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INTERNATIONAL BANCSHARES CORP - Quarter Report: 2005 March (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 March 31, 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.  Yesý     No     o

 

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act).    Yesý     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

 

51,067,201 shares outstanding at
April 29, 2005

 

 



 

PART I - FINANCIAL INFORMATION

 

Item 1. Financial Statements

 

INTERNATIONAL BANCSHARES CORPORATION AND SUBSIDIARIES

Consolidated Statements of Condition (Unaudited)

(Dollars in Thousands)

 

 

 

March 31,
2005

 

December 31,
2004

 

Assets

 

 

 

 

 

 

 

 

 

 

 

Cash and due from banks

 

$

188,806

 

$

174,770

 

Federal funds sold

 

89,000

 

21,000

 

 

 

 

 

 

 

Total cash and cash equivalents

 

277,806

 

195,770

 

 

 

 

 

 

 

Time deposits with banks

 

396

 

396

 

 

 

 

 

 

 

Investment securities:

 

 

 

 

 

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

 

2,385

 

2,385

 

Available-for-sale (Amortized cost of $4,078,799 on March 31, 2005 and $3,851,741 on December 31, 2004)

 

4,052,300

 

3,874,833

 

 

 

 

 

 

 

Total investment securities

 

4,054,685

 

3,877,218

 

 

 

 

 

 

 

Loans, net of unearned discounts

 

4,964,339

 

4,888,974

 

Less allowance for possible loan losses

 

(86,849

)

(84,905

)

 

 

 

 

 

 

Net loans

 

4,877,490

 

4,804,069

 

 

 

 

 

 

 

Bank premises and equipment, net

 

309,238

 

302,230

 

Accrued interest receivable

 

43,873

 

41,140

 

Other investments

 

323,962

 

301,578

 

Identified intangible assets, net

 

43,102

 

44,400

 

Goodwill, net

 

289,262

 

289,262

 

Other assets

 

57,580

 

61,888

 

 

 

 

 

 

 

Total assets

 

$

10,277,394

 

$

9,917,951

 

 

2



 

INTERNATIONAL BANCSHARES CORPORATION AND SUBSIDIARIES

 

Consolidated Statements of Condition (Unaudited)

 

(Dollars in Thousands)

 

 

 

March 31,
2005

 

December 31,
2004

 

Liabilities and Shareholders’ Equity

 

 

 

 

 

 

 

 

 

 

 

Deposits:

 

 

 

 

 

Demand – non-interest bearing

 

$

1,232,382

 

$

1,150,999

 

Savings and interest bearing demand

 

2,230,177

 

2,232,102

 

Time

 

3,136,051

 

3,188,003

 

 

 

 

 

 

 

Total deposits

 

6,598,610

 

6,571,104

 

 

 

 

 

 

 

Securities sold under repurchase agreements

 

806,014

 

619,806

 

Other borrowed funds

 

1,810,196

 

1,670,199

 

Junior subordinated deferrable interest debentures

 

235,651

 

235,395

 

Other liabilities

 

66,965

 

68,357

 

 

 

 

 

 

 

Total liabilities

 

9,517,436

 

9,164,861

 

 

 

 

 

 

 

Shareholders’ equity:

 

 

 

 

 

 

 

 

 

 

 

Common shares of $1.00 par value. Authorized 75,000,000 shares; issued 68,559,810 shares on March 31, 2005 and 68,431,225 shares on December 31, 2004

 

68,560

 

68,431

 

Surplus

 

132,015

 

130,597

 

Retained earnings

 

743,302

 

705,642

 

Accumulated other comprehensive (loss) income

 

(17,225

)

15,010

 

 

 

926,652

 

919,680

 

 

 

 

 

 

 

Less cost of shares in treasury, 17,612,998 shares on March 31, 2005 and 17,610,126 shares on December 31, 2004

 

(166,694

)

(166,590

)

 

 

 

 

 

 

Total shareholders’ equity

 

759,958

 

753,090

 

 

 

 

 

 

 

Total liabilities and shareholders’ equity

 

$

10,277,394

 

$

9,917,951

 

 

See accompanying notes to consolidated financial statements.

