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INTERNATIONAL BANCSHARES CORP - Quarter Report: 2019 June (Form 10-Q)

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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

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

For the quarterly period ended June 30, 2019

OR

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

For the transition period from              to           

Commission file number 000-09439

INTERNATIONAL BANCSHARES CORPORATION

(Exact name of registrant as specified in its charter)

Texas

74-2157138

(State or other jurisdiction of

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

incorporation or organization)

1200 San Bernardo Avenue, Laredo, Texas 78042-1359

(Address of principal executive offices)

(Zip Code)

(956) 722-7611

(Registrant’s telephone number, including area code)

None

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

Securities registered pursuant to Section 12(b) of the Act:

Title of each class:

    

Trading Symbol

    

Name of each exchange on which registered:

Common Stock, $1.00 par value

IBOC

NASDAQ

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

Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files). Yes No

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

Large accelerated filer

Accelerated filer

Non-accelerated filer

Smaller reporting company

Emerging growth company

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act.

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

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

Class

Shares Issued and Outstanding

Common Stock, $1.00 par value

65,658,153 shares outstanding at August 5, 2019

PART I - FINANCIAL INFORMATION

Item 1. Financial Statements

INTERNATIONAL BANCSHARES CORPORATION AND SUBSIDIARIES

Consolidated Statements of Condition (Unaudited)

(Dollars in Thousands)

June 30,

December 31,

    

2019

    

2018

 

Assets

Cash and cash equivalents

$

321,119

$

316,797

Investment securities:

Held to maturity debt securities (Market value of $2,400 on June 30, 2019 and $1,200 on December 31, 2018)

 

2,400

 

1,200

Available for sale debt securities (Amortized cost of $3,473,480 on June 30, 2019 and $3,481,165 on December 31, 2018)

 

3,467,913

 

3,411,350

Equity securities with readily determinable fair values

6,127

5,937

Total investment securities

 

3,476,440

 

3,418,487

Loans

 

6,842,701

 

6,561,289

Less allowance for probable loan losses

 

(58,203)

 

(61,384)

Net loans

 

6,784,498

 

6,499,905

Bank premises and equipment, net

 

505,696

 

506,899

Accrued interest receivable

 

37,956

 

36,803

Other investments

 

299,913

 

337,507

Cash surrender value of life insurance policies

286,056

282,646

Goodwill

 

282,532

 

282,532

Other assets

 

232,806

 

190,376

Total assets

$

12,227,016

$

11,871,952

1

INTERNATIONAL BANCSHARES CORPORATION AND SUBSIDIARIES

Consolidated Statements of Condition, continued (Unaudited)

(Dollars in Thousands)

June 30,

December 31,

    

2019

    

2018

 

Liabilities and Shareholders’ Equity

Liabilities:

Deposits:

Demand—non-interest bearing

$

3,554,907

$

3,454,840

Savings and interest bearing demand

 

3,304,326

 

3,268,237

Time

 

1,969,425

 

1,973,468

Total deposits

 

8,828,658

 

8,696,545

Securities sold under repurchase agreements

 

241,188

 

229,989

Other borrowed funds

 

808,376

 

705,665

Junior subordinated deferrable interest debentures

 

134,642

 

160,416

Other liabilities

 

153,833

 

139,755

Total liabilities

 

10,166,697

 

9,932,370

Shareholders’ equity:

Common shares of $1.00 par value. Authorized 275,000,000 shares; issued 96,151,204 shares on June 30, 2019 and 96,104,029 shares on December 31, 2018

 

96,151

 

96,104

Surplus

 

146,614

 

145,283

Retained earnings

 

2,133,239

 

2,064,134

Accumulated other comprehensive loss

 

(4,252)

 

(54,634)

 

2,371,752

 

2,250,887

Less cost of shares in treasury, 30,497,401 shares on June 30, 2019 and 30,494,143 on December 31, 2018

 

(311,433)

 

(311,305)

Total shareholders’ equity

 

2,060,319

 

1,939,582

Total liabilities and shareholders’ equity

$

12,227,016

$

11,871,952

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

Six Months Ended

    

June 30,

June 30,

2019

    

2018

    

2019

    

2018

Interest income:

Loans, including fees

$

105,564

$

92,083

$

208,369

$

179,916

Investment securities:

Taxable

19,602

20,694

 

38,902

41,908

Tax-exempt

 

1,377

2,087

 

3,026

4,282

Other interest income

 

317

202

 

626

367

Total interest income

 

126,860

115,066

 

250,923

226,473

Interest expense:

Savings deposits

 

4,249

3,291

 

8,492

5,519

Time deposits

 

5,044

3,010

 

9,422

5,679

Securities sold under repurchase agreements

 

591

348

 

1,180

1,371

Other borrowings

 

3,513

4,379

 

7,007

9,068

Junior subordinated deferrable interest debentures

 

1,681

1,765

 

3,631

3,291

Total interest expense

 

15,078

12,793

 

29,732

24,928

Net interest income

111,782

102,273

 

221,191

201,545

Provision for probable loan losses

 

2,665

(2,730)

 

10,085

(1,068)

Net interest income after provision for probable loan losses

 

109,117

105,003

 

211,106

202,613

Non-interest income:

Service charges on deposit accounts

 

17,610

17,555

 

34,870

35,267

Other service charges, commissions and fees

Banking

 

11,764

11,152

 

22,640

22,274

Non-banking

 

2,238

2,028

 

3,747

3,388

Investment securities transactions, net

 

(6)

 

(10)

Other investments, net

 

(1,703)

5,841

 

2,245

10,567

Other income

 

4,513

5,727

 

7,053

9,782

Total non-interest income

$

34,416

$

42,303

$

70,545

$

81,278

3

INTERNATIONAL BANCSHARES CORPORATION AND SUBSIDIARIES

Consolidated Statements of Income, continued (Unaudited)

(Dollars in Thousands, except per share data)

Three Months Ended

Six Months Ended

    

June 30,

June 30,

2019

    

2018

    

2019

    

2018

Non-interest expense:

Employee compensation and benefits

$

37,246

$

34,692

$

73,655

$

69,310

Occupancy

 

6,580

 

7,163

 

12,957

 

13,238

Depreciation of bank premises and equipment

 

7,032

 

6,364

 

14,013

 

12,637

Professional fees

 

3,745

 

3,375

 

7,337

 

5,947

Deposit insurance assessments

 

859

 

974

 

1,642

 

1,974

Net expense, other real estate owned

 

1,203

 

2,649

 

2,198

 

2,378

Advertising

 

2,081

 

1,808

 

4,163

 

3,647

Software and software maintenance

5,003

4,390

9,500

8,462

Other

 

15,864

 

19,186

 

27,099

 

31,917

Total non-interest expense

 

79,613

 

80,601

 

152,564

 

149,510

Income before income taxes

63,920

 

66,705

 

129,087

 

134,381

Provision for income taxes

 

13,900

 

13,818

 

27,161

 

28,074

Net income

$

50,020

$

52,887

$

101,926

$

106,307

Basic earnings per common share:

Weighted average number of shares outstanding

 

65,648,090

 

66,114,497

 

65,633,117

 

66,103,499

Net income

$

0.76

$

.80

$

1.55

$

1.61

Fully diluted earnings per common share:

 

 

 

 

Weighted average number of shares outstanding

 

65,867,234

 

66,932,113

65,849,281

66,898,065

Net income

$

0.76

$

.79

$

1.55

$

1.59

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

Six Months Ended

    

June 30,

June 30,

2019

    

2018

    

2019

    

2018

Net income

$

50,020

$

52,887

$

101,926

$

106,307

Other comprehensive income, net of tax:

Net unrealized holding gains (losses) on securities available for sale arising during period (net of tax effects of $6,685, $(2,974), $13,391, and $(13,594))

 

25,148

 

(11,187)

 

50,374

 

(51,140)

Reclassification adjustment for losses on securities available for sale included in net income (net of tax effects of $1, $0, $2 and $0)

 

5

 

 

8

 

 

25,153

 

(11,187)

 

50,382

 

(51,140)

Comprehensive income

$

75,173

$

41,700

$

152,308

$

55,167

See accompanying notes to consolidated financial statements.

5

INTERNATIONAL BANCSHARES CORPORATION AND SUBSIDIARIES

Consolidated Statements of Shareholders’ Equity

Three Months ended June 30, 2019 and 2018

(in Thousands, except per share amounts)

   

   

Number

   

   

   

   

Other

   

   

of

Common

Retained

Comprehensive

Treasury

Shares

Stock

Surplus

Earnings

Income (Loss)

Stock

Total

Balance at March 31, 2019

 

96,137

$

96,137

$

146,113

$

2,083,219

$

(29,405)

$

(311,359)

$

1,984,705

Net Income

50,020

50,020

Purchase of treasury (1,953 shares)

(74)

(74)

Exercise of stock options

14

14

262

276

Stock compensation expense recognized in earnings

239

239

Other comprehensive income, net of tax:

Net change in unrealized gains and losses on available for sale securities, net of reclassification adjustments

25,153

25,153

Balance at June 30, 2019

96,151

$

96,151

$

146,614

$

2,133,239

$

(4,252)

$

(311,433)

$

2,060,319

   

   

Number

   

   

   

   

Other

   

   

of

Common

Retained

Comprehensive

Treasury

Shares

Stock

Surplus

Earnings

Income (Loss)

Stock

Total

Balance at March 31, 2018

 

96,044

$

96,044

$

172,416

$

1,923,411

$

(68,350)

$

(292,263)

$

1,831,258

Net Income

52,887

52,887

Purchase of treasury (1,298 shares)

(57)

(57)

Exercise of stock options

22

22

355

377

Stock compensation expense recognized in earnings

285

285

Cumulative adjustment for adoption of new accounting standards

6,167

(6,167)

Other comprehensive income, net of tax:

Net change in unrealized gains and losses on available for sale securities, net of reclassification adjustments

(5,020)

(5,020)

Balance at June 30, 2018

96,066

$

96,066

$

173,056

$

1,982,465

$

(79,537)

$

(292,320)

$

1,879,730

See accompanying notes to consolidated financial statements.

6

INTERNATIONAL BANCSHARES CORPORATION AND SUBSIDIARIES

Consolidated Statements of Shareholders’ Equity

Six Months ended June 30, 2019 and 2018

(in Thousands, except per share amounts)

   

   

Number

   

   

   

   

Other

   

   

of

Common

Retained

Comprehensive

Treasury

Shares

Stock

Surplus

Earnings

Income (Loss)

Stock

Total

Balance at December 31, 2018

 

96,104

$

96,104

$

145,283

$

2,064,134

$

(54,634)

$

(311,305)

$

1,939,582

Net Income

101,926

101,926

Dividends:

Cash ($.50 per share)

(32,821)

(32,821)

Purchase of treasury (3,258 shares)

(128)

(128)

Exercise of stock options

47

47

827

874

Stock compensation expense recognized in earnings

504

504

Other comprehensive income, net of tax:

Net change in unrealized gains and losses on available for sale securities, net of reclassification adjustments

50,382

50,382

Balance at June 30, 2019

96,151

$

96,151

$

146,614

$

2,133,239

$

(4,252)

$

(311,433)

$

2,060,319

   

   

Number

   

   

   

   

Other

   

   

of

Common

Retained

Comprehensive

Treasury

Shares

Stock

Surplus

Earnings

Income (Loss)

Stock

Total

Balance at December 31, 2017

 

96,019

$

96,019

$

171,816

$

1,891,805

$

(28,397)

$

(292,263)

$

1,838,980

Net Income

106,307

106,307

Dividends:

Cash ($.33 per share)

(21,814)

(21,815)

Purchase of treasury (1,298 shares)

(57)

(57)

Exercise of stock options

47

47

770

818

Stock compensation expense recognized in earnings

470

470

Cumulative adjustment for adoption of new accounting standards

6,167

(6,167)

Other comprehensive income, net of tax:

Net change in unrealized gains and losses on available for sale securities, net of reclassification adjustments

(44,973)

(44,973)

Balance at June 30, 2018

96,066

$

96,066

$

173,056

$

1,982,465

$

(79,537)

$

(292,320)

$

1,879,730

See accompanying notes to consolidated financial statements.

7

INTERNATIONAL BANCSHARES CORPORATION AND SUBSIDIARIES

Consolidated Statements of Cash Flows (Unaudited)

(Dollars in Thousands)

Six Months Ended

    

June 30,

2019

    

2018

Operating activities:

Net income

$

101,926

$

106,307

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

Provision for probable loan losses

10,085

(1,068)

Specific reserve, other real estate owned

88

2,658

Depreciation of bank premises and equipment

 

14,013

12,637

Gain on sale of bank premises and equipment

 

(194)

(147)

Gain on sale of other real estate owned

 

(639)

(688)

Accretion of investment securities discounts

 

(186)

(133)

Amortization of investment securities premiums

 

8,240

10,857

Investment securities transactions, net

 

10

Unrealized (gain) loss on equity securities with readily determinable fair values

(190)

1,021

Stock based compensation expense

 

504

470

Earnings from affiliates and other investments

 

(290)

(7,683)

Deferred tax expense

 

764

363

Increase in accrued interest receivable

 

(1,153)

(1,306)

Increase in other assets

 

(25,589)

(42,795)

Net increase in other liabilities

 

18,028

21,724

Net cash provided by operating activities

 

125,417

102,217

Investing activities:

Proceeds from maturities of securities

1,075

Proceeds from sales and calls of available for sale securities

60,695

18,145

Purchases of available for sale securities

(380,095)

(47,346)

Principal collected on mortgage backed securities

 

317,822

363,406

Net increase in loans

(316,959)

(126,153)

Purchases of other investments

 

(35,766)

(27,457)

Distributions from other investments

 

56,181

8,702

Purchases of bank premises and equipment

 

(14,409)

(10,274)

Proceeds from sales of bank premises and equipment

 

1,793

901

Proceeds from sales of other real estate owned

 

1,470

2,191

Net cash (used in) provided by investing activities

$

(309,268)

$

183,190

8

INTERNATIONAL BANCSHARES CORPORATION AND SUBSIDIARIES

Consolidated Statements of Cash Flows, continued (Unaudited)

(Dollars in Thousands)

Six Months Ended

    

June 30,

2019

    

2018

Financing activities:

Net increase in non-interest bearing demand deposits

$

100,067

$

193,768

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

 

36,089

 

(14,745)

Net decrease in time deposits

 

(4,043)

 

(54,287)

Net increase (decrease) in securities sold under repurchase agreements

 

11,199

 

(47,050)

Net increase (decrease) in other borrowed funds

 

102,711

 

(342,275)

Redemption of long-term debt

(25,774)

Purchase of treasury stock

 

(128)

 

(57)

Proceeds from stock transactions

 

874

 

818

Payments of cash dividends - common

 

(32,822)

 

(21,814)

Net cash provided by (used in) financing activities

 

188,173

 

(285,642)

Increase (decrease) in cash and cash equivalents

4,322

 

(235)

Cash and cash equivalents at beginning of period

 

316,797

 

265,357

Cash and cash equivalents at end of period

$

321,119

$

265,122

Supplemental cash flow information:

Interest paid

$

28,602

$

11,593

Income taxes paid

27,864

 

27,948

Non-cash investing and financing activities:

Net transfers from loans to other real estate owned

$

22,281

$

31,139

Establishment of lease liability and right-of-use asset

 

6,171

See accompanying notes to consolidated financial statements.

