International Bancshares Corporation — 3Q 2012 Form 10-Q Summary
Business context and reporting period
International Bancshares Corporation is a Texas-based bank holding company serving commercial, consumer and international customers in South, Central and Southeast Texas and Oklahoma, with significant cross-border activity involving Mexico. The unaudited report covers the three and nine months ended September 30, 2012, with balance-sheet comparisons to December 31, 2011 and income and cash-flow comparisons to the same periods of 2011. Dollar amounts are in thousands except per-share data.
Key financial metrics
- Assets: $12.117 billion, up 3.2% from December 31, 2011.
- Loans: Gross loans were $4.883 billion, down 3.4%; net loans were $4.810 billion, down 3.2%. Management attributed the decline primarily to weak loan demand.
- Deposits: $7.991 billion, up 0.6%. Non-interest-bearing demand deposits increased $182.5 million, while time deposits declined $114.5 million.
- Investment securities: $5.727 billion, up from $5.216 billion, including $5.725 billion of available-for-sale securities. The portfolio was predominantly residential mortgage-backed securities.
- Third-quarter revenue and earnings: Net interest income was $76.4 million, non-interest income was $74.0 million, and net income was $25.9 million. Net income available to common shareholders was $22.0 million, or $0.33 basic and diluted EPS.
- Nine-month revenue and earnings: Net interest income was $225.1 million, non-interest income was $158.0 million, and net income was $82.1 million. Net income available to common shareholders was $71.6 million, or $1.06 basic and diluted EPS.
- Margins and efficiency: The filing does not provide a clear net interest margin. Calculated non-interest expense divided by net interest income plus non-interest income was approximately 70.6% for the third quarter and 64.4% for the nine-month period, including the $31.6 million repurchase-agreement termination charge.
- Credit quality: The allowance for probable loan losses was $72.7 million, or 1.5% of gross loans, versus $84.2 million, or 1.7%, at year-end 2011. Non-accrual loans declined to $75.5 million from $118.5 million.
- Cash flow: Nine-month operating cash flow was $118.6 million, versus $196.8 million in 2011. Investing activities used $49.0 million, compared with $233.9 million provided in 2011. Financing activities used $71.4 million, compared with $399.0 million used in 2011. Cash and cash equivalents ended at $260.1 million.
- Debt and funding: Other borrowed funds increased 24.5% to $615.1 million. Repurchase agreements declined to $1.174 billion from $1.349 billion. Junior subordinated deferrable interest debentures remained $190.7 million.
- Capital and liquidity: Shareholders’ equity was $1.605 billion. The leverage ratio was 12.79%, risk-weighted Tier 1 capital was 21.77%, and risk-weighted total capital was 22.93%. Management stated that liquidity and capital remained adequate.
Material changes versus prior comparable period
- Third-quarter net income available to common shareholders decreased 19.3%, and nine-month earnings decreased 17.6%. EPS declined from $0.41 to $0.33 for the quarter and from $1.28 to $1.06 for nine months.
- Net interest income declined 5.2% in the quarter and 8.4% year to date as loan demand remained weak and investment-security yields declined. Interest expense fell 24.5% and 20.2%, respectively, partly offsetting lower interest income.
- Non-interest income increased 44.5% in the quarter and 7.2% year to date, primarily because of gains on available-for-sale securities. Net securities gains were $32.9 million in the quarter and $35.5 million year to date, versus $6.6 million and $9.4 million in the comparable 2011 periods.
- Banking service charges and fees declined, reflecting regulatory changes affecting interchange income and overdraft programs.
- Non-interest expense increased 32.6% in the quarter and 2.9% year to date. The third quarter included a one-time $31.55 million early termination fee on long-term repurchase agreements.
- The provision for probable loan losses increased to $16.7 million for nine months from $7.8 million, despite lower loans and a lower ending allowance. Other real estate owned and related credit exposures continued to require monitoring.
- The company repurchased 6,894 common shares during the quarter at an average price of $17.58, with approximately $39.5 million remaining under the authorized program at September 30, 2012.
- The company redeemed $40 million of TARP preferred stock in July 2012. A further $45 million redemption occurred on November 1, 2012, after the reporting date.
Outlook, management commentary, risks and unusual items
Management did not provide specific quantitative earnings or revenue guidance. It expects operating results to remain sensitive to loan demand, interest rates, deposit pricing, regulatory changes and credit conditions. Management stated that Texas and Oklahoma markets were improving and that collateral and guarantor support mitigated potential losses, while acknowledging that the prolonged economic downturn continued to affect the loan portfolio.
- Interest-rate risk: The company was liability-sensitive in the earliest repricing period, with a three-month repricing gap of negative $863.7 million, and asset-sensitive over longer periods. Falling rates could pressure net interest income.
- Credit risk: Real-estate collateral values, construction and land-development credits, commercial real estate, unemployment and broader economic conditions could increase future provisions or charge-offs.
- Investment securities: The company held $14.1 million of gross unrealized losses in available-for-sale securities and recorded $0.6 million of credit-related impairment charges year to date. Non-agency mortgage-backed securities were valued using Level 3 assumptions concerning prepayments, defaults and loss severity.
- Funding and liquidity: The company relies on deposits, Federal Home Loan Bank borrowings, repurchase agreements and other external financing. Competition for deposits and funding-market disruption could raise costs or limit availability.
- Regulatory and operating risks: Dodd-Frank requirements, interchange and overdraft restrictions, potential Basel III capital rules, regulatory oversight, cybersecurity, litigation and U.S.-Mexico trade conditions may affect revenue, expenses and capital.
- Legal and tax matters: Various lender-liability proceedings were assessed as unlikely to result in material losses. A previously disputed LFIN tax judgment of approximately $24.4 million was paid in February 2012 and the matter was concluded. A $1.2 million Texas franchise-tax refund reduced the effective tax rate to 31% for the nine months.
- Controls: Management reported effective disclosure controls, no material weaknesses and no material changes to internal control over financial reporting.
Important facts for investors to verify
- Whether loan demand, gross loans and net interest income stabilize or continue to decline.
- Whether the $31.55 million repurchase-agreement termination charge and unusually large securities gains distort the sustainability of reported earnings.
- Future credit losses, non-accrual loans, impaired loans, other real estate owned and adequacy of the $72.7 million allowance.
- The composition, duration, fair-value sensitivity and credit performance of the $5.7 billion securities portfolio, particularly Level 3 and non-agency mortgage-backed securities.
- Deposit retention, pricing pressure, reliance on repurchase agreements and the 24.5% increase in other borrowed funds.
- Capital effects of additional TARP preferred-stock redemptions, dividends, stock repurchases and evolving regulatory capital requirements.