 

3



 

INTERNATIONAL BANCSHARES CORPORATION AND SUBSIDIARIES

Consolidated Statements of Income (Unaudited)

(Dollars in Thousands, except per share data)

 

 

 

Three Months Ended
March 31,

 

 

 

2005

 

2004

 

Interest income:

 

 

 

 

 

Loans, including fees

 

$

79,825

 

$

43,426

 

Federal funds sold

 

567

 

469

 

Investment securities:

 

 

 

 

 

Taxable

 

36,513

 

25,623

 

Tax-exempt

 

1,217

 

1,284

 

Other interest income

 

197

 

168

 

 

 

 

 

 

 

Total interest income

 

118,319

 

70,970

 

 

 

 

 

 

 

Interest expense:

 

 

 

 

 

Savings deposits

 

5,474

 

2,217

 

Time deposits

 

14,480

 

9,051

 

Federal funds purchased and securities sold under repurchase agreements

 

5,448

 

4,757

 

Other borrowings

 

11,604

 

2,207

 

Junior subordinated deferrable interest debentures

 

4,200

 

2,487

 

 

 

 

 

 

 

Total interest expense

 

41,206

 

20,719

 

 

 

 

 

 

 

Net interest income

 

77,113

 

50,251

 

 

 

 

 

 

 

Provision for possible loan losses

 

2,610

 

1,342

 

 

 

 

 

 

 

Net interest income after provision for possible loan losses

 

74,503

 

48,909

 

 

 

 

 

 

 

Non-interest income:

 

 

 

 

 

Service charges on deposit accounts

 

20,045

 

14,409

 

Other service charges, commissions and fees

 

 

 

 

 

Banking

 

6,045

 

3,843

 

Non-banking

 

1,632

 

896

 

Investment securities transactions, net

 

(26

)

4,772

 

Other investments, net

 

4,417

 

2,512

 

Other income

 

10,310

 

1,881

 

 

 

 

 

 

 

Total non-interest income

 

42,423

 

28,313

 

 

4



 

INTERNATIONAL BANCSHARES CORPORATION AND SUBSIDIARIES

Consolidated Statements of Income (Unaudited)

(Dollars in Thousands, except per share data)

 

 

 

Three Months Ended
March 31,

 

 

 

2005

 

2004

 

Non-interest expense:

 

 

 

 

 

Employee compensation and benefits

 

$

27,475

 

$

16,441

 

Occupancy

 

5,448

 

3,273

 

Depreciation of bank premises and equipment

 

5,710

 

4,051

 

Professional fees

 

3,208

 

1,574

 

Stationery and supplies

 

1,367

 

979

 

Amortization of identified intangible assets

 

1,298

 

246

 

Advertising

 

2,786

 

1,856

 

Other

 

12,732

 

9,268

 

 

 

 

 

 

 

Total non-interest expense

 

60,024

 

37,688

 

 

 

 

 

 

 

Income before income taxes

 

56,902

 

39,534

 

 

 

 

 

 

 

Provision for income taxes

 

19,242

 

13,015

 

 

 

 

 

 

 

Net income

 

$

37,660

 

$

26,519

 

 

 

 

 

 

 

Basic earnings per common share:

 

 

 

 

 

 

 

 

 

 

 

Weighted average number of shares outstanding:

 

50,882,971

 

48,433,898

 

 

 

 

 

 

 

Net income

 

$

.74

 

$

.55

 

 

 

 

 

 

 

Fully diluted earnings per common share:

 

 

 

 

 

 

 

 

 

 

 

Weighted average number of shares outstanding:

 

51,659,784

 

49,517,524

 

 

 

 

 

 

 

Net income

 

$

.73

 

$

.54

 

 

See accompanying notes to consolidated financial statements.

