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 June 30, 2022
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
62,242,125 shares outstanding at August 1, 2022
PART I - FINANCIAL INFORMATION
Item 1. Financial Statements
INTERNATIONAL BANCSHARES CORPORATION AND SUBSIDIARIES
Consolidated Statements of Condition (Unaudited)
(Dollars in Thousands)
June 30,
December 31,
2022
2021
Assets
Cash and cash equivalents
$
3,416,716
3,209,242
Investment securities:
Held to maturity debt securities (Market value of $3,400 on June 30, 2022 and $3,400 on December 31, 2021)
3,400
Available for sale debt securities (Amortized cost of $4,648,031 on June 30, 2022 and $4,254,960 on December 31, 2021)
4,294,360
4,213,920
Equity securities with readily determinable fair values
5,581
6,079
Total investment securities
4,303,341
4,223,399
Loans
7,027,129
7,209,151
Less allowance for credit losses
(112,572)
(110,374)
Net loans
6,914,557
7,098,777
Bank premises and equipment, net
435,183
447,082
Accrued interest receivable
30,730
30,593
Other investments
368,601
296,882
Cash surrender value of life insurance policies
300,494
297,218
Goodwill
282,532
Other assets
219,025
160,511
Total assets
16,271,179
16,046,236
1
Consolidated Statements of Condition, continued (Unaudited)
Liabilities and Shareholders’ Equity
Liabilities:
Deposits:
Demand—non-interest bearing
6,102,050
5,838,526
Savings and interest bearing demand
4,660,835
4,590,548
Time
2,180,367
2,188,803
Total deposits
12,943,252
12,617,877
Securities sold under repurchase agreements
513,368
439,672
Other borrowed funds
436,042
436,138
Junior subordinated deferrable interest debentures
134,642
Other liabilities
146,644
109,426
Total liabilities
14,173,948
13,737,755
Shareholders’ equity:
Common shares of $1.00 par value. Authorized 275,000,000 shares; issued 96,368,414 shares on June 30, 2022 and 96,350,977 shares on December 31, 2021
96,368
96,351
Surplus
152,743
152,144
Retained earnings
2,544,148
2,470,710
Accumulated other comprehensive loss
(276,735)
(31,980)
2,516,524
2,687,225
Less cost of shares in treasury, 33,993,101 shares on June 30, 2022 and 32,979,273 on December 31, 2021
(419,293)
(378,744)
Total shareholders’ equity
2,097,231
2,308,481
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
Six Months Ended
Interest income:
Loans, including fees
87,630
91,816
169,118
183,930
Taxable
16,938
5,014
30,128
9,889
Tax-exempt
351
377
701
772
Other interest income
4,665
6,069
1,262
Total interest income
109,584
97,979
206,016
195,853
Interest expense:
Savings deposits
1,296
990
2,397
1,919
Time deposits
2,277
2,929
4,781
6,127
241
142
425
283
Other borrowings
1,907
1,908
3,795
3,797
962
702
1,671
1,410
Total interest expense
6,683
6,671
13,069
13,536
Net interest income
102,901
91,308
192,947
182,317
Provision for credit losses
3,735
1,144
5,216
2,336
Net interest income after provision for credit losses
99,166
90,164
187,731
179,981
Non-interest income:
Service charges on deposit accounts
18,248
15,774
35,505
30,677
Other service charges, commissions and fees
Banking
12,935
13,233
25,451
25,416
Non-banking
2,042
2,345
3,807
3,785
Investment securities transactions, net
—
(4)
Other investments, net
1,219
58,920
4,101
63,005
Other income
8,798
7,634
17,890
11,264
Total non-interest income
43,242
97,906
86,754
134,143
3
Consolidated Statements of Income, continued (Unaudited)
Non-interest expense:
Employee compensation and benefits
31,045
30,548
62,164
60,710
Occupancy
6,189
6,530
12,461
12,147
Depreciation of bank premises and equipment
5,455
6,436
10,930
13,235
Professional fees
2,942
2,281
5,260
5,117
Deposit insurance assessments
1,979
927
3,036
1,814
Net operations, other real estate owned
(47)
3,668
(455)
4,913
Advertising
1,455
1,456
2,895
2,879
Software and software maintenance
4,372
4,526
8,549
8,966
Other
15,366
13,582
28,034
22,358
Total non-interest expense
68,756
69,954
132,874
132,139
Income before income taxes
73,652
118,116
141,611
181,985
Provision for income taxes
15,681
26,090
30,147
39,188
Net income
57,971
92,026
111,464
142,797
Basic earnings per common share:
Weighted average number of shares outstanding
62,950,103
63,362,817
63,150,061
63,335,289
0.92
1.45
1.77
2.25
Fully diluted earnings per common share:
63,085,429
63,518,556
63,290,738
63,469,284
1.76
See accompanying notes to consolidated financial statements
4
Consolidated Statements of Comprehensive Income (Unaudited)
Other comprehensive loss, net of tax:
Net unrealized holding (losses) gains on securities available for sale arising during period (net of tax effects of $(19,033), $127, $(65,061), and $(674))
(71,599)
479
(244,755)
(2,536)
Reclassification adjustment for losses on securities available for sale included in net income (net of tax effects of $0, $0, $0 and $1)
(2,533)
Comprehensive (loss) income
(13,628)
92,505
(133,291)
140,264
5
Consolidated Statements of Shareholders’ Equity
Three and Six Months ended June 30, 2022 and 2021
(in Thousands, except per share amounts)
Number
of
Common
Retained
Comprehensive
Treasury
Shares
Stock
Earnings
Income (Loss)
Total
Balance at March 31, 2022
96,357
152,405
2,486,177
(205,136)
(382,124)
2,147,679
Purchase of treasury stock (930,762 shares)
(37,169)
Exercise of stock options
11
230
Stock compensation expense recognized in earnings
108
Other comprehensive income, net of tax:
Net change in unrealized gains and losses on available for sale securities, net of reclassification adjustments
Balance at June 30, 2022
Balance at March 31, 2021
96,312
150,972
2,305,584
17,813
(378,076)
2,192,605
20
426
446
114
Balance at June 30, 2021
96,332
151,512
2,397,610
18,292
2,285,670
Balance at December 31, 2021
Dividends:
Cash ($.60 per share)
(38,026)
Purchase of treasury stock (1,013,828 shares)
(40,549)
17
370
387
229
6
Balance at December 31, 2020
96,241
149,334
2,289,626
20,825
(378,028)
2,177,998
Cash ($.55 per share)
(34,813)
Purchase of treasury stock (999 shares)
(48)
91
1,905
1,996
273
7
Consolidated Statements of Cash Flows (Unaudited)
Operating activities:
Adjustments to reconcile net income to net cash provided by operating activities:
Provision for credit loss
Specific reserve, other real estate owned
16
2,065
(Gain) loss on sale of bank premises and equipment
(3,080)
15
(Gain) loss on sale of other real estate owned
(1,174)
519
Accretion of investment securities discounts
(732)
(279)
Amortization of investment securities premiums
8,773
22,329
Unrealized loss on equity securities with readily determinable fair values
498
65
Proceeds from settlements of claims
2,870
Stock based compensation expense
Earnings from affiliates and other investments
(4,079)
(61,313)
Deferred income taxes
(589)
(821)
(Increase) decrease in accrued interest receivable
(137)
4,902
(Increase) decrease in other assets
(3,774)
12,097
Increase in other liabilities
43,821
24,904
Net cash provided by operating activities
167,382
165,998
Investing activities:
