the guidance is adopted. The accounting standard will be effective for us on January 1, 2020. We continue to evaluate the impact the adoption of the update will have on us and do not have a current estimate, however, we do expect that that final impact of the adoption could be significantly impacted by a change in the mix of loans, characteristics and quality of our loan portfolio at the end of the year as well the economic conditions and forecasts at the time of adoption. The task force formed last year, which includes key members of the teams that work with the current calculation of the allowance for probable loan losses with members representing the corporate accounting and risk management areas has continued to work with the implementation of the update. Initial implementation activities and decisions have been reached around key data needed for the new calculation including portfolio segmentation. Validation of our primary model/tool is substantially completed and ongoing activities around forecasting models and documentation of the process will continue during the fourth quarter of 2019.
Note 2 — Fair Value Measurements
ASC Topic 820, “Fair Value Measurements and Disclosures” (“ASC 820”), defines fair value, establishes a framework for measuring fair value in generally accepted accounting principles, and expands disclosures about fair value measurements. ASC 820 applies to all financial instruments that are being measured and reported on a fair value basis. ASC 820 defines fair value 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:
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.
11
The following table represents assets and liabilities reported on the consolidated balance sheets at their fair value on a recurring basis as of September 30, 2019 by level within the fair value measurement hierarchy:
Fair Value Measurements at
Reporting Date Using
(in Thousands)
Quoted
Prices in
Active
Significant
Assets/Liabilities
Markets for
Measured at
Identical
Observable
Unobservable
Fair Value
Inputs
September 30, 2019
(Level 1)
(Level 2)
(Level 3)
Measured on a recurring basis:
Assets:
Available for sale debt securities
Residential mortgage-backed securities
3,097,409
States and political subdivisions
95,462
Equity Securities
3,199,043
3,192,871
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, 2018 by level within the fair value measurement hierarchy:
December 31, 2018
Available for sale securities
Residential mortgage - backed securities
3,223,010
188,340
3,417,287
Available-for-sale debt securities are classified within Level 2 of the valuation hierarchy. Equity securities with readily determinable fair values are classified within Level 1. For debt investments classified as Level 2 in the fair value hierarchy, we obtain fair value measurements 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.
Certain financial assets and financial liabilities are measured at fair value on a non-recurring basis. The instruments 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 financial instruments measured at fair value on a non-recurring basis as of and for the period ended September 30, 2019 by level within the fair value measurement hierarchy:
Fair Value Measurements at Reporting
Date Using
(in thousands)
Net Provision
Period ended
(Credit)
During
Period
Measured on a non-recurring basis:
Impaired loans
914
189
Other real estate owned
27,376
Equity investments without readily determinable fair values
28,166
4,775
The following table represents financial instruments measured at fair value on a non-recurring basis as of and for the period ended December 31, 2018 by level within the fair value measurement hierarchy:
Markets
Net (Credit)
Year ended
for Identical
Provision
1,563
356
38,871
3,071
Our assets measured at fair value on a non-recurring basis are limited to impaired loans, other real estate owned, and an equity investment without a readily determinable fair value. The determination of the fair value of the equity investment without a readily determinable fair value is based on the estimated value to be received upon the sale of the investment, which is expected to occur at the end of 2019. Impaired loans are classified within Level 3 of the valuation hierarchy. The fair value of impaired loans is derived in accordance with FASB ASC 310, “Receivables”. Impaired loans are primarily comprised of collateral-dependent commercial loans. As the primary sources of loan repayments decline, the secondary repayment source, the collateral, takes on greater significance. Correctly evaluating the fair value becomes even more important. Re-measurement of the impaired loan to fair value is done through a specific valuation allowance included in the allowance for probable loan losses. The fair value of impaired loans is based on the fair value of the collateral, as determined through either an appraisal or evaluation process. The basis for our appraisal and appraisal review process is based on regulatory guidelines and strives to comply with all regulatory appraisal laws, regulations, and the Uniform Standards of Professional Appraisal Practice. All appraisals and evaluations are “as is” (the property’s highest and best use) valuations based on the current conditions of the property/project at that point in time. The determination of the fair value of the collateral is based on the net realizable value, which is the appraised value less any closing costs, when applicable. As of September 30, 2019, we had $10,666,000 of impaired commercial collateral dependent loans, of which $7,184,000 had an appraisal performed within the immediately preceding twelve months, and of which $1,490,000 had an evaluation performed within the immediately preceding twelve months. As of December 31, 2018, we had approximately $14,306,000 of impaired commercial collateral dependent loans, of which $10,911,000 had an appraisal performed within the immediately preceding twelve months and of which $0 had an evaluation performed within the immediately preceding twelve months.
13
Our determination to either seek an appraisal or to perform an evaluation begins in weekly credit quality meetings, where the committee analyzes the existing collateral values of the impaired loans and where obsolete appraisals are identified. In order to determine whether we would obtain a new appraisal or perform an internal evaluation to determine the fair value of the collateral, the credit committee reviews the existing appraisal to determine if the collateral value is reasonable in view of the current use of the collateral and the economic environment related to the collateral. If the analysis of the existing appraisal does not find that the collateral value is reasonable under the current circumstances, we would obtain a new appraisal on the collateral or perform an internal evaluation of the collateral. The ultimate decision to get a new appraisal rests with the independent credit administration group. A new appraisal is not required if an internal evaluation, as performed by in-house experts, is able to appropriately update the original appraisal assumptions to reflect current market conditions and provide an estimate of the collateral’s market value for impairment analysis. The internal evaluations must be in writing and contain sufficient information detailing the analysis, assumptions and conclusions, and they must support performing an evaluation in lieu of ordering a new appraisal.
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, through a charge to operations. Other real estate owned is included in other assets on the consolidated financial statements. For the three and nine months ended September 30, 2019 and the twelve months ended December 31, 2018, we recorded $33,000, $9,533,000, and $170,000, respectively, in charges to the allowance for probable loan losses in connection with loans transferred to other real estate owned. The $9,500,000 charge recorded in the second quarter of 2019 is related to the deterioration on one loan relationship discussed further in Note 4 – Allowance for Loan Losses. For the three and nine months ended September 30, 2019 and the twelve months ended December 31, 2018, we recorded $66,000, $154,000, and $3,071,000, respectively, in adjustments to fair value in connection with other real estate owned.
The fair value estimates, methods, and assumptions for our financial instruments at September 30, 2019 and December 31, 2018 are outlined below.
Cash and Cash Equivalents
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.
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 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. See disclosures of fair value of investment securities in Note 6.
14
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. Fixed-rate performing loans are within Level 3 of the fair value hierarchy. At September 30, 2019 and December 31, 2018, the carrying amount of fixed-rate performing loans was $1,522,399,000 and $1,515,437,000, respectively, and the estimated fair value was $1,503,049,000 and $1,469,231,000, 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 September 30, 2019 and December 31, 2018. The fair value of time deposits is based on the discounted value of contractual cashflows. The discount rate is based on currently offered rates. Time deposits are within Level 3 of the fair value hierarchy. At September 30, 2019 and December 31, 2018, the carrying amount of time deposits was $1,981,369,000 and $1,973,468,000, respectively, and the estimated fair value was $1,981,073,000 and $1,976,156,000, respectively.