 

5



 

INTERNATIONAL BANCSHARES CORPORATION AND SUBSIDIARIES

Consolidated Statements of Comprehensive Income (Unaudited)

(Dollars in Thousands)

 

 

 

Three Months Ended
March 31,

 

 

 

2005

 

2004

 

 

 

 

 

 

 

Net income

 

$

37,660

 

$

26,519

 

 

 

 

 

 

 

Other comprehensive income (loss), net of tax

 

 

 

 

 

 

 

 

 

 

 

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

 

(32,235

)

5,569

 

 

 

 

 

 

 

Comprehensive income

 

$

5,425

 

$

32,088

 

 

See accompanying notes to consolidated financial statements.

 

6



 

INTERNATIONAL BANCSHARES CORPORATION AND SUBSIDIARIES

Consolidated Statements of Cash Flows (Unaudited)

(Dollars in Thousands)

 

 

 

Three Months Ended
March 31,

 

 

 

2005

 

2004

 

Operating activities:

 

 

 

 

 

 

 

 

 

 

 

Net income

 

$

37,660

 

$

26,519

 

 

 

 

 

 

 

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

 

 

 

 

 

Provision for possible loan losses

 

2,610

 

1,342

 

Depreciation of bank premises and equipment

 

5,710

 

4,051

 

Gain on sale of bank premises and equipment

 

(73

)

(17

)

Depreciation and amortization of leased assets

 

422

 

422

 

Accretion of investment securities discounts

 

(176

)

(123

)

Amortization of investment securities premiums

 

7,474

 

7,973

 

Investment securities transactions, net

 

26

 

(4,772

)

Accretion of junior subordinated debenture discounts

 

256

 

256

 

Amortization of identified intangible assets

 

1,298

 

246

 

Earnings from affiliates and other investments

 

(3,374

)

(2,343

)

Deferred tax expense (benefit)

 

568

 

(203

)

(Increase) decrease in accrued interest receivable

 

(2,733

)

1,430

 

Net decrease in other assets

 

3,885

 

1,504

 

Net increase in other liabilities

 

15,396

 

12,878

 

 

 

 

 

 

 

Net cash provided by operating activities

 

68,949

 

49,163

 

 

 

 

 

 

 

Investing activities:

 

 

 

 

 

 

 

 

 

 

 

Proceeds from maturities of securities

 

500

 

2,293

 

Proceeds from sales of available-for-sale securities

 

75,960

 

279,535

 

Purchases of available for sale securities

 

(474,819

)

(268,930

)

Principal collected on mortgage-backed securities

 

163,977

 

145,883

 

Net increase in loans

 

(76,031

)

(44,999

)

(Purchases) distributions of other investments

 

(19,010

)

43,310

 

Purchases of bank premises and equipment

 

(13,052

)

(7,827

)

Proceeds from sale of bank premises and equipment

 

407

 

17

 

 

 

 

 

 

 

Net cash (used in) provided by investing activities

 

(342,068

)

149,282

 

 

7



 

INTERNATIONAL BANCSHARES CORPORATION AND SUBSIDIARIES

Consolidated Statements of Cash Flows (Unaudited)

(Dollars in Thousands)

 

 

 

Three Months Ended
March 31,

 

 

 

2005

 

2004

 

Financing activities:

 

 

 

 

 

 

 

 

 

 

 

Net increase in non-interest bearing demand deposits

 

$

81,383

 

$

20,357

 

Net decrease in savings and interest bearing demand deposits

 

(1,925

)

(8,553

)

Net (decrease) increase in time deposits

 

(51,952

)

40,738

 

Net increase in securities sold under repurchase agreements

 

186,208

 

2,640

 

Proceeds from issuance of other borrowed funds

 

1,145,000

 

90,000

 

Principal payments on other borrowed funds

 

(1,005,003

)

(185,064

)

Purchase of treasury stock

 

(104

)

(332

)

Proceeds from stock transactions

 

1,548

 

1,458

 

 

 

 

 

 

 

Net provided by (used in) financing activities

 

355,155

 

(38,756

)

 

 

 

 

 

 

Increase in cash and cash equivalents

 

82,036

 

159,689

 

 

 

 

 

 

 

Cash and cash equivalents at beginning of period

 

195,770

 

215,729

 

 

 

 

 

 

 

Cash and cash equivalents at end of period

 

$

277,806

 

$

375,418

 

 

 

 

 

 

 

Supplemental cash flow information:

 

 

 

 

 

Interest paid

 

$

39,353

 

$

20,400

 

Income taxes paid

 

4,443

 

 

 

See accompanying notes to consolidated financial statements.