Proceeds from maturities of securities
2,075
1,200
Proceeds from sales and calls of available for sale securities
2,865
Purchases of available for sale securities
(818,988)
(2,129,883)
Principal collected on mortgage backed securities
415,801
1,009,379
Net decrease in loans
177,727
134,517
Purchases of other investments
(68,253)
(42,037)
Distributions from other investments
3,133
59,955
Purchases of bank premises and equipment
(8,571)
(4,259)
Proceeds from sales of bank premises and equipment
10,144
1,255
Proceeds from sales of other real estate owned
6,237
6,320
Net cash used in investing activities
(280,695)
(960,688)
8
Consolidated Statements of Cash Flows, continued (Unaudited)
Financing activities:
Net increase in non-interest bearing demand deposits
263,524
703,414
Net increase in savings and interest bearing demand deposits
70,287
461,049
Net decrease in time deposits
(8,436)
(9,554)
Net increase in securities sold under repurchase agreements
73,696
2,382
Net decrease in other borrowed funds
(96)
(94)
Purchase of treasury stock
Proceeds from stock transactions
Payments of cash dividends
Net cash provided by financing activities
320,787
1,124,332
Increase in cash and cash equivalents
207,474
329,642
Cash and cash equivalents at beginning of period
1,997,238
Cash and cash equivalents at end of period
2,326,880
Supplemental cash flow information:
Interest paid
12,701
13,991
Income taxes paid
3,643
16,130
Non-cash investing and financing activities:
Net transfers from loans to other real estate owned
1,277
16,587
Net transfers from bank premises and equipment to other assets
2,476
9
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, Emerald Galveston Holdings, LLC, IBC Capital Corporation, and Diamond Beach Holdings, LLC. 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, 2021 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 six months ended June 30, 2022 are not necessarily indicative of the results for the year ending December 31, 2022 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.
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:
10
A description of the valuation methodologies used for instruments measured at fair value, as well as the general classification of such instruments pursuant to the valuation hierarchy is set forth below.
The following table represents assets and liabilities reported on the consolidated balance sheets at their fair value on a recurring basis as of June 30, 2022 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
June 30, 2022
(Level 1)
(Level 2)
(Level 3)
Measured on a recurring basis:
Assets:
Available for sale debt securities
U.S. Treasury securities
48,951
Residential mortgage-backed securities
4,203,931
States and political subdivisions
41,478
Equity Securities
4,299,941
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, 2021 by level within the fair value measurement hierarchy:
December 31, 2021
Available for sale securities
Residential mortgage - backed securities
4,169,363
44,557
4,219,999
Available-for-sale debt securities are classified within Level 1 or 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 June 30, 2022 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:
Watch-List doubtful loans
105
29
Other real estate owned
144
The following table represents financial instruments measured at fair value on a non-recurring basis as of and for the period ended December 31, 2021 by level within the fair value measurement hierarchy:
Markets
Net (Credit)
Year ended
for Identical
Provision
55
209
18,095
2,655
Our assets measured at fair value on a non-recurring basis are limited to loans classified as Watch List – Doubtful and other real estate owned. The fair value of Watch List-Doubtful loans is derived in accordance with FASB ASC 310, “Receivables”. They 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 loan to fair value is done through a specific valuation allowance included in the allowance for credit losses (“ACL”). The fair value of the loan is based on the fair value of the collateral, as determined through either an appraisal or internal 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 internal 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 June 30, 2022, we had $1,030,000 of doubtful commercial collateral dependent loans, of which $0 had an appraisal performed within the immediately preceding twelve months, and of which $1,030,000 had an internal evaluation performed within the immediately preceding twelve months. As of December 31, 2021, we had approximately $993,000 of doubtful commercial collateral dependent loans, of which $0 had an appraisal performed within the immediately preceding twelve months and of which $896,000 had an internal evaluation performed within the immediately preceding twelve months.
12
Our determination to either seek an appraisal or to perform an internal evaluation begins in weekly credit quality meetings, where the committee analyzes the existing collateral values of the doubtful 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 analysis of the doubtful loan. 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 ACL, 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 six months ended June 30, 2022 and the twelve months ended December 31, 2021, we recorded $0, $0 and $2,000, respectively, in charges to the ACL in connection with loans transferred to other real estate owned. For the three and six months ended June 30, 2022 and the twelve months ended December 31, 2021, we recorded $16,000, $16,000 and $2,655,000, 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 June 30, 2022 and December 31, 2021 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.
13
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 June 30, 2022 and December 31, 2021, the carrying amount of fixed rate performing loans was $1,256,737,000 and $1,363,313,000, respectively, and the estimated fair value was $1,202,590,000 and $1,323,223,000, respectively.
Accrued Interest
The carrying amounts of accrued interest approximate fair value.
Deposits
The fair value of deposits with no stated maturity, such as non-interest-bearing demand deposit accounts, savings accounts and interest-bearing demand deposit accounts, was equal to the amount payable on demand as of June 30, 2022 and December 31, 2021. 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 June 30, 2022 and December 31, 2021, the carrying amount of time deposits was $2,180,367,000 and $2,188,803,000, respectively, and the estimated fair value was $2,180,348,000 and $2,186,547,000, respectively.
Securities Sold Under Repurchase Agreements
Securities sold under repurchase agreements are short-term maturities. Due to the contractual terms of the instruments, the carrying amounts approximated fair value at June 30, 2022 and December 31, 2021.
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 June 30, 2022 and December 31, 2021.