9

INTERNATIONAL BANCSHARES CORPORATION AND SUBSIDIARIES

Notes to Consolidated Financial Statements

(Unaudited)

As used in this report, the words “Company,” “we,” “us” and “our” refer to International Bancshares Corporation, a Texas corporation, its five wholly-owned subsidiary banks, and other subsidiaries. The information that follows may contain forward-looking statements, which are qualified as indicated under “Cautionary Notice Regarding Forward-Looking Statements” in Item 2 (Management’s Discussion and Analysis of Financial Condition and Results of Operations) of this report. Our website address is www.ibc.com.

Note 1 — Basis of Presentation

Our accounting and reporting policies conform to accounting principles generally accepted in the United States of America and to general practices within the banking industry. Our consolidated financial statements include the accounts of International Bancshares Corporation, and our wholly-owned bank subsidiaries, International Bank of Commerce, Laredo (“IBC”), Commerce Bank, International Bank of Commerce, Zapata, International Bank of Commerce, Brownsville, International Bank of Commerce, Oklahoma (the “Subsidiary Banks”) and our wholly-owned non-bank subsidiaries, IBC Trading Company, Premier Tierra Holdings, Inc., IBC Charitable and Community Development Corporation, and IBC Capital Corporation. Effective January 1, 2019, we dissolved one of our non-bank subsidiaries, IBC Subsidiary Corporation, a second-tier bank holding company incorporated in the State of Delaware. All significant inter-company balances and transactions have been eliminated in consolidation. Our consolidated financial statements are unaudited, but include all adjustments, which, in the opinion of management, are necessary for a fair presentation of the results of the periods presented. All such adjustments were of a normal and recurring nature. These financial statements should be read in conjunction with the financial statements and the notes thereto in our latest Annual Report on Form 10-K. Our consolidated statement of condition at December 31, 2018 has been derived from the audited financial statements at that date but does not include all of the information and footnotes required by accounting principles generally accepted in the United States of America (“US GAAP”) for complete financial statements. Certain reclassifications have been made to make prior periods comparable. Operating results for the three and six months ended June 30, 2019 are not necessarily indicative of the results for the year ending December 31, 2019 or any future period.

We operate as one segment. The operating information used by our chief executive officer for purposes of assessing performance and making operating decisions is the consolidated statements presented in this report. We have five active operating subsidiaries, the Subsidiary Banks. We apply the provisions of Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”), FASB ASC 280, “Segment Reporting,” in determining our reportable segments and related disclosures.

We have evaluated all events or transactions that occurred through the date we issued these financial statements. During this period, we did not have any material recognizable or non-recognizable subsequent events.

On January 1, 2019, we adopted the provisions of ASU 2016-02, “Leases.” ASU 2016-02 amends existing standards for accounting for leases by lessees, with accounting for leases by lessors remaining mainly unchanged from current guidance. The update requires that lessees recognize a lease liability and a right of use asset for all leases (with the exception of short-term leases) at the commencement date of the lease and disclose key information about leasing arrangements. The update is to be applied on a modified retrospective basis for leases existing at, or entered into after, the beginning of the earliest comparative period presented in the consolidated financial statements. In January 2018, the FASB issued a proposal that provides an additional transition method that would allow entities to not apply the guidance in the update in the comparative periods presented in the consolidated financial statements, but instead recognize a cumulative-effect adjustment to the opening balance of retained earnings in the period of adoption. As part of our business model, we primarily own all property we occupy, with the exception of certain branches operating in grocery stores or shopping centers and certain ATM locations and were classified as operating leases under previous guidance. The adoption of the standard did not have a significant impact on our consolidated financial statements. As of the date of

10

adoption, we recorded a right of use asset and a lease liability of approximately $6.4 million. The right of use asset and lease liability are included in other assets and other liabilities, respectively, on our consolidated statement of condition. Amortization of the right of use asset for the three and six months ended June 30, 2019 was approximately $245,000 and $459,000, respectively, and is included as a part of occupancy expense in our consolidated income statement.

Note 2 — Fair Value Measurements

ASC Topic 820, “Fair Value Measurements and Disclosures” (“ASC 820”), defines fair value, establishes a framework for measuring fair value in generally accepted accounting principles, and expands disclosures about fair value measurements. ASC 820 applies to all financial instruments that are being measured and reported on a fair value basis. ASC 820 defines fair value as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date; it also establishes a fair value hierarchy that prioritizes the inputs used in valuation methodologies into the following three levels:

Level 1 Inputs - Unadjusted quoted prices in active markets for identical assets or liabilities.
Level 2 Inputs - Observable inputs other than Level 1 inputs, 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.

The following table represents assets and liabilities reported on the consolidated balance sheets at their fair value on a recurring basis as of June 30, 2019 by level within the fair value measurement hierarchy:

Fair Value Measurements at

Reporting Date Using

(in Thousands)

Quoted

Prices in

Active

Significant

Assets/Liabilities

Markets for

Other

Significant

Measured at

Identical

Observable

Unobservable

Fair Value

Assets

Inputs

Inputs

June 30, 2019

(Level 1)

(Level 2)

(Level 3)

Measured on a recurring basis:

    

    

    

    

    

    

    

    

Assets:

Available for sale debt securities

Residential mortgage-backed securities

$

3,340,220

$

$

3,340,220

$

States and political subdivisions

 

127,693

 

 

127,693

 

Equity Securities

 

6,127

 

6,127

 

 

$

3,474,040

$

6,127

$

3,467,913

$

11

The following table represents assets and liabilities reported on the consolidated balance sheets at their fair value on a recurring basis as of December 31, 2018 by level within the fair value measurement hierarchy:

Fair Value Measurements at

Reporting Date Using

(in Thousands)

Quoted

Prices in

Active

Significant

Assets/Liabilities

Markets for

Other

Significant

Measured at

Identical

Observable

Unobservable

Fair Value

Assets

Inputs

Inputs

December 31, 2018

(Level 1)

(Level 2)

(Level 3)

Measured on a recurring basis:

    

    

    

    

    

    

    

    

Assets:

Available for sale securities

Residential mortgage - backed securities

$

3,223,010

$

$

3,223,010

$

States and political subdivisions

 

188,340

 

 

188,340

 

Equity Securities

 

5,937

 

5,937

 

 

$

3,417,287

$

5,937

$

3,411,350

$

Available-for-sale debt securities are classified within Level 2 of the valuation hierarchy. Equity securities with readily determinable fair values are classified within Level 1. For debt investments classified as Level 2 in the fair value hierarchy, we obtain fair value measurements from an independent pricing service. The fair value measurements consider observable data that may include dealer quotes, market spreads, cash flows, the U.S. Treasury yield curve, live trading levels, trade execution data, market consensus prepayment speeds, credit information and the bond’s terms and conditions, among other things.

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

The following table represents financial instruments measured at fair value on a non-recurring basis as of and for the period ended June 30, 2019 by level within the fair value measurement hierarchy:

Fair Value Measurements at Reporting

Date Using

(in thousands)

Quoted

Assets/Liabilities

Prices in

Measured at

Active

Significant

Fair Value

Markets for

Other

Significant

Net Provision

Year ended

Identical

Observable

Unobservable

(Credit)

June 30,

Assets

Inputs

Inputs

During

2019

(Level 1)

(Level 2)

(Level 3)

Period

Measured on a non-recurring basis:

    

    

    

    

    

    

    

    

    

    

Assets:

Impaired loans

$

2,999

$

$

$

2,999

$

1,133

Other real estate owned

 

26,703

 

 

 

26,703

 

88

Equity investment without readily determinable fair value

28,166

28,166

4,775

12

The following table represents financial instruments measured at fair value on a non-recurring basis as of and for the period ended December 31, 2018 by level within the fair value measurement hierarchy:

Fair Value Measurements at Reporting

Date Using

(in thousands)

Quoted

Assets/Liabilities

Prices in

Measured at

Active

Significant

Fair Value

Markets

Other

Significant

Net (Credit)

Year ended

for Identical

Observable

Unobservable

Provision

December 31,

Assets

Inputs

Inputs

During

2018

(Level 1)

(Level 2)

(Level 3)

Period

Measured on a non-recurring basis:

    

    

    

    

    

    

    

    

    

    

Assets:

Impaired loans

$

1,563

$

$

$

1,563

$

356

Other real estate owned

 

38,871

 

 

 

38,871

 

3,071

Our assets measured at fair value on a non-recurring basis are limited to impaired loans, other real estate owned, and an equity investment without a readily determinable fair value. Impaired loans are classified within Level 3 of the valuation hierarchy. The fair value of impaired loans is derived in accordance with FASB ASC 310, “Receivables”. Impaired loans are primarily comprised of collateral-dependent commercial loans. As the primary sources of loan repayments decline, the secondary repayment source, the collateral, takes on greater significance. Correctly evaluating the fair value becomes even more important. Re-measurement of the impaired loan to fair value is done through a specific valuation allowance included in the allowance for probable loan losses. The fair value of impaired loans is based on the fair value of the collateral, as determined through either an appraisal or evaluation process. The basis for our appraisal and appraisal review process is based on regulatory guidelines and strives to comply with all regulatory appraisal laws, regulations, and the Uniform Standards of Professional Appraisal Practice. All appraisals and evaluations are “as is” (the property’s highest and best use) valuations based on the current conditions of the property/project at that point in time. The determination of the fair value of the collateral is based on the net realizable value, which is the appraised value less any closing costs, when applicable. As of June 30, 2019, we had $14,287,000 of impaired commercial collateral dependent loans, of which $2,369,000 had an appraisal performed within the immediately preceding twelve months, and of which $8,756,000 had an evaluation performed within the immediately preceding twelve months. As of December 31, 2018, we had approximately $14,306,000 of impaired commercial collateral dependent loans, of which $10,911,000 had an appraisal performed within the immediately preceding twelve months and of which $0 had an evaluation performed within the immediately preceding twelve months.

Our determination to either seek an appraisal or to perform an evaluation begins in weekly credit quality meetings, where the committee analyzes the existing collateral values of the impaired loans and where obsolete appraisals are identified. In order to determine whether we would obtain a new appraisal or perform an internal evaluation to determine the fair value of the collateral, the credit committee reviews the existing appraisal to determine if the collateral value is reasonable in view of the current use of the collateral and the economic environment related to the collateral. If the analysis of the existing appraisal does not find that the collateral value is reasonable under the current circumstances, we would obtain a new appraisal on the collateral or perform an internal evaluation of the collateral. The ultimate decision to get a new appraisal rests with the independent credit administration group. A new appraisal is not required if an internal evaluation, as performed by in-house experts, is able to appropriately update the original appraisal assumptions to reflect current market conditions and provide an estimate of the collateral’s market value for impairment analysis. The internal evaluations must be in writing and contain sufficient information detailing the analysis, assumptions and conclusions, and they must support performing an evaluation in lieu of ordering a new appraisal.

Other real estate owned is comprised of real estate acquired by foreclosure and deeds in lieu of foreclosure. Other real estate owned is carried at the lower of the recorded investment in the property or its fair value less estimated costs to sell such property (as determined by independent appraisal) within Level 3 of the fair value hierarchy. Prior to foreclosure, the value of the underlying loan is written down to the fair value of the real estate to be acquired by a charge to the allowance for probable loan losses, if necessary. The fair value is reviewed periodically and subsequent write-downs are made, accordingly, through a charge to operations. Other real estate owned is included in other assets on the

13

consolidated financial statements. For the three and six months ended June 30, 2019 and the twelve months ended December 31, 2018, we recorded $9,500,000, $9,500,000, and $170,000, respectively, in charges to the allowance for probable loan losses in connection with loans transferred to other real estate owned. The $9,500,000 charge is related to the deterioration on one loan relationship discussed further in Note 4 – Allowance for Loan Losses. For the three and six months ended June 30, 2019 and the twelve months ended December 31, 2018, we recorded $80,000, $88,000, and $3,071,000, respectively, in adjustments to fair value in connection with other real estate owned.

The fair value estimates, methods, and assumptions for our financial instruments at June 30, 2019 and December 31, 2018 are outlined below.

Cash and Cash Equivalents

For these short-term instruments, the carrying amount is a reasonable estimate of fair value.

Time Deposits with Banks

The carrying amounts of time deposits with banks approximate fair value.

Investment Securities Held-to-Maturity

The carrying amounts of investments held-to-maturity approximate fair value.

Investment Securities

For investment securities, which include U.S. Treasury securities, obligations of other U.S. government agencies, obligations of states and political subdivisions and mortgage pass-through and related securities, fair values are from an independent pricing service. The fair value measurements consider observable data that may include dealer quotes, market spreads, cash flows, the U.S. Treasury yield curve, live trading levels, trade execution data, market consensus prepayment speeds, credit information and the bond’s terms and conditions, among other things. See disclosures of fair value of investment securities in Note 6.

Loans

Fair values are estimated for portfolios of loans with similar financial characteristics. Loans are segregated by type, such as commercial, real estate and consumer loans, as outlined by regulatory reporting guidelines. Each category is segmented into fixed and variable interest rate terms and by performing and non-performing categories.

For variable rate performing loans, the carrying amount approximates the fair value. For fixed-rate performing loans, except residential mortgage loans, the fair value is calculated by discounting scheduled cash flows through the estimated maturity using estimated market discount rates that reflect the credit and interest rate risk inherent in the loan. For performing residential mortgage loans, fair value is estimated by discounting contractual cash flows adjusted for prepayment estimates using discount rates based on secondary market sources or the primary origination market. Fixed-rate performing loans are within Level 3 of the fair value hierarchy. At June 30, 2019 and December 31, 2018, the carrying amount of fixed-rate performing loans was $1,522,893,000 and $1,515,437,000, respectively, and the estimated fair value was $1,498,527,000 and $1,469,231,000, respectively.

Accrued Interest

The carrying amounts of accrued interest approximate fair value.

Deposits

The fair value of deposits with no stated maturity, such as non-interest bearing demand deposit accounts, savings accounts and interest bearing demand deposit accounts, was equal to the amount payable on demand as of June

14

30, 2019 and December 31, 2018. The fair value of time deposits is based on the discounted value of contractual cashflows. The discount rate is based on currently offered rates. Time deposits are within Level 3 of the fair value hierarchy. At June 30, 2019 and December 31, 2018, the carrying amount of time deposits was $1,969,425,000 and $1,973,468,000, respectively, and the estimated fair value was $1,970,714,000 and $1,976,156,000, respectively.

Securities Sold Under Repurchase Agreements

Securities sold under repurchase agreements include short- and long-term maturities. Due to the contractual terms of the short-term instruments, the carrying amounts approximated fair value at June 30, 2019 and December 31, 2018.

