INTERNATIONAL BANCSHARES CORP quarterly report, Q3 FY2016

International Bancshares Corporation — Q3 2016 Form 10-Q Summary

Business context and reporting period

International Bancshares Corporation is a Texas-based bank holding company headquartered in Laredo, Texas. Through its bank subsidiaries, it provides commercial, consumer and international banking services across South, Central and Southeast Texas and Oklahoma, with significant business linked to U.S.-Mexico trade. The company reported unaudited consolidated results for the three and nine months ended September 30, 2016. The company operates as one reportable segment.

Financial performance and condition

Metric	Q3 2016	Q3 2015	9M 2016	9M 2015
Interest income	$96.6 million	$100.7 million	$291.6 million	$298.8 million
Net interest income	$85.4 million	$89.6 million	$258.6 million	$265.2 million
Provision for probable loan losses	$(1.3) million credit	$8.8 million expense	$14.9 million	$19.0 million
Non-interest income	$40.5 million	$43.0 million	$118.1 million	$120.0 million
Non-interest expense	$76.7 million	$74.9 million	$216.6 million	$210.8 million
Net income	$35.8 million	$32.0 million	$98.5 million	$101.8 million
Basic and diluted EPS	$0.54	$0.48	$1.49	$1.53

Q3 net income increased 11.8%, primarily because of the loan-loss provision credit resulting from an approximately $6 million recovery on a previously charged-off loan.
Nine-month net income declined 3.2%, reflecting lower net interest income and non-interest income and higher operating expenses.
Approximate efficiency ratios were 60.9% for Q3 2016 and 57.5% for the first nine months of 2016, compared with approximately 56.5% and 54.8%, respectively, in the comparable 2015 periods.
Total assets were $11.94 billion at September 30, 2016, up 1.4% from December 31, 2015. Net loans were $5.82 billion, down 1.0%, while deposits were $8.55 billion, up 0.1%.
Investment securities totaled $4.43 billion, including $4.43 billion of available-for-sale securities, predominantly residential mortgage-backed securities.
The allowance for probable loan losses was $64.0 million, or 1.09% of total loans, compared with $67.0 million, or 1.13%, at year-end 2015.
Non-accrual loans declined to $35.1 million from $47.7 million at December 31, 2015. Total impaired loans were $47.6 million, compared with $60.4 million at year-end.
Shareholders’ equity increased 4.9% to $1.75 billion, primarily through retained earnings and higher accumulated other comprehensive income, partly offset by dividends and treasury-stock purchases.

Cash flow, debt and liquidity

Operating activities generated $156.7 million of cash during the first nine months of 2016, compared with $180.0 million in the prior-year period.
Investing activities used $190.5 million, primarily reflecting $1.19 billion of purchases of available-for-sale securities, partly offset by security sales, mortgage-backed-security principal collections and a $43.9 million decrease in loans.
Financing activities provided $9.6 million, including a $121.3 million increase in other borrowed funds, offset by lower time deposits, lower repurchase-agreement funding, dividends and treasury-stock purchases.
Cash and cash equivalents declined to $248.9 million from $273.1 million at December 31, 2015.
Other borrowed funds, primarily Federal Home Loan Bank borrowings, increased 24.0% to $627.0 million. Securities sold under repurchase agreements were $732.9 million, and junior subordinated deferrable-interest debentures were $161.4 million.
Management stated that liquidity is supported by deposits, FHLB access, repurchase agreements, large certificates of deposit and a sizable high-quality investment portfolio. The filing does not provide a formal liquidity coverage ratio.
Regulatory capital remained strong: CET1 was 16.76%, Tier 1 leverage was 13.61%, risk-weighted Tier 1 capital was 18.55% and total risk-weighted capital was 19.35%. Management stated that the company and its subsidiary banks were well-capitalized.

Material changes versus prior comparable periods

Net interest income decreased 4.6% in Q3 and 2.5% for the first nine months. Q3 loan interest income declined 3.6%, while investment-securities interest income also declined.
Non-interest income decreased 5.8% in Q3 and 1.6% year to date. Lower deposit-account service charges were attributed to reduced overdraft volumes; year-to-date results benefited from approximately $2.4 million of income from sales of two merchant-banking investments.
Non-interest expense increased 2.4% in Q3 and 2.7% year to date, driven principally by employee costs, software and technology expenses. Management cited network-infrastructure modifications as a significant factor.
The allowance declined despite a $16.8 million additional charge-down of a commercial relationship secured primarily by transportation equipment. The charge-down followed litigation involving the borrower and a resulting going-concern concern.
Q3 included a $1.8 million early-termination fee related to repurchase agreements, compared with $3.5 million in Q3 2015. Q3 also included $1.3 million of net losses on investment-securities transactions.
Available-for-sale securities increased from $4.20 billion at year-end 2015 to $4.43 billion. Accumulated other comprehensive income increased to $31.9 million from $2.2 million, primarily reflecting unrealized securities gains.

Outlook, risks, contingencies and unusual items

The filing provides no formal earnings, revenue or margin guidance. Management stated that current-period results are not necessarily indicative of full-year or future performance and that it believes the company is appropriately positioned for interest-rate changes. The company was liability-sensitive in the near-term repricing periods and asset-sensitive over longer periods.

Key credit risks include weaker economic conditions, lower real-estate values, lower oil prices, unemployment, collateral deterioration, litigation affecting borrowers and regulatory changes affecting loan classifications and reserves.
The company has significant exposure to residential mortgage-backed securities and uses Level 3 discounted-cash-flow valuations for certain non-agency mortgage-backed securities. Future defaults, prepayments or loss severities could materially affect valuations.
Credit-related impairment charges on available-for-sale securities were $0.3 million for the first nine months of 2016. Unrealized losses on available-for-sale securities totaled approximately $10.9 million at September 30, 2016.
Deposits from customers domiciled in Mexico are a stable but material funding source. Risks include U.S.-Mexico trade conditions, border crossings, immigration policies and IRS reporting requirements affecting nonresident-alien deposits.
The company maintains a $40 million share-repurchase authorization through April 9, 2017 and adopted a Rule 10b5-1 plan during the quarter, but made no repurchases during Q3.
Legal proceedings are ongoing, but management believes material losses are remote or would not be material. The filing states that no material changes occurred in previously disclosed risk factors.
The company is evaluating the expected-credit-loss standard issued in ASU 2016-13; the filing does not quantify its expected financial impact.
Management reported no material weakness in disclosure controls and no material changes in internal control over financial reporting.

Important facts for investors to verify

Whether the unusual Q3 loan-loss recovery and resulting provision credit are nonrecurring and how normalized credit costs will affect earnings.
Performance of the transportation-equipment relationship and any additional charge-downs, recoveries or litigation developments.
Trends in net interest margin, deposit pricing, loan growth and reliance on FHLB and repurchase-agreement funding.
Credit quality, collateral values, non-accrual loans, troubled debt restructurings and the adequacy of the $64.0 million allowance.
Valuation sensitivity and future impairment risk in the mortgage-backed-securities portfolio, particularly Level 3 holdings.
The sustainability of fee income, merchant-banking investment gains and the company’s elevated operating and technology costs.
Future effects of Basel III capital requirements, the expected-credit-loss standard and other regulatory changes on capital, dividends and repurchases.