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INTERNATIONAL BANCSHARES CORP - Quarter Report: 2005 June (Form 10-Q)

 

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

FORM 10-Q

 

ý QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934

 

For the quarterly period ended June 30, 2005

 

OR

 

o TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934

 

For the transition period from                to                

 

Commission file number  0-9439

 

INTERNATIONAL BANCSHARES CORPORATION

(Exact name of registrant as specified in its charter)

 

Texas

 

74-2157138

(State or other jurisdiction of
incorporation or organization)

 

(I.R.S. Employer Identification No.)

 

1200 San Bernardo Avenue, Laredo, Texas 78042-1359

(Address of principal executive offices)

(Zip Code)

 

(956) 722-7611

(Registrant’s telephone number, including area code)

 

None

(Former name, former address and former fiscal year, if changed since last report)

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.  Yes  ý       No  o

 

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act).   Yes  ý      No  o

 

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.

 

Class

 

Shares Issued and Outstanding

 

 

 

Common Stock, $1.00 par value

 

63,699,061 shares outstanding at August 1, 2005

 

 



 

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,

 

 

 

2005

 

2004

 

Assets

 

 

 

 

 

 

 

 

 

 

 

Cash and due from banks

 

$

184,347

 

$

174,770

 

Federal funds sold

 

90,000

 

21,000

 

 

 

 

 

 

 

Total cash and cash equivalents

 

274,347

 

195,770

 

 

 

 

 

 

 

Time deposits with banks

 

396

 

396

 

 

 

 

 

 

 

Investment securities:

 

 

 

 

 

Held-to-maturity (Market value of $2,385 on June 30, 2005 and December 31, 2004)

 

2,385

 

2,385

 

Available-for-sale (Amortized cost of $4,088,153 on June 30, 2005 and $3,851,741 on December 31, 2004)

 

4,080,066

 

3,874,833

 

 

 

 

 

 

 

Total investment securities

 

4,082,451

 

3,877,218

 

 

 

 

 

 

 

Loans, net of unearned discounts

 

4,924,983

 

4,888,974

 

Less allowance for possible loan losses

 

(82,114

)

(81,351

)

 

 

 

 

 

 

Net loans

 

4,842,869

 

4,807,623

 

 

 

 

 

 

 

Bank premises and equipment, net

 

321,901

 

302,230

 

Accrued interest receivable

 

44,703

 

41,140

 

Other investments

 

321,273

 

301,578

 

Identified intangible assets, net

 

41,803

 

44,400

 

Goodwill, net

 

289,262

 

289,262

 

Other assets

 

54,965

 

61,888

 

 

 

 

 

 

 

Total assets

 

$

10,273,970

 

$

9,921,505

 

 

1



 

INTERNATIONAL BANCSHARES CORPORATION AND SUBSIDIARIES

 

Consolidated Statements of Condition (Unaudited)

 

(Dollars in Thousands)

 

 

 

June 30,

 

December 31,

 

 

 

2005

 

2004

 

Liabilities and Shareholders’ Equity

 

 

 

 

 

 

 

 

 

 

 

Liabilities:

 

 

 

 

 

 

 

 

 

 

 

Deposits:

 

 

 

 

 

Demand – non-interest bearing

 

$

1,205,474

 

$

1,150,999

 

Savings and interest bearing demand

 

2,188,577

 

2,232,102

 

Time

 

3,125,950

 

3,188,003

 

 

 

 

 

 

 

Total deposits

 

6,520,001

 

6,571,104

 

 

 

 

 

 

 

Securities sold under repurchase agreements

 

783,938

 

619,806

 

Other borrowed funds

 

1,885,193

 

1,670,199

 

Junior subordinated deferrable interest debentures

 

235,908

 

235,395

 

Other liabilities

 

68,791

 

71,911

 

 

 

 

 

 

 

Total liabilities

 

9,493,831

 

9,168,415

 

 

 

 

 

 

 

Shareholders’ equity:

 

 

 

 

 

 

 

 

 

 

 

Common shares of $1.00 par value. Authorized 275,000,000 shares; issued 85,985,257 shares on June 30, 2005 and 68,431,225 shares on December 31, 2004

 

85,985

 

68,431

 

Surplus

 

134,345

 

130,597

 

Retained earnings

 

739,054

 

705,642

 

Accumulated other comprehensive (loss) income

 

(5,257

)

15,010

 

 

 

954,127

 

919,680

 

 

 

 

 

 

 

Less cost of shares in treasury, 22,288,359 shares on June 30, 2005 and 17,610,126 shares on December 31, 2004

 

(173,988

)

(166,590

)

 

 

 

 

 

 

Total shareholders’ equity

 

780,139

 

753,090

 

 

 

 

 

 

 

Total liabilities and shareholders’ equity

 

$

10,273,970

 

$

9,921,505

 

 

See accompanying notes to consolidated financial statements.

 

2



 

INTERNATIONAL BANCSHARES CORPORATION AND SUBSIDIARIES

 

Consolidated Statements of Income (Unaudited)

 

(Dollars in Thousands, except per share data)

 

 

 

Three Months Ended
June 30,

 

Six Months Ended
June 30,

 

 

 

2005

 

2004

 

2005

 

2004

 

 

 

 

 

 

 

 

 

 

 

Interest income:

 

 

 

 

 

 

 

 

 

Loans, including fees

 

$

84,845

 

$

45,596

 

$

164,670

 

$

89,022

 

Time deposits with banks

 

2

 

14

 

3

 

20

 

Federal funds sold

 

787

 

433

 

1,354

 

902

 

Investment securities:

 

 

 

 

 

 

 

 

 

Taxable

 

39,178

 

25,078

 

75,691

 

50,701

 

Tax-exempt

 

1,220

 

1,272

 

2,437

 

2,556

 

Other interest income

 

128

 

111

 

324

 

273

 

 

 

 

 

 

 

 

 

 

 

Total interest income

 

126,160

 

72,504

 

244,479

 

143,474

 

 

 

 

 

 

 

 

 

 

 

Interest expense:

 

 

 

 

 

 

 

 

 

Savings deposits

 

6,161

 

2,504

 

11,635

 

4,721

 

Time deposits

 

16,602

 

9,835

 

31,082

 

18,886

 

Securities sold under repurchase agreements

 

7,091

 

4,783

 

12,539

 

9,540

 

Other borrowings

 

13,829

 

2,437

 

25,433

 

4,644

 

Junior subordinated interest deferrable debentures

 

4,518

 

2,638

 

8,718

 

5,125

 

Senior notes

 

 

84

 

 

84

 

 

 

 

 

 

 

 

 

 

 

Total interest expense

 

48,201

 

22,281

 

89,407

 

43,000

 

 

 

 

 

 

 

 

 

 

 

Net interest income

 

77,959

 

50,223

 

155,072

 

100,474

 

 

 

 

 

 

 

 

 

 

 

Provision for possible loan losses

 

221

 

1,375

 

2,831

 

2,717

 

 

 

 

 

 

 

 

 

 

 

Net interest income after provision for possible loan losses

 

77,738

 

48,848

 

152,241

 

97,757

 

 

 

 

 

 

 

 

 

 

 

Non-interest income:

 

 

 

 

 

 

 

 

 

Service charges on deposit accounts

 

20,859

 

15,911

 

40,904

 

30,320

 

Other service charges, commissions and fees

 

 

 

 

 

 

 

 

 

Banking

 

6,233

 

4,443

 

12,278

 

8,286

 

Non-banking

 

2,479

 

1,652

 

4,111

 

2,548

 

Gain (loss) on investment securities transactions, net

 

(155

)

3,689

 

(181

)

8,461

 

Other investments, net

 

3,446

 

3,313

 

7,863

 

5,825

 

Other income

 

4,445

 

2,082

 

14,755

 

3,963

 

 

 

 

 

 

 

 

 

 

 

Total non-interest income

 

37,307

 

31,090

 

79,730

 

59,403

 

 

3



 

 

 

Three Months Ended
June 30,

 

Six Months Ended
June 30,

 

 

 

2005

 

2004

 

2005

 

2004

 

 

 

 

 

 

 

 

 

 

 

Non-interest expense:

 

 

 

 

 

 

 

 

 

Employee compensation and benefits

 

$

28,295

 

$

17,123

 

$

55,770

 

$

33,564

 

Occupancy

 

5,938

 

3,626

 

11,386

 

6,899

 

Depreciation of bank premises and equipment

 

6,097

 

4,415

 

11,807

 

8,466

 

Professional fees

 

3,011

 

1,309

 

6,219

 

2,882

 

Stationery and supplies

 

1,384

 

910

 

2,751

 

1,889

 

Amortization of identified intangible assets

 

1,299

 

246

 

2,597

 

492

 

Advertising

 

2,622

 

2,237

 

5,408

 

4,093

 

Other

 

16,343

 

11,023

 

29,075

 

20,291

 

 

 

 

 

 

 

 

 

 

 

Total non-interest expense

 

64,989

 

40,889

 

125,013

 

78,576

 

 

 

 

 

 

 

 

 

 

 

Income before income taxes

 

50,056

 

39,049

 

106,958

 

78,584

 

 

 

 

 

 

 

 

 

 

 

Provision for income taxes

 

16,684

 

12,820

 

35,926

 

25,836

 

 

 

 

 

 

 

 

 

 

 

Net income

 

$

33,372

 

$

26,229

 

$

71,032

 

$

52,748

 

 

 

 

 

 

 

 

 

 

 

Basic earnings per common share:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Weighted average number of shares outstanding:

 

63,775,930

 

61,071,060

 

63,690,298

 

60,806,716

 

 

 

 

 

 

 

 

 

 

 

Net income

 

$

.52

 

$

.43

 

$

1.12

 

$

.87

 

 

 

 

 

 

 

 

 

 

 

Fully diluted earnings per common share:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Weighted average number of shares outstanding:

 

64,511,916

 

62,458,789

 

64,543,799

 

62,177,846

 

 

 

 

 

 

 

 

 

 

 

Net income

 

$

.52

 

$

.42

 

$

1.10

 

$

.85

 

 

See accompanying notes to consolidated financial statements.