Junior Subordinated Deferrable Interest Debentures

We currently have floating-rate junior subordinated deferrable interest debentures outstanding. Due to the contractual terms of the floating-rate junior subordinated deferrable interest debentures, the carrying amounts approximated fair value at June 30, 2019 and December 31, 2018.

Other Borrowed Funds

We currently have short- and long-term borrowings issued from the Federal Home Loan Bank (“FHLB”). Due to the contractual terms of the short-term borrowings, the carrying amounts approximated fair value at June 30, 2019 and December 31, 2018. The long-term borrowings outstanding at June 30, 2019 and December 31, 2018 are fixed-rate borrowings and the fair value is based on established market spreads for similar types of borrowings. The fixed rate long-term borrowings are included in Level 2 of the fair value hierarchy. At June 30, 2019 and December 31, 2018, the carrying amount of the fixed rate long-term FHLB borrowings was $436,601,000 and $436,690,000, respectively, and the estimated fair value was $445,252,000 and $436,238,000, respectively.

Commitments to Extend Credit and Letters of Credit

Commitments to extend credit and fund letters of credit are principally at current interest rates, and, therefore, the carrying amount approximates fair value.

Limitations

Fair value estimates are made at a point in time, based on relevant market information and information about the financial instrument. These estimates do not reflect any premium or discount that could result from offering for sale at one time our entire holdings of a particular financial instrument. Because no market exists for a significant portion of our financial instruments, fair value estimates are based on judgments regarding future expected loss experience, current economic conditions, risk characteristics of various financial instruments and other factors. These estimates are subjective in nature and involve uncertainties and matters of significant judgment and therefore cannot be determined with precision. Changes in assumptions could significantly affect the estimates.

Fair value estimates are based on existing on- and off-statement of condition financial instruments without attempting to estimate the value of anticipated future business and the value of assets and liabilities that are not considered financial instruments. Other significant assets and liabilities that are not considered financial assets or liabilities include the bank premises and equipment and core deposit value. In addition, the tax ramifications related to the effect of fair value estimates have not been considered in the above estimates.

15

Note 3 — Loans

A summary of loans, by loan type at June 30, 2019 and December 31, 2018 is as follows:

June 30,

December 31,

2019

2018

(Dollars in Thousands)

Commercial, financial and agricultural

    

$

3,452,170

    

$

3,305,124

Real estate - mortgage

 

1,185,442

 

1,173,101

Real estate - construction

 

2,010,198

 

1,886,231

Consumer

 

46,713

 

46,316

Foreign

 

148,178

 

150,517

Total loans

$

6,842,701

$

6,561,289

Note 4 — Allowance for Probable Loan Losses

The allowance for probable loan losses primarily consists of the aggregate loan loss allowances of the Subsidiary Banks. The allowances are established through charges to operations in the form of provisions for probable loan losses. Loan losses or recoveries are charged or credited directly to the allowances. The allowance for probable loan losses of each Subsidiary Bank is maintained at a level considered appropriate by management, based on estimated probable losses in the loan portfolio. The allowance for probable loan losses is derived from the following elements: (i) allowances established on specific impaired loans, which are based on a review of the individual characteristics of each loan, including the customer’s ability to repay the loan, the underlying collateral values, and the industry in which the customer operates; (ii) allowances based on actual historical loss experience for similar types of loans in our loan portfolio; and (iii) allowances based on general economic conditions, changes in the mix of loans, company resources, border risk and credit quality indicators, among other things. All segments of the loan portfolio continue to be impacted by economic uncertainty as the economy recovers from the recent prolonged downturn.

Our management continually reviews the allowance for loan losses of the Subsidiary Banks using the amounts determined from the allowances established on specific impaired loans, the allowance established on quantitative historical loss percentages, and the allowance based on qualitative data to establish an appropriate amount to maintain in our allowance for loan losses. Should any of the factors considered by management in evaluating the adequacy of the allowance for probable loan losses change, our estimate of probable loan losses could also change, which could affect the level of future provisions for probable loan losses. While the calculation of the allowance for probable loan losses utilizes management’s best judgment and all information reasonably available, the adequacy of the allowance is dependent on a variety of factors beyond our control, including, among other things, the performance of the entire loan portfolio, the economy, changes in interest rates and the view of regulatory authorities towards loan classifications.

The loan loss provision is determined using the following methods. On a weekly basis, loan past due reports are reviewed by the credit quality committee to determine if a loan has any potential problems and if a loan should be placed on the internal classified report of the Subsidiary Banks. Additionally, the credit department of each Subsidiary Bank reviews the majority of our loans for proper internal classification purposes, regardless of whether they are past due, and segregates any loans with potential problems for further review. The credit department will discuss the potential problem loans with the servicing loan officers to determine any relevant issues that were not discovered in the evaluation. Also, an analysis of loans that is provided through examinations by regulatory authorities is considered in the review process. After the above analysis is completed, we determine if a loan should be placed on an internal classified report because of issues related to the analysis of the credit, credit documents, collateral and/or payment history.

16

A summary of the transactions in the allowance for probable loan losses by loan class is as follows:

Three Months Ended June 30, 2019

Domestic

Foreign

 

    

    

Commercial

    

    

    

    

    

    

    

Real Estate:

Other

Commercial

Construction &

Real Estate:

Commercial

Land

Farmland &

Real Estate:

Residential:

Residential:

Commercial

Development

Commercial

Multifamily

First Lien

Junior Lien

Consumer

Foreign

Total

(Dollars in Thousands)  

Balance at March 31,

$

11,412

$

14,789

$

25,880

$

2,345

$

3,546

$

7,745

$

462

$

851

$

67,030

Losses charged to allowance

 

(5,016)

 

 

(6,878)

 

 

(1)

 

(94)

 

(55)

 

 

(12,044)

Recoveries credited to allowance

 

408

 

56

 

15

 

 

10

 

55

 

8

 

 

552

Net (losses) recoveries charged to allowance

 

(4,608)

 

56

 

(6,863)

 

 

9

 

(39)

 

(47)

 

 

(11,492)

Provision charged to operations

 

4,976

 

428

 

(1,988)

 

(496)

 

72

 

(394)

 

73

 

(6)

 

2,665

Balance at June 30,

$

11,780

$

15,273

$

17,029

$

1,849

$

3,627

$

7,312

$

488

$

845

$

58,203

Three Months Ended June 30, 2018

Domestic

Foreign

 

    

    

Commercial

    

    

    

    

    

    

    

Real Estate:

Other

Commercial

Construction &

Real Estate:

Commercial

Land

Farmland &

Real Estate:

Residential:

Residential:

Commercial

Development

Commercial

Multifamily

First Lien

Junior Lien

Consumer

Foreign

Total

(Dollars in Thousands)  

Balance at March 31,

$

20,691

$

11,798

$

24,803

$

947

$

3,006

$

4,689

$

437

$

783

$

67,154

Losses charged to allowance

 

(2,284)

 

 

(70)

 

(30)

 

(9)

 

(65)

 

 

(2,458)

Recoveries credited to allowance

 

447

 

2

 

192

 

 

1

 

229

 

15

 

1

 

887

Net (losses) recoveries charged to allowance

 

(1,837)

 

2

 

122

 

 

(29)

 

220

 

(50)

 

1

 

(1,571)

Provision charged to operations

 

(2,258)

 

2,903

 

(6,629)

 

627

 

614

 

1,884

 

63

 

66

 

(2,730)

Balance at June 30,

$

16,596

$

14,703

$

18,296

$

1,574

$

3,591

$

6,793

$

450

$

850

$

62,853

Six Months Ended June 30, 2019

Domestic

Foreign

    

    

Commercial

    

    

    

    

    

    

    

Real Estate:

Other

Commercial

Construction &

Real Estate:

Commercial

Land

Farmland &

Real Estate:

Residential:

Residential:

Commercial

Development

Commercial

Multifamily

First Lien

Junior Lien

Consumer

Foreign

Total

(Dollars in Thousands)  

Balance at December 31,

$

12,596

$

15,123

$

19,353

$

1,808

$

3,467

$

7,719

$

447

$

871

$

61,384

Losses charged to allowance

 

(7,780)

 

 

(6,879)

 

(2)

 

(100)

 

(118)

 

 

(14,879)

Recoveries credited to allowance

 

1,046

 

76

 

298

 

 

11

 

157

 

25

 

 

1,613

Net (losses) recoveries charged to allowance

 

(6,734)

 

76

 

(6,581)

 

 

9

 

57

 

(93)

 

 

(13,266)

Provision charged to operations

 

5,918

 

74

 

4,257

 

41

 

151

 

(464)

 

134

 

(26)

 

10,085

Balance at June 30,

$

11,780

$

15,273

$

17,029

$

1,849

$

3,627

$

7,312

$

488

$

845

$

58,203

17

Six Months Ended June 30, 2018

Domestic

Foreign

 

    

    

Commercial

    

    

    

    

    

    

    

Real Estate:

Other

Commercial

Construction &

Real Estate:

Commercial

Land

Farmland &

Real Estate:

Residential:

Residential:

Commercial

Development

Commercial

Multifamily

First Lien

Junior Lien

Consumer

Foreign

Total

(Dollars in Thousands)  

Balance at December 31,

$

27,905

$

11,675

$

16,663

$

1,109

$

2,950

$

6,103

$

440

$

842

$

67,687

Losses charged to allowance

 

(4,999)

(1)

 

(70)

 

 

(44)

 

(39)

 

(182)

 

 

(5,335)

Recoveries credited to allowance

 

1,030

 

4

 

210

 

 

2

 

295

 

27

 

1

 

1,569

Net (losses) recoveries charged to allowance

 

(3,969)

 

3

 

140

 

 

(42)

 

256

 

(155)

 

1

 

(3,766)

Provision charged to operations

 

(7,340)

 

3,025

 

1,493

 

465

 

683

 

434

 

165

 

7

 

(1,068)

Balance at June 30,

$

16,596

$

14,703

$

18,296

$

1,574

$

3,591

$

6,793

$

450

$

850

$

62,853

The allowance for probable loan losses is a reserve established through a provision for probable loan losses charged to expense, which represents management’s best estimate of probable loan losses when evaluating loans individually or collectively. The increase in provision for probable loan losses charged to expense and charge offs charged to the allowance for probable loan losses for the three and six months ended June 30, 2019 can be attributed to a relationship that is secured by multiple pieces of real property on which car dealerships are operated. The relationship began deteriorating in the fourth quarter of 2018, triggered by significant fraud by a high level insider of the car dealership resulting in the dealerships unexpectedly filing for bankruptcy and creating an exposure for potential loss since the operations of the dealerships were the source of repayment from the borrower. The relationship further deteriorated in the first quarter of 2019 after the sponsor of the court approved debtor in possession plan discontinued its role in the process and thus did not fulfill its obligation to assume full responsibility of the accrued and unpaid interest. Although the relationship is secured by real property (the dealerships’ real estate), the real property has specialized use, contributing to the potential exposure for probable loss. During the first quarter of 2019, in light of the circumstances and management’s evaluation of the relationship, the decision was made to place the relationship on impaired, non-accrual status and place a specific reserve on the relationship in the amount of $9.5 million. During the second quarter of 2019, management continued to evaluate the relationship and decided to foreclose on the underlying real estate collateral, resulting in a charge off of approximately $9,500,000, reflected in the tables above as part of the Commercial and Commercial Real Estate: Farmland and Commercial categories.

18

The table below provides additional information on the balance of loans individually or collectively evaluated for impairment and their related allowance, by loan class as of June 30, 2019 and December 31, 2018:

June 30, 2019

Loans Individually

Loans Collectively

Evaluated For

Evaluated For

Impairment

Impairment

Recorded

Recorded

Investment

Allowance

Investment

Allowance

(Dollars in Thousands)

Domestic

Commercial

    

$

8,473

    

$

648

    

$

1,194,270

    

$

11,132

Commercial real estate: other construction & land development

 

1,924

 

116

 

2,008,274

 

15,157

Commercial real estate: farmland & commercial

 

4,160

 

935

 

2,023,836

 

16,094

Commercial real estate: multifamily

 

505

 

 

220,926

 

1,849

Residential: first lien

 

6,297

 

 

453,881

 

3,627

Residential: junior lien

 

1,023

 

 

724,241

 

7,312

Consumer

 

1,046

 

 

45,667

 

488

Foreign

 

279

 

 

147,899

 

845

Total

$

23,707

$

1,699

$

6,818,994

$

56,504

December 31, 2018

Loans Individually

Loans Collectively

Evaluated For

Evaluated For

Impairment

Impairment

Recorded

Recorded

Investment

Allowance

Investment

Allowance

(Dollars in Thousands)

Domestic

Commercial

    

$

9,179

    

$

656

    

$

1,119,790

    

$

11,940

Commercial real estate: other construction & land development

 

2,092

 

116

 

1,884,139

 

15,007

Commercial real estate: farmland & commercial

 

3,509

 

 

1,946,389

 

19,353

Commercial real estate: multifamily

 

507

 

 

225,750

 

1,808

Residential: first lien

 

6,244

 

 

439,556

 

3,467

Residential: junior lien

 

901

 

 

726,400

 

7,719

Consumer

 

1,175

 

 

45,141

 

447

Foreign

 

293

 

 

150,224

 

871

Total

$

23,900

$

772

$

6,537,389

$

60,612

19

The table below provides additional information on loans accounted for on a non-accrual basis by loan class at June 30, 2019 and December 31, 2018:

June 30, 2019

December 31, 2018

(Dollars in Thousands)

Domestic

Commercial

    

$

8,440

    

$

9,143

Commercial real estate: other construction & land development

 

1,924

 

2,092

Commercial real estate: farmland & commercial

 

4,160

 

3,509

Commercial real estate: multifamily

 

505

 

507

Residential: first lien

 

391

 

347

Residential: junior lien

 

289

 

171

Consumer

 

9

 

22

Total non-accrual loans

$

15,718

$

15,791

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

The following tables detail key information regarding our impaired loans by loan class at June 30, 2019 and December 31, 2018:

June 30, 2019

Quarter to Date

Year to Date

Unpaid

Average

Average

Recorded

Principal

Related

Recorded

Interest

Recorded

Interest

Investment

Balance

Allowance

Investment

Recognized

Investment

Recognized

(Dollars in Thousands)

Loans with Related Allowance

    

    

    

    

    

    

    

    

    

Domestic

Commercial

$

1,309

$

1,904

$

648

$

1,316

$

$

1,322

$

Commercial real estate: other construction & land development

131

169

116

 

132

 

133

Commercial real estate: farmland & commercial

2,369

2,399

935

2,369

2,369

Total impaired loans with related allowance

$

3,809

$

4,472

$

1,699

$

3,817

$

$

3,824

$

June 30, 2019

Quarter to Date

Year to Date

Unpaid

Average

    

    

Average

    

Recorded

Principal

Recorded

Interest

Recorded

Interest

Investment

Balance

Investment

Recognized

Investment

Recognized

(Dollars in Thousands)