 

8



 

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 subsidiaries 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, Note 8.

 

Note 2 – Loans

 

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

 

 

 

March 31,
2005

 

December 31,
2004

 

 

 

(Dollars in thousands)

 

 

 

 

 

 

 

Commercial, financial and agricultural

 

$

2,689,096

 

$

2,710,270

 

Real estate-mortgage

 

958,641

 

960,599

 

Real estate – construction

 

826,679

 

749,689

 

Consumer

 

240,701

 

229,302

 

Foreign

 

249,557

 

239,622

 

 

 

 

 

 

 

Total loans

 

4,964,674

 

4,889,482

 

 

 

 

 

 

 

Unearned discount

 

(335

)

(508

)

 

 

 

 

 

 

Loans, net of unearned discount

 

$

4,964,339

 

$

4,888,974

 

 

9



 

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 March 31, 2005, the Company had one stock-based employee compensation plan and certain options granted outside the 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
March 31,

 

 

 

2005

 

2004

 

 

 

(Dollars in Thousands,
except per share data)

 

 

 

 

 

 

 

Net income, as reported

 

$

37,660

 

$

26,519

 

 

 

 

 

 

 

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

 

(91

)

(142

)

 

 

 

 

 

 

Pro forma net income

 

$

37,569

 

$

26,377

 

 

 

 

 

 

 

Earnings per share:

 

 

 

 

 

Basic earnings

 

 

 

 

 

As reported

 

$

.74

 

$

.55

 

Pro forma

 

.74

 

.54

 

 

 

 

 

 

 

Diluted earnings

 

 

 

 

 

As reported

 

$

.73

 

$

.54

 

Pro forma

 

.73

 

.53

 

 

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 income (loss) and accumulated other comprehensive income (loss) until realized.

 

10



 

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:

 

 

 

March 31,
2005

 

December 31,
2004

 

 

 

(Dollars in Thousands)

 

 

 

 

 

 

 

U.S. Treasury and federal agencies

 

 

 

 

 

Available-for-sale

 

$

3,931,010

 

$

3,752,501

 

States and political subdivisions

 

 

 

 

 

Available-for-sale

 

103,839

 

104,317

 

Other

 

 

 

 

 

Held-to-maturity

 

2,385

 

2,385

 

Available-for-sale

 

17,451

 

18,015

 

 

 

 

 

 

 

Total investment securities

 

$

4,054,685

 

$

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:

 

 

 

March 31,
2005

 

March 31,
2004

 

 

 

(Dollars in Thousands)

 

 

 

 

 

 

 

Balance at December 31,

 

$

84,905

 

$

48,646

 

 

 

 

 

 

 

Losses charged to allowance

 

(1,231

)

(702

)

Recoveries credited to allowance

 

565

 

560

 

Net losses charged to allowance

 

(666

)

(142

)

 

 

 

 

 

 

Provisions charged to operations

 

2,610

 

1,342

 

 

 

 

 

 

 

Balance at March 31,

 

$

86,849

 

$

49,846

 

 

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.