Securities Sold Under Repurchase Agreements
Securities sold under repurchase agreements include short- and long-term maturities. Due to the contractual terms of the short-term instruments, the carrying amounts approximated fair value at September 30, 2019 and December 31, 2018.
Junior Subordinated Deferrable Interest Debentures
We currently have 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 September 30, 2019 and December 31, 2018.
Other Borrowed Funds
We currently have 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 September 30, 2019 and December 31, 2018. The long-term borrowings outstanding at September 30, 2019 and December 31, 2018 are fixed-rate borrowings and the fair value is based on established market spreads for similar types of borrowings. The fixed rate long-term borrowings are included in Level 2 of the fair value hierarchy. At September 30, 2019 and December 31, 2018, the carrying amount of the fixed rate long-term FHLB borrowings was $436,556,000 and $436,690,000, respectively, and the estimated fair value was $463,409,000 and $436,238,000, respectively.
15
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 our entire holdings of a particular financial instrument. Because no market exists for a significant portion of our 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 loans, by loan type at September 30, 2019 and December 31, 2018 is as follows:
Commercial, financial and agricultural
3,504,936
3,305,124
Real estate - mortgage
1,151,764
1,173,101
Real estate - construction
2,044,410
1,886,231
Consumer
47,072
46,316
Foreign
146,960
150,517
Total loans
Note 4 — Allowance for Probable Loan Losses
The allowance for probable loan losses primarily consists of the aggregate loan loss allowances of the Subsidiary Banks. 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 Bank 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 impaired 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 our 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 economic uncertainty as the economy recovers from the recent prolonged downturn.
Our management continually reviews the allowance for loan losses of the Subsidiary Banks using the amounts determined from the allowances established on specific impaired loans, the allowance established on quantitative historical loss percentages, and the allowance based on qualitative data to establish an appropriate amount to maintain in our allowance for loan losses. Should any of the factors considered by management in evaluating the adequacy of the allowance for probable loan losses change, our estimate of probable loan losses could also change, which could affect the
16
level of future provisions for probable loan losses. While the calculation of the allowance for probable loan losses utilizes management’s best judgment and all information reasonably available, the adequacy of the allowance is dependent on a variety of factors beyond our 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 loan loss provision is determined using the following methods. On a weekly basis, loan past due reports are reviewed by the credit quality committee to determine if a loan has any potential problems and if a loan should be placed on the internal classified report of the Subsidiary Banks. Additionally, the credit department of each Subsidiary Bank reviews the majority of our loans for proper internal classification purposes, 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, an analysis of loans that is provided through examinations by regulatory authorities is considered in the review process. After the above analysis is completed, we 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:
Three Months Ended September 30, 2019
Domestic
Commercial
Real Estate:
Construction &
Land
Farmland &
Residential:
Development
Multifamily
First Lien
Junior Lien
Balance at June 30,
11,780
15,273
17,029
1,849
3,627
7,312
488
845
58,203
Losses charged to allowance
(3,231)
(468)
(164)
(214)
(216)
(4,293)
Recoveries credited to allowance
585
672
Net (losses) recoveries charged to allowance
(2,646)
(458)
(161)
(149)
(211)
(3,621)
Provision charged to operations
1,837
1,573
230
350
263
852
199
(26)
Balance at September 30,
10,971
16,850
16,801
2,199
3,729
8,015
476
819
59,860
Three Months Ended September 30, 2018
16,596
14,703
18,296
1,574
3,591
6,793
450
850
62,853
(6,798)
(74)
(133)
(80)
(3)
(7,088)
489
19
23
53
609
(6,309)
(51)
(68)
(6,479)
3,039
397
1,050
(138)
(354)
194
57
35
13,326
15,104
19,365
1,436
3,186
6,907
439
891
60,654
Nine Months Ended September 30, 2019
Balance at December 31,
12,596
15,123
19,353
1,808
3,467
7,719
447
871
61,384
(11,011)
(7,347)
(166)
(314)
(334)
(19,172)
1,631
80
308
222
30
2,285
(9,380)
(7,039)
(152)
(92)
(304)
(16,887)
7,755
1,647
4,487
391
414
388
333
(52)
Nine Months Ended September 30, 2018
27,905
11,675
16,663
1,109
2,950
6,103
440
842
67,687
(11,798)
(1)
(70)
(118)
(172)
(262)
(12,424)
1,520
229
25
348
39
2,179
(10,278)
159
(93)
176
(223)
(10,245)
(4,301)
3,422
2,543
327
329
628
42
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 individually or collectively. The increase in provision for probable loan losses charged to expense and charge offs charged to the allowance for probable loan losses for the nine months ended September 30, 2019 can be primarily attributed to a relationship that is secured by multiple pieces of real property on which car dealerships are operated. The relationship began deteriorating in the fourth quarter of 2018, triggered by significant fraud by a high level insider of the car dealership resulting in the dealerships unexpectedly filing for bankruptcy and creating an exposure for potential loss since the operations of the dealerships were the source of repayment from the borrower. The relationship further deteriorated in the first quarter of 2019 after the sponsor of the court approved debtor in possession plan discontinued its role in the process and thus did not fulfill its obligation to assume full responsibility of the accrued and unpaid interest. Although the relationship is secured by real property (the dealerships’ real estate), the real property has specialized use, contributing to the potential exposure for probable loss. During the first quarter of 2019, in light of the circumstances and management’s evaluation of the relationship, the decision was made to place the relationship on impaired, non-accrual status and place a specific reserve on the relationship in the amount of $9.5 million. During the second quarter of 2019, management continued to evaluate the relationship and decided to foreclose on the underlying real estate collateral, resulting in a charge off of approximately $9,500,000, reflected in the tables above as part of the Commercial and Commercial Real Estate: Farmland and Commercial categories.
18
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 September 30, 2019 and December 31, 2018:
Loans Individually
Loans Collectively
Evaluated For
Impairment
Recorded
Investment
Allowance
7,412
395
1,288,324
10,576
Commercial real estate: other construction & land development
1,794
116
2,042,616
16,734
Commercial real estate: farmland & commercial
1,740
1,965,371
Commercial real estate: multifamily
649
241,440
Residential: first lien
6,286
432,186
Residential: junior lien
704
712,588
1,131
45,941
273
146,687
19,989
511
6,875,153
59,349
9,179
656
1,119,790
11,940
2,092
1,884,139
15,007
3,509
1,946,389
507
225,750
6,244
439,556
901
726,400
1,175
45,141
293
150,224
23,900
772
6,537,389
60,612
The table below provides additional information on loans accounted for on a non-accrual basis by loan class at September 30, 2019 and December 31, 2018:
7,379
9,143
583
347
171
22
Total non-accrual loans
12,150
15,791
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. We have identified these loans through our normal loan review procedures. Impaired loans are measured 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 our impaired loans are measured at the fair value of the collateral. In limited cases, we may use other methods to determine the level of impairment of a loan if such loan is not collateral dependent.
