UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

FORM 10-Q

 

x QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF

THE SECURITIES EXCHANGE ACT OF 1934

 

For the quarterly period ended June 30, 2008

 

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)

 

 

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

 

Indicate by check mark if the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company.  See the definitions of “large accelerated filer,” “accelerated filer” and “small reporting company” in Rule 12b-2 of the Exchange Act.

 

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes  o          No  x

 

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

 

 

 

 

PART I - FINANCIAL INFORMATION

 

Item 1. Financial Statements

 

INTERNATIONAL BANCSHARES CORPORATION AND SUBSIDIARIES

 

Consolidated Statements of Condition (Unaudited)

 

(Dollars in Thousands)

 

		June 30, 2008			December 31, 2007
Assets
Cash and due from banks		$	256,754		$	329,052
Federal funds sold		6,000			17,000
Total cash and cash equivalents		262,754			346,052
Time deposits with banks		396			4,852
Investment securities:
Held-to-maturity (Market value of $2,300 on June 30, 2008 and $2,300 on December 31, 2007)		2,300			2,300
Available-for-sale (Amortized cost of $3,944,716 on June 30, 2008 and $4,167,624 on December 31, 2007)		3,960,388			4,167,888
Total investment securities		3,962,688			4,170,188
Loans, net of unearned discounts		5,690,075			5,536,628
Less allowance for possible loan losses		(65,407		)	(61,726		)
Net loans		5,624,668			5,474,902
Bank premises and equipment, net		445,327			435,654
Accrued interest receivable		48,501			54,301
Other investments		315,150			323,565
Identified intangible assets, net		28,909			31,507
Goodwill, net		282,357			283,198
Other assets		39,799			42,942
Total assets		$	11,010,549		$	11,167,161

 

1

 

		June 30, 2008			December 31, 2007
Liabilities and Shareholders’ Equity
Liabilities:
Deposits:
Demand – non-interest bearing		$	1,532,668		$	1,512,627
Savings and interest bearing demand		2,315,771			2,292,589
Time		3,352,924			3,352,390
Total deposits		7,201,363			7,157,606
Securities sold under repurchase agreements		1,475,147			1,328,983
Other borrowed funds		1,048,089			1,456,936
Junior subordinated deferrable interest debentures		201,009			200,929
Other liabilities		95,497			86,802
Total liabilities		10,021,105			10,231,256
Commitments, Contingent Liabilities and Other Tax Matters (Note 10)
Shareholders’ equity:
Common shares of $1.00 par value. Authorized 275,000,000 shares; issued 95,458,437 shares on June 30, 2008 and 95,440,983 shares on December 31, 2007		95,458			95,441
Surplus		144,734			144,140
Retained earnings		973,050			929,145
Accumulated other comprehensive income		10,098			165
		1,223,340			1,168,891
Less cost of shares in treasury, 26,891,101 shares on June 30, 2008 and 26,848,880 shares on December 31, 2007		(233,896		)	(232,986		)
Total shareholders’ equity		989,444			935,905
Total liabilities and shareholders’ equity		$	11,010,549		$	11,167,161

 

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,
		2008			2007			2008			2007
Interest income:
Loans, including fees		$	91,028		$	112,723		$	190,549		$	221,979
Federal funds sold		312			821			681			1,517
Investment securities:
Taxable		44,610			45,782			92,250			97,438
Tax-exempt		881			1,078			1,835			2,209
Other interest income		100			2,004			277			2,120
Total interest income		136,931			162,408			285,592			325,263
Interest expense:
Savings deposits		6,892			13,695			15,802			26,791
Time deposits		28,086			36,236			61,267			71,273
Securities sold under repurchase agreements		12,484			10,213			26,125			18,535
Other borrowings		5,813			18,177			17,413			45,382
Junior subordinated interest deferrable debentures		3,473			4,526			7,125			8,945
Other interest expense		42			—			88			—
Total interest expense		56,790			82,847			127,820			170,926
Net interest income		80,141			79,561			157,772			154,337
Provision for possible loan losses		4,101			1,198			5,653			2,559
Net interest income after provision for possible loan losses		76,040			78,363			152,119			151,778
Non-interest income:
Service charges on deposit accounts		25,488			21,058			49,242			41,283
Other service charges, commissions and fees
Banking		10,150			8,843			20,162			16,961
Non-banking		1,647			3,887			3,145			8,831
Gain (loss) on investment securities transactions, net		6,264			2,257			6,410			(14,910		)
Other investments, net		3,685			4,785			8,110			10,568
Other income		3,783			6,436			10,242			10,774
Total non-interest income		51,017			47,266			97,311			73,507