Other Borrowed Funds
We currently have long-term borrowings issued from the Federal Home Loan Bank (“FHLB”). The long-term borrowings outstanding at June 30, 2022 and December 31, 2021 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 June 30, 2022 and December 31, 2021, the carrying amount of the fixed rate long-term FHLB borrowings was $436,042,000 and $436,138,000, respectively, and the estimated fair value was $438,843,000 and $455,187,000, respectively.
Commitments to Extend Credit and Letters of Credit
Commitments to extend credit and fund letters of credit are principally at current interest rates, and, therefore, the carrying amount approximates fair value.
14
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 June 30, 2022 and December 31, 2021 is as follows:
Commercial, financial and agricultural
4,252,063
4,497,444
Real estate - mortgage
842,742
867,831
Real estate - construction
1,733,234
1,668,113
Consumer
40,815
40,966
Foreign
158,275
134,797
Total loans
Note 4 — Allowance for Credit Losses
The estimation of the ACL is based on a loss-rate methodology that measures lifetime losses on loan pools that have similar risk characteristics. Loans that do not have similar risk characteristics are evaluated on an individual basis. The segmentation of the loan portfolio into pools requires a balancing process between capturing similar risk characteristics and containing sufficient loss history to provide meaningful results. Our segmentation starts at the general loan category with further sub-segmentation based on collateral types that may be of meaningful size and/or may contain sufficient differences in risk characteristics based on management’s judgement that would warrant further segmentation. The general loan categories along with primary risk characteristics used in our calculation are as follows:
Commercial and industrial loans. This category includes loans extended to a diverse array of businesses for working capital or equipment purchases. These loans are mostly secured by the collateral pledged by the borrower that is directly related to the business activities of the company such as equipment, accounts receivable and inventory. The borrower’s abilities to generate revenues from equipment purchases, collect accounts receivable, and to turn inventory into sales are risk factors in the repayment of the loan. A small portion of this loan category is related to loans secured by oil & gas production and loans secured by aircraft.
Construction and land development loans. This category includes the development of land from unimproved land to lot development for both residential and commercial use and vertical construction across residential and commercial real estate classes. These loans carry risk of repayment when projects incur cost overruns, have an increase in the price of construction materials, encounter zoning, entitlement and environmental issues, or encounter other factors that may affect the completion of a project on time and on budget. Additionally, repayment risk may be negatively impacted when the market experiences a deterioration in the value of real estate. Risks specifically related to 1-4
family development loans also include mortgage rate risk and the practice by the mortgage industry of more restrictive underwriting standards, which inhibits the buyer from obtaining long term financing creating excessive housing and lot inventory in the market.
Commercial real estate loans. This category includes loans secured by farmland, multifamily properties, owner occupied commercial properties, and non-owner occupied commercial properties. Owner occupied commercial properties include warehouses often along the border for import/export operations, office space where the borrower is the primary tenant, restaurants and other single-tenant retail. Non-owner occupied commercial properties include hotels, retail centers, office and professional buildings, and leased warehouses. These loans carry risk of repayment when market values deteriorate, the business experiences turnover in key management, the business has an inability to attract or keep occupancy levels stable, or when the market experiences an exit of a specific business type that is significant to the local economy, such as a manufacturing plant.
1-4 family mortgages. This category includes both first and second lien mortgages for the purpose of home purchases or refinancing of existing mortgage loans. A small portion of this loan category is related to home equity lines of credits, lots purchases, and home construction. Loan repayments may be affected by unemployment or underemployment and deteriorating market values of real estate.
Consumer loans. This category includes deposit secured, vehicle secured, and unsecured loans, including overdrafts, made to individuals. Repayment is primarily affected by unemployment or underemployment.
The loan pools are further broken down using a risk-based segmentation based on internal classifications for commercial loans and past due status for consumer mortgage loans. Non-mortgage consumer loans are evaluated as one segment. On a weekly basis, commercial 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 our internal Watch List report. Additionally, our credit department 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 will determine if a loan should be placed on an internal Watch List report because of issues related to the analysis of the credit, credit documents, collateral and/or payment history.
Our internal Watch List report is segregated into the following categories: (i) Pass, (ii) Economic Monitoring, (iii) Special Review, (iv) Watch List—Pass, (v) Watch List—Substandard, and (vi) Watch List—Doubtful. The loans placed in the Special Review category and lower rated credits reflect our opinion that the loans reflect potential weakness which require monitoring on a more frequent basis. Credits in those categories are reviewed and discussed on a regular basis, no less frequently than quarterly, 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 category and lower rated credits reflect our opinion that the credit contains weaknesses which represent a greater degree of risk, which warrant “extra attention.” Credits in this category 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 category 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 may sustain some future loss if such weaknesses are not corrected. The loans placed in the Watch List—Doubtful category have shown defined weaknesses and it is likely, based on current information and events, that we will be unable to collect all principal and/or interest amounts contractually due. Watch List—Doubtful loans are placed on non-accrual when they are moved to that category.
For the purposes of the ACL, in order to maintain segments with sufficient history for meaningful results, the credits in the Pass and Economic Monitoring categories are aggregated, the credits in the Special Review and Watch List—Pass credits are aggregated, and the credits in the Watch List—Substandard category remain in their own segment. For loans that are classified as Watch List—Doubtful, management evaluates these credits in accordance with ASC
310-10, “Receivables,” and, if deemed necessary, a specific reserve is allocated to the loan. 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) net realizable value of the fair value of the collateral if the loan is collateral dependent. Substantially all of our loans evaluated as Watch List—Doubtful under ASC 310-10 are measured using the fair value of collateral method. In rare 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.
Within each collectively evaluated pool, the robustness of the lifetime historical loss-rate is evaluated and, if needed, is supplemented with peer loss rates through a model risk adjustment. Certain qualitative loss factors are then evaluated to incorporate management’s two-year reasonable and supportable forecast period followed by a reversion to the pool’s average lifetime loss-rate. Those qualitative loss factors are: (i) trends in portfolio volume and composition, (ii) volume and trends in classified loans, delinquencies, non-accruals and TDR’s, (iii) concentration risk, (iv) trends in underlying collateral value, (v) changes in policies, procedures, and strategies, and (vi) economic conditions. Qualitative factors also include potential losses stemming from operational risk factors arising from fraud, natural disasters, pandemics and geopolitical events. Should any of the factors considered by management in evaluating the adequacy of the ACL change, our estimate could also change, which could affect the level of future credit loss expense.
We have elected to not measure an ACL for accrued interest receivable given our timely approach in identifying and writing off uncollectible accrued interest. An ACL for off-balance sheet exposure is derived from a projected usage rate of any unfunded commitment multiplied by the historical loss rate, plus model risk adjustment, if any, of the on-balance sheet loan pools.