 

4



 

INTERNATIONAL BANCSHARES CORPORATION AND SUBSIDIARIES

 

Consolidated Statements of Comprehensive Income (Loss) (Unaudited)

 

(Dollars in Thousands)

 

 

 

Three Months Ended

 

Six Months Ended

 

 

 

June 30,

 

June 30,

 

 

 

2005

 

2004

 

2005

 

2004

 

 

 

 

 

 

 

 

 

 

 

Net income

 

$

33,372

 

$

26,229

 

$

71,032

 

$

52,748

 

 

 

 

 

 

 

 

 

 

 

Other comprehensive income (loss), net of tax

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Unrealized holding gains (losses) on securities arising during period, net of reclassification adjustment for gains included in net income

 

11,968

 

(40,794

)

(20,267

)

(35,226

)

 

 

 

 

 

 

 

 

 

 

Comprehensive income (loss)

 

$

45,340

 

$

(14,565

)

$

50,765

 

$

17,522

 

 

See accompanying notes to consolidated financial statements.

 

5



 

INTERNATIONAL BANCSHARES CORPORATION AND SUBSIDIARIES

 

Consolidated Statements of Cash Flows (Unaudited)

 

(Dollars in Thousands)

 

 

 

Six Months Ended
June 30,

 

 

 

2005

 

2004

 

Operating activities:

 

 

 

 

 

 

 

 

 

 

 

Net income

 

$

71,032

 

$

52,748

 

 

 

 

 

 

 

Adjustments to reconcile net income to net cash provided by operating activities:

 

 

 

 

 

Provision for possible loan losses

 

2,831

 

2,717

 

Depreciation of bank premises and equipment

 

11,807

 

8,466

 

Gain on sale of bank premises and equipment

 

(87

)

(19

)

Depreciation and amortization of leased assets

 

883

 

843

 

Accretion of investment securities discounts

 

(326

)

(861

)

Amortization of investment securities premiums

 

14,133

 

15,892

 

Investment securities transactions, net

 

181

 

(8,461

)

Accretion of junior subordinated debenture discounts

 

513

 

513

 

Amortization of identified intangible assets

 

2,597

 

492

 

Earnings from affiliates and other investments

 

(5,870

)

(5,375

)

Deferred tax benefit

 

(4,667

)

(9,958

)

(Increase) decrease in accrued interest receivable

 

(3,563

)

237

 

Net decrease in other assets

 

6,040

 

26,597

 

Net increase (decrease) in other liabilities

 

12,459

 

(18,153

)

 

 

 

 

 

 

Net cash provided by operating activities

 

107,963

 

65,678

 

 

 

 

 

 

 

Investing activities:

 

 

 

 

 

 

 

 

 

 

 

Proceeds from maturities of securities

 

1,400

 

27,062

 

Proceeds from sales of available for sale securities

 

189,187

 

647,828

 

Purchases of available for sale securities

 

(815,995

)

(754,979

)

Principal collected on mortgage-backed securities

 

375,008

 

410,717

 

Proceeds from matured time deposits with banks

 

 

63,800

 

Purchases of time deposits with banks

 

 

(296

)

Net increase in loans

 

(38,077

)

(149,558

)

(Purchases) distributions of other investments

 

(13,825

)

50,461

 

Purchases of bank premises and equipment

 

(31,827

)

(19,979

)

Proceeds from sale of bank premises and equipment

 

436

 

30

 

Cash paid in purchase transaction

 

 

(276,555

)

Cash acquired in purchase transaction

 

 

66,009

 

 

 

 

 

 

 

Net cash (used in) provided by investing activities

 

(333,693

)

64,540

 

 

6



 

 

 

Six Months Ended
June 30,

 

 

 

2005

 

2004

 

 

 

 

 

 

 

Financing activities:

 

 

 

 

 

 

 

 

 

 

 

Net increase in non-interest bearing demand deposits

 

$

54,475

 

$

17,858

 

Net (decrease) increase in savings and interest bearing demand deposits

 

(43,525

)

6,738

 

Net (decrease) increase in time deposits

 

(62,053

)

64,029

 

Net increase in securities sold under repurchase agreements

 

164,132

 

6,748

 

Proceeds from issuance of other borrowed funds

 

2,070,000

 

720,000

 

Principal payments on other borrowed funds

 

(1,855,006

)

(869,449

)

Purchase of treasury stock

 

(7,398

)

(384

)

Proceeds from stock transactions

 

4,130

 

4,504

 

Payment of cash dividends

 

(20,423

)

(19,419

)

Payment of cash dividends in lieu of fractional shares

 

(25

)

(38

)

 

 

 

 

 

 

Net cash provided by (used in) financing activities

 

304,307

 

(69,413

)

 

 

 

 

 

 

Increase in cash and cash equivalents

 

78,577

 

60,805

 

 

 

 

 

 

 

Cash and cash equivalents at beginning of period

 

195,770

 

215,729

 

 

 

 

 

 

 

Cash and cash equivalents at end of period

 

$

274,347

 

$

276,534

 

 

 

 

 

 

 

Supplemental cash flow information:

 

 

 

 

 

Interest paid

 

$

84,754

 

$

42,861

 

Income taxes paid

 

38,894

 

35,239

 

 

See accompanying notes to consolidated financial statements.

 

7



 

INTERNATIONAL BANCSHARES CORPORATION AND SUBSIDIARIES

 

Notes to Consolidated Financial Statements

 

(Unaudited)

 

Note 1 - Basis of Presentation

 

The accounting and reporting policies of International Bancshares Corporation (“Corporation”) and Subsidiaries (the Corporation and Subsidiaries collectively referred to herein as the “Company”) conform to accounting principles generally accepted in the United States of America and to general practices within the banking industry.  The consolidated financial statements include the accounts of the Corporation and its wholly-owned subsidiaries, International Bank of Commerce, Laredo (“IBC”), Commerce Bank, International Bank of Commerce, Zapata, International Bank of Commerce, Brownsville and the Corporation’s wholly-owned non-bank subsidiaries, IBC Subsidiary Corporation, IBC Life Insurance Company, IBC Trading Company, and IBC Capital Corporation, as well as the GulfStar Group in which the Company owns a controlling interest.  All significant inter-company balances and transactions have been eliminated in consolidation.  The consolidated financial statements are unaudited, but include all adjustments, which, in the opinion of management, are necessary for a fair presentation of the results of the periods presented.  All such adjustments were of a normal and recurring nature.  It is suggested that these financial statements be read in conjunction with the financial statements and the notes thereto in the Company’s latest Annual Report on Form 10K.  The consolidated statement of condition at December 31, 2004 has been derived from the audited financial statements at that date but does not include all of the information and footnotes required by accounting principles generally accepted in the United States of America for complete financial statements.  Certain reclassifications have been made to make prior periods comparable.

 

The Company operates as one segment.  The operating information used by the Company’s chief executive officer for purposes of assessing performance and making operating decisions about the Company is the consolidated statements presented in this report.  The Company has four active operating subsidiaries, namely, the bank subsidiaries, otherwise known as International Bank of Commerce, Laredo, Commerce Bank, International Bank of Commerce, Zapata and International Bank of Commerce, Brownsville.  The Company applies the provisions of SFAS No. 131, “Disclosures about Segments of an Enterprise and Related Information,” in determining its reportable segments and related disclosures.  None of the Company’s other operating segments meets the 10% threshold for disclosure under SFAS No. 131.

 

All per share data presented has been restated to reflect the stock splits effected through stock dividends, see Note 8.

