UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

FORM 10-Q

 

(Mark One)

 

ý QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended March 31, 2003

 

OR

 

o TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934

For the transition period from               to              

 

Commission file number  0-9439

 

INTERNATIONAL BANCSHARES CORPORATION

(Exact name of registrant as specified in its charter)

 

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.  Yes ý         No  o

 

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange

Act).    Yes ý  Noo

 

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.

 

 

 

PART I - FINANCIAL INFORMATION

 

Item 1. Financial Statements

 

INTERNATIONAL BANCSHARES CORPORATION AND SUBSIDIARIES

 

Consolidated Statements of Condition (Unaudited)

 

(Dollars in Thousands)

 

		March 31, 2003			December 31, 2002
Assets
Cash and due from banks		$	135,345		$	141,104
Federal funds sold		61,500			13,000
Total cash and cash equivalents		196,845			154,104
Time deposits with banks		199			199
Investment securities:
Held to maturity (Market value of $2,060 on March 31, 2003 and $2,060 on December 31, 2002)		2,060			2,060
Available for sale (Amortized cost of $2,853,919 on March 31, 2003 and $2,992,906 on December 31, 2002)		2,932,680			3,070,711
Total investment securities		2,934,740			3,072,771
Loans:
Commercial, financial and agricultural		1,536,813			1,595,140
Real estate – mortgage		512,242			507,837
Real estate – construction		313,802			276,595
Consumer		154,076			160,546
Foreign		227,843			233,276
Total loans		2,744,776			2,773,394
Less unearned discounts		(3,247		)	(3,832		)
Loans, net of unearned discounts		2,741,529			2,769,562
Less allowance for possible loan losses		(45,753		)	(44,213		)
Net loans		2,695,776			2,725,349
Bank premises and equipment, net		189,112			185,477
Accrued interest receivable		33,529			35,193
Other investments		206,673			203,733
Identified intangible assets		6,850			7,169
Goodwill		67,442			67,442
Other assets		55,333			44,198
Total assets		$	6,386,499		$	6,495,635

 

1

 

INTERNATIONAL BANCSHARES CORPORATION AND SUBSIDIARIES

 

Consolidated Statements of Condition, continued

 

(Dollars in Thousands)

 

		March 31, 2003			December 31, 2002
Liabilities
Deposits:
Demand – non-interest bearing		$	753,612		$	683,966
Savings and interest bearing demand		1,311,976			1,262,907
Time		2,261,408			2,293,026
Total deposits		4,326,996			4,239,899
Securities sold under repurchase agreements		474,658			457,915
Other borrowed funds and long term debt		945,653			1,185,857
Other liabilities		89,435			64,700
Total liabilities		5,836,742			5,948,371
Shareholders’ equity:
Common shares of $1.00 par value.  Authorized 75,000,000 shares; issued 41,946,348 shares on March 31, 2003 and 41,766,439 shares on December 31, 2002		41,946			41,766
Surplus		32,685			30,821
Retained earnings		578,641			560,613
Accumulated other comprehensive income		51,188			49,957
		704,460			683,157
Less cost of shares in treasury, 11,020,967 shares on March 31, 2003 and 10,506,298 shares on December 31, 2002		(154,703		)	(135,893		)
Total shareholders’ equity		549,757			547,264
Total liabilities and shareholders’ equity		$	6,386,499		$	6,495,635

 

See accompanying notes to consolidated financial statements.

 

2

 

INTERNATIONAL BANCSHARES CORPORATION AND SUBSIDIARIES

 

Consolidated Statements of Income (Unaudited)

 

(Dollars in Thousands, except per share data)

 