 

3

 

		Three Months Ended June 30,						Six Months Ended June 30,
		2008			2007			2008			2007
Non-interest expense:
Employee compensation and benefits		$	31,420		$	31,962		$	62,460		$	63,155
Occupancy		9,022			8,303			17,098			15,343
Depreciation of bank premises and equipment		9,092			7,813			17,638			15,369
Professional fees		3,170			2,791			5,885			5,469
Stationery and supplies		1,266			1,490			2,594			2,971
Amortization of identified intangible assets		1,299			1,320			2,598			2,529
Advertising		3,479			3,169			6,662			6,420
Other		17,636			16,581			32,446			34,242
Total non-interest expense		76,384			73,429			147,381			145,498
Income before income taxes		50,673			52,200			102,049			79,787
Minority interest in consolidated subsidiaries		—			(78		)	—			—
Provision for income taxes		17,624			17,688			35,520			26,553
Net income		$	33,049		$	34,590		$	66,529		$	53,234
Basic earnings per common share:
Weighted average number of shares outstanding:		68,565,037			69,313,121			68,574,155			69,314,282
Net income		$	.48		$	.50		$	.97		$	.77
Fully diluted earnings per common share:
Weighted average number of shares outstanding:		68,716,210			69,686,149			68,708,657			69,820,072
Net income		$	.48		$	.50		$	.97		$	.76

 

See accompanying notes to consolidated financial statements.

 

4

 

INTERNATIONAL BANCSHARES CORPORATION AND SUBSIDIARIES

 

Consolidated Statements of Comprehensive Income (Unaudited)

 

(Dollars in Thousands)

 

		Three Months Ended June 30,						Six Months Ended June 30,
		2008			2007			2008			2007
Net income		$	33,049		$	34,590		$	66,529		$	53,234
Other comprehensive income, net of tax
Net unrealized holding (losses) gains on securities available for sale arising during period		(17,472		)	(9,072		)	3,523			28,520
Reclassification adjustment for gains (losses) on securities available for sale included in net income		6,264			2,257			6,410			(14,910		)
Comprehensive income		$	21,841		$	27,775		$	76,462		$	66,844

 

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,
		2008			2007
Operating activities:
Net income		$	66,529		$	53,234
Adjustments to reconcile net income to net cash provided by operating activities:
Provision for possible loan losses		5,653			2,559
Amortization of loan premiums		122			233
Accretion of time deposits with banks		1			(32		)
Accretion of time deposit discounts		(19		)	—
Depreciation of bank premises and equipment		17,638			15,369
Gain on sale of bank premises and equipment		(85		)	(2,431		)
Depreciation and amortization of leased assets		640			1,083
Accretion of investment securities discounts		(338		)	(321		)
Amortization of investment securities premiums		3,288			2,076
Investment securities transactions, net		(6,410		)	14,910
Amortization of junior subordinated debenture discounts		80			215
Amortization of identified intangible assets		2,598			2,529
Stock based compensation expense		376			369
Earnings from affiliates and other investments		(5,936		)	(5,038		)
Deferred tax benefit		(3,535		)	(349		)
Decrease in accrued interest receivable		5,800			3,288
Net decrease in other assets		3,443			2,347
Net increase in other liabilities		6,653			3,360
Net cash provided by operating activities		96,498			93,401
Investing activities:
Proceeds from maturities of securities		13,938			16,015
Proceeds from sales of available for sale securities		8,359			739,069
Purchases of available for sale securities		(518,958		)	(484,958		)
Principal collected on mortgage-backed securities		723,029			470,673
Maturities of time deposits with banks		4,457			25,084
Net increase in loans		(155,541		)	(60,561		)
Purchases of other investments		(4,006		)	(5,412		)
Distributions of other investments		18,357			49,187
Purchases of bank premises and equipment		(27,856		)	(38,596		)
Proceeds from sale of bank premises and equipment		630			5,966
Adjustment to goodwill related to prior acquisition		—			5,885
Cash paid in purchase transaction		—			(23,470		)
Cash acquired in purchase transaction		—			30,772
Net cash provided by investing activities		62,409			729,654