Loans with No Related Allowance

    

    

    

    

    

    

    

Domestic

Commercial

$

7,163

$

7,294

$

16,788

$

1

$

17,078

$

1

Commercial real estate: other construction & land development

 

1,793

 

2,078

 

1,792

 

 

1,813

 

Commercial real estate: farmland & commercial

 

1,792

 

2,382

 

14,203

 

 

20,551

 

Commercial real estate: multifamily

 

505

 

536

 

507

 

 

507

 

Residential: first lien

 

6,297

 

6,459

 

6,480

 

78

 

6,579

 

153

Residential: junior lien

 

1,023

 

1,032

 

1,028

 

11

 

1,033

 

22

Consumer

 

1,046

 

1,046

 

1,046

 

1,063

 

Foreign

 

279

 

279

 

281

 

3

 

285

 

6

Total impaired loans with no related allowance

$

19,898

$

21,106

$

42,125

$

93

$

48,909

$

182

20

December 31, 2018

Unpaid

Average

Recorded

Principal

Related

Recorded

Interest

Investment

Balance

Allowance

Investment

Recognized

(Dollars in Thousands)

Loans with Related Allowance

    

    

    

    

    

    

    

    

Domestic

Commercial

$

1,563

$

2,161

$

656

$

1,741

$

Commercial real estate: other construction & land development

135

169

116

 

141

 

Total impaired loans with related allowance

$

1,698

$

2,330

$

772

$

1,882

$

December 31, 2018

Unpaid

 

Average

Recorded

Principal

 

Recorded

Interest

Investment

Balance

 

Investment

Recognized

(Dollars in Thousands)

Loans with No Related Allowance

Domestic

Commercial

    

$

7,616

$

7,730

$

16,194

$

3

Commercial real estate: other construction & land development

 

1,957

 

2,205

 

2,151

 

Commercial real estate: farmland & commercial

 

3,509

 

4,031

 

36,632

 

Commercial real estate: multifamily

 

507

 

538

 

565

 

Residential: first lien

 

6,244

 

6,386

 

7,136

 

305

Residential: junior lien

 

901

 

911

 

976

 

44

Consumer

 

1,175

 

1,190

 

1,211

 

2

Foreign

 

293

 

293

 

327

 

14

Total impaired loans with no related allowance

$

22,202

$

23,284

$

65,192

$

368

The following table details key information regarding our impaired loans by loan class at June 30, 2018:

June 30, 2018

Quarter to Date

Year to Date

Average

Average

Recorded

Interest

Recorded

Interest

Investment

Recognized

Investment

Recognized

(Dollars in Thousands)

Loans with Related Allowance

    

    

    

Domestic

Commercial

$

1,604

$

$

1,661

$

Commercial real estate: other construction & land development

 

143

 

 

144

 

Total impaired loans with related allowance

$

1,747

$

$

1,805

$

June 30, 2018

Quarter to Date

Year to Date

Average

 

Average

Recorded

Interest

 

Recorded

Interest

Investment

Recognized

 

Investment

Recognized

(Dollars in Thousands)

Loans with No Related Allowance

Domestic

Commercial

    

$

16,594

$

1

$

16,738

$

1

Commercial real estate: other construction & land development

 

2,148

 

 

2,216

 

Commercial real estate: farmland & commercial

 

36,790

 

 

36,686

 

Commercial real estate: multifamily

 

664

 

 

568

 

Residential: first lien

 

6,426

 

76

 

6,864

 

152

Residential: junior lien

 

803

 

12

 

811

 

22

Consumer

 

1,145

 

1

 

1,179

 

2

Foreign

 

333

 

4

 

337

 

7

Total impaired loans with no related allowance

$

64,903

$

94

$

65,399

$

184

21

A portion of the impaired loans have adequate collateral and credit enhancements not requiring a related allowance for loan loss. Management recognizes the risks associated with these impaired loans, however, management is confident our loss exposure regarding these credits will be significantly reduced due to our long-standing practices that encompass the following principles: (i) the financial strength of the borrower, including strong earnings, a high net worth, significant liquidity and an acceptable debt to worth ratio, (ii) managerial and business competence, (iii) the ability to repay, (iv) for a new business, projected cash flows, (v) loan to value, (vi) in the case of a secondary guarantor, a guarantor financial statement, and (vii) financial and/or other character references. Management’s decision to place loans in this category does not necessarily mean that we will experience significant losses from these loans or significant increases in impaired loans from these levels.

The following table details loans accounted for as “troubled debt restructuring,” segregated by loan class. Loans accounted for as troubled debt restructuring are included in impaired loans.

    

June 30, 2019

    

December 31, 2018

(Dollars in Thousands)

Domestic

Commercial

 

$

34

 

$

35

Residential: first lien

5,905

5,947

Residential: junior lien

734

730

Consumer

1,037

1,153

Foreign

279

293

Total troubled debt restructuring

$

7,989

$

8,158

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

While our management believes that it is generally able to identify borrowers with financial problems reasonably early and to monitor credit extended to such borrowers carefully, there is no precise method of predicting loan losses. The determination that a loan is likely to be uncollectible and that it should be wholly or partially charged-off as a loss is an exercise of judgment. Similarly, the determination of the adequacy of the allowance for probable loan losses can be made only on a subjective basis. It is the judgment of our management that the allowance for probable loan losses at June 30, 2019 was adequate to absorb probable losses from loans in the portfolio at that date.

22

The following tables present information regarding the aging of past due loans by loan class at June 30, 2019 and December 31, 2018:

June 30, 2019

90 Days or

Total

30 - 59

60 - 89

90 Days or

greater &

Past

Total

Days

Days

Greater

still accruing

Due

Current

Portfolio

(Dollars in Thousands)

Domestic

Commercial

    

$

3,160

    

$

696

    

$

8,840

    

$

1,312

    

$

12,696

    

$

1,190,047

    

$

1,202,743

Commercial real estate: other construction & land development

 

308

 

 

1,030

 

206

 

1,338

 

2,008,860

 

2,010,198

Commercial real estate: farmland & commercial

 

1,534

 

4,844

 

767

 

325

 

7,145

 

2,020,851

 

2,027,996

Commercial real estate: multifamily

 

 

155

 

505

 

 

660

 

220,771

 

221,431

Residential: first lien

 

2,632

 

1,419

 

4,312

 

3,948

 

8,363

 

451,815

 

460,178

Residential: junior lien

 

633

 

374

 

1,360

 

1,070

 

2,367

 

722,897

 

725,264

Consumer

 

742

 

111

 

28

 

24

 

881

 

45,832

 

46,713

Foreign

 

1,867

 

638

 

167

 

167

 

2,672

 

145,506

 

148,178

Total past due loans

$

10,876

$

8,237

$

17,009

$

7,052

$

36,122

$

6,806,579

$

6,842,701

December 31, 2018

90 Days or

Total

30 - 59

60 - 89

90 Days or

greater &

Past

Total

Days

Days

Greater

still accruing

Due

Current

Portfolio

 

(Dollars in Thousands)

Domestic

    

    

    

    

    

    

    

    

    

    

    

    

    

    

Commercial

$

4,651

    

$

1,089

    

$

19,851

    

$

10,890

    

$

25,591

    

$

1,103,378

    

$

1,128,969

Commercial real estate: other construction & land development

 

727

 

1,707

 

922

 

16

 

3,356

 

1,882,875

 

1,886,231

Commercial real estate: farmland & commercial

 

2,928

 

784

 

27,239

 

24,910

 

30,951

 

1,918,947

 

1,949,898

Commercial real estate: multifamily

 

927

 

 

578

 

71

 

1,505

 

224,752

 

226,257

Residential: first lien

 

3,998

 

1,677

 

3,362

 

3,079

 

9,037

 

436,763

 

445,800

Residential: junior lien

 

1,155

 

618

 

1,108

 

937

 

2,881

 

724,420

 

727,301

Consumer

 

486

 

19

 

45

 

32

 

550

 

45,766

 

46,316

Foreign

 

1,106

 

117

 

739

 

739

 

1,962

 

148,555

 

150,517

Total past due loans

$

15,978

$

6,011

$

53,844

$

40,674

$

75,833

$

6,485,456

$

6,561,289

The decrease in the 90 days or greater and still accruing at June 30, 2019 compared to December 31, 2018 can be primarily attributed to the previously discussed relationship secured by real property on which car dealerships are operated and the foreclosure of the underlying real estate assets securing the relationship in the second quarter of 2019.

Our internal classified report is segregated into the following categories: (i) “Special Review Credits,” (ii) “Watch List-Pass Credits,” and (iii) “Watch List-Substandard Credits.” The loans placed in the “Special Review Credits” category reflect management’s opinion that the loans reflect potential weakness which requires monitoring on a more frequent basis. The “Special Review Credits” are reviewed and discussed on a regular basis with the credit department and the lending staff to determine if a change in category is warranted. The loans placed in the “Watch List-Pass Credits” category reflect our opinion that the credit contains weaknesses which represent a greater degree of risk, which warrant “extra attention.” The “Watch List-Pass Credits” are reviewed and discussed on a regular basis with the credit department and the lending staff to determine if a change in category is warranted. The loans placed in the “Watch List-Substandard Credits” classification are considered to be potentially inadequately protected by the current sound worth and debt service capacity of the borrower or of any pledged collateral. These credit obligations, even if apparently protected by collateral value, have shown defined weaknesses related to adverse financial, managerial, economic, market or political conditions which may jeopardize repayment of principal and interest. Furthermore, there is the possibility that we could sustain some future loss if such weaknesses are not corrected. For loans that are classified as impaired, management evaluates these credits in accordance with the provisions of ASC 310-10, “Receivables,” and, if deemed

23

necessary, a specific reserve is allocated to the credit. The specific reserve allocated under ASC 310-10 is based on (i) the present value of expected future cash flows discounted at the loan’s effective interest rate; (ii) the loan’s observable market price; or (iii) the fair value of the collateral if the loan is collateral dependent. Substantially all of our loans evaluated as impaired under ASC 310-10 are measured using the fair value of collateral method. In limited cases, we may use other methods to determine the specific reserve of a loan under ASC 310-10 if such loan is not collateral dependent.

The allowance based on historical loss experience on our remaining loan portfolio, which includes the “Special Review Credits,” “Watch List - Pass Credits,” and “Watch List - Substandard Credits” is determined by segregating the remaining loan portfolio into certain categories such as commercial loans, installment loans, international loans, loan concentrations and overdrafts. Installment loans are then further segregated by number of days past due. A historical loss percentage, adjusted for (i) management’s evaluation of changes in lending policies and procedures, (ii) current economic conditions in the market area we serve, (iii) other risk factors, (iv) the effectiveness of the internal loan review function, (v) changes in loan portfolios, and (vi) the composition and concentration of credit volume is applied to each category. Each category is then added together to determine the allowance allocated under ASC 450-20.

A summary of the loan portfolio by credit quality indicator by loan class at June 30, 2019 and December 31, 2018 is as follows:

June 30, 2019

Special

Watch

Watch List—

Watch List—

Pass

Review

List—Pass

Substandard

Impaired

(Dollars in Thousands)

Domestic

Commercial

    

$

1,141,456

    

$

19

    

$

1,694

    

$

51,101

    

$

8,473

Commercial real estate: other construction & land development

 

1,942,982

 

 

9,310

 

55,982

 

1,924

Commercial real estate: farmland & commercial

 

1,834,448

 

56,158

 

34,394

 

98,836

 

4,160

Commercial real estate: multifamily

 

220,023

 

 

 

903

 

505

Residential: first lien

 

452,493

 

 

143

 

1,245

 

6,297

Residential: junior lien

 

723,385

 

 

856

 

 

1,023

Consumer

 

45,667

 

 

 

 

1,046

Foreign

 

147,899

 

 

 

 

279

Total

$

6,508,353

$

56,177

$

46,397

$

208,067

$

23,707

December 31, 2018

Special

Watch

Watch List—

Watch List—

Pass

Review

List—Pass

Substandard

Impaired

(Dollars in Thousands)

Domestic

Commercial

    

$

998,625

    

$

441

    

$

44,544

    

$

76,180

    

$

9,179

Commercial real estate: other construction & land development

 

1,817,098

 

1,648

 

9,055

 

56,338

 

2,092

Commercial real estate: farmland & commercial

 

1,726,711

 

62,046

 

38,373

 

119,259

 

3,509

Commercial real estate: multifamily

 

224,823

 

 

 

927

 

507

Residential: first lien

 

438,773

 

 

142

 

641

 

6,244

Residential: junior lien

 

725,538

 

 

862

 

 

901

Consumer

 

45,141

 

 

 

 

1,175

Foreign

 

150,224

 

 

 

 

293

Total

$

6,126,933

$

64,135

$

92,976

$

253,345

$

23,900

The decrease in Watch List – Pass credits at June 30, 2019 from Decmeber 31, 2018 can be primarily attirubuted to the reclassification of a relationship secured by oil and gas properties to Pass. The decrease in Watch List- Substandard credits at June 30, 2019 can be primarily attributed to the foreclosure of the underlying real estate assets in the previously discussed relationship on which car dealerships were operated and a pay down on a relationship secured primarily by aircraft.

24

Note 5 — Stock Options

On April 5, 2012, the Board of Directors adopted the 2012 International Bancshares Corporation Stock Option Plan (the “2012 Plan”). There are 800,000 shares of common stock available for stock option grants under the 2012 Plan, which may be qualified incentive stock options (“ISOs”) or non-qualified stock options. Options granted may be exercisable for a period of up to 10 years from the date of grant, excluding ISOs granted to 10% shareholders, which may be exercisable for a period of up to only five years. As of June 30, 2019, 26,876 shares were available for future grants under the 2012 Plan.

A summary of option activity under the stock option plan for the six months ended June 30, 2019 is as follows:

    

    

    

Weighted

    

    

Weighted

average

average

remaining

Aggregate

Number of

exercise

contractual

intrinsic

options

price

term (years)

value ($)

(in Thousands)

Options outstanding at December 31, 2018

 

788,977

$

25.91

Plus: Options granted

 

11,500

 

36.59

Less:

Options exercised

 

47,175

 

18.52

Options expired

 

 

Options forfeited

 

29,176

 

27.11

Options outstanding at June 30, 2019

 

724,126

 

26.51

 

5.80

$

8,234

Options fully vested and exercisable at June 30, 2019

 

369,795

$

21.07

 

4.24

$

6,159

Stock-based compensation expense included in the consolidated statements of income for the three and six months ended June 30, 2019 is $239,000 and $504,000, respectively. Stock-based compensation expense included in the consolidated statements of income for the three and six months ended June 30, 2018 was $286,000 and $470,000, respectively. As of June 30, 2019, there was approximately $2,336,000 of total unrecognized stock-based compensation cost related to non-vested options granted under our plans that will be recognized over a weighted average period of 1.9 years.

