International Bancshares Corporation — 2017 Q2 Form 10-Q
Business context and reporting period
International Bancshares Corporation is a Texas-based bank holding company operating through five bank subsidiaries in South, Central and Southeast Texas and Oklahoma. It provides commercial, consumer and international banking services and has significant business and deposit relationships connected to cross-border activity with Mexico. The filing covers the unaudited three and six months ended June 30, 2017, compared primarily with the corresponding 2016 periods and December 31, 2016 balance-sheet data.
Key financial metrics
| Metric | Three months ended June 30, 2017 | Three months ended June 30, 2016 | Change |
|---|---|---|---|
| Total interest income | $103.2 million | $97.9 million | 5.4% |
| Net interest income | $94.4 million | $86.9 million | 8.6% |
| Provision for loan losses | $0.8 million | $7.1 million | (88.7%) |
| Non-interest income | $34.0 million | $36.6 million | (7.2%) |
| Non-interest expense | $73.7 million | $72.0 million | 2.4% |
| Income before taxes | $53.8 million | $44.4 million | 21.2% |
| Net income | $40.6 million | $29.7 million | 36.7% |
| Basic earnings per share | $0.61 | $0.45 | 35.6% |
| Diluted earnings per share | $0.61 | $0.45 | 35.6% |
| Metric | Six months ended June 30, 2017 | Six months ended June 30, 2016 | Change |
|---|---|---|---|
| Net interest income | $182.1 million | $173.1 million | 5.2% |
| Provision for loan losses | $2.5 million | $16.2 million | (84.6%) |
| Non-interest income | $71.7 million | $77.5 million | (7.6%) |
| Non-interest expense | $149.3 million | $139.9 million | 6.7% |
| Net income | $72.6 million | $62.7 million | 15.8% |
| Basic earnings per share | $1.10 | $0.95 | 15.8% |
| Diluted earnings per share | $1.09 | $0.95 | 14.7% |
Reported second-quarter net income margin, calculated as net income divided by total interest income plus non-interest income, was approximately 29.6%, compared with approximately 22.1% in the prior-year quarter. The filing does not provide a clear consolidated net interest margin.
Balance sheet, liquidity and capital
- Total assets were $12.04 billion at June 30, 2017, up 2.0% from December 31, 2016.
- Gross loans were $6.21 billion and net loans were $6.14 billion, up 4.0% and 4.1%, respectively, from year-end. Loan growth was concentrated in commercial, mortgage real estate and construction lending.
- Total deposits were $8.71 billion, up 1.1%. Non-interest-bearing demand deposits increased to $3.28 billion, while time deposits declined to $2.19 billion.
- Cash and cash equivalents were $316.9 million, up from $269.2 million at year-end.
- Other borrowed funds increased 20.9% to $886.5 million, primarily to fund daily operations, available-for-sale securities purchases and the termination of certain long-term repurchase agreements. Securities sold under repurchase agreements declined to $360.4 million from $505.0 million.
- Shareholders’ equity increased 4.2% to $1.80 billion. The company paid a $0.33 per-share cash dividend during the quarter and had a $40 million share-repurchase authorization through April 9, 2018.
- Six-month operating cash flow was $104.0 million, compared with $103.2 million in the prior-year period. Investing activities used $139.9 million, largely reflecting securities purchases and $244.9 million of net loan growth. Financing activities provided $83.6 million.
- Regulatory capital remained strong: CET1 ratio was 16.98%, Tier 1 risk-based capital was 18.66%, total risk-based capital was 19.44%, and the leverage ratio was 14.29%. Management stated that the company and its subsidiary banks were well-capitalized and exceeded applicable Basel III requirements.
Material changes versus prior comparable periods
- Profit growth was driven primarily by higher net interest income and sharply lower loan-loss provisions. The reduction in provisions reflected lower historical commercial loan losses as earlier charge-offs rolled out of the company’s three-year loss history.
- Net interest income benefited from a 6.5% increase in second-quarter loan interest income and a 20.2% decline in interest expense. Interest expense on repurchase agreements fell substantially, partially offset by higher expense on other borrowings.
- Non-interest income declined because 2016 benefited from investment gains and the 2017 period included $2.5 million of net losses on investment securities transactions.
- Six-month 2017 results included a $5.8 million early termination fee related to $200 million of long-term repurchase agreements, reducing pretax earnings. Management indicated that approximately $900 million of long-term repurchase agreements had been terminated since 2014.
- Second-quarter and six-month 2017 earnings benefited from a $4.9 million tax refund related to the deductibility of a judgment associated with the 2004 acquisition of Local Financial Corporation. The company also received $163,000 of taxable statutory interest.
- Credit indicators improved in several areas: non-accrual loans declined to $32.4 million from $37.2 million at year-end, impaired loans declined to $43.4 million from $48.4 million, and total past-due loans declined to $52.6 million from $61.4 million. Watch-list substandard credits increased, however, to $272.0 million from $209.0 million.
Outlook, risks, contingencies and unusual items
The filing provides no formal earnings, revenue or margin guidance. Management stated that current operating results are not necessarily indicative of full-year or future results and that it believes the company is appropriately positioned for interest-rate changes. The company was liability-sensitive in the first-year repricing periods and asset-sensitive over longer periods.
- Key credit risks include lower real-estate values, weaker oil prices, economic weakness, unemployment, collateral deterioration and continued weakness in commercial borrowers. Management believes the $64.9 million allowance for probable loan losses is adequate, but acknowledges that future provisions depend on economic conditions, portfolio performance, interest rates and regulatory classifications.
- Funding and liquidity depend partly on FHLB, Federal Reserve and other external sources. FHLB borrowings are primarily short-term and are secured by investment securities and portions of the loan portfolio.
- Cross-border exposure includes customers and deposits connected to Mexico. Foreign loans were $184.2 million, or 1.5% of total assets; 86.8% was secured directly or indirectly by U.S. assets, certificates of deposit or real estate.
- Investment securities available for sale totaled $4.12 billion and were primarily residential mortgage-backed securities. Unrealized losses were $42.7 million, principally attributed to interest-rate changes. The company sold its non-agency mortgage-backed securities during the first quarter of 2017 and reported no remaining credit-related impairment balance at June 30, 2017.
- Legal proceedings are ongoing, but management assessed material losses as remote or immaterial based on information available at the filing date.
- Additional risks include interest-rate and market volatility, deposit competition, regulatory and capital changes, U.S.-Mexico trade and immigration developments, cybersecurity and technology failures, competition, acquisitions, goodwill impairment, natural disasters and changes in accounting or tax rules.
- Management reported effective disclosure controls and procedures, no material weaknesses, and no material changes in internal control over financial reporting.
Most important facts for investors to verify
- Whether the unusually low 2017 loan-loss provision and related earnings uplift persist as prior commercial charge-offs roll out of historical loss calculations.
- The recurring versus nonrecurring effects of the $4.9 million tax refund, $5.8 million repurchase-agreement termination fee and prior-year investment gains.
- Future growth and credit performance in commercial real estate, construction, oil-and-gas-related lending and cross-border portfolios, including the rise in watch-list substandard credits.
- The sustainability and cost of deposits, FHLB borrowings and other wholesale funding as deposit competition and interest rates change.
- Interest-rate sensitivity and the effect of the liability-sensitive near-term repricing position on future net interest income.
- The level and composition of unrealized losses in the available-for-sale securities portfolio and the company’s ability to avoid forced sales or future impairment charges.
- Future dividend and share-repurchase activity, including the company’s discretion not to repurchase shares under the authorized program.