Our management continually reviews the ACL of the Subsidiary Banks using the amounts determined from the estimates established on specific doubtful loans, the estimate established on quantitative historical loss percentages, and the estimate based on qualitative current conditions and reasonable and supportable two-year forecasted data. Our methodology reverts to the average lifetime loss-rate beyond the forecast period when we can no longer develop reasonable and supportable forecasts. Should any of the factors considered by management in evaluating the adequacy of the estimate for current expected credit losses change, our estimate of current expected credit losses could also change, which could affect the level of future credit loss expense. While the calculation of our ACL utilizes management’s best judgment and all information reasonably available, the adequacy of the ACL is dependent on a variety of factors beyond our control, including, among other things, the performance of the entire loan portfolio, the economy, government actions, changes in interest rates and the view of regulatory authorities towards loan classifications.
A summary of the transactions in the allowance for credit loan losses by loan class is as follows:
Three Months Ended June 30, 2022
Domestic
Commercial
Real Estate:
Construction &
Land
Farmland &
Residential:
Development
Multifamily
First Lien
Junior Lien
23,901
36,372
34,854
3,062
4,016
7,046
264
712
110,227
Losses charged to allowance
(2,001)
(57)
(34)
(2,092)
Recoveries credited to allowance
508
168
Net (losses) recoveries charged to allowance
(1,493)
111
(29)
(1,390)
Credit loss expense
3,169
340
410
(206)
(166)
35
143
25,577
36,713
35,270
2,856
4,137
6,894
270
855
112,572
Three Months Ended June 30, 2021
22,163
34,406
32,203
5,935
3,917
8,736
279
769
108,408
(1,655)
(117)
(21)
(55)
(1,848)
24
37
577
(1,157)
(93)
(44)
(1,271)
2,057
(803)
2,028
(1,729)
92
(556)
33
22
23,063
33,603
34,238
4,206
3,916
8,196
268
791
108,281
Six Months Ended June 30, 2022
23,178
35,390
35,654
3,291
4,073
7,754
272
762
110,374
(4,113)
(2)
(156)
(28)
(122)
(4,421)
1,110
198
62
1,403
(3,003)
42
34
(106)
(3,018)
5,402
1,322
(398)
(435)
(894)
104
93
Six Months Ended June 30, 2021
21,908
37,612
30,000
5,051
3,874
9,570
291
753
109,059
(3,548)
(356)
(189)
(87)
(4,201)
956
19
58
1,087
(2,592)
(337)
(154)
(68)
(3,114)
3,747
(4,009)
4,575
(845)
196
(1,411)
45
38
The pool specific qualitative loss factors management deemed appropriate for the ACL calculation at December 31, 2021 remained constant in the June 30, 2022 ACL calculation.
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 June 30, 2022 and December 31, 2021:
Loans Individually
Loans Collectively
Evaluated For
Impairment
Recorded
Investment
Allowance
238
1,475,126
Commercial real estate: other construction & land development
564
70
1,732,670
36,643
Commercial real estate: farmland & commercial
333
2,542,421
Commercial real estate: multifamily
123
233,822
Residential: first lien
83
405,303
Residential: junior lien
437,356
1,341
7,025,788
112,502
298
1,501,554
23,149
589
1,667,524
35,320
562
2,710,494
131
284,405
87
403,571
464,173
1,667
99
7,207,484
110,275
The table below provides additional information on loans accounted for on a non-accrual basis by loan class at June 30, 2022 and December 31, 2021:
313
341
Total non-accrual loans
1,571
1,921
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 Watch List—Doubtful loans.
1,670
2,254
103
763
878
59
Total troubled debt restructuring
2,595
3,253
We have worked with our customers affected by the prolonged economic crisis arising from COVID-19. We have offered and are prepared to continue to offer assistance in accordance with regulatory guidance. That includes continuously reaching out to our customers and, in some cases, offering deferral plans. As of August 2, 2022, we had approximately $113,347,000 in loans with some degree of payment deferrals in our system. In accordance with interagency regulatory guidance, these short-term deferrals are not considered troubled debt restructurings. The $113,347,000 is comprised primarily of loans related to industries that have been significantly impacted by the COVID-19 pandemic, including the hospitality sector and special use facilities.
With the passage of the Paycheck Protection Program (“PPP”), administered by the Small Business Association (“SBA”), we assisted our customers with applications for loans through the PPP. PPP loans earn interest at 1% and PPP loans made prior to June 5, 2020 have a two-year term, while those made after June 5, 2020 have a five-year term; however, PPP loans also include forgiveness provisions that we expect most customers will utilize. Customers began submitting applications for the forgiveness program in the third quarter of 2020. PPP loans were intended to support up to 24 weeks of payroll and certain other costs to help those businesses remain viable and allow their employees to pay their bills. As of August 1, 2022, we had 393 PPP loans totaling approximately $20,933,000 outstanding. The PPP loans are fully guaranteed by the U.S. government through the SBA.
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 ACL can be made only on a subjective basis. It is the judgment of our management that the ACL at June 30, 2022 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 June 30, 2022 and December 31, 2021:
90 Days or
30 - 59
60 - 89
greater &
Past
Days
Greater
still accruing
Due
Current
Portfolio
3,498
440
101
68
4,039
1,471,325
1,475,364
8,133
30,203
499
38,835
1,694,399
8,253
420
1,647
1,314
10,320
2,532,434
2,542,754
72
195
233,750
233,945
2,035
696
5,596
5,452
8,327
397,059
405,386
525
277
1,328
2,130
435,226
260
78
356
40,459
286
157,850
Total past due loans
23,062
32,360
9,205
8,230
64,627
6,962,502
2,534
303
3,414
1,498,438
1,501,852
334
188
1,021
1,667,092
18,164
172
644
307
18,980
2,692,076
2,711,056
284,536
2,342
1,212
5,129
4,937
8,683
394,975
403,658
747
115
1,055
1,917
462,256
231
88
323
40,643
1,319
232
1,574
3,125
131,672
25,836
2,456
9,171
8,642
37,463
7,171,688
The increase in Commercial real estate – other construction and land development loans past due 60 – 89 days at June 30, 2022 can be primarily attributed to a relationship secured by a commercial property used in the production of soft drinks that matured and is in the process of being renewed.