 

Note 2 – Loans

 

A summary of net loans, by loan type at June 30, 2005 and December 31, 2004 is as follows:

 

 

 

 

June 30,

 

December 31,

 

 

 

2005

 

2004

 

 

 

(Dollars in thousands)

 

 

 

 

 

 

 

Commercial, financial and agricultural

 

$

2,632,115

 

$

2,710,270

 

Real estate-mortgage

 

956,817

 

960,599

 

Real estate – construction

 

867,557

 

749,689

 

Consumer

 

208,914

 

229,302

 

Foreign

 

259,841

 

239,622

 

 

 

 

 

 

 

Total loans

 

4,925,244

 

4,889,482

 

 

 

 

 

 

 

Unearned discount

 

(261

)

(508

)

 

 

 

 

 

 

Loans, net of unearned discount

 

$

4,924,983

 

$

4,888,974

 

 

8



 

Note 3 – Stock Options

 

In December 2002, the Financial Accounting Standards Board (“FASB”) issued Statement of Financial Accounting Standards No. 148 (“SFAS No. 148”), “Accounting for Stock-Based Compensation – Transition and Disclosure, an amendment of FASB Statement No. 123.”  SFAS No. 148 amends Statement of Financial Accounting Standards No. 123 (“SFAS No. 123”), “Accounting for Stock-Based Compensation,” to provide alternative methods of transition for a voluntary change to the fair value based method of accounting for stock-based employee compensation.  In addition, SFAS No. 148 amends the disclosure requirement of SFAS No. 123 to require prominent disclosures in both annual and interim financial statements about the fair value based method of accounting for stock-based employee compensation for those companies that have elected to continue to apply Accounting Principles Board Opinion No. 25 (“APB 25”), “Accounting for Stock Issued to Employees.”   In December 2004, the FASB issued Statement of Financial Accounting Standards No. 123R (“SFAS No. 123R”), “Share-Based Payment (Revised 2004).” SFAS 123R eliminates the ability to account for stock-based compensation using APB 25 and requires that such transactions be recognized as compensation expense in the consolidated statement of income based on their fair values on the date of the grant.  The Company will be required to adopt the provisions of SFAS No. 123R on January 1, 2006.

 

At June 30, 2005, the Company had one stock-based employee compensation plan under which options are outstanding and certain options granted outside the plan.  An additional stock-based employee compensation plan has been adopted by the Company, but no options have been granted under such plan.  The Company accounts for options under the recognition and measurement principles of APB 25, and related interpretations.  No stock-based employee cost is reflected in net income, as all options granted had an exercise price equal to the market value of the underlying common stock on the date of grant.  The following table, as prescribed by SFAS No. 148, illustrates the effect on net income and earnings per share if the Company had applied the fair value recognition provisions of SFAS No. 123 to stock based employee compensation.

 

 

 

Three Months Ended
June 30,

 

Six Months Ended
June 30,

 

 

 

2005

 

2004

 

2005

 

2004

 

 

 

(Dollars in Thousands, except per share data)

 

 

 

 

 

 

 

 

 

 

 

Net income, as reported

 

$

33,372

 

$

26,229

 

$

71,032

 

$

52,748

 

 

 

 

 

 

 

 

 

 

 

Deduct: Total stock-based compensation expense determined under the fair value based method for all awards, net of tax related tax effects

 

(88

)

(143

)

(179

)

(286

)

 

 

 

 

 

 

 

 

 

 

Pro forma net income

 

$

33,284

 

$

26,086

 

$

70,853

 

$

52,462

 

 

 

 

 

 

 

 

 

 

 

Earnings per share:

 

 

 

 

 

 

 

 

 

Basic earnings

 

 

 

 

 

 

 

 

 

As reported

 

$

.52

 

$

.43

 

$

1.12

 

$

.87

 

Pro forma

 

.52

 

.43

 

1.11

 

.86

 

 

 

 

 

 

 

 

 

 

 

Diluted earnings

 

 

 

 

 

 

 

 

 

As reported

 

$

.52

 

$

.42

 

$

1.10

 

$

.85

 

Pro forma

 

.52

 

.42

 

1.10

 

.84

 

 

Note 4 - Investment Securities

 

The Company classifies debt and equity securities into one of three categories:  held-to maturity, available-for-sale, or trading.  Such classifications 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 (loss) income and accumulated other comprehensive (loss) income until realized.

 

9



 

A summary of the investment securities held for investment and securities available for sale as reflected on the books of the Company is as follows:

 

 

 

June 30,

 

December 31,

 

 

 

2005

 

2004

 

 

 

(Dollars in Thousands)

 

 

 

 

 

 

 

U.S. Treasury and federal agencies

 

 

 

 

 

 

 

Available for sale

 

$

3,958,444

 

$

3,752,501

 

States and political subdivisions

 

 

 

 

 

Available for sale

 

105,026

 

104,317

 

Other

 

 

 

 

 

Held to maturity

 

2,385

 

2,385

 

Available for sale

 

16,596

 

18,015

 

 

 

 

 

 

 

Total investment securities

 

$

4,082,451

 

$

3,877,218

 

 

Note 5 - Allowance for Possible Loan Losses

 

A summary of the transactions in the allowance for possible loan losses is as follows:

 

 

 

June 30,

 

June 30,

 

 

 

2005

 

2004

 

 

 

(Dollars in Thousands)

 

 

 

 

 

 

 

Balance at December 31,

 

$

81,351

 

$

48,646

 

 

 

 

 

 

 

Losses charged to allowance

 

(3,573

)

(1,391

)

Recoveries credited to allowance

 

1,505

 

715

 

Net losses charged to allowance

 

(2,068

)

(676

)

 

 

 

 

 

 

Provision charged to operations

 

2,831

 

2,717

 

 

 

 

 

 

 

Net allowance acquired in purchase transaction

 

 

33,884

 

 

 

 

 

 

 

Balance at June 30,

 

$

82,114

 

$

84,571

 

 

Impaired loans are those loans where it is probable that all amounts due according to contractual terms of the loan agreement will not be collected.  The Company has identified these loans through its normal loan review procedures.    Impaired loans are measured based on (1) the present value of expected future cash flows discounted at the loan’s effective interest rate; (2) the loan’s observable market price; or (3) the fair value of the collateral if the loan is collateral dependent.  Substantially all of the Company’s impaired loans are measured at the fair value of the collateral. In limited cases the Company may use other methods to determine the level of impairment of a loan if such loan is not collateral dependent.

 

10



 

The following table details key information regarding the Company’s impaired loans:

 

 

 

June 30,

 

December 31,

 

 

 

2005

 

2004

 

 

 

(Dollars in Thousands)

 

 

 

 

 

 

 

Balance of impaired loans where there is a related allowance for loan loss

 

$

26,218

 

$

37,037

 

Balance of impaired loans where there is no related allowance for loan loss

 

 

 

 

 

 

 

 

 

Total impaired loans

 

$

26,218

 

$

37,037

 

 

 

 

 

 

 

Allowance allocated to impaired loans

 

$

16,265

 

$

15,666

 

 

The impaired loans included in the table above were primarily comprised of collateral dependent commercial loans, which have not been fully charged off.  The average recorded investment in impaired loans was $39,008,000 and $34,226,000 for June 30, 2005 and December 31, 2004, respectively.  The interest recognized on impaired loans was not significant.

 

Management of the Company recognizes the risks associated with these impaired loans.  However, management’s decision to place loans in this category does not necessarily mean that losses will occur.

 

The bank subsidiaries charge off that portion of any loan which management considers to represent a loss as well as that portion of any other loan which is classified as a “loss” by bank examiners.  Commercial and industrial or real estate loans are generally considered by management to represent a loss, in whole or part, when an exposure beyond any collateral coverage is apparent and when no further collection of the loss portion is anticipated based on the borrower’s financial condition and general economic conditions in the borrower’s industry. Generally, unsecured consumer loans are charged-off when 90 days past due.

 

While management of the Company considers that it is generally able to identify borrowers with financial problems reasonably early and to monitor credit extended to such borrowers carefully, there is no precise method of predicting loan losses.  The determination that a loan is likely to be un-collectible and that it should be wholly or partially charged-off as a loss is an exercise of judgment.  Similarly, the determination of the adequacy of the allowance for possible loan losses can be made only on a subjective basis.  It is the judgment of the Company’s management that the allowance for possible loan losses at June 30, 2005 was adequate to absorb probable losses from loans in the portfolio at that date.

 

Note 6 – Other Borrowed Funds

 

Other borrowed funds include Federal Home Loan Bank borrowings, which are short or long term, variable or fixed borrowings issued by the Federal Home Loan Bank of Dallas at the market price offered at the time of funding.  These borrowings are secured by mortgage-backed investment securities and a portion of the Company’s loan portfolio.  At June 30, 2005, other borrowed funds totaled $1,885,193,000 an increase of 12.9% from $1,670,199,000 at December 31, 2004.  The increase in other borrowed funds can be attributed to the additional funding needs of the Company.