 

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

 

 

 

March 31,
2005

 

December 31,
2004

 

 

 

(Dollars in Thousands)

 

 

 

 

 

 

 

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

 

$

33,811

 

$

37,037

 

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

 

 

 

 

 

 

 

 

 

Total impaired loans

 

$

33,811

 

$

37,037

 

 

 

 

 

 

 

Allowance allocated to impaired loans

 

$

15,192

 

$

15,666

 

 

11



 

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 $37,653,000 and $34,226,000 for March 31, 2005 and December 31, 2004, respectively.  The increase in impaired loans can be attributed to the Local Financial Corporation (“LFIN”) acquisition.  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 March 31, 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 March 31, 2005, other borrowed funds totaled $1,810,196,000, an increase of 8.4% from $1,670,199,000 at December 31, 2004.  The increase in other borrowed funds can be attributed to the additional funding requirements of the Company.

 

Note 7 – Junior Subordinated Deferrable Interest 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 March 31, 2005, the principal amount of debentures outstanding totaled $235,651,000.

 

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 $235,651,000 will be included in Tier 1 capital after the five-year transition period ending March 31, 2009.

 

12



 

The following table illustrates key information about each of the Capital and Common Securities and their interest rate at March 31, 2005:

 

 

 

Junior
Subordinated
Deferrable
Interest
Debentures

 

Repricing
Frequency

 

Interest Rate

 

Interest Rate
Index

 

Maturity Date

 

Optional
Redemption Date

 

 

 

(in thousands)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Trust I

 

$

10,190

 

Fixed

 

10.18

%

Fixed

 

June 2031

 

June 2011

 

Trust II

 

$

25,641

 

Semi-Annually

 

6.71

%

LIBOR + 3.75

 

July 2031

 

July 2006

 

Trust III

 

$

33,855

 

Semi-Annually

 

6.44

%

LIBOR + 3.75

 

December 2031

 

December 2006

 

Trust IV

 

$

22,445

 

Semi-Annually

 

6.00

%

LIBOR + 3.70

 

April 2032

 

April 2007

 

Trust V

 

$

20,349

 

Quarterly

 

6.31

%

LIBOR + 3.65

 

July 2032

 

July 2007

 

Trust VI

 

$

25,399

 

Quarterly

 

6.24

%

LIBOR + 3.45

 

November 2032

 

November 2007

 

Trust VII

 

$

10,310

 

Quarterly

 

5.99

%

LIBOR + 3.25

 

April 2033

 

April 2008

 

Trust VIII

 

$

25,347

 

Quarterly

 

5.71

%

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

 

6.24

%

LIBOR + 3.45

 

November 2032

 

November 2007

 

 

 

$

235,651

 

 

 

 

 

 

 

 

 

 

 

 

Note 8 – Common Stock and Cash Dividends

 

All per share data presented has been restated to reflect the stock splits effected through stock dividends, which became effective May 3, 2004 and were paid on May 28, 2004.  Cash dividends of $.40 per share were paid on April 29, 2005 to all holders of record on April 15, 2005. A stock dividend of 25% will be paid on May 31, 2005 to all holders of record on May 2, 2005.

 

The pro forma effect of the May 31, 2005 stock dividend is as follows:

 

 

 

Three Months Ended
March 31,

 

 

 

2005

 

2004

 

 

 

 

 

 

 

Basic earnings per common share:

 

 

 

 

 

 

 

 

 

 

 

Weighted average number of shares outstanding:

 

63,603,714

 

60,542,373

 

 

 

 

 

 

 

Net income

 

$

.59

 

$

.44

 

 

 

 

 

 

 

Fully diluted earnings per common share:

 

 

 

 

 

 

 

 

 

 

 

Weighted average number of shares outstanding:

 

64,574,730

 

61,896,905

 

 

 

 

 

 

 

Net income

 

$

.58

 

$

.43

 

 

13



 

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 April 29, 2005, a total of 3,672,964 shares had been repurchased under this program at a cost of $145,978,000, which shares are now reflected as 7,262,843 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 April 29, 2005, the Company has approximately $166,951,000 invested in treasury shares, which amount has been accumulated since the inception of the Company.

 

Note 9 - Commitments, Contingent Liabilities and Other Tax Matters

 

The Company is involved in various legal proceedings that are in various stages of litigation.  Some of these actions allege “lender liability” claims on a variety of theories and claim 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 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 March 31, 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.