Note 6 — Investment Securities and Equity Securities with Readily Determinable Fair Values

We classify debt securities into one of three categories: held-to maturity, available-for-sale, or trading. Such debt securities are reassessed for appropriate classification at each reporting date. Securities classified as “held-to-maturity” are carried at amortized cost for financial statement reporting, while securities classified as “available-for-sale” and “trading” are carried at their fair value. Unrealized holding gains and losses are included in net income for those securities classified as “trading,” while unrealized holding gains and losses related to those securities classified as “available-for-sale” are excluded from net income and reported net of tax as other comprehensive income (loss) and accumulated other comprehensive income (loss) until realized, or in the case of losses, when deemed other than temporary. In accordance with the provisions of ASU 2016-01, which we adopted on January 1, 2018, unrealized holding gains and losses related to equity securities with readily determinable fair values are included in net income.

25

The amortized cost and estimated fair value by type of investment security at June 30, 2019 are as follows:

Held to Maturity

Gross

Gross

Amortized

unrealized

unrealized

Estimated

Carrying

cost

gains

losses

fair value

value

(Dollars in Thousands)

Other securities

    

$

2,400

    

$

    

$

    

$

2,400

    

$

2,400

Total investment securities

$

2,400

$

$

$

2,400

$

2,400

Available for Sale Debt Securities

Gross

Gross

Amortized

unrealized

unrealized

Estimated

Carrying

cost

gains

losses

fair value

value(1)

(Dollars in Thousands)

Residential mortgage-backed securities

    

$

3,348,834

    

$

15,432

    

$

(24,046)

    

$

3,340,220

    

$

3,340,220

Obligations of states and political subdivisions

 

124,646

 

3,047

 

 

127,693

 

127,693

Total investment securities

$

3,473,480

$

18,479

$

(24,046)

$

3,467,913

$

3,467,913

(1)Included in the carrying value of residential mortgage-backed securities are $544,659 of mortgage-backed securities issued by Ginnie Mae and $2,795,561 of mortgage-backed securities issued by Fannie Mae and Freddie Mac.

The amortized cost and estimated fair value by type of investment security at December 31, 2018 are as follows:

Held to Maturity

Gross

Gross

Amortized

unrealized

unrealized

Estimated

Carrying

cost

gains

losses

fair value

value

(Dollars in Thousands)

Other securities

    

$

1,200

    

$

    

$

    

$

1,200

    

$

1,200

Total investment securities

$

1,200

$

$

$

1,200

$

1,200

Available for Sale

Gross

Gross

Estimated

Amortized

unrealized

unrealized

fair

Carrying

cost

gains

losses

value

value(1)

(Dollars in Thousands)

Residential mortgage-backed securities

    

$

3,295,366

    

$

6,813

    

$

(79,169)

    

$

3,223,010

    

$

3,223,010

Obligations of states and political subdivisions

 

185,799

 

2,646

 

(105)

 

188,340

 

188,340

Total investment securities

$

3,481,165

$

9,459

$

(79,274)

$

3,411,350

$

3,411,350

(1)Included in the carrying value of residential mortgage-backed securities are $501,293 of mortgage-backed securities issued by Ginnie Mae and $2,721,717 of mortgage-backed securities issued by Fannie Mae and Freddie.

26

The amortized cost and estimated fair value of investment securities at June 30, 2019, by contractual maturity, are shown below. Expected maturities will differ from contractual maturities because borrowers may have the right to prepay obligations with or without prepayment penalties.

Held to Maturity

Available for Sale

Amortized

Estimated

Amortized

Estimated

Cost

fair value

Cost

fair value

(Dollars in Thousands)

Due in one year or less

    

$

1,075

    

$

1,075

    

$

    

$

Due after one year through five years

 

1,325

 

1,325

 

 

Due after five years through ten years

 

 

 

2,244

 

2,283

Due after ten years

 

 

 

122,402

 

125,410

Residential mortgage-backed securities

 

 

 

3,348,834

 

3,340,220

Total investment securities

$

2,400

$

2,400

$

3,473,480

$

3,467,913

Residential mortgage-backed securities are securities primarily issued by the Federal Home Loan Mortgage Corporation (“Freddie Mac”), Federal National Mortgage Association (“Fannie Mae”), or the Government National Mortgage Association (“Ginnie Mae”). Investments in residential mortgage-backed securities issued by Ginnie Mae are fully guaranteed by the U.S. Government. Investments in residential mortgage-backed securities issued by Freddie Mac and Fannie Mae are not fully guaranteed by the U.S. Government, however, we believe that the quality of the bonds is similar to other AAA rated bonds with limited credit risk, particularly given the placement of Fannie Mae and Freddie Mac into conservatorship by the federal government in early September 2008 and because securities issued by others that are collateralized by residential mortgage-backed securities issued by Fannie Mae or Freddie Mac are rated consistently as AAA rated securities.

The amortized cost and fair value of available-for-sale debt investment securities pledged to qualify for fiduciary powers, to secure public monies as required by law, repurchase agreements and short-term fixed borrowings was $1,063,745,000 and $1,057,009,000, respectively, at June 30, 2019.

Proceeds from the sale and calls of debt securities available-for-sale were $19,275,000 and $60,695,000 for the three and six months ended June 30, 2019, which included $0 and $0 of mortgage-backed securities, respectively. Gross gains of $1 and $3 and gross losses of $7 and $13 were realized on the sales and calls for the three and six months ended June 30, 2019, respectively. Proceeds from the sale and call of debt securities available-for-sale were $0 and $18,145,000 for the three and six months ended June 30, 2018, which included $0 and $0 of mortgage-backed securities, respectively. Gross gains of $0 and $0 and gross losses of $0 and $0 were realized on the sales and calls for the three and six months ended June 30, 2018, respectively.

Gross unrealized losses on debt investment securities and the fair value of the related securities, aggregated by investment category and length of time that individual debt securities have been in a continuous unrealized loss position at June 30, 2019, were as follows:

Less than 12 months

12 months or more

Total

Unrealized

Unrealized

Unrealized

Fair Value

Losses

Fair Value

Losses

Fair Value

Losses

(Dollars in Thousands)

Available for sale:

Residential mortgage-backed securities

    

$

23,726

    

$

(72)

    

$

2,080,460

    

$

(23,974)

    

$

2,104,186

    

$

(24,046)

$

23,726

$

(72)

$

2,080,460

$

(23,974)

$

2,104,186

$

(24,046)

27

Gross unrealized losses on investment securities and the fair value of the related securities, aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position, at December 31, 2018 were as follows:

Less than 12 months

12 months or more

Total

Unrealized

Unrealized

Unrealized

Fair Value

Losses

Fair Value

Losses

Fair Value

Losses

(Dollars in Thousands)

Available for sale:

Residential mortgage-backed securities

    

$

208,384

    

$

(2,124)

    

$

2,537,181

    

$

(77,045)

    

$

2,745,565

    

$

(79,169)

Obligations of states and political subdivisions

 

12,756

 

(99)

 

512

 

(6)

 

13,268

 

(105)

$

221,140

$

(2,223)

$

2,537,693

$

(77,051)

$

2,758,833

$

(79,274)

The unrealized losses on investments in residential mortgage-backed securities are primarily caused by changes in market interest rates. Residential mortgage-backed securities are primarily securities issued by Freddie Mac, Fannie Mae and Ginnie Mae. The contractual cash obligations of the securities issued by Ginnie Mae are fully guaranteed by the U.S. Government. The contractual cash obligations of the securities issued by Freddie Mac and Fannie Mae are not fully guaranteed by the U.S. Government; however, we believe that the quality of the bonds is similar to other AAA rated bonds with limited credit risk, particularly given the placement of Fannie Mae and Freddie Mac into conservatorship by the federal government in early September 2008, and because securities issued by others that are collateralized by residential mortgage-backed securities issued by Fannie Mae and Freddie Mac are rated consistently as AAA rated securities. The decrease in fair value on residential mortgage-backed securities issued by Freddie Mac, Fannie Mae and Ginnie Mae is due to market interest rates. We have no intent to sell and will more than likely not be required to sell before a market price recovery or maturity of the securities; therefore, it is our conclusion that the investments in residential mortgage-backed securities issued by Freddie Mac, Fannie Mae and Ginnie Mae are not considered other-than-temporarily impaired.

Equity securities with readily determinable fair values consist primarily of Community Reinvestment Act funds. At June 30, 2019 and December 31, 2018, the balance in equity securities with readily determinable fair values recorded at fair value were $6,127,000 and $5,937,000, respectively. Prior to January 1, 2018, the equity securities were included in available-for-sale securities, with the related unrealized gain or loss recorded as a component of other comprehensive income. The following is a summary of unrealized and realized gains and losses recognized in net income on equity securities during the three and six months ended June 30, 2019 and the three and six months ended June 30, 2018:

Three Months Ended

June 30, 2019

(Dollars in Thousands)

Net gains (losses) recognized during the period on equity securities

    

$

52

Less: Net gains and (losses) recognized during the period on equity securities sold during the period

 

Unrealized gains (losses) recognized during the reporting period on equity securities still held at the reporting date

$

52

28

Three Months Ended

June 30, 2018

(Dollars in Thousands)

Net gains (losses) recognized during the period on equity securities

    

$

(247)

Less: Net gains and (losses) recognized during the period on equity securities sold during the period

 

Unrealized gains (losses) recognized during the reporting period on equity securities still held at the reporting date

$

(247)

Six Months Ended

June 30, 2019

(Dollars in Thousands)

Net gains (losses) recognized during the period on equity securities

    

$

190

Less: Net gains and (losses) recognized during the period on equity securities sold during the period

 

Unrealized gains (losses) recognized during the reporting period on equity securities still held at the reporting date

$

190

Six Months Ended

June 30, 2018

(Dollars in Thousands)

Net gains (losses) recognized during the period on equity securities

    

$

(1,021)

Less: Net gains and (losses) recognized during the period on equity securities sold during the period

 

Unrealized gains (losses) recognized during the reporting period on equity securities still held at the reporting date

$

(1,021)

Note 7 — Other Borrowed Funds

Other borrowed funds include FHLB borrowings, which are short-term and long-term borrowings issued by the FHLB of Dallas and the FHLB of Topeka at the market price offered at the time of funding. These borrowings are secured by residential mortgage-backed investment securities and a portion of our loan portfolio. At June 30, 2019, other borrowed funds totaled $808,376,000, an increase of 14.6% from $705,665,000 at December 31, 2018. The increase in borrowings can be primarily attributed to increased liquidity needs to fund operations and loan activity.

Note 8 — Junior Subordinated Interest Deferrable Debentures

As of June 30, 2019, we have five statutory business trusts under the laws of the State of Delaware, for the purpose of issuing trust preferred securities. The five statutory business trusts we formed (the “Trusts”) have each issued Capital and Common Securities and invested the proceeds thereof in an equivalent amount of junior subordinated debentures (“Debentures”) that we issued. As of June 30, 2019 and December 31, 2018, the principal amount of Debentures outstanding totaled $134,642,000 and $160,416,000, respectively. On May 7, 2019, after receiving the required regulatory approvals, we redeemed the full $25,000,000 of Junior Subordinated Deferrable Interest Debentures related to IB Capital Trust VI.

The Debentures are subordinated and junior in right of payment to all present and future senior indebtedness (as defined in the respective Indentures) and are pari passu with one another. The interest rate payable on, and the payment

29

terms of the Debentures are the same as the distribution rate and payment terms of the respective issues of Capital and Common Securities issued by the Trusts. We have fully and unconditionally guaranteed the obligations of each of the Trusts with respect to the Capital and Common Securities. We have the right, unless an Event of Default (as defined in the Indentures) has occurred and is continuing, to defer payment of interest on the Debentures for up to twenty consecutive quarterly periods on Trusts VIII, IX, X, XI and XII. If interest payments on any of the Debentures are deferred, distributions on both the Capital and Common Securities related to that Debenture would also be deferred. The redemption prior to maturity of any of the Debentures may require the prior approval of the Federal Reserve and/or other regulatory bodies.

For financial reporting purposes, the Trusts are treated as our investments and not consolidated in our consolidated financial statements. Although the Capital and Common Securities issued by each of the Trusts are not included as a component of shareholders’ equity on the consolidated statement of condition, the Capital and Common Securities are treated as capital for regulatory purposes. Specifically, under applicable regulatory guidelines, the Capital and Common Securities issued by the Trusts qualify as Tier 1 capital up to a maximum of 25% of Tier 1 capital on an aggregate basis. Any amount that exceeds the 25% threshold would qualify as Tier 2 capital. At June 30, 2019 and December 31, 2018, the total $134,642,000 and $160,416,000 of the Capital and Common Securities outstanding qualified as Tier 1 capital.

The following table illustrates key information about each of the Capital and Common Securities and their interest rate at June 30, 2019:

    

Junior

    

    

    

    

    

Subordinated

Deferrable

Interest

Repricing

Interest

Interest

Optional

Debentures

Frequency

Rate

Rate Index(1)

Maturity Date

Redemption Date(1)

(Dollars in Thousands)

Trust VIII

$

25,774

 

Quarterly

 

5.65

%

LIBOR

+

3.05

 

October 2033

 

October 2008

Trust IX

 

41,238

 

Quarterly

 

4.21

%

LIBOR

+

1.62

 

October 2036

 

October 2011

Trust X

 

21,021

 

Quarterly

 

4.23

%

LIBOR

+

1.65

 

February 2037

 

February 2012

Trust XI

 

25,990

 

Quarterly

 

4.21

%

LIBOR

+

1.62

 

July 2037

 

July 2012

Trust XII

 

20,619

 

Quarterly

 

3.97

%

LIBOR

+

1.45

 

September 2037

 

September 2012

$

134,642

(1)   The Capital and Common Securities may be redeemed in whole or in part on any interest payment date after the Optional Redemption Date.

Note 9 — Common Stock and Dividends

On April 15, 2019 we paid cash dividends of $0.50 per share to record holders of our common stock on April 1, 2019. On April 16, 2018 we paid cash dividends of $0.33 per share to record holders of our common stock on April 2, 2018,

In April 2009, the Board of Directors re-established a formal stock repurchase program that authorized the repurchase of up to $40 million of common stock within the following 12 months. Annually since then, including on March 11, 2019, the Board of Directors extended the repurchase program and this year authorized an increase to purchase up to $50 million of common stock during the 12 month period commencing again on April 9, 2019. Shares of common stock may be purchased from time to time on the open market or through privately negotiated transactions. Shares purchased in this program will be held in treasury for reissue for various corporate purposes, including employee compensation plans. During the first quarter of 2019, the Board of Directors adopted a Rule 10b5-1 trading plan, and intends to adopt additional Rule 10b5-1 trading plans, that will allow us to purchase shares of our common stock during certain trading blackout periods when we ordinarily would not be in the market due to trading restrictions in our insider trading policy. During the term of a Rule 10b5-1 trading plan, purchases of common stock are automatic to the extent the conditions of the plan’s trading instructions are met. Shares purchased under the Rule 10b5-1 trading plan will be held in treasury for reissue for various corporate purposes, including employee stock compensation plans. As of August 5, 2019,

30

a total of 9,803,514 shares had been repurchased under all programs at a cost of $311,433,000. We are not obligated to purchase shares under our stock repurchase program outside of its Rule 10b5-1 trading plan.