The following tables detail key information regarding our impaired loans by loan class at September 30, 2019 and December 31, 2018:
Quarter to Date
Year to Date
Unpaid
Average
Principal
Related
Interest
Balance
Recognized
Loans with Related Allowance
598
621
616
128
169
129
132
Total impaired loans with related allowance
726
790
731
748
Loans with No Related Allowance
6,814
6,963
8,002
17,945
1,666
1,953
1,674
1,767
2,368
3,222
22,389
684
653
6,400
6,427
78
6,698
231
708
1,028
32
1,088
274
281
Total impaired loans with no related allowance
19,263
20,480
22,297
92
51,852
20
2,161
1,741
135
1,698
2,330
1,882
7,616
7,730
16,194
1,957
2,205
2,151
4,031
36,632
538
565
6,386
7,136
305
976
44
1,190
1,211
22,202
23,284
65,192
368
The following table details key information regarding our impaired loans by loan class at September 30, 2018:
September 30, 2018
1,620
139
142
1,759
1,936
15,758
16,464
1,994
2,203
5,986
36,633
590
575
6,362
76
6,929
228
743
807
33
1,187
1,192
318
331
32,938
65,134
276
A portion of the impaired loans have adequate collateral and credit enhancements not requiring a related allowance for loan loss. Management recognizes the risks associated with these impaired loans, however, management
21
is confident our loss exposure regarding these credits will be significantly reduced due to our long-standing practices that encompass the following principles: (i) the financial strength of the borrower, including strong earnings, a high net worth, significant liquidity and an acceptable debt to worth ratio, (ii) managerial and business competence, (iii) the ability to repay, (iv) for a new business, projected cash flows, (v) loan to value, (vi) in the case of a secondary guarantor, a guarantor financial statement, and (vii) financial and/or other character references. Management’s decision to place loans in this category does not necessarily mean that we will experience significant losses from these loans or significant increases in impaired loans from these levels.
The following table details loans accounted for as “troubled debt restructuring,” segregated by loan class. Loans accounted for as troubled debt restructuring are included in impaired loans.
5,703
5,947
730
1,126
1,153
Total troubled debt restructuring
7,839
8,158
The Subsidiary Banks 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 our management believes 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 our management that the allowance for probable loan losses at September 30, 2019 was adequate to absorb probable losses from loans in the portfolio at that date.
The following tables present information regarding the aging of past due loans by loan class at September 30, 2019 and December 31, 2018:
90 Days or
30 - 59
60 - 89
greater &
Past
Days
Greater
still accruing
Due
Current
Portfolio
902
7,408
1,477
11,803
1,283,933
1,295,736
8,977
18,504
1,100
286
28,581
2,015,829
3,210
56,125
1,270
737
60,605
1,906,506
1,967,111
24
290
1,265
764
1,579
240,510
242,089
2,961
1,169
3,303
2,930
7,433
431,039
438,472
1,316
1,216
2,837
710,455
713,292
770
69
967
46,105
2,119
490
147
2,756
144,204
Total past due loans
22,870
77,913
7,626
116,561
6,778,581
4,651
1,089
19,851
10,890
25,591
1,103,378
1,128,969
727
1,707
922
3,356
1,882,875
2,928
784
27,239
24,910
30,951
1,918,947
1,949,898
927
578
71
1,505
224,752
226,257
3,998
1,677
3,362
3,079
9,037
436,763
445,800
1,155
618
1,108
937
2,881
724,420
727,301
486
45
550
45,766
1,106
117
739
1,962
148,555
15,978
6,011
53,844
40,674
75,833
6,485,456
The increase in loans past due 60 – 89 days at September 30, 2019 compared to December 31, 2018 can be primarily attributed to a loan relationship secured by real property on which a commercial office building is being constructed and a relationship secured by real estate on which private education centers are operated. The decrease in the 90 days or greater and still accruing loans at September 30, 2019 compared to December 31, 2018 can be primarily attributed to the previously discussed relationship secured by real property on which car dealerships are operated and the foreclosure of the underlying real estate assets securing the relationship in the second quarter of 2019.
Our internal classified report is segregated into the following categories: (i) “Special Review Credits,” (ii) “Watch List-Pass Credits,” and (iii) “Watch List-Substandard Credits.” The loans placed in the “Special Review Credits” category reflect management’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 our 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 we could sustain some future loss if such weaknesses are not corrected. For loans that are classified as impaired, management evaluates these credits in accordance with the provisions of ASC 310-10, “Receivables,” 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 our loans evaluated as impaired under ASC 310-10 are measured using the fair value of collateral method. In limited cases, we 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 our 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 we serve, (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 450-20.
A summary of the loan portfolio by credit quality indicator by loan class at September 30, 2019 and December 31, 2018 is as follows:
Special
Watch
Watch List—
Pass
Review
List—Pass
Substandard
Impaired
1,228,895
957
58,453
1,948,752
37,566
56,298
1,771,180
7,975
34,067
152,149
240,535
905
430,825
143
1,218
711,747
841
146,550
137
6,524,425
7,994
73,574
269,160
998,625
441
44,544
76,180
1,817,098
1,648
9,055
56,338
1,726,711
62,046
38,373
119,259
224,823
438,773
641
725,538
862
6,126,933
64,135
92,976
253,345
The decrease in Special Review credits at September 30, 2019 compared to December 31, 2018 can be primarily attributed to a relationship secured by real property on which education centers are operated being downgraded
to Watch-List Substandard. The decrease in Watch List – Pass credits at September 30, 2019 from December 31, 2018 can be primarily attributed to the reclassification of a relationship secured by oil and gas properties to Pass offset by the addition of two relationships secured by real estate on which commercial buildings are being constructed. The increase in Watch List- Substandard credits at September 30, 2019 compared to December 31, 2018 can be primarily attributed to the previously mentioned relationship secured by real estate on which education centers are operated offset by the foreclosure of the underlying real estate assets in the previously discussed relationship on which car dealerships were operated and a pay down on a relationship secured primarily by aircraft.
Note 5 — Stock Options
On April 5, 2012, the Board of Directors adopted the 2012 International Bancshares Corporation Stock Option Plan (the “2012 Plan”). There are 800,000 shares of common stock available for stock option grants under the 2012 Plan, which may be qualified incentive stock options (“ISOs”) or non-qualified stock options. 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 September 30, 2019, 27,276 shares were available for future grants under the 2012 Plan.
A summary of option activity under the stock option plan for the nine months ended September 30, 2019 is as follows:
Weighted
average
remaining
Aggregate
Number of
exercise
contractual
intrinsic
options
price
term (years)
value ($)
Options outstanding at December 31, 2018
788,977
25.91
Plus: Options granted
16,500
35.34
Less:
Options exercised
87,663
17.30
Options expired
Options forfeited
34,576
26.95
Options outstanding at September 30, 2019
683,238
27.19
5.86
7,809
Options fully vested and exercisable at September 30, 2019
322,772
22.08
4.62
5,339
Stock-based compensation expense included in the consolidated statements of income for the three and nine months ended September 30, 2019 is $240,000 and $744,000, respectively. Stock-based compensation expense included in the consolidated statements of income for the three and nine months ended September 30, 2018 was $285,000 and $755,000, respectively. As of September 30, 2019, there was approximately $2,158,000 of total unrecognized stock-based compensation cost related to non-vested options granted under our plans that will be recognized over a weighted average period of 1.9 years.