		Three Months Ended March 31,
		2003			2002
Interest income:
Loans, including fees		$	45,344		$	46,464
Time deposits with banks		4			19
Federal funds sold		131			219
Investment securities:
Taxable		35,074			39,082
Tax-exempt		1,288			1,209
Other interest income		132			—
Total interest income		81,973			86,993
Interest expense:
Savings deposits		2,950			3,620
Time deposits		11,278			16,901
Federal funds purchased and securities sold under repurchase agreements		4,613			5,148
Other borrowings and long term debt		5,152			4,628
Total interest expense		23,993			30,297
Net interest income		57,980			56,696
Provision for possible loan losses		1,989			2,074
Net interest income after provision for possible loan losses		55,991			54,622
Non-interest income:
Service charges on deposit accounts		14,335			11,632
Other service charges, commissions and fees
Banking		3,461			3,215
Non-banking		4,034			1,217
Investment securities transactions, net		2,763			102
Other investments, net		1,983			(3,570		)
Other income		2,569			2,617
Total non-interest income		29,145			15,213

 

3

 

INTERNATIONAL BANCSHARES CORPORATION AND SUBSIDIARIES

 

Consolidated Statements of Income - continued

 

(Dollars in Thousands, except per share data)

 

		Three Months Ended March 31,
		2003			2002
Non-interest expense:
Employee compensation and benefits		$	18,464		$	16,462
Occupancy		2,960			2,820
Depreciation of bank premises and equipment		3,934			3,820
Professional fees		1,522			1,222
Stationery and supplies		885			917
Amortization of intangible assets		319			48
Advertising		1,743			1,437
Other		8,260			8,496
Total non-interest expense		38,087			35,222
Income before income taxes		47,049			34,613
Provision for income taxes		15,724			12,054
Income before cumulative effect of a change in accounting principle		31,325			22,559
Cumulative effect of a change in accounting principle, net of tax		—			(5,130		)
Net income		$	31,325		$	17,429
Basic earnings per common share:
Weighted average number of shares outstanding:		31,033,615			32,527,569
Income before cumulative effect of a change in accounting principle		$	1.01		$	.69
Cumulative effect of a change in accounting principle, net of tax		—			(.16		)
Net income		$	1.01		$	.53
Fully diluted earnings per common share:
Weighted average number of shares outstanding:		31,718,624			32,990,443
Income before cumulative effect of a change in accounting principle		$	.99		$	.68
Cumulative effect of a change in accounting principle, net of tax		—			(.15		)
Net income		$	.99		$	.53

 

See accompanying notes to consolidated financial statements.

 

4

 

INTERNATIONAL BANCSHARES CORPORATION AND SUBSIDIARIES

 

Consolidated Statement of Comprehensive Income (Unaudited)

 

(Dollars in Thousands)

 

		Three Months Ended March 31,
		2003			2002
Net income		$	31,325		$	17,429
Other comprehensive income, net of tax
Unrealized holding gains (losses) on securities arising during period, net of reclassification adjustment for (gains) losses included in net income		615			(4,081		)
Change in fair value of equity method investee’s derivatives		616			655
Comprehensive income		$	32,556		$	14,003

 

See accompanying notes to consolidated financial statements.

 

5

 

INTERNATIONAL BANCSHARES CORPORATION AND SUBSIDIARIES

 

Consolidated Statements of Cash Flows (Unaudited)

 

(Dollars in Thousands)

 

		Three Months Ended March 31,
		2003			2002
Operating activities:
Net income		$	31,325		$	17,429
Adjustments to reconcile net income to net cash provided by operating activities:
Impairment charges and write downs on investments		—			7,893
Provision for possible loan losses		1,989			2,074
Depreciation of bank premises and equipment		3,934			3,820
Gain on sale of bank premises and equipment		—			(146		)
Depreciation and amortization of leasing assets		569			654
Accretion of investment securities discounts		(337		)	(1,430		)
Amortization of investment securities premiums		5,086			3,749
Gain on investment securities transactions		(2,763		)	(102		)
Amortization of identified intangibles		319			48
Equity (earnings) losses from affiliates and other investments		(1,488		)	4,026
Deferred tax expense		125			452
Decrease in accrued interest receivable		1,664			611
Net increase in other assets		(11,704		)	(3,648		)
Net increase in other liabilities		23,947			11,560
Net cash provided by operating activities		52,666			46,990
Investing activities:
Proceeds from maturities of securities		1,500			1,300
Proceeds from sales of available for sale securities		117,350			66,537
Purchases of available for sale securities		(393,210		)	(312,271		)
Principal collected on mortgage-backed securities		411,351			350,689
Proceeds from matured time deposits with banks		—			674
Net decrease in loans		27,584			7,667
Purchases of other investments		(504		)	(1,139		)
Distributions from other investments		—			3,929
Purchases of bank premises and equipment		(7,569		)	(2,928		)
Proceeds from sale of bank premises and equipment		—			342
Net cash provided by investing activities		156,502			114,800