Note 10 — Commitments and Contingent Liabilities and Other Tax Matters

We are involved in various legal proceedings that are in various stages of litigation. We have determined, based on discussions with its counsel, that any material loss in such actions, individually or in the aggregate, is remote or the damages sought, even if fully recovered, would not be considered material to our consolidated financial position or results of operations. However, many of these matters are in various stages of proceedings and further developments could cause management to revise its assessment of these matters.

Note 11 — Capital Ratios

Banks and bank holding companies are subject to various regulatory capital requirements administered by state and federal banking agencies. Capital adequacy guidelines and, additionally for banks, prompt corrective action regulations, involve quantitative measures of assets, liabilities, and certain off-balance sheet items calculated under regulatory accounting practices. Capital amount and classifications are also subject to qualitative judgements by regulators about components, risk-weighting and other factors.

In July 2013, the Federal Deposit Insurance Corporation (“FDIC”) and other regulatory bodies established a new, comprehensive capital framework for U.S. banking organizations, consisting of minimum requirements that increase both the quantity and quality of capital held by banking organizations. The final rules are a result of the implementation of the BASEL III capital reforms and various Dodd-Frank Wall Street Reform and Consumer Protection Act (“Dodd Frank”) related capital provisions. Consistent with the Basel international framework, the rules include a new minimum ratio of Common Equity Tier 1 (“CET1”) to risk-weighted assets of 4.5% and a CET1 capital conservation buffer of 2.5% of risk-weighted assets.  The capital conservation buffer began phasing-in on January 1, 2016 at .625% and increased each year until January 1, 2019, when we were required to have a 2.5% capital conservation buffer, effectively resulting in a minimum ratio of CET1 capital to risk-weighted assets of at least 7% upon full implementation. The rules also raised the minimum ratio of Tier 1 capital to risk-weighted assets from 4% to 6% and include a minimum leverage ratio of 4% for all banking organizations. Regarding the quality of capital, the rules emphasize CET1 capital and implements strict eligibility criteria for regulatory capital instruments. The rules also improve the methodology for calculating risk-weighted assets to enhance risk sensitivity. The rules were subject to a four-year phase in period for mandatory compliance and we were required to begin to phase in the new rules beginning on January 1, 2015.  We believe that as of June 30, 2019, we meet all fully phased-in capital adequacy requirements.

On November 21, 2017, the OCC, the Federal Reserve and the FDIC finalized a proposed rule that extends the current treatment under the regulatory capital rules for certain regulatory capital deductions and risk weights and certain minority interest requirements, as they apply to banking organizations that are not subject to the advanced approaches capital rules.  Effective January 1, 2018, the rule also pauses the full transition to the Basel III treatment of mortgage servicing assets, certain deferred tax assets, investments in the capital of unconsolidated financial institutions and minority interests.  The agencies are also considering whether to make adjustments to the capital rules in response to CECL (the FASB Standard relating to current expected credit loss) and its potential impact on regulatory capital.

On December 7, 2017, the Basel Committee on Banking Supervision unveiled the latest round of its regulatory capital framework, commonly called “Basel IV.”  The framework makes changes to the capital framework first introduced as “Basel III” in 2010.  The committee targeted 2022-2027 as the timeframe for implementation by regulators in individual countries, including the U.S. federal bank regulatory agencies (after notice and comment).

The aforementioned capital conservation buffer is designed to absorb losses during periods of economic stress. Banking institutions with a ratio of CET1 capital to risk-weighted assets above the minimum but below the conservation buffer will face constraints on dividends, equity repurchases and compensation based on the amount of the shortfall.

As of June 30, 2019, our capital levels exceed all capital adequacy requirements under the Basel III Capital Rules as currently applicable to us.

31

On May 24, 2018, the EGRRCPA was enacted and, among other things, it includes a simplified capital rule change which effectively exempts banks with assets of less than $10 billion that exceed the “community bank leverage ratio,” from all risk-based capital requirements, including Basel III and its predecessors. The federal banking agencies must establish the “community bank leverage ratio” (a ratio of tangible equity to average consolidated assets) between 8% and 10% before community banks can begin to take advantage of this regulatory relief provision. Some of the Subsidiary Banks, with assets of less than $10 billion, may qualify for this exemption. Additionally, under the EGRRCPA, qualified bank holding companies with assets of up to $3 billion (currently $1 billion) will be eligible for the Federal Reserve’s Small Bank Holding Company Policy Statement, which eases limitations on the issuance of debt by holding companies. On August 28, 2018, the Federal Reserve issued an interim final rule expanding the applicability of its Small Bank Holding Company Policy Statement. While holding companies that meet the conditions of the policy statement are excluded from consolidated capital requirements, their depository institutions continue to be subject to minimum capital requirements. Finally, for banks that continue to be subject to the risk-based capital rules of Basel III (e.g., 150%), certain commercial real estate loans that were formally classified as high volatility commercial real estate 31 (“HVCRE”) will not be subject to heightened risk weights if they meet certain criteria. Also, while acquisition, development, and construction (“ADC”) loans will generally be subject to heightened risk weights, certain exceptions will apply. On September 18, 2018, the federal banking agencies issued a proposed rule modifying the agencies’ capital rules for HVCRE.

We had a CET1 to risk-weighted assets ratio of 17.82% on June 30, 2019 and 17.55% on December 31, 2018. We had a Tier 1 capital-to-average-total-asset (leverage) ratio of 16.03% and 15.87%, risk-weighted Tier 1 capital ratio of 19.04% and 19.06% and risk-weighted total capital ratio of 19.67% and 19.74% at June 30, 2019 and December 31, 2018, respectively. Our CET1 capital consists of common stock and related surplus, net of treasury stock, and retained earnings. We and our Subsidiary Banks elected to opt-out of the requirement to include most components of accumulated other comprehensive income (loss) in the calculation of CET1 capital. CET1 is reduced by goodwill and other intangible assets, net of associated deferred tax liabilities and subject to transition provisions. Tier 1 capital includes CET1 capital and additional Tier 1 capital. Additional Tier 1 capital includes the Capital and Common Securities issued by the Trusts (see Note 8 above) up to a maximum of 25% of Tier 1 capital on an aggregate basis. Any amount that exceeds the 25% threshold qualifies as Tier 2 capital. As of June 30, 2019, the total of $134,642,000 of the Capital and Common Securities outstanding qualified as Tier 1 capital. We actively monitor the regulatory capital ratios to ensure that our Subsidiary Banks are well-capitalized under the regulatory framework.

The CET1, Tier 1 and Total capital ratios are calculated by dividing the respective capital amounts by risk-weighted assets. Risk-weighted assets are calculated based on regulatory requirements and include total assets, excluding goodwill and other intangible assets, allocated by risk-weight category, and certain off-balance-sheet items, among other things. The leverage ratio is calculated by dividing Tier 1 capital by adjusted quarterly average total assets, which exclude goodwill and other intangible assets, among other things.

We and our Subsidiary Banks are subject to the regulatory capital requirements administered by the Federal Reserve, and, for our Subsidiary Banks, the FDIC. Regulatory authorities can initiate certain mandatory actions if we or any of our Subsidiary Banks fail to meet the minimum capital requirements, which could have a direct material effect on our financial statements. Management believes, as of June 30, 2019, that we and each of our Subsidiary Banks meet all capital adequacy requirements to which we are subject.

32

As used in this report, the words “Company,” “we,” “us” and “our” refer to International Bancshares Corporation, a Texas corporation, its five wholly-owned subsidiary banks, and other subsidiaries.  The information that follows may contain forward-looking statements, which are qualified as indicated under “Cautionary Notice Regarding Forward-Looking Statements” in Item 2 (Management’s Discussion and Analysis of Financial Condition and Results of Operations) of this report.  Our website address is www.ibc.com.

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

The following discussion should be read in conjunction with our consolidated financial statements, and notes thereto, for the year ended December 31, 2018, included in our 2018 Form 10-K. Operating results for the three and six months ended June 30, 2019 are not necessarily indicative of the results for the year ending December 31, 2019, or any future period.

Special Cautionary Notice Regarding Forward Looking Information

Certain matters discussed in this report, excluding historical information, include forward-looking statements, within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended, and are subject to the safe harbor created by these sections. Although we believe such forward-looking statements are based on reasonable assumptions, no assurance can be given that every objective will be reached. The words “estimate,” “expect,” “intend,” “believe” and “project,” as well as other words or expressions of a similar meaning are intended to identify forward-looking statements. Readers are cautioned not to place undue reliance on forward-looking statements, which speak only as of the date of this report. Such statements are based on current expectations, are inherently uncertain, are subject to risks and should be viewed with caution. Actual results and experience may differ materially from the forward-looking statements as a result of many factors.

Risk factors that could cause actual results to differ materially from any results that we project, forecast, estimate or budget in forward-looking statements include, among others, the following possibilities:

Local, regional, national and international economic business conditions and the impact they may have on us, our customers, and such customers’ ability to transact profitable business with us, including the ability of our borrowers to repay their loans according to their terms or a change in the value of the related collateral.
Volatility and disruption in national and international financial markets.
Government intervention in the U.S. financial system.
The unavailability of funding from the FHLB, Fed or other sources in the future could adversely impact our growth strategy, prospects and performance.
Changes in consumer spending, borrowing and saving habits.
Changes in interest rates and market prices, including, the repeal of federal prohibitions on the payment of interest on demand deposits.
Changes in the capital markets we utilize, including changes in the interest rate environment that may reduce margins.
Changes in state and/or federal laws and regulations, including the impact of the Consumer Financial Protection Bureau (“CFPB”) as a regulator of financial institutions, changes in the accounting, tax and regulatory treatment of trust preferred securities, as well as changes in banking, tax, securities, insurance, employment, environmental and immigration laws and regulations and the risk of litigation that may follow.
Changes in U.S.—Mexico trade, including, reductions in border crossings and commerce, renegotiation and recent changes made to the North American Free Trade Agreement, set to be replaced by the 2018 United States-Mexico-Canada Agreement or the possible imposition of tariffs on imported goods.
The reduction of deposits from nonresident alien individuals due to the IRS rules requiring U.S. financial institutions to report deposit interest payments made to such individuals.
The loss of senior management or operating personnel.
The timing, impact and other uncertainties of potential future acquisitions as well as our ability to maintain our current branch network and enter new markets to capitalize on growth opportunities.

33

Changes in estimates of future reserve requirements based upon periodic review thereof under relevant regulatory and accounting requirements.
Additions to our loan loss allowance as a result of changes in local, national or international conditions which adversely affect our customers.
Greater than expected costs or difficulties related to the development and integration of new products and lines of business.
Increased labor costs and effects related to health care reform and other laws, regulations and legal developments impacting labor costs.
Impairment of carrying value of goodwill could negatively impact our earnings and capital.
Changes in the soundness of other financial institutions with which we interact.
Political instability in the United States or Mexico.
Technological changes or system failures or breaches of our network security, as well as other cyber security risks, could subject us to increased operating costs, litigation and other liabilities.
Acts of war or terrorism.
Natural disasters.
Reduced earnings resulting from the write down of the carrying value of securities held in our securities available-for-sale portfolios.
The effect of changes in accounting policies and practices by the Public Company Accounting Oversight Board, the Financial Accounting Standards Board and other accounting standards setters.
The costs and effects of regulatory developments or regulatory or other governmental inquiries and the results of regulatory examinations or reviews and obtaining required regulatory approvals.
The effect of final rules amending Regulation E that prohibit financial institutions from charging consumer fees for paying overdrafts on ATM and one-time debit card transactions, as well as the effect of any other regulatory or legal developments that limit overdraft services.
The reduction of income and possible increase in required capital levels related to the adoption of legislation and the implementing rules and regulations, including those that establish debit card interchange fee standards and prohibit network exclusivity arrangements and routing restrictions.
The increase in required capital levels related to the implementation of capital and liquidity rules of the federal banking agencies that address or are impacted by the Basel III capital and liquidity standards.
The enhanced due diligence burden imposed on banks related to the banks’ inability to rely on credit ratings under Dodd-Frank.
Our failure or circumvention of ourinternal controls and risk management, policies and procedures.

Forward-looking statements speak only as of the date on which such statements are made. It is not possible to foresee or identify all such factors. We make no commitment to update any forward-looking statement, or to disclose any facts, events or circumstances after the date hereof that may affect the accuracy of any forward-looking statement, unless required by law.

Overview

We are headquartered in Laredo, Texas with 189 facilities and 288 ATMs, and provide banking services for commercial, consumer and international customers of North, South, Central and Southeast Texas and the State of Oklahoma. We are one of the largest independent commercial bank holding companies headquartered in Texas. We, through our Subsidiary Banks, are in the business of gathering funds from various sources and investing those funds in order to earn a return. We either directly or through a Subsidiary Bank, own an insurance agency, a liquidating subsidiary, a broker/dealer and a fifty percent interest in an investment banking unit that owns a broker/dealer. Our primary earnings come from the spread between the interest earned on interest-bearing assets and the interest paid on interest-bearing liabilities. In addition, we generate income from fees on products offered to commercial, consumer and international customers. The sales team of each of our Subsidiary Banks aims to match the right mix of products and services to each customer to best serve the customer’s needs. That process entails spending time with customers to assess those needs and servicing the sales arising from those discussions on a long-term basis. The Subsidiary Banks have various compensation plans, including incentive based compensation, for fairly compensating employees. The Subsidiary Banks also have a robust process in place to review sales that support the incentive based compensation plan

34

to monitor the quality of the sales and identify any significant irregularities, a process that has been in place for many years.

We are very active in facilitating trade along the United States border with Mexico. We do a large amount of business with customers domiciled in Mexico. Deposits from persons and entities domiciled in Mexico comprise a large and stable portion of the deposit base of our Subsidiary Banks. We also serve the growing Hispanic population through our facilities located throughout South, Central and Southeast Texas and the State of Oklahoma.

Expense control is an essential element in our long-term profitability. As a result, we monitor closely the efficiency ratio, which is a measure of non-interest expense to net interest income plus non-interest income. As we adjust to regulatory changes related to Dodd-Frank, including congressional efforts to revamp or reform it, our efficiency ratio may suffer because the additional regulatory compliance costs are expected to increase non-interest expense. We monitor this ratio over time to assess our efficiency relative to our peers. We use this measure as one factor in determining if we are accomplishing our long-term goals of providing superior returns to our shareholders.