Note 6 — Investment Securities and Equity Securities with Readily Determinable Fair Values
We classify debt securities into one of three categories: held-to maturity, available-for-sale, or trading. Such debt 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. In accordance with the provisions of ASU 2016-01, which we adopted on January 1, 2018, unrealized holding gains and losses related to equity securities with readily determinable fair values are included in net income.
The amortized cost and estimated fair value by type of investment security at September 30, 2019 are as follows:
Held to Maturity
Gross
Amortized
unrealized
Estimated
Carrying
cost
gains
losses
fair value
value
Other securities
Available for Sale Debt Securities
value(1)
3,095,049
19,558
(17,197)
3,097,410
Obligations of states and political subdivisions
92,199
3,263
3,187,248
22,821
The amortized cost and estimated fair value by type of investment security at December 31, 2018 are as follows:
Available for Sale
fair
3,295,366
6,813
(79,169)
185,799
2,646
(105)
3,481,165
9,459
(79,274)
26
The amortized cost and estimated fair value of investment securities at September 30, 2019, 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.
Cost
Due in one year or less
Due after one year through five years
1,325
Due after five years through ten years
2,243
2,267
Due after ten years
89,956
93,195
Residential mortgage-backed securities are securities primarily issued by the Federal Home Loan Mortgage Corporation (“Freddie Mac”), Federal National Mortgage Association (“Fannie Mae”), or 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, we believe 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 and because securities issued by others that are collateralized by residential mortgage-backed securities issued by Fannie Mae or Freddie Mac are rated consistently as AAA rated securities.
The amortized cost and fair value of available-for-sale debt investment securities pledged to qualify for fiduciary powers, to secure public monies as required by law, repurchase agreements and short-term fixed borrowings was $1,143,623,000 and $1,142,310,000, respectively, at September 30, 2019.
Proceeds from the sale and calls of debt securities available-for-sale were $32,285,000 and $92,980,000 for the three and nine months ended September 30, 2019, which included $0 and $0 of mortgage-backed securities, respectively. Gross gains of $1 and $4 and gross losses of $3 and $16 were realized on the sales and calls for the three and nine months ended September 30, 2019, respectively. Proceeds from the sale and call of debt securities available-for-sale were $19,530,000 and $37,675,000 for the three and nine months ended September 30, 2018, which included $0 and $0 of mortgage-backed securities, respectively. Gross gains of $2 and $3 and gross losses of $0 and $0 were realized on the sales and calls for the three and nine months ended September 30, 2018, respectively.
Gross unrealized losses on debt investment securities and the fair value of the related securities, aggregated by investment category and length of time that individual debt securities have been in a continuous unrealized loss position at September 30, 2019, were as follows:
Less than 12 months
12 months or more
Unrealized
Losses
Available for sale:
209,786
(600)
1,593,578
(16,597)
1,803,364
27
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, 2018 were as follows:
208,384
(2,124)
2,537,181
(77,045)
2,745,565
12,756
(99)
512
(6)
13,268
221,140
(2,223)
2,537,693
(77,051)
2,758,833
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. The contractual cash obligations of the securities issued by Ginnie Mae are fully guaranteed by the U.S. Government. The contractual cash obligations of the securities issued by Freddie Mac and Fannie Mae are not fully guaranteed by the U.S. Government; however, we believe 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, and because securities issued by others that are collateralized by residential mortgage-backed securities issued by Fannie Mae and Freddie Mac are rated consistently as AAA rated securities. 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. We have 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 our conclusion that the investments in residential mortgage-backed securities issued by Freddie Mac, Fannie Mae and Ginnie Mae are not considered other-than-temporarily impaired.
Equity securities with readily determinable fair values consist primarily of Community Reinvestment Act funds. At September 30, 2019 and December 31, 2018, the balance in equity securities with readily determinable fair values recorded at fair value were $6,172,000 and $5,937,000, respectively. Prior to January 1, 2018, the equity securities were included in available-for-sale securities, with the related unrealized gain or loss recorded as a component of other comprehensive income. The following is a summary of unrealized and realized gains and losses recognized in net income on equity securities during the three and nine months ended September 30, 2019 and the three and nine months ended September 30, 2018:
Net gains recognized during the period on equity securities
Less: Net gains and (losses) recognized during the period on equity securities sold during the period
Unrealized gains recognized during the reporting period on equity securities still held at the reporting date
28
Net losses recognized during the period on equity securities
(62)
(771)
709
235
(1,083)
Unrealized losses recognized during the reporting period on equity securities still held at the reporting date
(312)
Note 7 — Other Borrowed Funds
Other borrowed funds include FHLB borrowings, which are short-term and long-term borrowings issued by the FHLB of Dallas and the FHLB of Topeka at the market price offered at the time of funding. These borrowings are secured by residential mortgage-backed investment securities and a portion of our loan portfolio. At September 30, 2019, other borrowed funds totaled $456,556,000, a decrease of 35.3% from $705,665,000 at December 31, 2018. The decrease in borrowings can be primarily attributed to decreased liquidity needs to fund operations and loan activity.
Note 8 — Junior Subordinated Interest Deferrable Debentures
As of September 30, 2019, we have five statutory business trusts under the laws of the State of Delaware, for the purpose of issuing trust preferred securities. The five statutory business trusts we formed (the “Trusts”) have each issued Capital and Common Securities and invested the proceeds thereof in an equivalent amount of junior subordinated debentures (“Debentures”) that we issued. As of September 30, 2019 and December 31, 2018, the principal amount of Debentures outstanding totaled $134,642,000 and $160,416,000, respectively. On May 7, 2019, after receiving the required regulatory approvals, we redeemed the full $25,000,000 of Junior Subordinated Deferrable Interest Debentures related to IB Capital Trust VI.
The Debentures are subordinated and junior in right of payment to all present and future senior indebtedness (as defined in the respective Indentures) and are pari passu with one another. The interest rate payable on, and the payment
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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. We have fully and unconditionally guaranteed the obligations of each of the Trusts with respect to the Capital and Common Securities. We have 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 twenty consecutive quarterly periods on Trusts 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.
For financial reporting purposes, the Trusts are treated as our investments and not consolidated in our consolidated financial statements. Although the Capital and Common Securities issued by each of the Trusts are not included as a component of shareholders’ equity on the consolidated statement of condition, the Capital and Common Securities are treated as capital for regulatory purposes. Specifically, under applicable regulatory guidelines, the Capital and Common 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 September 30, 2019 and December 31, 2018, the total $134,642,000 and $160,416,000 of the Capital and Common 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 September 30, 2019:
Junior
Subordinated
Deferrable
Repricing
Optional
Debentures
Frequency
Rate
Rate Index(1)
Maturity Date
Redemption Date(1)
Trust VIII
25,774
Quarterly
5.35
%
LIBOR
+
3.05
October 2033
October 2008
Trust IX
41,238
3.94
1.62
October 2036
October 2011
Trust X
21,021
3.90
1.65
February 2037
February 2012
Trust XI
25,990
July 2037
July 2012
Trust XII
20,619
3.58
1.45
September 2037
September 2012
(1) The Capital and Common Securities may be redeemed in whole or in part on any interest payment date after the Optional Redemption Date.
