IBOC

Business Context and Reporting Period

Company: International Bancshares Corporation (International Bancshares Corp)

Filing Type: Form 10-Q (Quarterly Report)

Reporting Period: Quarter and six months ended June 30, 2009

Overview: The Company is a Texas-based bank holding company operating primarily in South, Central, and Southeast Texas and Oklahoma. It serves commercial, consumer, and international customers, with significant exposure to the U.S.-Mexico border trade. The Company operates as a single segment and is a participant in the TARP Capital Purchase Program.

Key Financial Metrics

Capital Ratios (June 30, 2009): Tier 1 Leverage Ratio: 10.37%; Risk-Weighted Tier 1 Capital Ratio: 16.64%; Risk-Weighted Total Capital Ratio: 17.89%.

Material Changes vs. Prior Period

• Net Income: Increased 3.2% year-over-year for the six-month period to $68.7 million, despite a significant rise in loan loss provisions. Q2 2009 net income decreased 5.8% compared to Q2 2008.
• Net Interest Income: Increased 25.3% year-over-year to $197.7 million, driven by a substantial reduction in interest expense (down 40.0%) due to lower funding costs and the Federal Reserve's reduction of the prime rate.
• Provision for Loan Losses: Surged 520.6% to $35.1 million for the six months ended June 30, 2009, compared to $5.7 million in the prior year. This reflects management's response to economic weakness and increased charge-offs ($24.2 million).
• Loan Portfolio: Total loans decreased 2.2% to $5.74 billion, attributed to reduced demand due to negative economic conditions.
• Borrowings: "Other borrowed funds" decreased 47.5% to $1.32 billion, indicating a reduction in reliance on Federal Home Loan Bank borrowings.
• Non-Interest Expense: Increased 5.4% to $155.4 million, largely due to professional fees (up 100.1%) driven by a $5.1 million FDIC special assessment and costs associated with aggressive branch expansion (15 new branches in 2009).

Guidance, Outlook, Risks, and Unusual Items

• Outlook: Management notes that while Texas and Oklahoma economies are stronger than national averages, they are not immune to the recession. The increase in loan loss provisions is not necessarily an indicator of future provision levels at the same magnitude.
• Unusual Items:
  • FDIC Special Assessment: The Company accrued $5.1 million for a special assessment levied by the FDIC to rebuild the Deposit Insurance Fund, negatively impacting earnings by approximately $3.3 million after-tax.
  • Security Sales: Non-interest income included $11.7 million in gains from the sale of investment securities (primarily mortgage-backed securities) for the six-month period.
• Risks and Contingencies:
  • Credit Risk: Impaired loans totaled $153.1 million (down from $164.9 million at year-end 2008). Management believes collateral and guarantor support mitigate potential losses.
  • Legal/Tax: The Company is involved in various "lender liability" lawsuits, deemed remote for material loss. Additionally, the IRS issued a Notice of Final Partnership Administrative Adjustments (FPAA) regarding lease-financing transactions, for which the Company has expensed approximately $25.7 million in adjustments and interest.
  • TARP Restrictions: Participation in the TARP Capital Purchase Program restricts stock repurchases and dividend payments unless approved by the Treasury. The Company obtained consent to repurchase up to $40 million of stock and pay quarterly dividends.

Investor Verification Checklist

• Loan Loss Adequacy: Verify the sufficiency of the $84.96 million allowance for loan losses (1.5% of total loans) given the 520% increase in the provision and the $24.2 million in charge-offs.
• Impaired Loan Composition: Review the $153.1 million in impaired loans, noting that $107.6 million has a related allowance while $45.4 million does not, and assess the quality of the underlying collateral.
• FDIC Assessment Impact: Confirm the final cost of the FDIC special assessment and the potential for additional assessments in the third and fourth quarters of 2009.
• IRS Dispute Status: Monitor the status of the IRS FPAA regarding the $25.7 million tax adjustment and interest on lease-financing partnerships.
• Branch Expansion ROI: Evaluate the long-term profitability of the 33 branches added in 2008 and 2009, which have negatively impacted the efficiency ratio in the short term.
• TARP Compliance: Ensure ongoing compliance with Treasury restrictions on dividends and share repurchases under the TARP Capital Purchase Program.