 

6

 

		Six Months Ended June 30,
		2008			2007
Financing activities:
Net increase (decrease) in non-interest bearing demand deposits		$	20,041		$	(23,191	)
Net increase in savings and interest bearing demand deposits		23,182			92,255
Net increase (decrease) in time deposits		553			(37,654		)
Net increase in securities sold under repurchase agreements		146,164			262,061
Net decrease in other borrowed funds		(408,847		)	(1,029,409		)
Proceeds of issuance of long-term debt		—			53,609
Principal payments of long term-debt		—			(22,681		)
Purchase of treasury stock		(910		)	(16,912		)
Proceeds from stock transactions		235			3,992
Payment of cash dividends		(22,623		)	(22,086		)
Payment of cash dividends in lieu of fractional shares		—			(27		)
Net cash used in financing activities		(242,205		)	(740,043		)
(Decrease) increase in cash and cash equivalents		(83,298		)	83,012
Cash and cash equivalents at beginning of period		346,052			297,207
Cash and cash equivalents at end of period		$	262,754		$	380,219
Supplemental cash flow information:
Interest paid		$	135,514		$	176,295
Income taxes paid		34,208			29,981
Adjustment to goodwill arising from prior acquisition		—			2,076

 

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.  All significant inter-company balances and transactions have been eliminated in consolidation.  The consolidated financial statements are unaudited, but include all adjustments, which, in the opinion of management, are necessary for a fair presentation of the results of the periods presented.  All such adjustments were of a normal and recurring nature.  It is suggested that these financial statements be read in conjunction with the financial statements and the notes thereto in the Company’s latest Annual Report on Form 10-K.  The consolidated statement of condition at December 31, 2007 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.

 

Effective January 1, 2008, the Company adopted Statement of Financial Accounting Standards No. 157 (“SFAS No. 157”), “Fair Value Measurements” for financial assets and financial liabilities.  In accordance with Financial Accounting Standards Board Staff Position No. 157-2, (“FSP No. 157-2”), “Effective date of FASB Statement No. 157,” the Company will delay application of SFAS No. 157 for non-financial assets and non-financial liabilities until January 1, 2009, except  for those that are recognized or disclosed at fair value on a recurring basis.  SFAS No. 157 defines fair value, establishes a framework for measuring fair value in generally accepted accounting principles, and expands disclosures about fair value measurements.  SFAS No. 157 applies to all financial instruments that are being measured and reported on a fair value basis.  SFAS No. 157 defines fair value as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date.  SFAS No. 157 also establishes a fair value hierarchy that prioritizes the inputs used in valuation methodologies into the following three levels:

 

·                  Level 1 Inputs – Unadjusted quoted prices in active markets for identical assets or liabilities.

·                  Level 2 Inputs – Observable inputs other than Level 1 prices, such as quoted prices for similar assets or liabilities; quoted prices in markets that are not active; or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the assets or liabilities.

·                  Level 3 Inputs – Unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the assets or liabilities.  Level 3 assets and liabilities include financial instruments whose value is determined using pricing models, discounted cash flow methodologies, or other valuation techniques, as well as instruments for which the determination of fair value requires significant management judgment or estimation.

 

A description of the valuation methodologies used for instruments measured at fair value, as well as the general classification of such instruments pursuant to the valuation hierarchy is set forth below.