Note 9 — Common Stock and Dividends
We paid cash dividends of $0.50 and $0.55 per share on April 15 and October 15, 2019 to record holders of our common stock on April 1 and September 30, 2019, respectively. We paid cash dividends of $0.33 and $0.42 per share on April 16 and October 16, 2018 to record holders of our common stock on April 2 and October 9, 2018, respectively.
In April 2009, the Board of Directors re-established a formal stock repurchase program that authorized the repurchase of up to $40 million of common stock within the following 12 months. Annually since then, including on March 11, 2019, the Board of Directors extended the repurchase program and this year authorized an increase to purchase up to $50 million of common stock during the 12 month period commencing again on April 9, 2019. Shares of common stock may be purchased from time to time on the open market or through privately negotiated transactions. Shares purchased in this program will be held in treasury for reissue for various corporate purposes, including employee compensation plans. During the second quarter of 2019, the Board of Directors adopted a Rule 10b5-1 trading plan, and intends to adopt additional Rule 10b5-1 trading plans, that will allow us to purchase shares of our common stock during certain trading blackout periods when we ordinarily would not be in the market due to trading restrictions in our insider trading policy. During the term of a Rule 10b5-1 trading plan, purchases of common stock are automatic to the extent the conditions of the plan’s trading instructions are met. Shares purchased under the Rule 10b5-1 trading plan will be held in treasury for reissue for various corporate purposes, including employee stock compensation plans. As of November 1,
2019, a total of 10,320,487 shares had been repurchased under all programs at a cost of $329,122,000. We are not obligated to purchase shares under our stock repurchase program outside of its Rule 10b5-1 trading plan.
Note 10 — Commitments and Contingent Liabilities and Other Tax Matters
We are involved in various legal proceedings that are in various stages of litigation. We have 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 our consolidated financial position or results of operations. However, many of these matters are in various stages of proceedings and further developments could cause management to revise its assessment of these matters.
Note 11 — Capital Ratios
Banks and bank holding companies are subject to various regulatory capital requirements administered by state and federal banking agencies. Capital adequacy guidelines and, additionally for banks, prompt corrective action regulations, involve quantitative measures of assets, liabilities, and certain off-balance sheet items calculated under regulatory accounting practices. Capital amount and classifications are also subject to qualitative judgements by regulators about components, risk-weighting and other factors.
In July 2013, the Federal Deposit Insurance Corporation (“FDIC”) and other regulatory bodies established a new, comprehensive capital framework for U.S. banking organizations, consisting of minimum requirements that increase both the quantity and quality of capital held by banking organizations. The final rules are a result of the implementation of the BASEL III capital reforms and various Dodd-Frank Wall Street Reform and Consumer Protection Act (“Dodd Frank”) related capital provisions. Consistent with the Basel international framework, the rules include a minimum ratio of Common Equity Tier 1 (“CET1”) to risk-weighted assets of 4.5% and a CET1 capital conservation buffer of 2.5% of risk-weighted assets. The capital conservation buffer began phasing-in on January 1, 2016 at .625% and increased each year until January 1, 2019, when we were required to have a 2.5% capital conservation buffer, effectively resulting in a minimum ratio of CET1 capital to risk-weighted assets of at least 7% upon full implementation. The rules also raised the minimum ratio of Tier 1 capital to risk-weighted assets from 4% to 6% and include a minimum leverage ratio of 4% for all banking organizations. Regarding the quality of capital, the rules emphasize CET1 capital and implements strict eligibility criteria for regulatory capital instruments. The rules also improve the methodology for calculating risk-weighted assets to enhance risk sensitivity. The rules were subject to a four-year phase in period for mandatory compliance and we were required to begin to phase in the rules beginning on January 1, 2015. We believe that as of September 30, 2019, we meet all fully phased-in capital adequacy requirements.
On November 21, 2017, the OCC, the Federal Reserve and the FDIC finalized a proposed rule that extends the current treatment under the regulatory capital rules for certain regulatory capital deductions and risk weights and certain minority interest requirements, as they apply to banking organizations that are not subject to the advanced approaches capital rules. Effective January 1, 2018, the rule also pauses the full transition to the Basel III treatment of mortgage servicing assets, certain deferred tax assets, investments in the capital of unconsolidated financial institutions and minority interests. The agencies are also considering whether to make adjustments to the capital rules in response to CECL (the FASB Standard relating to current expected credit loss) and its potential impact on regulatory capital.
On December 7, 2017, the Basel Committee on Banking Supervision unveiled the latest round of its regulatory capital framework, commonly called “Basel IV.” The framework makes changes to the capital framework first introduced as “Basel III” in 2010. The committee targeted 2022-2027 as the timeframe for implementation by regulators in individual countries, including the U.S. federal bank regulatory agencies (after notice and comment).
The aforementioned capital conservation buffer is designed to absorb losses during periods of economic stress. Banking institutions with a ratio of CET1 capital to risk-weighted assets above the minimum but below the conservation buffer will face constraints on dividends, equity repurchases and compensation based on the amount of the shortfall.
As of September 30, 2019, our capital levels exceed all capital adequacy requirements under the Basel III Capital Rules as currently applicable to us.
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On May 24, 2018, the EGRRCPA was enacted and, among other things, it includes a simplified capital rule change which effectively exempts banks with assets of less than $10 billion that exceed the “community bank leverage ratio,” from all risk-based capital requirements, including Basel III and its predecessors. The federal banking agencies must establish the “community bank leverage ratio” (a ratio of tangible equity to average consolidated assets) between 8% and 10% before community banks can begin to take advantage of this regulatory relief provision. Some of the Subsidiary Banks, with assets of less than $10 billion, may qualify for this exemption. Additionally, under the EGRRCPA, qualified bank holding companies with assets of up to $3 billion (currently $1 billion) will be eligible for the Federal Reserve’s Small Bank Holding Company Policy Statement, which eases limitations on the issuance of debt by holding companies. On August 28, 2018, the Federal Reserve issued an interim final rule expanding the applicability of its Small Bank Holding Company Policy Statement. While holding companies that meet the conditions of the policy statement are excluded from consolidated capital requirements, their depository institutions continue to be subject to minimum capital requirements. Finally, for banks that continue to be subject to the risk-based capital rules of Basel III (e.g., 150%), certain commercial real estate loans that were formally classified as high volatility commercial real estate 31 (“HVCRE”) will not be subject to heightened risk weights if they meet certain criteria. Also, while acquisition, development, and construction (“ADC”) loans will generally be subject to heightened risk weights, certain exceptions will apply. On September 18, 2018, the federal banking agencies issued a proposed rule modifying the agencies’ capital rules for HVCRE.