 

Note 7 – Junior Subordinated Interest Deferrable Debentures

 

The Company has formed eight statutory business trusts under the laws of the State of Delaware, for the purpose of issuing trust preferred securities.  As part of the LFIN acquisition, the Company acquired three additional statutory business trusts previously formed by LFIN for the purpose of issuing trust preferred securities.  The eight statutory business trusts formed by the Company and the three business trusts acquired in the LFIN transaction (the “Trusts”) have each issued Capital and Common Securities and invested the proceeds thereof in an equivalent amount of junior subordinated debentures (the “Debentures”) issued by the Company or LFIN, as appropriate.  The Company has succeeded to the obligations of LFIN under the LFIN Debentures, which have an outstanding principal balance of $62,115,000.  The Debentures will mature on various dates; however the Debentures may be redeemed at specified prepayment prices, in whole or in part after the optional redemption dates specified in the respective indentures or in whole upon the occurrence of any one of certain legal, regulatory or tax events specified in respective indentures.  As of June 30, 2005, the principal amount of debentures outstanding totaled $235,908,000.

 

11



 

In March 2005, the Federal Reserve Board issued a final rule that would continue to allow the inclusion of trust preferred securities in Tier 1 capital, but with stricter quantitative limits.  Under the final rule, after a five-year transition period ending March 31, 2009, the aggregate amount of trust preferred securities and certain other capital elements would be limited to 25% of Tier 1 capital elements, net of goodwill, less any associated deferred tax liability.  The amount of trust preferred securities and certain other elements in excess of the limit could be included in Tier 2 capital, subject to restrictions.  Bank holding companies with significant international operations will be expected to limit trust preferred securities to 15% of Tier 1 capital elements, net of goodwill; however, they may include qualifying mandatory convertible preferred securities up to the 25% limit.  The Company believes that substantially all of the $235,908,000 will be included in Tier 1 capital after the five-year transition period ending March 31, 2009.

 

The following table illustrates key information about each of the Capital and Common Securities and their interest rate at June 30, 2005:

 

 

 

Junior
Subordinated
Deferrable
Interest
Debentures

 

Repricing
F
requency

 

Interest Rate

 

Interest Rate
Index

 

Maturity Date

 

Optional
Redemption Date

 

 

(in thousands)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Trust I

 

$

10,200

 

Fixed

 

10.18

%

Fixed

 

June 2031

 

June 2011

Trust II

 

$

25,686

 

Semi-Annually

 

6.71

%

LIBOR + 3.75

 

July 2031

 

July 2006

Trust III

 

$

33,920

 

Semi-Annually

 

7.37

%

LIBOR + 3.75

 

December 2031

 

December 2006

Trust IV

 

$

22,484

 

Semi-Annually

 

7.11

%

LIBOR + 3.70

 

April 2032

 

April 2007

Trust V

 

$

20,379

 

Quarterly

 

7.25

%

LIBOR + 3.65

 

July 2032

 

July 2007

Trust VI

 

$

25,436

 

Quarterly

 

6.72

%

LIBOR + 3.45

 

November 2032

 

November 2007

Trust VII

 

$

10,310

 

Quarterly

 

6.46

%

LIBOR + 3.25

 

April 2033

 

April 2008

Trust VIII

 

$

25,378

 

Quarterly

 

6.19

%

LIBOR + 3.05

 

October 2033

 

October 2008

LFIN Trust I

 

$

41,495

 

Fixed

 

9.00

%

Fixed

 

September 2031

 

September 2006

LFIN Trust II

 

$

10,310

 

Semi-Annually

 

6.57

%

LIBOR + 3.625

 

July 2032

 

July 2007

LFIN Trust III

 

$

10,310

 

Quarterly

 

6.72

%

LIBOR + 3.45

 

November 2032

 

November 2007

 

 

$

235,908

 

 

 

 

 

 

 

 

 

 

 

12



 

Note 8 – Common Stock and Dividends

 

All per share data presented has been restated to reflect the stock splits effected through stock dividends, which became effective May 2, 2005 and May 3, 2004 and were paid on May 31, 2005 and May 28, 2004, respectively.  Cash dividends of $.32 per share, adjusted for stock dividends, were paid on April 29, 2005 to all holders of record on April 15, 2005.

 

The Company expanded its formal stock repurchase program on December 16, 2004.  Under the expanded stock repurchase program, the Company is authorized to repurchase up to $175,000,000 of its common stock through December 2005.  Stock repurchases may be made from time to time, on the open market or through private transactions.  Shares repurchased in this program will be held in treasury for reissue for various corporate purposes, including employee stock option plans.  As of August 1, 2005, a total of 3,934,393 shares had been repurchased under this program at a cost of $153,020,000.  Stock repurchases are reviewed quarterly at the Company’s Board of Directors meetings and the Board of Directors has stated that the aggregate investment in treasury stock should not exceed $195,973,000.  In the past, the Board of Directors has increased previous caps on treasury stock once they were met, but there are no assurances that an increase of the $195,973,000 cap will occur in the future.  As of August 1, 2005, the Company has approximately $173,994,000 invested in treasury shares, which amount has been accumulated since the inception of the Company.

 

On May 16, 2005, the Corporation’s shareholders adopted the 2005 International Bancshares Corporation Stock Option Plan (the “2005 Plan”).  The 2005 Plan became effective on April 1, 2005, the date it was approved and adopted by the Corporation’s Board of Directors, upon such shareholder approval.  The Plan replaces the 1996 International Bancshares Corporation Stock Option Plan (the “1996 Plan”), which will be terminated for purposes of granting further options.  The 2005 Plan provides for the grant of incentive stock options and non-statutory stock options.  The Stock Option Plan committee of the Board of Directors administers the 2005 Plan and determines the terms and conditions under with options to purchase shares of common stock of the Corporation may be awarded.  The aggregate number of shares of common stock of the Corporation that may be issued pursuant to the 2005 Plan is 380,000 shares, subject to adjustment as provided in the 2005 Plan.  Further, the maximum number of shares of common stock covered by options which may be granted to any one person in any fiscal year is 75,000, also subject to adjustment as provided in the 2005 Plan.  Neither the 380,000 aggregate shares limitation nor the 75,000 individual annual limitation described above reflects the appropriate adjustment for the May 2, 2005 stock dividend.

 

Note 9 - Commitments and Contingent Liabilities

 

The Company is involved in various legal proceedings that are in various stages of litigation.  Some of these actions allege “lender liability” claims on a variety of theories and claim actual and punitive damages.  The Company has determined, based on discussions with its counsel that any material loss in such actions, individually or in the aggregate, is remote or the damages sought, even if fully recovered, would not be considered material to the consolidated financial position or results of operations of the Company.  However, many of these matters are in various stages of proceedings and further developments could cause management to revise its assessment of these matters.

 

The Company’s lead bank subsidiary has invested in partnerships, which have entered into several lease-financing transactions.  The lease-financing transactions in two of the partnerships have been examined by the Internal Revenue Service (“IRS”).  In both partnerships, the lead bank subsidiary was the owner of a ninety-nine percent (99%) limited partnership interest.  The IRS has issued separate Notice of Final Partnership Administrative Adjustments (“FPAA”) to the partnerships and on September 25, 2001, and January 10, 2003, the Company filed lawsuits contesting the adjustments asserted in the FPAAs.

 

Prior to filing the lawsuits the Company was required to deposit the estimated tax due of approximately $4,083,000 with respect to the first FPAA, and $7,710,606 with respect to the second FPAA, with the IRS pursuant to the Internal Revenue Code.  If it is determined that the amount of tax due, if any, related to the lease-financing transactions is less than the amount of the deposits, the remaining amount of the deposits would be returned to the Company.

 

In order to curtail the accrual of additional interest related to the disputed tax benefits and because interest rates were unfavorable, on March 7, 2003, the Company submitted to the IRS a total of $13,640,797, which constitutes the interest that would have accrued based on the adjustments proposed in the FPAAs related to both of the lease-financing transactions.  If it is determined that the amount of interest due, if any, related to the lease-financing transactions is less than the $13,640,797, the remaining amount of the prepaid interest will be refunded to the Company, plus interest thereon.

 

No reliable prediction can be made at this time as to the likely outcome of the lawsuits; however, if the lawsuits are

 

13



 

decided adversely to the partnerships, all or a portion of the $12 million in tax benefits previously recognized by the Company in connection with the Partnerships’ lease-financing transactions would be in question and penalties and interest could be assessed by the IRS.  The Company has accrued approximately $12 million at June 30, 2005 in connection with the lawsuits.  Management intends to continue to evaluate the merits of each matter and make appropriate revisions to the accrued amount as deemed necessary.