21
A summary of the loan portfolio by credit quality indicator by loan class and by year of origination at June 30, 2022 and December 31, 2021 is presented below:
2020
2019
2018
Prior
Pass
357,293
820,154
124,285
53,239
49,922
32,410
1,437,303
Special Review
81
537
676
Watch List - Pass
3,002
743
3,745
Watch List - Substandard
30,023
3,067
258
54
33,402
Watch List - Doubtful
179
32
27
Total Commercial
390,399
823,937
124,575
54,040
49,976
32,437
388,540
847,686
204,559
221,348
33,028
14,199
1,709,360
210
23,100
465
Total Commercial real estate: other construction & land development
848,151
227,758
221,558
378,503
693,221
585,581
258,592
373,049
129,821
2,418,767
233
670
863
1,767
17,242
257
3,218
20,717
34,662
63,646
553
2,309
101,170
Total Commercial real estate: farmland & commercial
430,640
694,148
650,090
262,696
132,131
46,317
90,621
60,405
12,523
6,529
17,427
Total Commercial real estate: multifamily
60,528
88,520
86,918
54,395
44,902
37,259
92,776
404,770
100
433
533
Total Residential: first lien
88,620
87,351
54,478
48,374
119,846
102,124
45,454
24,213
97,345
Total Residential: junior lien
19,081
17,005
2,274
740
1,650
Total Consumer
85,738
50,331
6,787
5,513
5,614
4,292
Total Foreign
Total Loans
1,497,709
2,731,390
1,228,614
647,426
529,733
392,257
2017
1,041,763
167,691
77,579
58,439
37,104
5,144
1,387,720
74,559
497
139
75,276
33,920
33,930
3,581
716
57
4,628
224
74
1,154,047
168,461
78,434
58,577
37,178
5,155
966,946
312,389
308,673
37,124
16,642
2,439
1,644,213
211
485
967,431
335,593
308,884
1,001,335
680,777
288,333
417,353
96,096
97,119
2,581,013
929
1,292
3,448
61
5,730
18,790
44,059
94
62,944
54,097
3,899
2,355
456
60,807
337
1,021,054
780,449
292,569
420,801
98,606
97,577
133,152
40,766
78,609
10,632
14,217
7,029
40,897
128,742
52,725
57,249
49,259
29,477
85,838
403,290
56
122
281
128,798
52,812
57,352
29,599
130,629
123,062
59,113
30,603
40,855
79,911
32,053
5,693
1,370
189
1,652
74,811
33,360
9,223
8,852
4,790
3,761
3,641,975
1,540,327
885,554
616,037
241,896
283,362
The decrease in Commercial Special Review loans at June 30, 2022 compared to December 31, 2021 can be primarily attributed to a relationship in the oil and gas production industry that was upgraded to Pass. The decrease in Commercial Watch-List Pass loans at June 30, 2022 compared to December 31, 2021 can be primarily attributed to a relationship in energy production that was downgraded to Watch-List Substandard. The decrease in Commercial real estate: farmland & commercial Watch-List Pass loans can be primarily attributed to a relationship securing commercial property that was downgraded to Watch-List Substandard.
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. On April 4, 2022 the 2012 plan expired and was not renewed.
23
On April 18, 2022, the Board of Directors adopted the 2022 International Bancshares Corporation Stock Appreciation Rights Plan (the “SAR Plan”). There are 750,000 shares of underlying common stock that may be used for stock appreciation rights (“SAR”) grants under the plan, however, no actual shares will be granted. Upon exercise the SAR will be settled in cash. SARs granted may be exercisable for a period of up to 10 years from the date of grant.
A summary of option activity under the stock option plan for the six months ended June 30, 2022 is as follows:
Weighted
average
remaining
Aggregate
Number of
exercise
contractual
intrinsic
options
price
term (years)
value ($)
Options outstanding at December 31, 2021
520,551
28.28
Plus: Options granted
31,150
38.92
Less:
Options exercised
17,437
22.27
Options expired
Options forfeited
7,650
32.89
Options outstanding at June 30, 2022
526,614
29.04
4.36
5,812
Options fully vested and exercisable at June 30, 2022
302,669
24.70
2.59
4,656
Stock-based compensation expense included in the consolidated statements of income for the three and six months ended June 30, 2022 was $108,000 and $229,000, respectively. Stock-based compensation expense included in the consolidated statements of income for the three and six months ended June 30, 2021 was $114,000 and $273,000, respectively. As of June 30, 2022, there was approximately $982,000 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 1.8 years.
Note 6 — Investment Securities, Equity Securities with Readily Determinable Fair Values and Other Investments
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. Available-for-sale and held-to-maturity debt securities in an unrealized loss position are evaluated for the underlying cause of the loss. In the event that the deterioration in value is attributable to credit related reasons, then the amount of credit-related impairment will be recorded as a charge to our ACL with subsequent changes in the amount of impairment, up or down, also recorded through our ACL. We have evaluated the debt securities classified as available-for-sale and held-to-maturity at June 30, 2022 and have determined that no debt securities in an unrealized loss position are arising from credit related reasons and have therefore not recorded any allowances for debt securities in our ACL for the period. Unrealized 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 June 30, 2022 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)
49,314
(363)
4,557,327
423
(353,819)
Obligations of states and political subdivisions
41,390
261
(173)
4,648,031
684
(354,355)
The amortized cost and estimated fair value by type of investment security at December 31, 2021 are as follows:
Available for Sale
fair
4,213,441
14,159
(58,237)
41,519
3,038
4,254,960
17,197
25
The amortized cost and estimated fair value of investment securities at June 30, 2022, 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
1,325
Due after one year through five years
Due after ten years
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 $1,557,395,000 and $1,410,743,000, respectively, at June 30, 2022.
