INTERNATIONAL BANCSHARES CORP quarterly report, Q2 FY2016

International Bancshares Corporation — 2016 Q2 Form 10-Q

Business context and reporting period

International Bancshares Corporation is a Texas-based, one-segment bank holding company headquartered in Laredo, Texas. Through its banking subsidiaries, it serves commercial, consumer and international customers across South, Central and Southeast Texas and Oklahoma, with significant business connected to U.S.-Mexico trade. The filing covers the three and six months ended June 30, 2016; financial statements are unaudited.

Financial condition and key metrics

Metric	Three months ended June 30, 2016	Six months ended June 30, 2016
Interest income	$97.9 million	$195.0 million
Interest expense	$11.0 million	$21.8 million
Net interest income	$86.9 million	$173.1 million
Provision for probable loan losses	$7.1 million	$16.2 million
Non-interest income	$36.6 million	$77.5 million
Non-interest expense	$72.0 million	$139.9 million
Net income	$29.7 million	$62.7 million
Basic and diluted EPS	$0.45	$0.95

Total assets were $11.78 billion at June 30, 2016, essentially unchanged from December 31, 2015.
Gross loans were $5.95 billion and net loans were $5.89 billion. The allowance for probable loan losses was $62.0 million, or 1.04% of total loans, compared with 1.13% at year-end 2015.
Total deposits were $8.42 billion, down 1.3% from year-end. Other borrowed funds were $552.1 million, up 9.2%; securities sold under repurchase agreements were $794.9 million; and junior subordinated debentures were $161.4 million.
Shareholders’ equity was $1.74 billion, up 4.5% from December 31, 2015, primarily reflecting retained earnings and higher accumulated other comprehensive income, partly offset by dividends and treasury-stock purchases.
Cash and cash equivalents were $245.4 million at June 30, 2016, compared with $273.1 million at year-end.
Six-month operating cash flow was $103.2 million. Investing activities used $6.1 million and financing activities used $124.8 million, producing a $27.7 million decrease in cash.
Net interest margin and return-on-assets figures were not clearly provided in the filing text. Management monitors the efficiency ratio, but the filing does not present a specific reported ratio in the supplied text.
Regulatory capital remained strong: CET1 ratio was 17.15%, Tier 1 risk-based capital ratio was 19.02%, total risk-based capital ratio was 19.81%, and leverage ratio was 13.52%. Management stated that the Company and its subsidiary banks were well-capitalized and exceeded applicable Basel III requirements.

Material changes versus comparable periods

Second-quarter net income declined 12.4% from $33.9 million to $29.7 million; six-month net income declined 10.1% from $69.7 million to $62.7 million.
Net interest income decreased 1.0% in the quarter and 1.4% year to date, despite loan interest income increasing 2.3% and 2.4%, respectively. Lower investment-securities interest income was the principal offset.
The provision for loan losses declined 8.6% in the quarter but increased 60.0% year to date, reflecting higher commercial-loan loss experience and deterioration in a previously identified transportation-equipment relationship.
Non-interest income decreased 8.8% in the quarter but increased 0.7% year to date. Year-to-date results benefited from approximately $2.4 million of income from the sale of two investments held through merchant-banking entities. Deposit service charges declined because of lower overdraft-charge volume.
Non-interest expense increased 5.4% in the quarter and 2.9% year to date, driven mainly by higher technology and network-infrastructure costs, employee costs and other expenses.
Non-accrual loans decreased to $25.3 million from $47.7 million at December 31, 2015. Total past-due loans declined to $59.2 million from $68.3 million, although 30-to-59-day past-due loans increased.
The allowance decreased from $67.0 million to $62.0 million despite $16.2 million of year-to-date provision expense. A previously identified relationship was charged down by approximately $16.8 million after litigation involving the borrower created a going-concern issue and reduced the estimated value of transportation-equipment collateral.
Available-for-sale securities increased in fair value to $4.23 billion from $4.20 billion, and accumulated other comprehensive income increased substantially, primarily from unrealized securities gains.

Outlook, commentary, risks and unusual items

No specific earnings, revenue or balance-sheet guidance was provided. Management cautioned that quarterly and year-to-date results are not necessarily indicative of full-year or future results.
Management stated that deposit competition remains substantial, including competition involving rates above market levels. The Company allowed certain deposits to leave because of aggressive pricing.
Liquidity is supported by deposits, FHLB borrowings, repurchase agreements, large certificates of deposit and the sizable securities portfolio. Management stated that unused FHLB lines and unpledged available-for-sale securities provide additional liquidity sources.
The Company was liability-sensitive in the earliest repricing periods and asset-sensitive over longer periods. Changes in interest rates could affect net interest income, securities valuations and funding costs.
Credit risks include economic weakness, lower real-estate values, lower oil prices, unemployment, collateral deterioration, border-related economic conditions and potential increases in loan-loss provisions. Management stated that the allowance was adequate, but acknowledged that estimates depend on factors outside its control.
The Company held $4.23 billion of available-for-sale securities, including significant residential mortgage-backed securities. Unrealized losses were $7.7 million at June 30, 2016; management attributed most losses to interest-rate movements and recorded $191,000 of year-to-date credit-related impairment charges.
Level 3 securities totaled $19.4 million and were valued using discounted-cash-flow models with assumptions regarding prepayments, defaults, loss severity and discount rates. Changes in collateral performance could materially affect valuations.
The Board authorized up to $40 million of additional stock repurchases through April 9, 2017 and adopted a Rule 10b5-1 plan during the quarter. No shares were repurchased during the quarter; total repurchases under all programs were 9.24 million shares costing $271.1 million as of August 2, 2016.
The Company paid a $0.29 per-share dividend in April 2016. A Treasury-related warrant for 1.33 million shares remained outstanding and expires December 23, 2018.
Various legal proceedings remain pending, including lender-liability claims. Management considers any material loss remote, but noted that future developments could change that assessment.
The Company adopted no material accounting changes during the period. It was evaluating the potential impact of the new expected-credit-loss standard, which was scheduled to become effective for relevant periods after December 31, 2019.
Management reported effective disclosure controls, no material weaknesses and no material changes in internal control over financial reporting.

Important facts for investors to verify

Whether commercial-loan credit quality and the transportation-equipment exposure lead to additional charge-offs or provisions.
Whether the decline in deposits persists and increases reliance on higher-cost deposits, FHLB funding or repurchase agreements.
The sustainability of net interest income amid lower securities yields, deposit-price competition and changing interest rates.
Whether year-to-date non-interest income benefited from nonrecurring investment gains that are unlikely to recur.
Changes in the fair value and credit performance of the large mortgage-backed-securities portfolio, including Level 3 holdings.
Future technology, compliance, regulatory and litigation costs and their effect on the efficiency ratio.
The Company’s ability to maintain strong regulatory capital while paying dividends and repurchasing shares.