Results of Operations

Summary

Consolidated Statements of Condition Information

    

    

    

 

June 30, 2019

December 31, 2018

Percent Increase (Decrease)

 

(Dollars in Thousands)

 

Assets

$

12,227,016

$

11,871,952

3.0

%

Net loans

 

6,784,498

 

6,499,905

 

4.4

Deposits

 

8,828,658

 

8,696,545

 

1.5

Securities sold under repurchase agreements

241,188

229,989

4.9

Other borrowed funds

 

808,376

 

705,665

 

14.6

Junior subordinated deferrable interest debentures

 

134,642

 

160,416

 

(16.1)

Shareholders’ equity

 

2,060,319

 

1,939,582

 

6.2

Consolidated Statements of Income Information

Three Months Ended

Six Months Ended

June 30,

Percent

June 30,

Percent

 

(Dollars in Thousands)

Increase

(Dollars in Thousands)

Increase

    

2019

    

2018

    

(Decrease)

    

2019

    

2018

    

(Decrease)

 

Interest income

$

126,860

$

115,066

 

10.2

%

$

250,923

$

226,473

 

10.8

%

Interest expense

 

15,078

 

12,793

 

17.9

 

29,732

 

24,928

 

19.3

Net interest income

 

111,782

 

102,273

 

9.3

 

221,191

 

201,545

 

9.7

Provision for probable loan losses

 

2,665

 

(2,730)

 

197.6

 

10,085

 

(1,068)

 

(1,044.3)

Non-interest income

 

34,416

 

42,303

 

(18.6)

 

70,545

 

81,278

 

(13.2)

Non-interest expense

 

79,613

 

80,601

 

(1.2)

 

152,564

 

149,510

 

2.0

Net income

 

50,020

 

52,887

 

(5.4)

%

 

101,926

 

106,307

 

(4.1)

%

Per common share:

Basic

$

.76

$

.80

 

(5.0)

%

$

1.55

$

1.61

 

(3.7)

%

Diluted

 

.76

 

.79

 

(3.8)

 

1.55

 

1.59

 

(2.5)

Net Income

Net income for the three and six months ended June 30, 2019 decreased by 5.4% and 4.1%, respectively, compared to the same periods of 2018. Net income for the three and six months ended June 30, 2019 continues to be positively affected by an increase in net interest income due to a higher volume of loans and an increase in the overall

35

yield of the loan portfolio. Interest expense increased for the three and six months ended June 30, 2019 and can be attributed primarily to an increase in the cost of borrowings expense, and an increase in the interest paid on savings and time deposit accounts, which have increased because of recent Federal Reserve Board actions to raise interest rates. Net income for 2019 was negatively impacted by an increase in the provision for probable loan losses due to a charge-off of $7.5 million, net of tax, on a relationship that was secured by real property on which car dealerships are operated.

Net Interest Income

Three Months Ended

Six Months Ended

    

June 30,

Percent

June 30,

Percent

(Dollars in Thousands)

Increase

(Dollars in Thousands)

Increase

2019

    

2018

    

(Decrease)

    

2019

    

2018

    

(Decrease)

 

Interest Income:

Loans, including fees

$

105,564

$

92,083

14.6

%

$

208,369

$

179,916

15.8

%

Investment securities:

Taxable

 

19,602

20,694

(5.3)

38,902

41,908

(7.2)

Tax-exempt

 

1,377

2,087

(34.0)

3,026

4,282

(29.3)

Other interest income

317

202

56.9

626

367

70.6

 

Total interest income

 

126,860

115,066

10.2

250,923

226,473

10.8

 

Interest expense:

 

Savings deposits

4,249

3,291

29.1

8,492

5,519

53.9

Time deposits

5,044

3,010

67.6

9,422

5,679

65.9

Securities sold under Repurchase agreements

 

591

348

69.8

1,180

1,371

(13.9)

Other borrowings

3,513

4,379

(19.8)

7,007

9,068

(22.7)

Junior subordinated interest deferrable debentures

 

1,681

1,765

(4.8)

3,631

3,291

10.3

 

Total interest expense

 

15,078

12,793

17.9

29,732

24,928

19.3

 

Net interest income

 

$

111,782

$

102,273

9.3

%

$

221,191

$

201,545

9.7

%

The increase in net interest income for the three and six months ended June 30, 2019 compared to the same period of 2018 can be primarily attributed to increased levels of interest income arising from an increase in loans outstanding. Interest expense on other borrowings consists of interest expense on FHLB borrowings and has steadily increased in line with increases in market interest rates as a result of Federal Reserve Board actions. Interest expense on savings and time deposits for the same periods also increased in line with internal rate increases paid on such deposits in line with market interest rates as a result of Federal Reserve Board actions and to remain competitive with competitors in the markets we serve. Net interest income is the spread between income on interest earning assets, such as loans and securities, and the interest expense on liabilities used to fund those assets, such as deposits, repurchase agreements and funds borrowed. As part of our strategy to manage interest rate risk, we strive to manage both assets and liabilities so that interest sensitivities match. One method of calculating interest rate sensitivity is through gap analysis. A gap is the difference between the amount of interest rate sensitive assets and interest rate sensitive liabilities that re-price or mature in a given time period. Positive gaps occur when interest rate sensitive assets exceed interest rate sensitive liabilities, and negative gaps occur when interest rate sensitive liabilities exceed interest rate sensitive assets. A positive gap position in a period of rising interest rates should have a positive effect on net interest income as assets will re-price faster than liabilities. Conversely, net interest income should contract somewhat in a period of falling interest rates. Our management can quickly change our interest rate position at any given point in time as market conditions dictate. Additionally, interest rate changes do not affect all categories of assets and liabilities equally or at the same time. Analytical techniques we employ to supplement gap analysis include simulation analysis to quantify interest rate risk exposure. The gap analysis prepared by management is reviewed by our Investment Committee twice a year (see table on page 42 for the June 30, 2019 gap analysis). Our management currently believes that we are properly positioned for interest rate changes; however if our management determines at any time that the we are not properly positioned, we will strive to adjust the interest rate sensitive assets and liabilities in order to manage the effect of interest rate changes.

36

Non-Interest Income

Three Months Ended

Six Months Ended

June 30,

Percent

June 30,

Percent

(Dollars in Thousands)

Increase

(Dollars in Thousands)

Increase

    

2019

    

2018

    

(Decrease)

    

2019

    

2018

    

(Decrease)

 

Service charges on deposit accounts

$

17,610

$

17,555

0.3

%

$

34,870

$

35,267

(1.1)

%

Other service charges, commissions and fees

Banking

11,764

11,152

5.5

22,640

22,274

1.6

Non-banking

2,238

2,028

10.4

3,747

3,388

10.6

Investment securities transactions, net

(6)

100.0

(10)

100.0

Other investments, net

(1,703)

5,841

(129.2)

2,245

10,567

(78.8)

Other income

4,513

5,727

(21.2)

7,053

9,782

(27.9)

Total non-interest income

$

34,416

$

42,303

(18.6)

%

$

70,545

$

81,278

(13.2)

%

Total non-interest income for the three and six months ended June 30, 2019 decreased 18.6% and 13.2%, respectively, compared to the same periods of 2018. Non-interest income from other investments in 2019 was primarily negatively impacted by the impairment of an equity investment of $3.7 million, net of tax as a result of a re-evaluation of the carrying value. Other income for the three and six months ended June 30, 2018 was positively impacted by our share of income from a real estate development partnership in which it holds a majority interest.

Non-Interest Expense

Three Months Ended

Six Months Ended

June 30,

Percent

June 30,

Percent

(Dollars in Thousands)

Increase

(Dollars in Thousands)

Increase

    

2019

    

2018

    

(Decrease)

    

2019

    

2018

    

(Decrease)

    

Employee compensation and benefits

    

$

37,246

    

$

34,692

    

7.4

%

$

73,655

$

69,310

6.3

%

Occupancy

 

6,580

 

7,163

 

(8.1)

 

12,957

 

13,238

(2.1)

Depreciation of bank premises and equipment

 

7,032

 

6,364

 

10.5

 

14,013

 

12,637

10.9

Professional fees

 

3,745

 

3,375

 

11.0

 

7,337

 

5,947

23.4

Deposit insurance assessments

 

859

 

974

 

(11.8)

 

1,642

 

1,974

(16.8)

Net expense, other real estate owned

 

1,203

 

2,649

 

(54.6)

 

2,198

 

2,378

(7.6)

Advertising

 

2,081

 

1,808

 

15.1

 

4,163

 

3,647

14.1

Software and software maintenance

5,003

4,390

14.0

9,500

8,462

12.3

Other

 

15,864

 

19,186

 

(17.3)

 

27,099

 

31,917

(15.1)

Total non-interest expense

$

79,613

$

80,601

 

(1.2)

%

$

152,564

$

149,510

2.0

%

Non-interest expense for the three and six months ended June 30, 2019 decreased 1.2% and increased 2.0%, respectively, compared to the same period of 2018. Non-interest expense for the three and six months ended June 30, 2019 was also negatively impacted by an increase in costs on our compensation and benefit plans as a result of our continued review of the programs and increases, when necessary to fairly compensate our staff based on their performance and remain competitive, as well as an increase in depreciation expense as we continue to invest in our network infrastructure, equipment and facilities.

Financial Condition

Allowance for Probable Loan Losses

The allowance for probable loan losses decreased 5.2% to $58,203,000 at June 30, 2019 from $61,384,000 at December 31, 2018. The provision for probable loan losses charged to expense increased 197.6% and 1,044.3% for the

37

three and six months ended June 30, 2019 to $2,665,000 and $10,085,000, respectively, compared to $(2,730,000) and $(1,068,000) for the same periods of 2018. The increase in provision for probable loan losses charged to expense for 2019 can be attributed to a specific reserve on a relationship that is secured by multiple pieces of real property on which car dealerships are operated. The relationship began deteriorating in the fourth quarter of 2018, triggered by significant fraud by a high level insider of the car dealerships resulting in the dealerships unexpectedly filing for bankruptcy and creating an exposure for potential loss since the operations of the car dealerships were the source of repayment from the borrower. The relationship further deteriorated in the first quarter of 2019 after the sponsor of the court approved debtor in possession plan discontinued its role in the process and thus did not fulfill its obligation to assume full responsibility of the accrued and unpaid interest. Although the relationship is secured by real property (the dealerships’ real estate), the real property has specialized use, contributing to the potential exposure for probable loss. During the first quarter of 2019, in light of the circumstances and management’s evaluation of the relationship, the decision was made to place the relationship on impaired, non-accrual status and place a specific reserve on the relationship in the amount of $9.5 million. During the second quarter of 2019, management continued to evaluate the relationship and decided to foreclose on the underlying real estate collateral. The allowance for probable loan losses was .85% and .94% of total loans at June 30, 2019 and December 31, 2018, respectively.

Investment Securities

Residential mortgage-backed debt securities are securities primarily issued by Freddie Mac, Fannie Mae, or Ginnie Mae. Investments in debt residential mortgage-backed securities issued by Ginnie Mae are fully guaranteed by the U.S. Government. Investments in debt residential mortgage-backed securities issued by Freddie Mac and Fannie Mae are not fully guaranteed by the U.S. Government, however, we believe that the quality of the bonds is similar to other AAA rated bonds with limited credit risk, particularly given the placement of Fannie Mae and Freddie Mac into conservatorship by the federal government in early September 2008 and because securities issued by others that are collateralized by residential mortgage-backed securities issued by Fannie Mae or Freddie Mac are rated consistently as AAA rated securities.

Loans

Net loans increased by 4.4% to $6,784,498,000 at June 30, 2019, from $6,499,905,000 at December 31, 2018.

Deposits

Deposits increased by 1.5% to $8,828,658,000 at June 30, 2019, compared to $8,696,545,000 at December 31, 2018. Although deposits at June 30, 2019 increased from December 31, 2018, and we have experienced some growth in deposits over the last few years, we are still experiencing a substantial amount of competition for deposits at higher than market rates. As a result, we have attempted to maintain certain deposit relationships but have allowed certain deposits to leave as the result of aggressive pricing by competitors.

Foreign Operations

On June 30, 2019, we had $12,227,016,000 of consolidated assets, of which approximately $148,178,000, or 1.2%, was related to loans outstanding to borrowers domiciled in foreign countries, compared to $150,517,000, or 1.3%, at December 31, 2018. Of the $148,178,000, 85.3% is directly or indirectly secured by U.S. assets, certificates of deposits and real estate; 14.5% is secured by foreign real estate or other assets; and 0.2% is unsecured.

Critical Accounting Policies

We have established various accounting policies that govern the application of accounting principles in the preparation of our consolidated financial statements. The significant accounting policies are described in the notes to the consolidated financial statements. Certain accounting policies involve significant subjective judgments and assumptions by management that have a material impact on the carrying value of certain assets and liabilities; management considers such accounting policies to be critical accounting policies.

38

We consider our allowance for probable loan losses as a policy critical to the sound operations of the Subsidiary Banks. The allowance for probable loan losses primarily consists of the aggregate loan loss allowances of the Subsidiary Banks. The allowances are established through charges to operations in the form of provisions for probable loan losses. Loan losses or recoveries are charged or credited directly to the allowances. The allowance for probable loan losses of each Subsidiary Bank is maintained at a level considered appropriate by management, based on estimated probable losses in the loan portfolio. The allowance is derived from the following elements: (i) allowances established on specific impaired loans, which are based on a review of the individual characteristics of each loan, including the customer’s ability to repay the loan, the underlying collateral values, and the industry in which the customer operates; (ii) allowances based on actual historical loss experience for similar types of loans in our loan portfolio; and (iii) allowances based on general economic conditions, changes in the mix of loans, company resources, border risk and credit quality indicators, among other things. See also discussion regarding the allowance for probable loan losses and provision for probable loan losses included in the results of operations and “Provision and Allowance for Probable Loan Losses” included in Notes 1 and 4 of the notes to Consolidated Financial Statements in our latest Annual Report on Form 10-K for further information regarding our provision and allowance for probable loan losses policy.

Liquidity and Capital Resources

The maintenance of adequate liquidity provides our Subsidiary Banks with the ability to meet potential depositor withdrawals, provide for customer credit needs, maintain adequate statutory reserve levels and take full advantage of high-yield investment opportunities as they arise. Liquidity is afforded by access to financial markets and by holding appropriate amounts of liquid assets. Our Subsidiary Banks derive their liquidity largely from deposits of individuals and business entities. Deposits from persons and entities domiciled in Mexico comprise a stable portion of the deposit base of our Subsidiary Banks. Other important funding sources for our Subsidiary Banks during 2019 and 2018 were borrowings from the FHLB, securities sold under repurchase agreements and large certificates of deposit, requiring management to closely monitor our asset/liability mix in terms of both rate sensitivity and maturity distribution. The borrowings from FHLB are primarily short-term in nature and are renewed at maturity. Our Subsidiary Banks have had a long-standing relationship with the FHLB and keep open unused lines of credit in order to fund liquidity needs. In the event that the FHLB bank indebtedness is not renewed, the repayment of the outstanding indebtedness would more than likely be repaid through proceeds generated from the sales of unpledged, available-for-sale securities. We maintain a sizable, high quality investment portfolio to provide significant liquidity. These securities can be sold, or sold under agreements to repurchase, to provide immediate liquidity. We will continue to monitor the volatility and cost of funds in an attempt to match maturities of rate-sensitive assets and liabilities and respond accordingly to anticipated fluctuations in interest rates over reasonable periods of time.