 

14



 

Note 10 – Capital Ratios

 

The Company had a leverage ratio of 6.80% and 6.91%, risk-weighted Tier 1 capital ratio of 11.34% and 10.74% and risk-weighted total capital ratio of 12.60% and 11.99% at March 31, 2005 and December 31, 2004, respectively.  The identified intangibles and goodwill of $332,364,000 as of March 31, 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 and Results 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.

                  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.

 

15



 

                  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 290 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 companys 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 53% 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.

 

Results of Operations

 

Summary

 

Consolidated Statements of Condition Information

 

 

 

March 31, 2005

 

December 31, 2004

 

Percent Increase
(Decrease)

 

 

 

(Dollars in Thousands)

 

 

 

 

 

 

 

 

 

 

 

Assets

 

$

10,277,394

 

$

9,917,951

 

3.6

%

Net loans

 

4,877,490

 

4,804,069

 

1.5

 

Deposits

 

6,598,610

 

6,571,104

 

.4

 

Other borrowed funds

 

1,810,196

 

1,670,199

 

8.4

 

Junior subordinated deferrable interest debentures

 

235,651

 

235,395

 

.1

 

Shareholders’ equity

 

759,958

 

753,090

 

.9

 

 

16



 

 

 

Quarter Ended
March 31, 2005

 

Quarter Ended
March 31, 2004

 

Percent Increase
(Decrease)

 

 

 

(in Thousands)

 

 

 

 

 

 

 

 

 

 

 

Interest income

 

$

118,319

 

$

70,970

 

66.7

%

Interest expense

 

41,206

 

20,719

 

98.9

 

Net interest income

 

77,113

 

50,251

 

53.5

 

Provision for possible loan losses

 

2,610

 

1,342

 

94.5

 

Non-interest income

 

42,423

 

28,313

 

49.8

 

Non-interest expense

 

60,024

 

37,688

 

59.3

 

Net income

 

37,660

 

26,519

 

42.0

 

 

 

 

 

 

 

 

 

Per common share:

 

 

 

 

 

 

 

Basic

 

$

.74

 

$

.55

 

34.5

%

Diluted

 

.73

 

.54

 

35.2

 

 

 

 

 

 

 

 

 

Efficiency Ratio

 

50.2

%

48.0

%

4.6

%

 

Net Income

 

Net income increased by 42.0% for the first quarter of 2005 from the same period in 2004.  Net income was positively impacted by the acquisition of Local Financial Corporation (“LFIN”) in June 2004 and was positively impacted by a $4,786,000 distribution, net of tax, from the January 2005 merger of the PULSE EFT Association with Discover Financial Services, a business unit of Morgan Stanley.  Members of the PULSE EFT Association received these distributions based in part upon their volume of transactions through the PULSE network.

 

Net Interest Income

 

 

 

Quarter Ended
March 31, 2005

 

Quarter Ended
March 31, 2004

 

Percent Increase (Decrease)

 

 

 

(in Thousands)

 

 

 

 

 

 

 

 

 

 

 

Interest income:

 

 

 

 

 

 

 

Loans, including fees

 

$

79,825

 

$

43,426

 

83.8

%

Federal funds sold

 

567

 

469

 

20.9

 

Investment securities:

 

 

 

 

 

 

 

Taxable

 

36,513

 

25,623

 

42.5

 

Tax-exempt

 

1,217

 

1,284

 

(5.2

)

Other interest income

 

197

 

168

 

17.3

 

 

 

 

 

 

 

 

 

Total interest income

 

118,319

 

70,970

 

66.7

 

 

 

 

 

 

 

 

 

Interest expense:

 

 

 

 

 

 

 

Savings deposits

 

5,474

 

2,217

 

146.9

 

Time deposits

 

14,480

 

9,051

 

60.0

 

Securities sold under repurchase agreements

 

5,448

 

4,757

 

14.5

 

Other borrowings

 

11,604

 

2,207

 

425.8

 

Junior subordinated interest deferrable debentures

 

4,200

 

2,487

 

68.9

 

 

 

 

 

 

 

 

 

Total interest expense

 

41,206

 

20,719

 

98.9

 

 

 

 

 

 

 

 

 

Net interest income

 

$

77,113

 

$

50,251

 

53.5

%

 

17



 

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 assets 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 March 31, 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.