We had a CET1 to risk-weighted assets ratio of 17.98% on September 30, 2019 and 17.55% on December 31, 2018. We had a Tier 1 capital-to-average-total-asset (leverage) ratio of 16.06% and 15.87%, risk-weighted Tier 1 capital ratio of 19.20% and 19.06% and risk-weighted total capital ratio of 19.85% and 19.74% at September 30, 2019 and December 31, 2018, respectively. Our CET1 capital consists of common stock and related surplus, net of treasury stock, and retained earnings. We and our Subsidiary Banks elected to opt-out of the requirement to include most components of accumulated other comprehensive income (loss) in the calculation of CET1 capital. CET1 is reduced by goodwill and other intangible assets, net of associated deferred tax liabilities and subject to transition provisions. Tier 1 capital includes CET1 capital and additional Tier 1 capital. Additional Tier 1 capital includes the Capital and Common Securities issued by the Trusts (see Note 8 above) 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 September 30, 2019, the total of $134,642,000 of the Capital and Common Securities outstanding qualified as Tier 1 capital. We actively monitor the regulatory capital ratios to ensure that our Subsidiary Banks are well-capitalized under the regulatory framework.
The CET1, Tier 1 and Total capital ratios are calculated by dividing the respective capital amounts by risk-weighted assets. Risk-weighted assets are calculated based on regulatory requirements and include total assets, excluding goodwill and other intangible assets, allocated by risk-weight category, and certain off-balance-sheet items, among other things. The leverage ratio is calculated by dividing Tier 1 capital by adjusted quarterly average total assets, which exclude goodwill and other intangible assets, among other things.
We and our Subsidiary Banks are subject to the regulatory capital requirements administered by the Federal Reserve, and, for our Subsidiary Banks, the FDIC. Regulatory authorities can initiate certain mandatory actions if we or any of our Subsidiary Banks fail to meet the minimum capital requirements, which could have a direct material effect on our financial statements. Management believes, as of September 30, 2019, that we and each of our Subsidiary Banks meet all capital adequacy requirements to which we are subject.
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
The following discussion should be read in conjunction with our consolidated financial statements, and notes thereto, for the year ended December 31, 2018, included in our 2018 Form 10-K. Operating results for the three and nine months ended September 30, 2019 are not necessarily indicative of the results for the year ending December 31, 2019, 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 we believe 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 we project, forecast, estimate or budget in forward-looking statements include, among others, the following possibilities:
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. We make 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
We are headquartered in Laredo, Texas with 189 facilities and 285 ATMs, and provide banking services for commercial, consumer and international customers of North, South, Central and Southeast Texas and the State of Oklahoma. We are one of the largest independent commercial bank holding companies headquartered in Texas. We, through our Subsidiary Banks, are in the business of gathering funds from various sources and investing those funds in order to earn a return. We either directly or through a Subsidiary Bank, own an insurance agency, a liquidating subsidiary, a broker/dealer and a fifty percent interest in an investment banking unit that owns a broker/dealer. Our primary earnings come from the spread between the interest earned on interest-bearing assets and the interest paid on interest-bearing liabilities. In addition, we generate income from fees on products offered to commercial, consumer and international customers. The sales team of each of our Subsidiary Banks aims to match the right mix of products and services to each customer to best serve the customer’s needs. That process entails spending time with customers to assess those needs and servicing the sales arising from those discussions on a long-term basis. The Subsidiary Banks have various compensation plans, including incentive based compensation, for fairly compensating employees. The Subsidiary Banks also have a robust process in place to review sales that support the incentive based compensation plan
34
to monitor the quality of the sales and identify any significant irregularities, a process that has been in place for many years.
We are very active in facilitating trade along the United States border with Mexico. We do 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 our Subsidiary Banks. We also serve the growing Hispanic population through our facilities located throughout South, Central and Southeast Texas and the State of Oklahoma.
Expense control is an essential element in our long-term profitability. As a result, we monitor closely the efficiency ratio, which is a measure of non-interest expense to net interest income plus non-interest income. As we adjust to regulatory changes related to Dodd-Frank, including congressional efforts to revamp or reform it, our efficiency ratio may suffer because the additional regulatory compliance costs are expected to increase non-interest expense. We monitor this ratio over time to assess our efficiency relative to our peers. We use this measure as one factor in determining if we are accomplishing our long-term goals of providing superior returns to our shareholders.
Results of Operations
Summary
Consolidated Statements of Condition Information
Percent Increase (Decrease)
0.8
5.2
1.3
25.8
(35.3)
(16.1)
Shareholders’ equity
6.6
Consolidated Statements of Income Information
Percent
Increase
(Decrease)
Interest income
4.9
8.8
Interest expense
10.4
16.1
4.1
7.8
23.3
378.3
Non-interest income
0.5
(8.5)
Non-interest expense
3.8
2.7
0.7
(2.6)
Per common share:
Basic
.79
2.6
(1.7)
Diluted
.78
(1.3)
Net income for the three and nine months ended September 30, 2019 increased by 0.7% and decreased by 2.6%, respectively, compared to the same periods of 2018. Net income for the three and nine months ended September 30, 2019 continues to be positively affected by an increase in net interest income due to a higher volume of loans and an
increase in the overall yield of the loan portfolio. Interest expense increased for the three and nine months ended September 30, 2019 and can be primarily attributed to an increase in the cost of borrowings expense, and an increase in the interest paid on savings and time deposit accounts, which have increased because of recent Federal Reserve Board actions to raise interest rates. Net income for 2019 was negatively impacted by an increase in the provision for probable loan losses due to a charge-off of $7.5 million, net of tax, on a relationship that was secured by real property on which car dealerships are operated.
Net Interest Income
Interest Income:
9.2
13.5
(10.8)
(8.3)
(48.6)
(35.4)
5.7
38.8
20.0
41.1
62.6
64.7
Securities sold under Repurchase agreements
36.8
(1.0)
(27.9)
(24.4)
Junior subordinated interest deferrable debentures
(22.6)
(1.4)
The increase in net interest income for the three and nine months ended September 30, 2019 compared to the same period of 2018 can be primarily attributed to increased levels of interest income arising from an increase in loans outstanding. Interest expense on other borrowings consists of interest expense on FHLB borrowings and has decreased as the level of borrowings outstanding has decreased. Interest expense on savings and time deposits for the same periods also increased in line with internal rate increases paid on such deposits in line with market interest rates as a result of Federal Reserve Board actions and to remain competitive with competitors in the markets we serve. 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 our strategy to manage interest rate risk, we strive 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. Our management can quickly change our 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 we employ to supplement gap analysis include simulation analysis to quantify interest rate risk exposure. The gap analysis prepared by management is reviewed by our Investment Committee twice a year (see table on page 42 for the September 30, 2019 gap analysis). Our management currently believes that we are properly positioned for interest rate changes; however if
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our management determines at any time that the we are not properly positioned, we will strive to adjust the interest rate sensitive assets and liabilities in order to manage the effect of interest rate changes.
Non-Interest Income
1.8
(0.1)
12.3
5.6
6.9
9.3
(98.6)
(91.5)
(56.6)
(71.1)
32.1
(11.6)
Total non-interest income for the three and nine months ended September 30, 2019 increased 0.5% and decreased 8.5%, respectively, compared to the same periods of 2018. Non-interest income from other investments in 2019 was primarily negatively impacted by the impairment of an equity investment of $3.7 million, net of tax as a result of a re-evaluation of the carrying value. Other income for the three and nine months ended September 30, 2018 was positively impacted by our share of income from a real estate development partnership in which it holds a majority interest.