 

6

 

INTERNATIONAL BANCSHARES CORPORATION AND SUBSIDIARIES

 

Consolidated Statements of Cash Flows, continued

 

(Dollars in Thousands)

 

		Three Months Ended March 31,
		2003			2002
Financing activities:
Net increase in non-interest bearing demand deposits		$	69,646		$	19,690
Net increase in savings and interest bearing demand deposits		49,069			33,071
Net decrease in time deposits		(31,618		)	(51,175		)
Net increase (decrease) in federal funds purchased and securities sold under repurchase agreements		16,743			(250,148		)
Proceeds from issuance of other borrowed funds and long term debt		440,000			378,219
Principal payments on other borrowed funds		(680,204		)	(376,257		)
Purchase of treasury stock		(18,810		)	(16,120		)
Proceeds from stock transactions		2,044			1,222
Payment of cash dividends		(13,297		)	(10,367		)
Net cash used in financing activities		(166,427		)	(271,865		)
Increase (decrease) in cash and cash equivalents		42,741			(110,075		)
Cash and cash equivalents at beginning of period		154,104			285,222
Cash and cash equivalents at end of period		$	196,845		$	175,147
Supplemental cash flow information:
Interest paid		$	24,285		$	31,244
Income taxes paid		—			330

 

See accompanying notes to consolidated financial statements.

 

7

 

INTERNATIONAL BANCSHARES CORPORATION AND SUBSIDIARIES

 

Notes to Consolidated Financial Statements

 

(Unaudited)

 

Note 1 - Basis of Presentation

 

The accounting and reporting policies of International Bancshares Corporation (“Corporation”) and Subsidiaries (the Corporation and Subsidiaries collectively referred to herein as the “Company”) conform to accounting principles generally accepted in the United States of America and to general practices within the banking industry.  The consolidated financial statements include the accounts of the Corporation and its wholly-owned subsidiaries, International Bank of Commerce, Laredo (“IBC”), Commerce Bank, International Bank of Commerce, Zapata, International Bank of Commerce, Brownsville and the Corporation’s wholly-owned non-bank subsidiaries, IBC Subsidiary Corporation, IBC Life Insurance Company, IBC Trading Company, IBC Capital Corporation, International Bancshares Capital Trusts I, II, III, IV, V, VI and VII, as well as the GulfStar Group in which the Company owns a controlling interest.  All significant inter-company balances and transactions have been eliminated in consolidation.  The consolidated financial statements are unaudited, but include all adjustments, which, in the opinion of management, are necessary for a fair presentation of the results of the periods presented.  All such adjustments were of a normal and recurring nature.  It is suggested that these financial statements be read in conjunction with the financial statements and the notes thereto in the Company’s latest Annual Report on Form 10K.  The consolidated statement of condition at December 31, 2002 has been derived from the audited financial statements at that date but does not include all of the information and footnotes required by accounting principles generally accepted in the United States of America for complete financial statements.  Certain reclassifications have been made to make prior periods comparable.

 

Management of the Company believes that it does not have separate reportable operating segments under the provisions of SFAS No. 131 “Disclosures about Segments of an Enterprise and Related Information.”  The Company’s non-banking operations do not meet the threshold for reporting as separate segments.

 

All per share data presented has been restated to reflect the stock splits effected through stock dividends.

 

8

 

Note 2 – Stock Options

 

At March 31, 2003, the Company had one stock-based employee compensation plan.  The Company accounts for the plan under the recognition and measurement principles of Accounting Principles Board Opinion No. 25 (“APB 25”), “Accounting for Stock Issued to Employees,” and related interpretations.  No stock-based employee cost is reflected in net income, as all options granted under the plans had an exercise price equal to the market value of the underlying common stock on the date of grant.  The following table, as prescribed by Statement of Financial Accounting Standards No. 148, “Accounting for Stock-Based Compensation — Transition and Disclosure, an amendment of FASB Statement No. 123,” illustrates the effect on net income and earnings per share if the Company had applied the fair value recognition provisions of Statement of Financial Accounting Standards No. 123, (“SFAS No. 123”), “Accounting for Stock-Based Compensation,” to stock based employee compensation.