Proceeds from the sale and calls of debt securities available-for-sale were $0 and $0 for the three and six months ended June 30, 2022, which included $0 and $0 of mortgage-backed securities. Gross gains of $0 and $0 and gross losses of $0 and $0 were realized on the sales and calls for the three and six months ended June 30, 2022. Proceeds from the sale and call of debt securities available-for-sale were $355,000 and $2,865,000 for the three and six months ended June 30, 2021, which included $0 and $0 of mortgage-backed securities. Gross gains of $0 and $0 and gross losses of $0 and $4,000 were realized on the sales and calls for the three and six months ended June 30, 2021, 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 June 30, 2022, were as follows:
Less than 12 months
12 months or more
Unrealized
Losses
Available for sale:
2,892,440
(254,453)
1,029,269
(99,366)
3,921,709
19,489
2,960,880
(254,989)
3,990,149
26
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, 2021 were as follows:
3,037,188
(53,060)
423,733
(5,177)
3,460,921
The unrealized losses on investments in residential mortgage-backed securities are primarily caused by changes in 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 June 30, 2022 and December 31, 2021, the balance in equity securities with readily determinable fair values recorded at fair value were $5,581,000 and $6,079,000, respectively. The following is a summary of unrealized and realized gains and losses recognized in net income on equity securities during the three and six months ended June 30, 2022 and the three and six months ended June 30, 2021:
Net losses recognized during the period on equity securities
(229)
Less: Net gains and (losses) recognized during the period on equity securities sold during the period
Unrealized losses recognized during the reporting period on equity securities still held at the reporting date
(498)
June 30, 2021
Net gains recognized during the period on equity securities
(65)
Other investments include equity and merchant banking investments held by our subsidiary banks and non-banking entities. We hold ownership interests in limited partnerships for the purpose of investing in low-income housing tax credit (“LIHTC”) projects. The partnerships may acquire, construct or rehabilitate housing for low- and moderate-income individuals. We realize a return primarily from federal tax credits and other federal tax deductions associated with the underlying projects. We are a limited partner in the partnerships, and not required to consolidate the entities in our consolidated financial statements. Investments in LIHTC projects totaled $236,718,000 at June 30, 2022 and $179,543,000 at December 31, 2021, and are included in other investments on the consolidated financial statements. Unfunded commitments to LIHTC projects totaled $45,890,000 at June 30, 2022 and $40,094,000 at December 31, 2021, and are included in other liabilities on the consolidated financial statements.
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 June 30, 2022, other borrowed funds totaled $436,042,000 compared to $436,138,000 at December 31, 2021.
Note 8 — Junior Subordinated Interest Deferrable Debentures
As of June 30, 2022, 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 June 30, 2022 and December 31, 2021, the principal amount of Debentures outstanding totaled $134,642,000.
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 terms of the Debentures are the same as the distribution rate and payment terms of the respective issues of Capital and
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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 June 30, 2022 and December 31, 2021, the total $134,642,000 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 June 30, 2022:
Junior
Subordinated
Deferrable
Interest
Repricing
Optional
Debentures
Frequency
Rate
Rate Index(1)
Maturity Date
Redemption Date(1)
Trust VIII
25,774
Quarterly
4.09
%
LIBOR
+
3.05
October 2033
October 2008
Trust IX
41,238
1.62
October 2036
October 2011
Trust X
21,021
2.94
1.65
February 2037
February 2012
Trust XI
25,990
July 2037
July 2012
Trust XII
20,619
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 $.60 per share on February 28, 2022 to record holders of our common stock on February 15, 2022. We paid cash dividends of $.60 on February 17, 2021, to record holders of our common Stock on February 5, 2021.
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 February 23, 2022, the Board of Directors extended and increased the repurchase program to purchase up to $150 million of common stock during the 12-month period commencing on March 15, 2022. 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 2022, the Board of Directors adopted a Rule 10b5-1 trading plan, and intends to adopt additional Rule 10b5-1 trading plans, which 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 August 1, 2022, a total of
13,435,377 shares had been repurchased under all programs at a cost of $403,680,000. 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 June 30, 2022, we continue to 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 paused 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 June 30, 2022, our capital levels continue to 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 19.96% on June 30, 2022 and 20.47% on December 31, 2021. We had a Tier 1 capital-to-average-total-asset (leverage) ratio of 13.51% and 13.94%, risk-weighted Tier 1 capital ratio of 20.86% and 21.59% and risk-weighted total capital ratio of 21.97% and 22.73% at June 30, 2022 and December 31, 2021, 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 June 30, 2022, 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 June 30, 2022, that we and each of our Subsidiary Banks meet all capital adequacy requirements to which we are subject.
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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, 2021, included in our 2021 Form 10-K. Operating results for the three and six months ended June 30, 2022 are not necessarily indicative of the results for the year ending December 31, 2022, 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 167 facilities and 259 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 fifty percent interest in an investment banking unit that owns a broker/dealer, a controlling interest in four merchant banking entities, and a majority ownership in a real-estate development partnership. 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 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.
In March 2020, the World Health Organization recognized the outbreak of COVID-19 as a pandemic. The spread of COVID-19 and resulting global health crisis has created extreme negative consequences and disruption in global financial markets and has curtailed activity in the governmental, commercial and consumer sectors in recent years. Government responses at all levels have included ordering non-essential businesses be closed, mandating that individuals not working in essential businesses restrict their movement, observe social distancing and shelter in place. Although some of the governmental mandates have been lifted with the development of several vaccines for COVID-19, the long-term consequences of those actions, and the responses by individuals and businesses affected, remain to be seen. The rapid decreases in consumer and commercial activity, rapid increases in unemployment, disruption in global supply chains, market downturns and volatility, drastic changes in consumer behavior, new legislation in response to the emergency, decreases in interest rates, and most currently, inflationary pressures, have continued to impact our business.
We have worked with our customers over the last two years to assist them through these difficult times and we remain conscious of the economic uncertainty still prevalent in the U.S. and are ensuring that we are poised to respond quickly to our customers should the need arise. We continue to rely on our strong capital position and strong liquidity to ensure that we are correctly positioned and have the financial strength to continue to navigate the lingering effect of the COVID-19 pandemic and lingering economic impacts to protect our Company, our employees, our customers and our shareholders.
On March 27, 2020, the Coronavirus Aid, Relief and Economic Security (“CARES”) Act was signed into law. It contains substantial tax and spending provisions intended to address the impact of the COVID-19 pandemic. The CARES Act includes the Paycheck Protection Program (“PPP”), originally a nearly $350 billion program designed to aid small businesses through federally guaranteed loans distributed through banks. These loans were originally intended to support eight weeks of payroll and certain other costs to help those businesses remain viable and allow their employees to pay their bills. Subsequently, on April 24, 2020, the Paycheck Protection Program and Health Care Enhancement Act (“CARES Part II”) was signed into law. CARES Part II provides an additional funding of $320 billion for the PPP program. Then, on June 5, 2020, the Paycheck Protection Program Flexibility Act (“PPPFA”) was signed into law. The PPPFA, among other things, extended the period of time that businesses could spend PPP loan proceeds on payroll and other eligible costs from eight weeks to the earlier of 24 weeks or December 31, 2020. On December 27, 2020, the Economic Aid to Hard-Hit Small Businesses, Nonprofits and Venues Act (the “Economic Aid Act”) was enacted, which among other things, reauthorized lending under the PPP to first-time borrowers and for second draws by certain borrowers who have previously received PPP loans. The Economic Aid Act made available an additional $147 billion for PPP loans requested by March 31, 2021. We have been active participants in helping our customers obtain PPP loans under all the PPP programs, and as of August 1, 2022, have approximately 393 loans with an approximate value of $20,933,000 outstanding.