Non-Interest Expense
4.7
5.8
6.7
0.9
10.3
10.7
16.8
20.7
(10.7)
(14.9)
73.2
14.8
(1.6)
8.5
9.6
(7.2)
(12.4)
Non-interest expense for the three and nine months ended September 30, 2019 increased 3.8% and 2.7%, respectively, compared to the same period of 2018. Non-interest expense for the three and nine months ended September 30, 2019 was impacted by an increase in costs on our compensation and benefit plans as a result of our continued review of those plans and necessary increases, remain competitive and compensate our staff based on their performance, as well as an increase in depreciation expense as we continue to invest in our network infrastructure, equipment and facilities.
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Financial Condition
Allowance for Probable Loan Losses
The allowance for probable loan losses decreased 2.5% to $59,860,000 at September 30, 2019 from $61,384,000 at December 31, 2018. The provision for probable loan losses charged to expense increased 23.3% and 378.3% for the three and nine months ended September 30, 2019 to $5,278,000 and $15,363,000, respectively, compared to $4,280,000 and $3,212,000 for the same periods of 2018. The increase in provision for probable loan losses charged to expense for 2019 can be primarily attributed to a specific reserve on a relationship that is secured by multiple pieces of real property on which car dealerships are operated. The relationship began deteriorating in the fourth quarter of 2018, triggered by significant fraud by a high level insider of the car dealerships resulting in the dealerships unexpectedly filing for bankruptcy and creating an exposure for potential loss since the operations of the car dealerships were the source of repayment from the borrower. The relationship further deteriorated in the first quarter of 2019 after the sponsor of the court approved debtor in possession plan discontinued its role in the process and thus did not fulfill its obligation to assume full responsibility of the accrued and unpaid interest. Although the relationship is secured by real property (the dealerships’ real estate), the real property has specialized use, contributing to the potential exposure for probable loss. During the first quarter of 2019, in light of the circumstances and management’s evaluation of the relationship, the decision was made to place the relationship on impaired, non-accrual status and place a specific reserve on the relationship in the amount of $9.5 million. During the second quarter of 2019, management continued to evaluate the relationship and decided to foreclose on the underlying real estate collateral. The allowance for probable loan losses was .87% and .94% of total loans at September 30, 2019 and December 31, 2018, respectively.
Residential mortgage-backed debt securities are securities primarily issued by Freddie Mac, Fannie Mae, or Ginnie Mae. Investments in debt residential mortgage-backed securities issued by Ginnie Mae are fully guaranteed by the U.S. Government. Investments in debt residential mortgage-backed securities issued by Freddie Mac and Fannie Mae are not fully guaranteed by the U.S. Government, however, we believe 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 and because securities issued by others that are collateralized by residential mortgage-backed securities issued by Fannie Mae or Freddie Mac are rated consistently as AAA rated securities.
Net loans increased by 5.2% to $6,835,282,000 at September 30, 2019, from $6,499,905,000 at December 31, 2018.
Deposits increased by 1.3% to $8,812,061,000 at September 30, 2019, compared to $8,696,545,000 at December 31, 2018. Although deposits at September 30, 2019 increased from December 31, 2018, and we have experienced some growth in deposits over the last few years, we are still experiencing a substantial amount of competition for deposits at higher than market rates. As a result, we have attempted to maintain certain deposit relationships but have allowed certain deposits to leave as the result of aggressive pricing by competitors.
Foreign Operations
On September 30, 2019, we had $11,966,034,000 of consolidated assets, of which approximately $146,960,000, or 1.2%, was related to loans outstanding to borrowers domiciled in foreign countries, compared to $150,517,000, or 1.3%, at December 31, 2018. Of the $146,960,000, 85.8% is directly or indirectly secured by U.S. assets, certificates of deposits and real estate; 14.1% is secured by foreign real estate or other assets; and 0.1% is unsecured.
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Critical Accounting Policies
We have established various accounting policies that govern the application of accounting principles in the preparation of our 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 that have a material impact on the carrying value of certain assets and liabilities; management considers such accounting policies to be critical accounting policies.
We consider our allowance for probable loan losses as a policy critical to the sound operations of the Subsidiary Banks. The allowance for probable loan losses primarily consists of the aggregate loan loss allowances of the Subsidiary Banks. 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 Bank 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 impaired 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 our 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 our latest Annual Report on Form 10-K for further information regarding our provision and allowance for probable loan losses policy.
Liquidity and Capital Resources
The maintenance of adequate liquidity provides our Subsidiary Banks 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. Our Subsidiary Banks 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 our Subsidiary Banks. Other important funding sources for our Subsidiary Banks during 2019 and 2018 were borrowings from the FHLB, securities sold under repurchase agreements and large certificates of deposit, requiring management to closely monitor our asset/liability mix in terms of both rate sensitivity and maturity distribution. The borrowings from FHLB are primarily short-term in nature and are renewed at maturity. Our Subsidiary Banks have had a long-standing relationship with the FHLB and keep open unused lines of credit in order to fund liquidity needs. In the event that the FHLB bank indebtedness is not renewed, the repayment of the outstanding indebtedness would more than likely be repaid through proceeds generated from the sales of unpledged, available-for-sale securities. We maintain a sizable, high quality investment portfolio to provide significant liquidity. These securities can be sold, or sold under agreements to repurchase, to provide immediate liquidity. We 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.
We maintain an adequate level of capital as a margin of safety for our depositors and shareholders. At September 30, 2019, shareholders’ equity was $2,067,924,000 compared to $1,939,582,000 at December 31, 2018. The increase in shareholders’ equity can be primarily attributed to the retention of earnings offset by the payment of dividends to shareholders’ and other comprehensive income.
In July 2013, the Federal Deposit Insurance Corporation (“FDIC”) and other regulatory bodies established a new, comprehensive capital framework for U.S. banking organizations, consisting of minimum requirements that increase both the quantity and quality of capital held by banking organizations. The final rules are a result of the implementation of the BASEL III capital reforms and various Dodd-Frank Act related capital provisions. Consistent with the Basel international framework, the rules include a minimum ratio of Common Equity Tier 1 (“CET1”) to risk-weighted assets of 4.5% and a CET1 capital conservation buffer of 2.5% of risk-weighted assets. The capital conservation buffer began phasing-in on January 1, 2016 at .625% and increased each year until January 1, 2019, when we were required to have a 2.5% capital conservation buffer, effectively resulting in a minimum ratio of CET1 capital to risk-weighted assets of at least 7% upon full implementation. The rules also raised the minimum ratio of Tier 1 capital to risk-weighted assets from 4% to 6% and include a minimum leverage ratio of 4% for all banking organizations. Regarding the quality of capital, the rules emphasize CET1 capital and implements strict eligibility criteria for regulatory capital instruments. The rules also improve the methodology for calculating risk-weighted assets to enhance risk sensitivity. The rules were subject to a four year phase in period for mandatory compliance and we were required to begin to phase in the rules beginning on January 1, 2015. Management believes, as of September 30, 2019, that we and each of our Subsidiary Banks meet all fully phased-in capital adequacy requirements.