 

Non-Interest Income

 

 

 

Quarter Ended
March 31, 2005

 

Quarter Ended
March 31, 2004

 

Percent Increase
(Decrease)

 

 

 

(in Thousands)

 

 

 

 

 

 

 

 

 

 

 

Service charges on deposit accounts

 

$

20,045

 

$

14,409

 

39.1

%

Other service charges, commissions and fees

 

 

 

 

 

 

 

Banking

 

6,045

 

3,843

 

57.3

 

Non-banking

 

1,632

 

896

 

82.1

 

Investment securities transactions, net

 

(26

)

4,772

 

(100.5

)

Other investments, net

 

4,417

 

2,512

 

75.8

 

Other income

 

10,310

 

1,881

 

448.1

 

 

 

 

 

 

 

 

 

Total non-interest income

 

$

42,423

 

$

28,313

 

49.8

%

 

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 $26,000 for the quarter ended March 31, 2005 compared to gains of $4,772,000 for the same period of 2004.  The increase in other income can be attributed primarily to a gain of $7,363,000 from a distribution resulting from the January 2005 merger of the PULSE EFT Association with Discover Financial Services, a business unit of Morgan Stanley.  Members of the PULSE EFT Association received these distributions based in part upon their volume of transactions through the PULSE network.

 

18



 

Non-Interest Expense

 

 

 

Quarter Ended
March 31, 2005

 

Quarter Ended
March 31, 2004

 

Percent Increase
(Decrease)

 

 

 

(in Thousands)

 

 

 

 

 

 

 

 

 

 

 

Employee compensation and benefits

 

$

27,475

 

$

16,441

 

67.1

%

Occupancy

 

5,448

 

3,273

 

66.5

 

Depreciation of bank premises and equipment

 

5,710

 

4,051

 

41.0

 

Professional fees

 

3,208

 

1,574

 

103.8

 

Stationery and supplies

 

1,367

 

979

 

39.6

 

Amortization of identified intangible assets

 

1,298

 

246

 

427.6

 

Advertising

 

2,786

 

1,856

 

50.1

 

Other

 

12,732

 

9,268

 

37.4

 

 

 

 

 

 

 

 

 

Total non-interest expense

 

$

60,024

 

$

37,688

 

59.3

%

 

The increase in employee compensation and benefits expense for the quarter ended March 31, 2005 compared to the quarter ended March 31, 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 $42,188,00 in identified intangible assets).

 

Financial Condition

 

Allowance for Possible Loan Losses

 

The allowance for possible loan losses increased 2.3% to $86,849,000 at March 31, 2005 from $84,905,000 at December 31, 2004.  The provision for possible loan losses charged to expense increased 94.5% to $2,610,000 for the quarter ended March 31, 2005 from $1,342,000 for the same quarter 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 March 31, 2005 and at December 31, 2004.

 

Investment Securities

 

Investment securities increased 4.6% to $4,054,685,000 at March 31, 2005, from $3,877,218,000 at December 31, 2004.

 

Foreign Operations

 

On March 31, 2005, the Company had $10,277,394,000 of consolidated assets, of which approximately $249,557,000, or 2.4%, was related to loans outstanding to borrowers domiciled in foreign countries, compared to $239,622,000, or 2.4%, at December 31, 2004.  Of the $249,557,000, 80.7% is directly or indirectly secured by U.S. assets, certificates of deposits and real estate; 17.7% is secured by Mexican real estate; .5% 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; .6% is unsecured; and .5% 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.

 

19



 

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.