We maintain an adequate level of capital as a margin of safety for our depositors and shareholders. At June 30, 2019, shareholders’ equity was $2,060,319,000 compared to $1,939,582,000 at December 31, 2018. The increase in shareholders’ equity can be primarily attributed to the retention of earnings offset by the payment of dividends to shareholders’ and a decrease in other comprehensive loss.

Banks and bank holding companies are subject to various regulatory capital requirements administered by state and federal banking agencies. Capital adequacy guidelines and, additionally for banks, prompt corrective action regulations, involve quantitative measures of assets, liabilities, and certain off-balance sheet items calculated under regulatory accounting practices. Capital amount and classifications are also subject to qualitative judgements by regulators about components, risk-weighting and other factors.

In July 2013, the Federal Deposit Insurance Corporation (“FDIC”) and other regulatory bodies established a new, comprehensive capital framework for U.S. banking organizations, consisting of minimum requirements that increase both the quantity and quality of capital held by banking organizations. The final rules are a result of the implementation of the BASEL III capital reforms and various Dodd-Frank Act related capital provisions. Consistent with the Basel international framework, the rules include a minimum ratio of Common Equity Tier 1 (“CET1”) to risk-weighted assets of 4.5% and a CET1 capital conservation buffer of 2.5% of risk-weighted assets.  The capital conservation buffer began phasing-in on January 1, 2016 at .625% and increased each year until January 1, 2019, when we were required to have a 2.5% capital conservation buffer, effectively resulting in a minimum ratio of CET1 capital to risk-weighted assets of at least 7% upon full implementation. The rules also raised the minimum ratio of Tier 1 capital to risk-weighted assets from 4% to 6% and

39

include a minimum leverage ratio of 4% for all banking organizations. Regarding the quality of capital, the rules emphasize CET1 capital and implements strict eligibility criteria for regulatory capital instruments. The rules also improve the methodology for calculating risk-weighted assets to enhance risk sensitivity. The rules were subject to a four year phase in period for mandatory compliance and we were required to begin to phase in the rules beginning on January 1, 2015.  Management believes, as of June 30, 2019, that we and each of our Subsidiary Banks meet all fully phased-in capital adequacy requirements.

On November 21, 2017, the Office of the Comptroller of the Currency (“OCC”), the FRB and the FDIC finalized a proposed rule that extends the current treatment under the regulatory capital rules for certain regulatory capital deductions and risk weights and certain minority interest requirements, as they apply to banking organizations that are not subject to the advanced approaches capital rules.  Effective January 1, 2018, the rule also pauses the full transition to the Basel III treatment of mortgage servicing assets, certain deferred tax assets, investments in the capital of unconsolidated financial institutions and minority interests.  The agencies are also considering whether to make adjustments to the capital rules in response to CECL (the FASB Standard relating to current expected credit loss) and its potential impact on regulatory capital.

On December 7, 2017, the Basel Committee on Banking Supervision unveiled the latest round of its regulatory capital framework, commonly called “Basel IV.”  The framework makes changes to the capital framework first introduced as “Basel III” in 2010.  The committee targeted 2022-2027 as the timeframe for implementation by regulators in individual countries, including the U.S. federal bank regulatory agencies (after notice and comment).

In December 2018, the federal banking regulators issued a final rule that would provide an optional three-year phase-in period for the day-one regulatory capital effects of the adoption of Accounting Standards Update (“ASU”) 2016-13 to ASC 326, “Financial Instruments – Credit Losses,” as amended, on January 1, 2020.

On May 24, 2018, the EGRRCPA was enacted and, among other things, it includes a simplified capital rule change which effectively exempts banks with assets of less than $10 billion that exceed the “community bank leverage ratio,” from all risk-based capital requirements, including Basel III and its predecessors. The federal banking agencies must establish the “community bank leverage ratio” (a ratio of tangible equity to average consolidated assets) between 8% and 10% before community banks can begin to take advantage of this regulatory relief provision. Some of the Subsidiary Banks, with assets of less than $10 billion, may qualify for this exemption. Additionally, under the EGRRCPA, qualified bank holding companies with assets of up to $3 billion (currently $1 billion) will be eligible for the Federal Reserve’s Small Bank Holding Company Policy Statement, which eases limitations on the issuance of debt by holding companies. On August 28, 2018, the Federal Reserve issued an interim final rule expanding the applicability of its Small Bank Holding Company Policy Statement. While holding companies that meet the conditions of the policy statement are excluded from consolidated capital requirements, their depository institutions continue to be subject to minimum capital requirements. Finally, for banks that continue to be subject to the risk-based capital rules of Basel III (e.g., 150%), certain commercial real estate loans that were formally classified as high volatility commercial real estate 31 (“HVCRE”) will not be subject to heightened risk weights if they meet certain criteria. Also, while acquisition, development, and construction (“ADC”) loans will generally be subject to heightened risk weights, certain exceptions will apply. On September 18, 2018, the federal banking agencies issued a proposed rule modifying the agencies’ capital rules for HVCRE.

We had a CET1 to risk-weighted assets ratio of 17.82% on June 30, 2019 and 17.55% on December 31, 2018. We had a Tier 1 capital-to-average-total-asset (leverage) ratio of 16.03% and 15.87%, risk-weighted Tier 1 capital ratio of 19.04% and 19.06% and risk-weighted total capital ratio of 19.67% and 19.74% at June 30, 2019 and December 31, 2018, respectively. Our CET1 capital consists of common stock and related surplus, net of treasury stock, and retained earnings. We and our Subsidiary Banks elected to opt-out of the requirement to include most components of accumulated other comprehensive income (loss) in the calculation of CET1 capital. CET1 is reduced by goodwill and other intangible assets, net of associated deferred tax liabilities and subject to transition provisions. Tier 1 capital includes CET1 capital and additional Tier 1 capital. Additional Tier 1 capital includes the Capital and Common Securities issued by the Trusts (see Note 8 above) up to a maximum of 25% of Tier 1 capital on an aggregate basis. Any amount that exceeds the 25% threshold qualifies as Tier 2 capital. As of June 30, 2019, the total of $134,642,000 of the Capital and Common Securities outstanding qualified as Tier 1 capital. We actively monitor the regulatory capital ratios to ensure that our Subsidiary Banks are well-capitalized under the regulatory framework.

40

The CET1, Tier 1 and Total capital ratios are calculated by dividing the respective capital amounts by risk-weighted assets. Risk-weighted assets are calculated based on regulatory requirements and include total assets, excluding goodwill and other intangible assets, allocated by risk-weight category, and certain off-balance-sheet items, among other things. The leverage ratio is calculated by dividing Tier 1 capital by adjusted quarterly average total assets, which exclude goodwill and other intangible assets, among other things.

We and our Subsidiary Banks are subject to the regulatory capital requirements administered by the Federal Reserve, and, for our Subsidiary Banks, the FDIC. Regulatory authorities can initiate certain mandatory actions if we or any of our Subsidiary Banks fail to meet the minimum capital requirements, which could have a direct material effect on our financial statements. Management believes, as of June 30, 2019, that we and each of our Subsidiary Banks meet all capital adequacy requirements to which we are subject.

We will continue to monitor the volatility and cost of funds in an attempt to match maturities of rate-sensitive assets and liabilities, and respond accordingly to anticipate fluctuations in interest rates by adjusting the balance between sources and uses of funds as deemed appropriate. The net-interest rate sensitivity as of June 30, 2019 is illustrated in the table entitled “Interest Rate Sensitivity,” below. This information reflects the balances of assets and liabilities for which rates are subject to change. A mix of assets and liabilities that are roughly equal in volume and re-pricing characteristics represents a matched interest rate sensitivity position. Any excess of assets or liabilities results in an interest rate sensitivity gap.

We undertake an interest rate sensitivity analysis to monitor the potential risk on future earnings resulting from the impact of possible future changes in interest rates on currently existing net asset or net liability positions. However, this type of analysis is as of a point-in-time position, when in fact that position can quickly change as market conditions, customer needs, and management strategies change. Thus, interest rate changes do not affect all categories of assets and liabilities equally or at the same time. As indicated in the table, we are asset sensitive in both the short and long term scenarios. Our Asset and Liability Committee semi-annually reviews the consolidated position along with simulation and duration models, and makes adjustments as needed to control our interest rate risk position. We use modeling of future events as a primary tool for monitoring interest rate risk.

41

Interest Rate Sensitivity

(Dollars in Thousands)

Rate/Maturity

Over 3

Over 1

3 Months

Months to

Year to 5

Over 5

June 30, 2019

or Less

1 Year

Years

Years

Total

(Dollars in Thousands)

Rate sensitive assets

    

    

    

    

    

Investment securities

$

208,245

$

562,968

$

2,577,534

$

127,693

$

3,476,440

Loans, net of non-accruals

 

5,358,077

 

223,486

 

139,047

 

1,106,373

 

6,826,983

Total earning assets

$

5,566,322

$

786,454

$

2,716,581

$

1,234,066

$

10,303,423

Cumulative earning assets

$

5,566,322

$

6,352,776

$

9,069,357

$

10,303,423

Rate sensitive liabilities

Time deposits

$

846,544

$

961,406

$

161,366

$

109

$

1,969,425

Other interest bearing deposits

 

3,304,326

 

 

 

 

3,304,326

Securities sold under repurchase agreements

 

240,118

 

1,070

 

 

 

241,188

Other borrowed funds

 

371,775

 

 

 

436,601

 

808,376

Junior subordinated deferrable interest debentures

 

134,642

 

 

 

 

134,642

Total interest bearing liabilities

$

4,897,405

$

962,476

$

161,366

$

436,710

$

6,457,957

Cumulative sensitive liabilities

$

4,897,405

$

5,859,881

$

6,021,247

$

6,457,957

Repricing gap

$

668,917

$

(176,022)

$

2,555,215

$

797,356

$

3,845,466

Cumulative repricing gap

 

668,917

 

492,895

 

3,048,110

 

3,845,466

Ratio of interest-sensitive assets to liabilities

 

1.14

 

0.82

 

16.83

 

2.83

 

1.60

Ratio of cumulative, interest-sensitive assets to liabilities

 

1.14

 

1.08

 

1.51

 

1.60

Item 3. Quantitative and Qualitative Disclosures about Market Risk

During the three and six months ended June 30, 2019, there were no material changes in market risk exposures that affected the quantitative and qualitative disclosures regarding market risk presented under the caption “Liquidity and Capital Resources” located on pages 18 through 22 of our 2018 Annual Report as filed as Exhibit 13 to our Form 10-K for the year ended December 31, 2018.

42

Item 4. Controls and Procedures

Disclosure Controls and Procedures

We maintain disclosure controls and procedures designed to ensure that information required to be disclosed in reports filed under the Securities Exchange Act of 1934, as amended, is recorded, processed, summarized and reported within specified time periods. As of the end of the period covered by this Quarterly Report on Form 10-Q, our principal executive officer and principal financial officer evaluated, with the participation of our management, the effectiveness of our disclosure controls and procedures (as defined in Exchange Act rules 13a-15(e) and 15d-15(e)). Based on the evaluation, which disclosed no material weaknesses, our principal executive officer and principal financial officer concluded that our disclosure controls and procedures were effective as of the end of the period covered by this report.

Internal Control Over Financial Reporting

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

PART II - OTHER INFORMATION

Item 1. Legal Proceedings

We are involved in various legal proceedings that are in various stages of litigation. We have determined, based on discussions with our counsel that any material loss in any current legal proceedings, individually or in the aggregate, is remote or the damages sought, even if fully recovered, would not be considered material to our consolidated financial position or results of operations. However, many of these matters are in various stages of proceedings and further developments could cause management to revise its assessment of these matters.

1A. Risk Factors

There were no material changes in the risk factors as previously disclosed in Item 1A to Part I of our Annual Report on Form 10-K for the fiscal year ended December 31, 2018.

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

In April 2009, following receipt of the Treasury Department’s consent, the Board of Directors re-established a formal stock repurchase program that authorized the repurchase of up to $40 million of common stock within the following 12 months. Annually since then, including on March 11, 2019, the Board of Directors extended the repurchase program and this year authorized an increase to purchase up to $50 million of common stock during the 12 month period commencing again on April 9, 2019. Shares of common stock may be purchased from time to time on the open market or through privately negotiated transactions. Shares purchased in this program will be held in treasury for reissue for various corporate purposes, including employee compensation plans. During the first quarter of 2019, the Board of Directors adopted a Rule 10b5-1 trading plan, and intends to adopt additional Rule 10b5-1 trading plans, that will allow us to purchase shares of our common stock during certain trading blackout periods when we ordinarily would not be in the market due to trading restrictions in our insider trading policy. During the term of a Rule 10b5-1 trading plan, purchases of common stock are automatic to the extent the conditions of the plan’s trading instructions are met. Shares purchased under the Rule 10b5-1 trading plan will be held in treasury for reissue for various corporate purposes, including employee stock compensation plans. As of August 5, 2019, a total of 9,803,514 shares had been repurchased under all programs at a cost of $311,433,000 We are not obligated to purchase shares under our stock repurchase program outside of its Rule 10b5-1 trading plan.

43

Except for repurchases in connection with the administration of an employee benefit plan in the ordinary course of business and consistent with past practices, common stock repurchases are only conducted under publicly announced repurchase programs approved by the Board of Directors. The following table includes information about common stock share repurchases for the quarter ended June 30, 2019.

    

    

    

Total Number of

    

Shares

Purchased as

Approximate

Average

Part of a

Dollar Value of

Total Number

Price Paid

Publicly-

Shares Available

of Shares

Per

Announced

for

Purchased

Share

Program

Repurchase(1)

April 1 – April 30, 2019

 

1,953

$

38.03

 

$

49,926,000

May 1 – May 31, 2019

 

 

 

 

49,926,000

June 1 – June 30, 2019

 

 

 

 

49,926,000

Total

 

1,953

$

38.03

 

(1)The repurchase program was extended and increased on March 11, 2019 and allows for the purchase of up to an additional $50,000,000 of common stock through April 9, 2020.

Item 6. Exhibits

The following exhibits are filed as a part of this Report:

31(a) —Certification of Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002

31(b) —Certification of Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002

32(a) —Certification of Chief Executive Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002

32(b) —Certification of Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002

101++ — Interactive Data File

++ Attached as Exhibit 101 to this report are the following documents formatted in Inline XBRL (Extensible Business Reporting Language): (i) the Condensed Consolidated Statement of Earnings for the three and six months ended June 30, 2019 and 2018; (ii) the Condensed Consolidated Balance Sheet as of June 30, 2019 and December 31, 2018; and (iii) the Condensed Consolidated Statement of Cash Flows for the six months ended June 30, 2019 and June 30, 2018.

44

SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

INTERNATIONAL BANCSHARES CORPORATION

Date:

August 8, 2019

/s/ Dennis E. Nixon

Dennis E. Nixon

President

Date:

August 8, 2019

/s/ Judith I. Wawroski

Judith I. Wawroski

Treasurer

45