Future economic conditions remain uncertain and the impact of those conditions on our business also remains uncertain. Our business depends on the willingness and ability of our customers to conduct banking and other financial transactions. Our revenue streams including service charges on deposits and banking and non-banking service charges and fees (ATM and Interchange Income) have been impacted and may continue to be impacted in the future if economic conditions do not improve. Expense control has been a long-time focus and essential element to our long-term profitability. We have kept that focus in mind as we continue to look at operations and create efficiencies and institute cost-control protocols at all levels. We will continue to monitor our efficiency ratio, a measure of non-interest expense
to net interest income plus non-interest income and our overhead burden ratio, a ratio of our operating expenses against total assets, closely. We use these measures in determining if we are accomplishing our long-term goals of controlling our costs in order to provide superior returns to our shareholders.
Results of Operations
Summary
Consolidated Statements of Condition Information
Percent Increase (Decrease)
1.4
(2.6)
2.6
16.8
(0.0)
Shareholders’ equity
(9.2)
Consolidated Statements of Income Information
Percent
Increase
(Decrease)
Interest income
11.8
5.2
Interest expense
0.2
(3.5)
12.7
5.8
Provision for probable loan losses
226.5
123.3
Non-interest income
(55.8)
(35.3)
Non-interest expense
(1.7)
0.6
(37.0)
(21.9)
Per common share:
Basic
.92
(36.6)
(21.3)
Diluted
(21.8)
Net Income
Net income for the three and six months ended June 30, 2022 decreased by 37.0% and 21.9%, respectively, compared to the same periods of 2021. Net income for the three and six months ended June 30, 2022 was positively impacted by an increase in net interest income compared to the same period of 2021 and can be attributed to an increase in the size of our investment securities portfolio and the interest earned on funds held at the Federal Reserve Bank, which has increased in line with recent Federal Reserve Board actions to raise interest rates. Non-interest income for the same periods was also positively impacted by gains on the sale of some properties from our branch network as we continue to monitor and evaluate our retail branch footprint and align the footprint with customer activity. The decrease in net income for the first six months of 2022 compared to the same period of 2021 is attributed to a non-recurring transaction in 2021 arising from the sale of an equity interest in a merchant banking investment held by one of our non-bank subsidiaries. The transaction resulted in income totaling $42.8 million, net of tax, and was recorded in the second quarter of 2021. Net income for the first six months of 2021 without the non-recurring item was $100.0 million, after tax, compared to $111.5 million for the same period of 2022, representing an 11.5% increase.
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Net Interest Income
Interest Income:
(4.6)
(8.1)
237.8
204.7
(6.9)
504.3
380.9
30.9
24.9
(22.3)
(22.0)
Securities sold under Repurchase agreements
69.7
50.2
(0.1)
Junior subordinated interest deferrable debentures
37.0
18.5
The increase in net interest income for the three and six months ended June 30, 2022 can be attributed to an increase in the size of our investment portfolio and the interest earned on funds held at the Federal Reserve from operations, which has increased in line with recent Federal Reserve Board actions to raise interest rates. The interest rate changes have positively impacted interest income generated by our loan portfolio; however, the overall size of our loan portfolio has decreased due to slow loan demand, thus reducing the benefit of the rate change on the floating rate loans in the portfolio. 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 44 for the June 30, 2022 gap analysis). Our management currently believes that we are properly positioned for interest rate changes; however if our management determines at any time that 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
15.7
(2.3)
0.1
(12.9)
-
(100.0)
(97.9)
(93.5)
15.2
58.8
Total non-interest income for the three and six months ended June 30, 2022 decreased by 55.8% and 35.3%, respectively, compared to the same periods of 2021. Non-interest income for the three and six months ended June 20, 2022 compared to the same periods of 2021 was positively impacted due to an increase in service charges on deposits as customer activity continues to increase from previously depressed levels resulting from the COVID-19 pandemic and by gains on the sale of some properties from our branch network as we continue to monitor and evaluate our retail branch footprint and align the footprint with customer activity. The decrease in other investment income for the three and six months ended June 30, 2022 compared to the same periods of 2021 can be primarily attributed to the sale of an equity interest in a merchant banking investment held by one of our non-bank subsidiaries in the second quarter of 2021.
Non-Interest Expense
1.6
2.4
(5.2)
(15.2)
(17.4)
29.0
2.8
113.5
67.4
(101.3)
(109.3)
(3.4)
(4.7)
13.1
25.4
Non-interest expense for the three months ended June 30, 2022 decreased by 1.7% compared to the same period of 2021. Non-interest expense for the six months ended June 30, 2022 compared to the same period of 2021 increased by 0.6%. We continue to monitor and manage our controllable non-interest expenses through a variety of measures with the ultimate goal of ensuring we align non-interest expenses with our operations and revenue streams.
Financial Condition
Allowance for Credit Losses
The allowance for credit losses increased 2.0% to $112,572,000 at June 30, 2022 from $110,374,000 at December 31, 2021. The provision for credit losses charged to expense increased 226.5% and 123.3%, respectively for
the three and six months ended June 30, 2022 to $3,735,000 and $5,216,000, compared to $1,144,000 and $2,336,000, respectively for the same periods of 2021. The pool specific qualitative loss factors management deemed appropriate for the ACL calculation at December 31, 2021 remained constant in the June 30, 2022 ACL calculation. The allowance for credit losses was 1.60% of total loans at June 30, 2022 and 1.53% of total loans at December 31, 2021.
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.
Total loans decreased by 2.5% to $7,027,129,000 at June 30, 2022, from $7,209,151,000 at December 31, 2021.
Deposits increased by 2.6% to $12,943,252,000 at June 30, 2022, compared to $12,617,877,000 at December 31, 2021. Deposits have continued to increase as customers have presumably decided to save and preserve cash earned and received from the various governmental stimulus programs instead of spending during these uncertain times.
Foreign Operations
On June 30, 2022, we had $16,271,179,000 of consolidated assets, of which approximately $158,275,000, or 1.0%, was related to loans outstanding to borrowers domiciled in foreign countries, compared to $134,797,000, or 0.8%, at December 31, 2021. Of the $158,275,000, 89.8% is directly or indirectly secured by U.S. assets, certificates of deposits and real estate; 3.2% is secured by foreign real estate or other assets; and 7.0% is unsecured.