 

As part of the LFIN acquisition, the Company acquired two tax matters. The first relates to deductions taken on amended returns filed by LFIN during 2003 for the tax years ended June 30, 1999 through December 31, 2001. The refunds requested on the amended returns amounted to approximately $7,000,000. At December 31, 2003, LFIN had received approximately $2,000,000 of the total refund requested. Because all the refunds are under review by the IRS, LFIN had established a reserve equal to the $2,000,000 received and did not recognize any benefit for the remaining $5,000,000. The second tax contingency, which is also approximately $7,000,000, relates to permanent differences applicable to prior periods taken as deductions in 2002 and was received by LFIN during 2003. LFIN had recorded a reserve equal to the amounts received pending final resolution with the IRS. Both reserves are included in the current income taxes payable of the Company.  The Company will continue to monitor the IRS reviews.

 

Note 10 – Capital Ratios

 

The Company had a leverage ratio of 6.80% and 6.91%, risk-weighted Tier 1 capital ratio of 11.69% and 10.74% and risk-weighted total capital ratio of 12.94% and 11.99% at June 30, 2005 and December 31, 2004, respectively.  The net identified intangibles and goodwill of $331,065,000 as of June 30, 2005, recorded in connection with the acquisitions made by the Company, are deducted from the sum of core capital elements when determining the capital ratios of the Company.  The Company actively monitors the regulatory capital ratios to ensure that the Company’s bank subsidiaries are well capitalized under the regulatory framework.

 

In March 2005, the Federal Reserve Board issued a final rule that would continue to allow the inclusion of trust preferred securities in Tier 1 capital, but with stricter quantitative limits.  Under the final rule, after a five-year transition period ending March 31, 2009, the aggregate amount of trust preferred securities and certain other capital elements would be limited to 25% of Tier 1 capital elements, net of goodwill, less any associated deferred tax liability.  The amount of trust preferred securities and certain other elements in excess of the limit could be included in Tier 2 capital, subject to restrictions.  Bank holding companies with significant international operations will be expected to limit trust preferred securities to 15% of Tier 1 capital elements, net of goodwill; however, they may include qualifying mandatory convertible preferred securities up to the 25% limit.

 

Item 2 - Management’s Discussion and Analysis of Financial Condition andResults of Operations

 

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 Exchange Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended, and are subject to the safe harbor created by these sections.  Although the Company believes such forward-looking statements are based on reasonable assumptions, no assurance can be given that every objective will be reached.  The words “estimate,” “expect,” “intend,” “believe” and “project,” as well as other words or expressions of a similar meaning are intended to identify forward-looking statements.  Readers are cautioned not to place undue reliance on forward-looking statements, which speak only as of the date of this report.  Such statements are based on current expectations, are inherently uncertain, are subject to risks and should be viewed with caution.  Actual results and experience may differ materially from the forward-looking statements as a result of many factors.

 

Factors that could cause actual results to differ materially from any results that are projected, forecasted, estimated or budgeted by the Company in forward-looking statements include, among others, the following possibilities:

 

                  Changes in interest rates and market prices, which could reduce the Company’s net interest margins, asset valuations and expense expectations.

                  Changes in the capital markets utilized by the Company and its subsidiaries, including changes in the interest rate environment that may reduce margins.

                  Changes in state and/or federal laws and regulations to which the Company and its subsidiaries, as well as their customers, competitors and potential competitors, are subject, including, without limitation, changes in the accounting, tax and regulatory treatment of trust preferred securities, as well as changes in banking, tax, securities, insurance and employment laws and regulations.

 

14



 

                  Changes in U.S. – Mexico trade, including, without limitation, reductions in border crossings and commerce resulting from the Homeland Security Programs called “US-VISIT,” which is derived from Section 110 of the Illegal Immigration Reform and Immigrant Responsibility Act of 1996.

                  The loss of senior management or operating personnel.

                  Increased competition from both within and outside the banking industry.

                  Changes in local, national and international economic business conditions that adversely affect the Company’s customers and their ability to transact profitable business with the Company, including the ability of its borrowers to repay their loans according to their terms or a change in the value of the related collateral.

                  The timing, impact and other uncertainties of the Company’s potential future acquisitions including the Company’s ability to identify suitable potential future acquisition candidates, the success or failure in the integration of their operations and the Company’s ability to maintain its current branch network and to enter new markets successfully and capitalize on growth opportunities.

                  Changes in the Company’s ability to pay dividends on its Common Stock.

                  The effects of the litigation and proceedings pending with the Internal Revenue Service regarding the Company’s lease financing transactions.

                  Additions to the Company’s loan loss allowance as a result of changes in local, national or international conditions which adversely affect the Company’s customers.

                  Political instability.

                  Technological changes.

                  Acts of war or terrorism.

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

 

It is not possible to foresee or identify all such factors.  The Company makes no commitment to update any forward-looking statement, or to disclose any facts, events or circumstances after the date hereof that may affect the accuracy of any forward-looking statement, unless required by law.

 

Overview

 

The Company, which is headquartered in Laredo, Texas, with more than 180 facilities and more than 300 ATMs, provides banking services for commercial, consumer and international customers of South, Central and Southeast Texas and the State of Oklahoma.  The Company is the one of the largest independent commercial bank holding companies headquartered in Texas.  The Company, through its bank subsidiaries, is in the business of gathering funds from various sources and investing those funds in order to earn a return.  The Company either directly or through a bank subsidiary owns two insurance agencies, a broker/dealer and a majority interest in an investment banking unit that owns a broker/dealer.  The Company’s primary earnings come from the spread between the interest earned on interest-bearing assets and the interest paid on interest-bearing liabilities.  In addition, the Company generates income from fees on products offered to commercial, consumer and international customers.

 

The Company is very active in facilitating trade along the United States border with Mexico.  The Company does a significant amount of business with customers domiciled in Mexico.  Deposits from persons and entities domiciled in Mexico comprise a significant and stable portion of the deposit base of the Company’s bank subsidiaries.  The Company also serves the growing Hispanic population through the Company’s facilities located throughout South, Central and Southeast Texas and the State of Oklahoma.

 

Expense control is an essential element in the Company’s long-term profitability.  As a result, one of the key ratios the Company monitors is the efficiency ratio, which is a measure of non-interest expense to net-interest income plus non-interest income.  The Company’s efficiency ratio has been under 54% for each of the last five years, which the Company believes is better than average compared to its national peer group.  One of the benefits derived from such operating efficiencies is that the Company is not subject to undue pressure to generate interest income from high-risk loans.

 

15



 

Results of Operations

 

Summary

 

Consolidated Statements of Condition Information

 

 

 

June 30, 2005

 

December 31, 2004

 

Percent Increase
(Decrease)

 

 

 

(Dollars in Thousands)

 

 

 

 

 

 

 

 

 

 

 

Assets

 

$

10,273,970

 

$

9,921,505

 

3.6

%

Net loans

 

4,842,869

 

4,807,623

 

.7

 

Deposits

 

6,520,001

 

6,571,104

 

(.8

)

Other borrowed funds

 

1,885,193

 

1,670,199

 

12.9

 

Junior subordinated deferrable interest debentures

 

235,908

 

235,395

 

.2

 

Shareholders’ equity

 

780,139

 

753,090

 

3.6

 

 

Consolidated Statements of Income Information

 

 

 

Three Months Ended
June 30,

 

Percent

 

Six Months Ended
June 30,

 

Percent

 

 

 

(Dollars in Thousands)

 

Increase

 

(Dollars in Thousands)

 

Increase

 

 

 

2005

 

2004

 

(Decrease)

 

2005

 

2004

 

(Decrease)

 

Interest income

 

$

126,160

 

$

72,504

 

74.0

%

$

244,479

 

$

143,474

 

70.4

%

Interest expense

 

48,201

 

22,281

 

116.3

 

89,407

 

43,000

 

107.9

 

Net interest income

 

77,959

 

50,223

 

55.2

 

155,072

 

100,474

 

54.3

 

Provision for possible loan losses

 

221

 

1,375

 

(83.9

)

2,831

 

2,717

 

4.2

 

Non-interest income

 

37,307

 

31,090

 

20.0

 

79,730

 

59,403

 

34.2

 

Non-interest expense

 

64,989

 

40,889

 

58.9

 

125,013

 

78,576

 

59.1

 

Net income

 

33,372

 

26,229

 

27.2

 

71,032

 

52,748

 

34.7

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Per common share (adjusted for stock dividends):

 

 

 

 

 

 

 

 

 

 

 

 

 

Basic

 

$

.52

 

$

.43

 

20.9

%

$

1.12

 

$

.87

 

28.7

%

Diluted

 

.52

 

.42

 

23.8

 

1.10

 

.85

 

29.4

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Efficiency Ratio

 

56.4

%

50.3

%

12.1

 

53.2

%

49.1

%

8.4

 

 

Net Income

 

Net income increased by 27.2% for the three months ended June 30, 2005 and 34.7% for the six months ended June 30, 2005 from the same periods in 2004.   Net income was positively impacted by the acquisition of Local Financial Corporation (“LFIN”) in June 2004.  Net income was also positively impacted by $5,613,000, net of tax, distributions from the January 2005 merger of the PULSE EFT Association with Discover Financial Services, a business unit of Morgan Stanley received in the first and second quarter 2005.  Members of the PULSE EFT Association received these distributions based in part upon their volume of transactions through the PULSE network.