 

8

 

The following table represents assets and liabilities reported on the consolidated balance sheets at their fair value as of June 30, 2008 by level within the SFAS No. 157 fair value measurement hierarchy:

 

					Fair Value Measurements at Reporting Date Using (Dollars in Thousands)
		Assets/Liabilities Measured at Fair Value June 30, 2008			Quoted Prices in Active Markets for Identical Assets (Level 1)			Significant Other Observable Inputs (Level 2)			Significant Unobservable Inputs (Level 3)
Measured on a recurring basis:
Assets:
Investment securities available-for-sale		$	3,960,388		$	627		$	3,959,761		$	—
Measured on a non-recurring basis:
Assets:
Impaired Loans		64,031			—			64,031			—

 

Investment securities available-for-sale are classified within Level 2 of the valuation hierarchy, with the exception of certain equity investments that are classified within Level 1.  The Company obtains fair value measurements for investment securities from an independent pricing service.  The fair value measurements consider observable data that may include dealer quotes, market spreads, cash flows, the U.S. Treasury yield curve, live trading levels, trade execution data, market consensus prepayment speeds, credit information and the bond’s terms and conditions, among other things.

 

Impaired loans are classified within Level 2 of the valuation hierarchy.  The fair value of impaired loans is derived in accordance with Statement of Financial Accounting Standards No. 114 (“SFAS No. 114”), “Accounting by Creditors for Impairment of a Loan.”  The fair value of impaired loans is based on the fair value of the collateral, as determined through an external appraisal process.  Impaired loans are primarily comprised of collateral-dependent commercial loans.

 

Certain financial assets and financial liabilities are measured at fair value on a nonrecurring basis.  The instruments are not measured at fair value on an ongoing basis but are subject to fair value adjustments in certain circumstances (for example, when there is evidence of impairment).

 

Note 2 —Acquisition

 

On March 16, 2007, the Company completed its acquisition of Southwest First Community, Inc. (“Southwest Community”), a bank holding company with approximately $133 million in assets that owned State Bank & Trust in Beeville, Texas and Commercial State Bank in Sinton, Texas.  The transaction was pursuant to the Agreement and Plan of Merger dated December 1, 2006 (the “Merger Agreement”).  The Company paid consideration totaling $23.5 million in cash.

 

9

 

Note 3– Loans

 

A summary of net loans, by loan type at June 30, 2008 and December 31, 2007 is as follows:

 

 

Note 4 - Allowance for Possible Loan Losses

 

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

 

		June 30, 2008			June 30, 2007
		(Dollars in Thousands)
Balance at December 31,		$	61,726		$	64,537
Losses charged to allowance		(2,320		)	(1,947		)
Recoveries credited to allowance		348			735
Net losses charged to allowance		(1,972		)	(1,212		)
Provision charged to operations		5,653			2,559
Allowance acquired in acquisition (Note 2)		—			1,054
Balance at June 30,		$	65,407		$	66,938

 

                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, 2008			December 31, 2007
		(Dollars in Thousands)
Balance of impaired loans where there is a related allowance for loan loss		$	55,231		$	39,618
Balance of impaired loans where there is no related allowance for loan loss		17,863			—
Total impaired loans		$	73,094		$	39,618
Allowance allocated to impaired loans		$	9,063		$	4,903

 

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 $53,870,000 and $22,590,000 for the six months and year ended June 30, 2008 and December 31, 2007, respectively.  The interest recognized on impaired loans was not significant.  The balance of impaired loans increased because of a certain energy related loan that filed for bankruptcy protection.  As a result of some recent collateral improvements and collateral enhancements of two impaired loans, the Company determined that the allowance allocated to the two credits was no longer justified; however the Company still deems the credits impaired as of June 30, 2008.

 

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 uncollectible and that it should be wholly or partially charged-off as a loss is an exercise of judgment.  Similarly, the determination of the adequacy of the allowance for 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, 2008 was adequate to absorb probable losses from loans in the portfolio at that date.