 

		Three Months Ended March 31,
		2003			2002
		(Dollars in Thousands, except per share data)
Net income, as reported		$	31,325		$	17,429
Deduct:  Total stock-based compensation expense determined under the fair value based method for all awards, net of tax related tax effects		(233		)	(524		)
Pro forma net income		$	31,092		$	16,905
Earnings per share:
Basic earnings
As reported		$	1.01		$	.53
Pro forma		1.00			.52
Diluted earnings
As reported		$	.99		$	.53
Pro forma		.98			.51

 

Note 3 – Investment Securities

 

The Company classifies debt and equity securities into one of three categories:  held-to maturity, available-for-sale, or trading. Such classifications are reassessed for appropriate classification at each reporting date.  Securities classified as “held-to-maturity” are carried at amortized cost for financial statement reporting, while securities classified as “available-for-sale” and “trading” are carried at their fair value.  Unrealized holding gains and losses are included in net income for those securities classified as “trading”, while unrealized holding gains and losses related to those securities classified as “available-for-sale” are excluded from net income and reported net of tax as other comprehensive income and accumulated other comprehensive income until realized.

 

9

 

A summary of the investment securities held for investment and securities available for sale as reflected on the books of the Company is as follows:

 

		March 31, 2003			December 31, 2002
		(Dollars in Thousands)
U.S. Treasury and federal agencies Available for sale		$	2,767,405		$	2,907,927
States and political subdivisions Available for sale		107,025			105,952
Other
Held to maturity		2,060			2,060
Available for sale		58,250			56,832
Total investment securities		$	2,934,740		$	3,072,771

 

Note 4 - Allowance for Possible Loan Losses

 

A summary of the transactions in the allowance for possible loan losses is as follows:

 

		March 31, 2003			March 31, 2002
		(Dollars in Thousands)
Balance at December 31,		$	44,213		$	40,065
Losses charged to allowance		(892		)	(1,211		)
Recoveries credited to allowance		443			342
Net losses charged to allowance		(449		)	(869		)
Provisions charged to operations		1,989			2,074
Balance at March 31,		$	45,753		$	41,270

 

The Company classifies as impaired those loans where it is probable that all amounts due according to contractual terms of the loan agreement will not be collected. The Company has identified these loans through its normal loan review procedures.  Impaired loans include 1) all non-accrual loans, 2) loans which are 90 days or over past due unless they are well secured (the collateral value is sufficient to cover principal and accrued interest) and are in the process of collection, and 3) other loans which management believes are impaired.  Substantially all of the Company’s impaired loans are measured based on the fair value of the collateral. In limited cases the Company may use other methods to determine the level of impairment of a loan if such loan is not collateral dependent.  Amounts received on non-accruals are applied, for financial accounting purposes, first to principal and then to interest after all principal has been collected.  Impaired loans at March 31, 2003 were $10,496,000.  The income associated with these loans is not significant.

 

Management of the Company recognizes the risks associated with these impaired loans.  However, management’s decision to place loans in this category does not necessarily mean that losses will occur.

 

The subsidiary banks charge off that portion of any loan which management considers representing a loss as well as that portion of any other loan that is classified as a “loss” by bank examiners.  Commercial and industrial or real estate loans are generally considered by management to represent a loss, in whole or part, when an exposure beyond any collateral coverage is apparent and when no further collection of the loss portion is anticipated based on the borrower’s financial condition and general economic conditions in the borrower’s industry.  Generally, unsecured consumer loans are charged-off when 90 days past due.

 

10

 

While management of the Company considers that it is generally able to identify borrowers with financial problems reasonably early and to monitor credit extended to such borrowers carefully, there is no precise method of predicting loan losses.  The determination that a loan is likely to be uncollectible and that it should be wholly or partially charged-off as a loss is an exercise of judgment.  Similarly, the determination of the adequacy of the allowance for possible loan losses can be made only on a subjective basis.  It is the judgment of the Company’s management that the allowance for possible loan losses at March 31, 2003, was adequate to absorb possible losses from loans in the portfolio at that date.