 

16



 

Net Interest Income

 

 

 

Three Months Ended
June 30,

 

Percent

 

Six Months Ended
June 30,

 

Percent

 

 

 

(in Thousands)

 

Increase

 

(in Thousands)

 

Increase

 

 

 

2005

 

2004

 

(Decrease)

 

2005

 

2004

 

(Decrease)

 

Interest income:

 

 

 

 

 

 

 

 

 

 

 

 

 

Loans, including fees

 

$

84,845

 

$

45,596

 

86.1

%

$

164,670

 

$

89,022

 

85.0

%

Time deposits with banks

 

2

 

14

 

(85.7

)

3

 

20

 

(85.0

)

Federal funds sold

 

787

 

433

 

81.8

 

1,354

 

902

 

50.1

 

Investment securities:

 

 

 

 

 

 

 

 

 

 

 

 

 

Taxable

 

39,178

 

25,078

 

56.2

 

75,691

 

50,701

 

49.3

 

Tax-exempt

 

1,220

 

1,272

 

(4.1

)

2,437

 

2,556

 

(4.7

)

Other interest income

 

128

 

111

 

15.3

 

324

 

273

 

18.7

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Total interest income

 

126,160

 

72,504

 

74.0

 

244,479

 

143,474

 

70.4

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Interest expense:

 

 

 

 

 

 

 

 

 

 

 

 

 

Savings deposits

 

6,161

 

2,504

 

146.0

 

11,635

 

4,721

 

146.5

 

Time deposits

 

16,602

 

9,835

 

68.8

 

31,082

 

18,886

 

64.6

 

Securities sold under repurchase agreements

 

7,091

 

4,783

 

48.3

 

12,539

 

9,540

 

31.4

 

Other borrowings

 

13,829

 

2,437

 

467.5

 

25,433

 

4,644

 

447.7

 

Junior subordinated interest deferrable debentures

 

4,518

 

2,638

 

71.3

 

8,718

 

5,125

 

70.1

 

Senior notes

 

 

84

 

(100.0

)

 

84

 

(100.0

)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Total interest expense

 

48,201

 

22,281

 

116.3

 

89,407

 

43,000

 

107.9

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net interest income

 

$

77,959

 

$

50,223

 

55.2

%

$

155,072

 

$

100,474

 

54.3

%

 

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.  Net interest income is the Company’s largest source of revenue.  Net interest income is affected by both changes in the level of interest rates and changes in the amount and composition of interest earning assets and interest bearing liabilities.  Net interest income was positively impacted by the acquisition of LFIN, as well as increasing portfolio levels and increasing market rates on interest bearing asset and interest bearing liabilities.

 

As part of its strategy to manage interest rate risk, the Company strives to manage both assets and liabilities so that interest sensitivities match. One method of calculating interest rate sensitivity is through gap analysis.  A gap is the difference between the amount of interest rate sensitive assets and interest rate sensitive liabilities that re-price or mature in a given time period.  Positive gaps occur when interest rate sensitive assets exceed interest rate sensitive liabilities, and negative gaps occur when interest rate sensitive liabilities exceed interest rate sensitive assets.  A positive gap position in a period of rising interest rates should have a positive effect on net interest income as assets will re-price faster than liabilities.  Conversely, net interest income should contract somewhat in a period of falling interest rates.  Management can quickly change the Company’s interest rate position at any given point in time as market conditions dictate.  Additionally, interest rate changes do not affect all categories of assets and liabilities equally or at the same time.  Analytical techniques employed by the Company to supplement gap analysis include simulation analysis to quantify interest rate risk exposure.  The gap analysis prepared by management is reviewed by the Investment Committee of the Company twice a year (see table on page 21 for the June 30, 2005 gap analysis).  Management currently believes that the Company is properly positioned for interest rate changes; however if management determines at any time that the Company is not properly positioned, it will strive to adjust the interest rate sensitive assets and liabilities in order to manage the effect of interest rate changes.

 

17



 

Non-Interest Income

 

 

 

Three Months Ended
June 30,

 

Percent

 

Six Months Ended
June 30,

 

Percent

 

 

 

(in Thousands)

 

Increase

 

(in Thousands)

 

Increase

 

 

 

2005

 

2004

 

(Decrease)

 

2005

 

2004

 

(Decrease)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Service charges on deposit accounts

 

$

20,859

 

$

15,911

 

31.1

%

$

40,904

 

$

30,320

 

34.9

%

Other service charges, commissions and fees

 

 

 

 

 

 

 

 

 

 

 

 

 

Banking

 

6,233

 

4,443

 

40.3

 

12,278

 

8,286

 

48.2

 

Non-banking

 

2,479

 

1,652

 

50.1

 

4,111

 

2,548

 

61.3

 

Investment securities transactions, net

 

(155

)

3,689

 

(104.2

)

(181

)

8,461

 

(102.1

)

Other investments, net

 

3,446

 

3,313

 

4.0

 

7,863

 

5,825

 

35.0

 

Other income

 

4,445

 

2,082

 

113.5

 

14,755

 

3,963

 

272.3

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Total non-interest income

 

$

37,307

 

$

31,090

 

20.00

%

$

79,730

 

$

59,403

 

34.2

%

 

The increase in non-banking service charges, commissions and fees can be attributed to the acquisition of LFIN.  The Company recorded investment securities losses of $181,000 for the six months ended June 30, 2005 compared to gains of $8,461,000 for the same period of 2004.  The increase in other income can be attributed primarily to a gain of $8,636,000 from a distribution resulting from the January 2005 merger of the PULSE EFT Association with Discover Financial Services, a business unit of Morgan Stanley, of which $7,363,000 was received in the first quarter 2005 and $1,273,000 was received in the second quarter.  Members of the PULSE EFT Association received these distributions based in part upon their volume of transactions through the PULSE network.

 

Non-Interest Expense

 

 

 

Three Months Ended
June 30,

 

Percent

 

Six Months Ended
June 30,

 

Percent

 

 

 

(in Thousands)

 

Increase

 

(in Thousands)

 

Increase

 

 

 

2005

 

2004

 

(Decrease)

 

(Decrease)

 

2004

 

(Decrease)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Employee compensation and benefits

 

$

28,295

 

$

17,123

 

65.2

%

$

55,770

 

$

33,564

 

66.2

%

Occupancy

 

5,938

 

3,626

 

63.8

 

11,386

 

6,899

 

65.0

 

Depreciation of bank premises and equipment

 

6,097

 

4,415

 

38.1

 

11,807

 

8,466

 

39.5

 

Professional fees

 

3,011

 

1,309

 

130.0

 

6,219

 

2,882

 

115.8

 

Stationery and supplies

 

1,384

 

910

 

52.1

 

2,751

 

1,889

 

45.6

 

Amortization of identified intangible assets

 

1,299

 

246

 

428.0

 

2,597

 

492

 

427.8

 

Advertising

 

2,622

 

2,237

 

17.2

 

5,408

 

4,093

 

32.1

 

Other

 

16,343

 

11,023

 

48.3

 

29,075

 

20,291

 

43.3

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Total non-interest expense

 

$

64,989

 

$

40,889

 

58.9

%

$

125,013

 

$

78,576

 

59.1

%

 

The increase in employee compensation and benefits expense for the quarter and six months ended June 30, 2005 compared to the quarter and six months ended June 30, 2004 can be attributed primarily to the expanded operations of the Company’s bank subsidiaries (including the acquisition of LFIN in June 2004, which added approximately 700 employees, 52 branches and $42,188,000 in identified intangible assets).

 

18



 

Financial Condition

 

Allowance for Possible Loan Losses

 

The allowance for possible loan losses increased .9% to $82,114,000 at June 30, 2005 from $81,351,000 at December 31, 2004.  The provision for possible loan losses charged to expense increased 4.2% to $2,831,000 for the six months ended June 30, 2005 from $2,717,000 for the same period in 2004.  The increase in the provision for possible loan losses charged to expense can be attributed primarily to the substantial increase in the loan portfolio as part of the LFIN acquisition.  The allowance for possible loan losses was 1.7% of total loans, net of unearned income, at June 30, 2005 and at December 31, 2004.

 

Investment Securities

 

Investment securities increased 5.3% to $4,082,451,000 at June 30, 2005, from $3,877,218,000 at December 31, 2004.