 

Note 5 – Stock Options

 

On April 1, 2005, the Board of Directors adopted the 2005 International Bancshares Corporation Stock Option Plan (the “2005 Plan”).  Effective May 19, 2008, the 2005 Plan was amended to increase the number of shares available for stock option grants under the 2005 Plan by 300,000 shares.  The 2005 Plan replaced the 1996 International Bancshares Corporation Key Contributor Stock Option Plan (the “1996 Plan”).  Under the 2005 Plan both qualified incentive stock options (“ISOs”) and non-qualified stock options (“NQSOs”) may be granted.  Options granted may be exercisable for a period of up to 10 years from the date of grant, excluding ISOs granted to 10% shareholders, which may be exercisable for a period of up to only five years.  As of June 30, 2008, 357,047 shares were available for future grants under the 2005 Plan.

 

11

 

                A summary of option activity under the stock option plans for the six months ended June 30, 2008 is as follows:

 

		Number of options		Weighted average exercise price			Weighted average remaining contractual term (years)		Aggregate intrinsic value ($)
Options outstanding at December 31, 2007		924,483		$	21.00
Plus:  Options granted		1,500		24.61
Less:
Options exercised		17,454		13.52
Options expired		—		—
Options forfeited		17,806		25.45
Options outstanding at June 30, 2008		890,723		$	21.06		4.04		$	2,568,000
Options fully vested and exercisable at June 30, 2008		442,902		$	16.28		2.18		$	2,567,000

 

                Stock-based compensation expense included in the consolidated statements of income for the three and six months ended June 30, 2008 was approximately $186,000 and $376,000, respectively.  As of June 30, 2008 there was approximately $1,400,000, of total unrecognized stock-based compensation cost related to non-vested options granted under the Company plans that will be recognized over a weighted average period of 1.6 years.

 

Note 6 - Investment Securities

 

The Company classifies debt and equity securities into one of three categories:  held-to maturity, available-for-sale, or trading.  Such securities are reassessed for appropriate classification at each reporting date.  Securities classified as “held-to-maturity” are carried at amortized cost for financial statement reporting, while securities classified as “available-for-sale” and “trading” are carried at their fair value.  Unrealized holding gains and losses are included in net income for those securities classified as “trading”, while unrealized holding gains and losses related to those securities classified as “available-for-sale” are excluded from net income and reported net of tax as other comprehensive income (loss) and accumulated other comprehensive income (loss) until realized, or in the case of losses, when deemed other than temporary.

 

In the first quarter 2007, the Company wrote down approximately $732.0 million of investment securities to fair value, which resulted in an impairment charge of approximately $17.0 million.  The write down was a result of the Company’s strategic identification of certain investment securities that were sold in the second quarter of 2007 with the proceeds used to reduce Federal Home Loan Bank (“FHLB”) borrowings.  The investments sold were certain hybrid mortgage backed securities with a coupon re-set date that exceeded 30 months and a weighted average yield to coupon re-set that was approximately 100 basis points less than the FHLB certificate of indebtedness short term-rate.  The sale of the securities facilitated a repositioning of the balance sheet to a more neutral position in terms of interest rate risk and improved the Company’s operating ratios.

 

12

 

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, 2008			December 31, 2007
		(Dollars in Thousands)
U.S. Treasury securities
Available-for-sale		$	1,319		$	1,308
Mortgage-backed securities
Available-for-sale		3,874,275			4,066,828
States and political subdivisions
Available-for-sale		70,667			84,633
Other
Held-to-maturity		2,300			2,300
Available-for-sale		14,127			15,119
Total investment securities		$	3,962,688		$	4,170,188

 

Included in mortgage-backed securities in the table above are $2,240,428 of mortgage-backed securities issued by either the Federal Home Loan Mortgage Corporation (“Freddie Mac”) or the Federal National Mortgage Corporation (“Fannie Mae”), $1,535,508 of mortgage-backed securities issued by the Government National Mortgage Corporation (“Ginnie Mae”) and $98,339 issued by non-government entities.  Investments in mortgage-backed securities issued by Ginnie Mae are fully guaranteed by the U.S. Government.  Investments in mortgage-backed securities issued by Freddie Mac and Fannie Mae are not fully guaranteed by the U.S. Government, but are rated AAA.  Investments in mortgage-backed securities issued by non-governmental entities are rated AAA.