 

The Company maintains an adequate level of capital as a margin of safety for its depositors and shareholders.  At March 31, 2005, shareholders’ equity was $759,958,000 compared to $753,090,000 at December 31, 2004, an increase of $6,868,000, or .9%.  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 11.34% and 10.74% and risk-weighted total capital ratio of 12.60% and 11.99% at March 31, 2005 and December 31, 2004, respectively.  The identified intangibles and goodwill of $332,364,000 as of March 31, 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 March 31, 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

 

March 31, 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

 

$

89,000

 

$

 

$

 

$

 

$

89,000

 

Time deposits with banks

 

396

 

 

 

 

396

 

Investment securities

 

259,363

 

538,566

 

1,040,262

 

2,216,494

 

4,054,685

 

Loans, net of non-accruals

 

3,114,702

 

390,545

 

666,660

 

764,880

 

4,936,787

 

 

 

 

 

 

 

 

 

 

 

 

 

Total earning assets

 

$

3,463,461

 

$

929,111

 

$

1,706,922

 

$

2,981,374

 

$

9,080,868

 

 

 

 

 

 

 

 

 

 

 

 

 

Cumulative earning assets

 

$

3,463,461

 

$

4,392,572

 

$

6,099,494

 

$

9,080,868

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Rate sensitive liabilities

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Time deposits

 

$

1,375,182

 

$

1,230,163

 

$

529,452

 

$

1,254

 

$

3,136,051

 

Other interest bearing deposits

 

2,230,177

 

 

 

 

2,230,177

 

Securities sold under repurchase agreements

 

232,352

 

268,715

 

4,946

 

300,000

 

806,013

 

Other borrowed funds

 

1,810,000

 

118

 

 

78

 

1,810,196

 

Junior subordinated deferrable interest debentures

 

148,015

 

35,951

 

 

51,685

 

235,651

 

 

 

 

 

 

 

 

 

 

 

 

 

Total interest bearing liabilities

 

$

5,795,726

 

$

1,534,947

 

$

534,398

 

$

353,017

 

$

8,218,088

 

 

 

 

 

 

 

 

 

 

 

 

 

Cumulative sensitive liabilities

 

$

5,795,726

 

$

7,330,673

 

$

7,865,071

 

$

8,218,088

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Repricing gap

 

$

(2,332,265

)

$

(605,836

)

$

1,172,524

 

$

2,628,357

 

$

862,780

 

Cumulative repricing gap

 

(2,332,265

)

(2,938,101

)

(1,765,577

)

862,780

 

 

 

Ratio of interest-sensitive assets to liabilities

 

.60

 

.61

 

3.19

 

8.45

 

1.11

 

Ratio of cumulative, interest - sensitive assets to liabilities

 

.60

 

.60

 

.78

 

1.11

 

 

 

 

Item 3.  Quantitative and Qualitative Disclosures about Market Risk

 

During the first quarter 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 and 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.

 

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 April 29, 2005, a total of 3,672,964 shares had been repurchased under this program at a cost of $145,978,000, which shares are now reflected as 7,262,843 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 April 29, 2005, the Company has approximately $166,951,000 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 March 31, 2005.

 

 

 

Total Number
of Shares
Purchased

 

Average Price
Paid Per Share

 

Shares Purchased
as Part of a
Publicly-Announced
Program

 

Approximate
Dollar Value of
Shares Available
for Repurchase (1)

 

January 1 - January 31, 2005

 

250

 

38.90

 

250

 

$

29,373,000

 

February 1 - February 28, 2005

 

610

 

38.68

 

 

29,350,000

 

March 1 - March 31, 2005

 

2,012

 

35.18

 

 

29,279,000

 

 

 

2,872

 

$

36.25

 

250

 

 

 

 


(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 $29,279,000 remains.

 

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

 

23



 

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:

May 3, 2005

 

/s/ Dennis E. Nixon

 

 

Dennis E. Nixon

 

President

 

 

 

 

Date:

May 3, 2005

 

/s/ Imelda Navarro

 

 

Imelda Navarro

 

Treasurer

 

24