 

Foreign Operations

 

On June 30, 2005, the Company had $10,273,970,000 of consolidated assets, of which approximately $259,841,000, or 2.5%, was related to loans outstanding to borrowers domiciled in Mexico, compared to $239,622,000, or 2.4%, at December 31, 2004.  Of the $259,841,000, 77.0% is directly or indirectly secured by U.S. assets, certificates of deposits and real estate; 17.7% is secured by Mexican real estate; .4% is secured by Mexican real estate related to maquiladora plants and guaranteed under lease obligations primarily by U.S. companies, many of which are on the Fortune 500 list of companies; 4.3% is unsecured; and .6% represents accrued interest receivable on the portfolio.

 

Critical Accounting Policies

 

The Company has established various accounting policies which govern the application of accounting principles in the preparation of the Company’s consolidated financial statements.  Certain accounting policies involve significant subjective judgments and assumptions by management which have a material impact on the carrying value of certain assets and liabilities; management considers such accounting policies to be critical accounting policies.

 

The Company considers its Allowance for Possible Loan Losses as a policy critical to the sound operations of the bank subsidiaries.  The allowance for possible loan losses consists of the aggregate loan loss allowances of the bank subsidiaries.  The allowances are established through charges to operations in the form of provisions for possible loan losses.  Loan losses or recoveries are charged or credited directly to the allowances.  The allowance for possible loan losses of each bank subsidiary is maintained at a level considered appropriate by management, based on estimated probable losses in the loan portfolio.  The allowance is derived from the following elements:  (i) allowances established on specific loans and (ii) allowances based on historical loss experience on the Company’s remaining loan portfolio, which includes general economic conditions and other qualitative risk factors both internal and external to the Company.  See also discussion regarding the allowance for possible loan losses and provision for possible loan losses included in the results of operations and “Provision and Allowance for Possible Loan Losses” included in Notes 1 and 5 of the notes to Consolidated Financial Statements in the Company’s latest Annual Report on Form 10K for further information regarding the Company’s provision and allowance for possible loan losses policy.

 

Liquidity and Capital Resources

 

The maintenance of adequate liquidity provides the Company’s bank subsidiaries with the ability to meet potential depositor withdrawals, provide for customer credit needs, maintain adequate statutory reserve levels and take full advantage of high-yield investment opportunities as they arise.  Liquidity is afforded by access to financial markets and by holding appropriate amounts of liquid assets.  The Company’s bank subsidiaries derive their liquidity largely from deposits of individuals and business entities.  Deposits from persons and entities domiciled in Mexico comprise a significant and stable portion of the deposit base of the Company’s bank subsidiaries. Other important funding sources for the Company’s bank subsidiaries during 2005 and 2004 have been borrowings from FHLB, securities sold under repurchase agreements and large certificates of deposit, requiring management to closely monitor its asset/liability mix in terms of both rate sensitivity and maturity distribution.  Primary liquidity of the Company and its subsidiaries has been maintained by means of increased investment in shorter-term securities, certificates of deposit and loans.  As in the past, the Company will continue to monitor the volatility and cost of funds in an attempt to match maturities of rate-sensitive assets and liabilities and respond accordingly to anticipated fluctuations in interest rates over reasonable periods of time.

 

19



 

The Company maintains an adequate level of capital as a margin of safety for its depositors and shareholders.  At June 30, 2005, shareholders’ equity was $780,139,000 compared to $753,090,000 at December 31, 2004, an increase of $27,049,000, or 3.6%.  The change in shareholders’ equity can be attributed to the retention of earnings offset by a decrease in the unrealized gain on available for sale investments.

 

The Company had a leverage ratio of 6.80% and 6.91%, risk-weighted Tier 1 capital ratio of 11.69% and 10.74% and risk-weighted total capital ratio of 12.94% and 11.99% at June 30, 2005 and December 31, 2004, respectively.  The identified intangibles and goodwill of $331,065,000 as of June 30, 2005, recorded in connection with the Company’s acquisitions, are deducted from the sum of core capital elements when determining the capital ratios of the Company.

 

As in the past, the Company will continue to monitor the volatility and cost of funds in an attempt to match maturities of rate-sensitive assets and liabilities, and respond accordingly to anticipate fluctuations in interest rates by adjusting the balance between sources and uses of funds as deemed appropriate.  The net-interest rate sensitivity as of June 30, 2005 is illustrated in the table on the following page.  This information reflects the balances of assets and liabilities for which rates are subject to change.  A mix of assets and liabilities that are roughly equal in volume and re-pricing characteristics represents a matched interest rate sensitivity position.  Any excess of assets or liabilities results in an interest rate sensitivity gap.

 

The Company undertakes an interest rate sensitivity analysis to monitor the potential risk on future earnings resulting from the impact of possible future changes in interest rates on currently existing net asset or net liability positions.  However, this type of analysis is as of a point-in-time position, when in fact that position can quickly change as market conditions, customer needs, and management strategies change. Thus, interest rate changes do not affect all categories of asset and liabilities equally or at the same time.  As indicated in the table, the Company is liability sensitive during the early time periods and asset sensitive in the longer periods.  The Company’s Asset and Liability Committee semi-annually reviews the consolidated position along with simulation and duration models, and makes adjustments as needed to control the Company’s interest rate risk position.  The Company uses modeling of future events as a primary tool for monitoring interest rate risk.

 

20



 

Interest Rate Sensitivity

(Dollars in Thousands)

 

 

 

 

Rate/Maturity

 

June 30, 2005

 

3 Months
or Less

 

Over 3 Months
to 1 Year

 

Over 1
Year to 5
Years

 

Over 5
Years

 

Total

 

 

 

 

 

 

 

 

 

 

 

 

 

Rate sensitive assets

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Federal funds sold

 

$

90,000

 

$

 

$

 

$

 

$

90,000

 

Time deposits with banks

 

396

 

 

 

 

396

 

Investment securities

 

23,580

 

946,201

 

1,201,144

 

1,911,526

 

4,082,451

 

Loans, net of non-accruals

 

3,127,182

 

382,270

 

602,438

 

792,752

 

4,904,642

 

 

 

 

 

 

 

 

 

 

 

 

 

Total earning assets

 

$

3,241,158

 

$

1,328,471

 

$

1,803,582

 

$

2,704,278

 

$

9,077,489

 

 

 

 

 

 

 

 

 

 

 

 

 

Cumulative earning assets

 

$

3,241,158

 

$

4,569,629

 

$

6,373,211

 

$

9,077,489

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Rate sensitive liabilities

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Time deposits

 

$

1,409,995

 

$

1,180,926

 

$

533,663

 

$

1,366

 

$

3,125,950

 

Other interest bearing deposits

 

2,188,577

 

 

 

 

2,188,577

 

Securities sold under repurchase agreements

 

390,652

 

86,917

 

6,369

 

300,000

 

783,938

 

Other borrowed funds

 

1,885,116

 

 

 

77

 

1,885,193

 

Junior subordinated deferrable interest debentures

 

127,809

 

56,404

 

 

51,695

 

235,908

 

 

 

 

 

 

 

 

 

 

 

 

 

Total interest bearing liabilities

 

$

6,002,149

 

$

1,324,247

 

$

540,032

 

$

353,138

 

$

8,219,566

 

 

 

 

 

 

 

 

 

 

 

 

 

Cumulative sensitive liabilities

 

$

6,002,149

 

$

7,326,396

 

$

7,866,428

 

$

8,219,566

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Repricing gap

 

$

(2,760,991

)

$

4,224

 

$

1,263,550

 

$

2,351,140

 

$

857,923

 

Cumulative repricing gap

 

(2,760,991

)

(2,756,767

)

(1,493,217

)

857,923

 

 

 

Ratio of interest-sensitive assets to liabilities

 

.54

 

1.00

 

3.34

 

7.66

 

1.10

 

Ratio of cumulative, interest- sensitive assets to liabilities

 

.54

 

.62

 

.81

 

1.10

 

 

 

 

Item 3.  Quantitative and Qualitative Disclosures about Market Risk

 

During the first six months of 2005, there were no material changes in market risk exposures that affected the quantitative and qualitative disclosures regarding market risk presented under the caption “Liquidity & Capital Resources” located on pages 18 through 21 of the Company’s 2004 Annual Report as filed as an exhibit to the Company’s Form 10-K for the year ended December 31, 2004.

 

21



 

Item 4.  Controls and Procedures

 

Disclosure Controls and Procedures

 

The Company maintains disclosure controls and procedures designed to ensure that information required to be disclosed in reports filed under the Securities Exchange Act of 1934, as amended, is recorded, processed, summarized and reported within specified time periods.  As of the end of the period covered by this Quarterly Report on Form 10-Q, the Company’s chief Executive Officer and Chief Financial Officer evaluated, with the participation of the Company’s management, the effectiveness of the Company’s disclosure controls and procedures (as defined in Exchange Act rules 13a-15(e) and 15d-15(e)).  Based on the evaluation, which disclosed no significant deficiencies or material weaknesses, the Company’s Chief Executive Officer and Chief Financial Officer concluded that the Company’s disclosure controls and procedures were effective as of the end of the period covered by this report.