 

Note 7 – Other Borrowed Funds

 

   Other borrowed funds include Federal Home Loan Bank borrowings, which are short-term, variable-rate 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, 2008, other borrowed funds totaled $1,048,089,000, a decrease of 28.1% from $1,456,936,000 at December 31, 2007.

 

Note 8 – Junior Subordinated Interest Deferrable Debentures

 

The Company has formed twelve statutory business trusts under the laws of the State of Delaware, for the purpose of issuing trust preferred securities.  As part of the Local Financial Corporation (“LFIN”) acquisition, the Company acquired three additional statutory business trusts previously formed by LFIN for the purpose of issuing trust preferred securities.  The twelve 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.  As of June 30, 2008, the Debentures issued by four of the trusts formed by the Company and the Debentures issued by all three of the trusts formed by LFIN have been redeemed by the Company.  As of June 30, 2008, the principal amount of debentures outstanding totaled $201,009,000.

 

                The Debentures are subordinated and junior in right of payment to all present and future senior indebtedness (as defined in the respective indentures) of the Company, and are pari passu with one another.  The interest rate payable on, and the payment terms of the Debentures are the same as the distribution rate and payment terms of the respective issues of Capital and Common Securities issued by the Trusts.  The Company has fully and unconditionally guaranteed the obligations of each of the Trusts with respect to the Capital and Common Securities.  The Company has the right, unless an Event of Default (as defined in the Indentures) has occurred and is continuing, to defer payment of interest on the Debentures for up to ten consecutive semi-annual periods on Trust I and for up to twenty consecutive quarterly periods on Trusts VI, VII, VIII, IX, X, XI and XII.  If interest

 

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payments on any of the Debentures are deferred, distributions on both the Capital and Common Securities related to that Debenture would also be deferred.  The redemption prior to maturity of any of the Debentures may require the prior approval of the Federal Reserve and/or other regulatory bodies.

 

For financial reporting purposes, the Trusts are treated as investments of the Company and not consolidated in the consolidated financial statements.  Although the Capital Securities issued by each of the Trusts are not included as a component of shareholders’ equity on the consolidated statement of condition, the Capital Securities are treated as capital for regulatory purposes.  Specifically, under applicable regulatory guidelines, the Capital Securities issued by the Trusts qualify as Tier 1 capital up to a maximum of 25% of Tier 1 capital on an aggregate basis.  Any amount that exceeds the 25% threshold would qualify as Tier 2 capital.  For June 30, 2008, the total $201,009,000, of the Capital Securities outstanding qualified as Tier 1 capital.

 

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 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 current trust preferred securities 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, 2008:

 

		Junior Subordinated Deferrable Interest Debentures			Repricing Frequency		Interest Rate		Interest Rate Index		Maturity Date		Optional Redemption Date
		(in thousands)
Trust I		$	10,304		Fixed		10.18	%	Fixed		June 2031		June 2011
Trust VI		$	25,774		Quarterly		6.13	%	LIBOR + 3.45		November 2032		August 2008
Trust VII		$	10,310		Quarterly		6.12	%	LIBOR + 3.25		April 2033		October 2008
Trust VIII		$	25,753		Quarterly		5.76	%	LIBOR + 3.05		October 2033		October 2008
Trust IX		$	41,238		Fixed		7.10	%	Fixed		October 2036		October 2011
Trust X		$	34,021		Fixed		6.66	%	Fixed		February 2037		February 2012
Trust XI		$	32,990		Fixed		6.82	%	Fixed		July 2037		July 2012
Trust XII		$	20,619		Fixed		6.85	%	Fixed		September 2037		September 2012
		$	201,009

 

(1) Trust IX, X, XI and XII accrue interest at a fixed rate for the first five years, then floating at LIBOR + 1.62%, 1.65%, 1.62% and 1.45% thereafter, respectively.

 

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