On November 21, 2017, the Office of the Comptroller of the Currency (“OCC”), the FRB and the FDIC finalized a proposed rule that extends the current treatment under the regulatory capital rules for certain regulatory capital deductions and risk weights and certain minority interest requirements, as they apply to banking organizations that are not subject to the advanced approaches capital rules. Effective January 1, 2018, the rule also pauses the full transition to the Basel III treatment of mortgage servicing assets, certain deferred tax assets, investments in the capital of unconsolidated financial institutions and minority interests. The agencies are also considering whether to make adjustments to the capital rules in response to CECL (the FASB Standard relating to current expected credit loss) and its potential impact on regulatory capital.
In December 2018, the federal banking regulators issued a final rule that would provide an optional three-year phase-in period for the day-one regulatory capital effects of the adoption of Accounting Standards Update (“ASU”) 2016-13 to ASC 326, “Financial Instruments – Credit Losses,” as amended, on January 1, 2020.
We had a CET1 to risk-weighted assets ratio of 17.98% on September 30, 2019 and 17.55% on December 31, 2018. We had a Tier 1 capital-to-average-total-asset (leverage) ratio of 16.06% and 15.87%, risk-weighted Tier 1 capital ratio of 19.20% and 19.06% and risk-weighted total capital ratio of 19.84% and 19.74% at September 30, 2019 and
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December 31, 2018, respectively. Our CET1 capital consists of common stock and related surplus, net of treasury stock, and retained earnings. We and our Subsidiary Banks elected to opt-out of the requirement to include most components of accumulated other comprehensive income (loss) in the calculation of CET1 capital. CET1 is reduced by goodwill and other intangible assets, net of associated deferred tax liabilities and subject to transition provisions. Tier 1 capital includes CET1 capital and additional Tier 1 capital. Additional Tier 1 capital includes the Capital and Common Securities issued by the Trusts (see Note 8 above) 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 September 30, 2019, the total of $134,642,000 of the Capital and Common Securities outstanding qualified as Tier 1 capital. We actively monitor the regulatory capital ratios to ensure that our Subsidiary Banks are well-capitalized under the regulatory framework.
We 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 September 30, 2019 is illustrated in the table entitled “Interest Rate Sensitivity,” below. 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.
We undertake 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 assets and liabilities equally or at the same time. As indicated in the table, we are asset sensitive in both the short and long term scenarios. Our Asset and Liability Committee semi-annually reviews the consolidated position along with simulation and duration models, and makes adjustments as needed to control our interest rate risk position. We use modeling of future events as a primary tool for monitoring interest rate risk.
Interest Rate Sensitivity
Rate/Maturity
Over 3
Over 1
3 Months
Months to
Year to 5
Over 5
or Less
1 Year
Years
Rate sensitive assets
Investment securities
266,667
529,769
2,309,545
95,463
Loans, net of non-accruals
5,389,563
237,427
125,747
1,130,255
6,882,992
Total earning assets
5,656,230
767,196
2,435,292
1,225,718
10,084,436
Cumulative earning assets
6,423,426
8,858,718
Rate sensitive liabilities
822,014
995,981
163,318
56
Other interest bearing deposits
20,000
436,556
Total interest bearing liabilities
4,520,752
436,612
6,116,663
Cumulative sensitive liabilities
5,516,733
5,680,051
Repricing gap
1,135,478
(228,785)
2,271,974
789,106
3,967,773
Cumulative repricing gap
906,693
3,178,667
Ratio of interest-sensitive assets to liabilities
1.25
0.77
14.91
2.81
Ratio of cumulative, interest-sensitive assets to liabilities
1.16
1.56
Item 3. Quantitative and Qualitative Disclosures about Market Risk
During the three and nine months ended September 30, 2019, 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 18 through 22 of our 2018 Annual Report as filed as Exhibit 13 to our Form 10-K for the year ended December 31, 2018.
Item 4. Controls and Procedures
Disclosure Controls and Procedures
We maintain 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, our principal executive officer and principal financial officer evaluated, with the participation of our management, the effectiveness of our 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, our principal executive officer and principal financial officer concluded that our 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 our internal control over financial reporting that occurred during our most recent fiscal quarter that have materially affected or are reasonably likely to materially affect our internal control over financial reporting.
PART II - OTHER INFORMATION
Item 1. Legal Proceedings
We are involved in various legal proceedings that are in various stages of litigation. We have determined, based on discussions with our counsel that any material loss in any current legal proceedings, individually or in the aggregate, is remote or the damages sought, even if fully recovered, would not be considered material to our consolidated financial position or results of operations. However, many of these matters are in various stages of proceedings and further developments could cause management to revise its assessment of these matters.
1A. Risk Factors
There were no material changes in the risk factors as previously disclosed in Item 1A to Part I of our Annual Report on Form 10-K for the fiscal year ended December 31, 2018.
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
In April 2009, following receipt of the Treasury Department’s consent, the Board of Directors re-established a formal stock repurchase program that authorized the repurchase of up to $40 million of common stock within the following 12 months. Annually since then, including on March 11, 2019, the Board of Directors extended the repurchase program and this year authorized an increase to purchase up to $50 million of common stock during the 12 month period commencing again on April 9, 2019. Shares of common stock may be purchased from time to time on the open market or through privately negotiated transactions. Shares purchased in this program will be held in treasury for reissue for various corporate purposes, including employee compensation plans. During the third quarter of 2019, the Board of Directors adopted a Rule 10b5-1 trading plan, and intends to adopt additional Rule 10b5-1 trading plans, that will allow us to purchase shares of our common stock during certain trading blackout periods when we ordinarily would not be in the market due to trading restrictions in our insider trading policy. During the term of a Rule 10b5-1 trading plan, purchases of common stock are automatic to the extent the conditions of the plan’s trading instructions are met. Shares purchased under the Rule 10b5-1 trading plan will be held in treasury for reissue for various corporate purposes, including employee stock compensation plans. As of November 1, 2019, a total of 10,320,487 shares had been repurchased under all programs at a cost of $329,122,000 We are not obligated to purchase shares under our stock repurchase program outside of its Rule 10b5-1 trading plan.
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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 September 30, 2019.
Total Number of
Purchased as
Approximate
Part of a
Dollar Value of
Total Number
Price Paid
Publicly-
Shares Available
of Shares
Per
Announced
for
Purchased
Share
Program
Repurchase(1)
July 1 – July 31, 2019
49,926,000
August 1 – August 31, 2019
458,931
34.07
34,291,000
September 1 – September 30, 2019
58,042
35.40
55,446
32,237,000
516,973
34.22
514,377
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
104++ — Cover Page Interactive Data File (included in Exhibit 101)
++ Attached as Exhibit 101 to this report are the following documents formatted in Inline XBRL (Extensible Business Reporting Language): (i) the Cover Page to this Form 10-Q; (ii) the Condensed Consolidated Statement of Earnings for the three and nine months ended September 30, 2019 and 2018; (iii) the Condensed Consolidated Balance Sheet as of September 30, 2019 and December 31, 2018; and (iv) the Condensed Consolidated Statement of Cash Flows for the nine months ended September 30, 2019 and September 30, 2018.
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:
November 6, 2019
/s/ Dennis E. Nixon
Dennis E. Nixon
President
/s/ Judith I. Wawroski
Judith I. Wawroski
Treasurer