 

Internal Control Over Financial Reporting

 

There were no significant changes in the Company’s internal control over financial reporting that occurred during the Company’s most recent fiscal quarter that have materially affected or are reasonably likely to materially affect the Company’s internal control over financial reporting.

 

PART II - OTHER INFORMATION

 

Item 1.  Legal Proceedings

 

The Company is involved in various legal proceedings that are in various stages of litigation.  Some of these actions allege “lender liability” claims on a variety of theories and claim substantial actual and punitive damages.  The Company has determined, based on discussions with its counsel that any material loss in such actions, individually or in the aggregate, is remote or the damages sought, even if fully recovered, would not be considered material to the consolidated financial position or results of operations of the Company.  However, many of these matters are in various stages of proceedings and further developments could cause management to revise its assessment of these matters.

 

The Company’s lead bank subsidiary has invested in partnerships, which have entered into several lease-financing transactions.  The lease-financing transactions in two of the partnerships have been examined by the Internal Revenue Service (“IRS”).  In both partnerships, the lead bank subsidiary is the owner of a ninety-nine percent (99%) limited partnership interest.  The IRS has issued separate Notice of Final Partnership Administrative Adjustments (“FPAA”) to the partnerships and on September 25, 2001, and January 10, 2003, the Company filed lawsuits contesting the adjustments asserted in the FPAAs.

 

Prior to filing the lawsuit the Company was required to deposit the estimated tax due of approximately $4,083,000 with respect to the first FPAA, and $7,710,606 with respect to the second FPAA, with the IRS pursuant to the Internal Revenue Code.  If it is determined that the amount of tax due, if any, related to the lease-financing transactions is less than the amount of the deposits, the remaining amount of the deposits would be returned to the Company.

 

In order to curtail the accrual of additional interest related to the disputed tax benefits and because interest rates were unfavorable, on March 7, 2003, the Company submitted to the IRS a total of $13,640,797, which constitutes the interest that would have accrued based on the adjustments proposed in the FPAAs related to both of the lease-financing transactions.  If it is determined that the amount of interest due, if any, related to the lease-financing transactions is less than the $13,640,797, the remaining amount of the prepaid interest will be refunded to the Company, plus interest thereon.

 

No reliable prediction can be made at this time as to the likely outcome of the lawsuits; however, if the lawsuits are decided adversely to the partnerships, all or a portion of the $12 million in tax benefits previously recognized by the Company in connection with the Partnerships’ lease-financing transactions would be in question and penalties and interest could be assessed by the IRS.  The Company has accrued approximately $12 million at June 30, 2005 in connection with the lawsuits.  Management intends to continue to evaluate the merits of each matter and make appropriate revisions to the accrued amount as deemed necessary.

 

As part of the LFIN acquisition, the Company acquired two tax matters. The first relates to deductions taken on amended returns filed by LFIN during 2003 for the tax years ended June 30, 1999 through December 31, 2001. The refunds requested on the amended returns amounted to approximately $7,000,000. At December 31, 2003, LFIN had received approximately $2,000,000 of the total refund requested. Because all the refunds are under review by the IRS, LFIN had established a reserve equal to the $2,000,000 received and did not recognize any benefit for the remaining $5,000,000. The second tax contingency, which is also approximately $7,000,000, relates to permanent differences applicable to prior periods taken as deductions in 2002 and was received by LFIN during 2003. LFIN had recorded a reserve equal to the amounts received pending final resolution with the IRS. Both reserves are included in the current income taxes payable of the Company.  The Company will continue to monitor the IRS reviews.

 

22



 

Item 2.  Unregistered Sales of Equity Securities and Use of Proceeds

 

The Company expanded its formal stock repurchase program on December 16, 2004. Under the expanded stock repurchase program, the Company is authorized to repurchase up to $175,000,000 of its common stock through December 2005.  Stock repurchases may be made from time to time, on the open market or through private transactions.  Shares repurchased in this program will be held in treasury for reissue for various corporate purposes, including employee stock option plans.  As of August 1, 2005, a total of 3,934,393 shares had been repurchased under this program at a cost of $153,020,000, which shares are now reflected as 10,805,090 shares of treasury stock as adjusted for stock dividends.  Stock repurchases are reviewed quarterly at the Company’s Board of Directors meetings and the Board of Directors has stated that the aggregate investment in treasury stock should not exceed $195,973,000.  In the past, the Board of Directors has increased previous caps on treasury stock once they were met, but there are no assurances that an increase of the $195,973,000 cap will occur in the future.  As of August 1, 2005, the Company has approximately $173,994,000 invested in treasury shares, which amount has been accumulated since the inception of the Company.

 

Share repurchases are only conducted under publicly announced repurchase programs approved by the Board of Directors.  The following table includes information about share repurchases for the quarter ended June 30, 2005.

 

 

 

Total Number of
Shares Purchased

 

Average Price
Paid Per
Share
(2)

 

Shares Purchased as
Part of a Publicly-
Announced
Program

 

Approximate Dollar
Value of Shares
Available for
Repurchase
(1) (2)

 

April 1 – April 30, 2005

 

6,556

 

27.76

 

 

$

29,051,000

 

May 1 – May 31, 2005

 

261,458

 

28.45

 

250,000

 

22,002,000

 

June 1 – June 30, 2005

 

595

 

28.00

 

 

21,985,000

 

 

 

268,609

 

$

28.43

 

250,000

 

 

 

 


(1)         The formal stock repurchase program was initiated in 1999 and has been expanded periodically.  The current program allows for the repurchase of up to $175,000,000 of treasury stock through December 2005 of which $21,985,000 remains.

(2)         The average price paid per share reflects the Company stock dividend paid on May 31, 2005.

 

23



 

Item 4.  Submission of Matters to a Vote of Security Holders

 

The Annual Meeting of Shareholders of the Company was held May 19, 2005 for the consideration of the following items, each of which was approved by the number of votes set forth below:

 

 

 

 

 

Votes

 

Votes

 

 

 

 

 

For

 

Withheld

 

 

 

 

 

 

 

 

 

1.

 

To elect eleven (11) directors of the Company until the next Annual Meeting of Shareholders and until their successors are elected and qualified; The following directors, constituting the entire board of directors, were elected:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Lester Avigael

 

43,007,985

 

1,132,594

 

 

 

Irving Greenblum

 

43,895,176

 

245,403

 

 

 

R. David Guerra

 

43,066,519

 

1,074,060

 

 

 

Daniel B. Hastings, Jr.

 

43,272,925

 

867,654

 

 

 

Richard E. Haynes

 

43,949,349

 

191,230

 

 

 

Imelda Navarro

 

43,065,891

 

1,074,688

 

 

 

Sioma Neiman

 

41,435,785

 

2,704,797

 

 

 

Peggy J. Newman

 

41,437,331

 

2,703,248

 

 

 

Dennis E. Nixon

 

42,791,335

 

1,349,244

 

 

 

Leonardo Salinas

 

43,881,648

 

258,931

 

 

 

A.R. Sanchez, Jr.

 

41,230,966

 

2,909,613

 

 

 

 

Broker Non-Votes:   575,886

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Votes

 

Votes

 

 

 

 

 

For

 

Against

 

 

 

 

 

 

 

 

 

2.

 

To approve the appointment of KPMG LLP as independent auditors for the 2005 fiscal year

 

44,408,586

 

98,651

 

 

 

 

 

 

 

 

 

 

 

Abstentions :   5,718,841

Broker Non-Votes:   575,887

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Votes

 

Votes

 

 

 

 

 

For

 

Against

 

 

 

 

 

 

 

 

 

3.

 

To approve the proposal to Amend Articles of Incorporation of the Company to increase the number of authorized shares of Common Stock of the Company.

 

38,854,675

 

5,577,323

 

 

 

 

 

 

 

 

 

 

 

Abstentions:   58,434

Broker Non-Votes:   575,888

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Votes

 

Votes

 

 

 

 

 

For

 

Against

 

 

 

 

 

 

 

 

 

4.

 

To approve the amendment of the 2005 International Bancshares Corporation Stock Option plan adopted by the Board of Directors on April 1, 2005

 

31,091,210

 

3,176,506

 

 

 

 

 

 

 

 

 

 

 

Abstentions:   173,537

Broker Non-Votes:   10,507,264

 

 

 

 

 

 

24



 

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

 

25



 

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.

 

 

 

INTERNATIONAL BANCSHARES CORPORATION

 

 

 

 

 

Date:

August 4, 2005

 

 

 /s/ Dennis E. Nixon

 

 

 

Dennis E. Nixon

 

 

President

 

 

 

 

 

 

Date:

August 4, 2005

 

 

 /s/ Imelda Navarro

 

 

 

Imelda Navarro

 

 

Treasurer

 

26