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 estimated ACL as a policy critical to the sound operations of our Subsidiary Banks. The ACL is deducted from the amortized cost of an instrument to present the net amount expected to be collected on the financial asset. Our ACL primarily consists of the aggregate ACL estimates of our Subsidiary Banks. The estimates are established through charges to operations in the form of charges to provisions for credit loss expense. Loan losses or recoveries are charged or credited directly to the ACL. The ACL of each Subsidiary Bank is maintained at a level considered appropriate by management, based on estimated current expected credit losses in the current loan portfolio, including information about past events, current conditions and reasonable and supportable forecasts.
The estimation of the ACL is based on a loss-rate methodology that measures lifetime losses on loan pools that have similar risk characteristics. Loans that do not have similar risk characteristics are evaluated on an individual basis. The segmentation of the loan portfolio into pools requires a balancing process between capturing similar risk characteristics and containing sufficient loss history to provide meaningful results. Our segmentation starts at the
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general loan category with further sub-segmentation based on collateral types that may be of meaningful size and/or may contain sufficient differences in risk characteristics based on management’s judgement that would warrant further segmentation. The general loan categories along with primary risk characteristics used in our calculation are as follows:
Construction and land development loans. This category includes the development of land from unimproved land to lot development for both residential and commercial use and vertical construction across residential and commercial real estate classes. These loans carry risk of repayment when projects incur cost overruns, have an increase in the price of construction materials, encounter zoning, entitlement and environmental issues, or encounter other factors that may affect the completion of a project on time and on budget. Additionally, repayment risk may be negatively impacted when the market experiences a deterioration in the value of real estate. Risks specifically related to 1-4 family development loans also include mortgage rate risk and the practice by the mortgage industry of more restrictive underwriting standards, which inhibits the buyer from obtaining long term financing creating excessive housing and lot inventory in the market.
Our internal Watch List report is segregated into the following categories: (i) Pass, (ii) Economic Monitoring, (iii) Special Review, (iv) Watch List—Pass, (v) Watch List—Substandard, and (vi) Watch List—Doubtful. The loans placed in the Special Review category and lower rated credits reflect our opinion that the loans reflect potential weakness which require monitoring on a more frequent basis. Credits in those categories are reviewed and discussed on a regular basis, no less frequently than quarterly, with the credit department and the lending staff to determine if a change in
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category is warranted. The loans placed in the Watch List—Pass category and lower rated credits reflect our opinion that the credit contains weaknesses which represent a greater degree of risk, which warrant “extra attention.” Credits in this category 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 category 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 may sustain some future loss if such weaknesses are not corrected. The loans placed in the Watch List—Doubtful category have shown defined weaknesses and it is likely, based on current information and events, that we will be unable to collect all principal and/or interest amounts contractually due. Watch List—Doubtful loans are placed on non-accrual when they are moved to that category.
For the purposes of the ACL, in order to maintain segments with sufficient history for meaningful results, the credits in the Pass and Economic Monitoring categories are aggregated, the credits in the Special Review and Watch List—Pass credits are aggregated, and the credits in the Watch List—Substandard category remain in their own segment. For loans that are classified as Watch List—Doubtful, management evaluates these credits in accordance with ASC 310-10, “Receivables,” and, if deemed necessary, a specific reserve is allocated to the loan. 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) net realizable value of the fair value of the collateral if the loan is collateral dependent. Substantially all of our loans evaluated as Watch List—Doubtful under ASC 310-10 are measured using the fair value of collateral method. In rare 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.
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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 2022 and 2021 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. 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 June 30, 2022, shareholders’ equity was $2,097,231,000 compared to $2,308,481,000 at December 31, 2021. The decrease in shareholders’ equity can be primarily attributed to an increase in other comprehensive loss and an increase in treasury stock.
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 June 30, 2022, that we and each of our Subsidiary Banks continue to 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 paused 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 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 June 30, 2022, that we and each of our Subsidiary Banks continue to meet all capital adequacy requirements to which we are subject.
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
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sources and uses of funds as deemed appropriate. The net-interest rate sensitivity as of June 30, 2022 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
241,873
742,399
3,277,591
Loans, net of non-accruals
5,755,470
281,703
192,410
795,975
7,025,558
Total earning assets
5,997,343
1,024,102
3,470,001
837,453
11,328,899
Cumulative earning assets
7,021,445
10,491,446
Rate sensitive liabilities
1,024,899
1,013,075
141,767
626
Other interest bearing deposits
501,906
11,462
Total interest bearing liabilities
6,322,282
1,024,537
436,668
7,925,254
Cumulative sensitive liabilities
7,346,819
7,488,586
Repricing gap
(324,939)
3,328,234
400,785
3,403,645
Cumulative repricing gap
(325,374)
3,002,860
Ratio of interest-sensitive assets to liabilities
0.95
1.00
24.48
1.92
1.43
Ratio of cumulative, interest-sensitive assets to liabilities
0.96
1.40
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Item 3. Quantitative and Qualitative Disclosures about Market Risk
During the three and six months ended June 30, 2022, 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 17 through 21 of our 2021 Annual Report as filed as Exhibit 13 to our Form 10-K for the year ended December 31, 2021.
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 the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2021.
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
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 February 23, 2022, the Board of Directors extended the repurchase program, and increased the program this year to purchase up to $150 million of common stock during the 12-month period commencing on March 15, 2022. 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 2022, the Board of Directors adopted a Rule 10b5-1 trading plan, and intends to adopt additional Rule 10b5-1 trading plans, which 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 August 1, 2022, a total of 13,435,377 shares had been repurchased under all programs at a cost of $403,680,000. We are not obligated to purchase shares under our stock repurchase program outside of its Rule 10b5-1 trading plan.
Except for repurchases in connection with the administration of an employee benefit plan in the ordinary course of business and consistent with past practices, common stock repurchases are only conducted under publicly announced repurchase programs approved by the Board of Directors. The following table includes information about common stock share repurchases for the quarter ended June 30, 2022.
Total Number of
Purchased as
Approximate
Average
Part of a
Dollar Value of
Total Number
Price Paid
Publicly-
Shares Available
of Shares
Per
Announced
for
Purchased
Share
Program
Repurchase(1)
April 1 – April 30, 2022
130,000
40.63
144,718,000
May 1 – May 31, 2022
374,016
39.97
129,769,000
June 1 – June 30, 2022
426,746
39.69
112,831,000
930,762
39.93
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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 six months ended June 30, 2022 and 2021; (iii) the Condensed Consolidated Balance Sheet as of June 30, 2022 and December 31, 2021; and (iv) the Condensed Consolidated Statement of Cash Flows for the six months ended June 30, 2022 and June 30, 2021.
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SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
Date:
August 4, 2022
/s/ Dennis E. Nixon
Dennis E. Nixon
President
/s/ Judith I. Wawroski
Judith I. Wawroski
Treasurer
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