 

Note 5 – Common Stock and Cash Dividends

 

All per share data presented has been restated to reflect the stock splits effected through stock dividends, which became effective May 20, 2002 and were paid on June 14, 2002.  Such stock dividends resulted in the issuance of 8,331,124 shares of Common Stock in 2002.  Cash dividends of $.43 per share were paid on April 15, 2003.

 

The Company expanded its formal stock repurchase program on November 6, 2002.  Under the expanded stock repurchase program, the Company is authorized to repurchase up to $140,000,000 of its common stock through December 2003.  Stock repurchases may be made from time to time, on the open market or through private transactions.  Shares repurchased in this program will be held in treasury for reissue for various corporate purposes, including employee stock option plans.  As of May 7, 2003, a total of 3,271,173 shares had been repurchased under this program at a cost of $130,522,000, which shares are now reflected as 4,208,455 shares of treasury stock as adjusted for stock dividends.  Stock repurchases are reviewed quarterly at the Company’s Board of Directors meetings and the Board of Directors has stated that the aggregate investment in treasury stock should not exceed $160,973,000.  In the past, the Board of Directors has increased previous caps on treasury stock once they were met, but there are no assurances that an increase of the $160,973,000 cap will occur in the future.  As of May 7, 2003, the Company has approximately $151,495,000 invested in treasury shares, which amount has been accumulated since the inception of the Company.

 

Note 6 - Commitments and Contingent Liabilities

 

The Company is involved in various legal proceedings that are in various stages of litigation.  Some of these actions allege “lender liability” claims on a variety of theories and claim substantial actual and punitive damages.  The Company has determined, based on discussions with its counsel that any material loss in such actions, individually or in the aggregate, is remote or the damages sought, even if fully recovered, would not be considered material to the consolidated financial position or results of operations of the Company.  However, many of these matters are in various stages of proceedings and further developments could cause management to revise its assessment of these matters.

 

The Company’s lead bank subsidiary has invested in partnerships, which have entered into several lease-financing transactions.  The lease-financing transactions in two of the partnerships have been examined by the Internal Revenue Service (“IRS”).  In both partnerships, the lead bank subsidiary is the owner of a ninety-nine percent (99%) limited partnership interest.  The IRS has issued separate Notice of Final Partnership Administrative Adjustments (“FPAA”) to the partnerships and on September 25, 2001, and January 10, 2003, the Company filed lawsuits contesting the adjustments asserted in the FPAAs.

 

Prior to filing the lawsuit the Company was required to deposit the estimated tax due of approximately $4,083,000 with respect to the first FPAA, and $7,710,606 with respect to the second FPAA, with the IRS pursuant to the Internal Revenue Code.  If it is determined that the amount of tax due, if any, related to the lease-financing transactions is less than the amount of the deposits, the remaining amount of the deposits would be returned to the Company.

 

In order to curtail the accrual of additional interest related to the disputed tax benefits and because interest rates are unfavorable, the Company decided to submit to the IRS the interest that would have accrued based on the adjustments proposed in the FPAAs related to both of the lease-financing transactions.  On March 7, 2003, the Company submitted to the IRS a total of $13,640,797 of interest on the proposed adjustments.  If it is determined that the amount of interest due, if any, related to the lease-financing transactions is less than $13,640,797, the remaining amount of the prepaid interest will be refunded to the Company, plus interest thereon.

 

11

 

No reliable prediction can be made at this time as to the likely outcome of the lawsuits; however, if the lawsuits are decided adversely to the partnerships, all or a portion of the $12 million in tax benefits previously recognized by the Company in connection with the Partnerships’ lease-financing transactions would be in question and penalties and interest could be assessed by the IRS.  Of the approximately $12 million in tax benefits deposited in connection with the lawsuits and $13,640,797 in interest deposited to the IRS, a total of approximately $12 million has been accrued as of March 31, 2003.  Management intends to continue to evaluate the merits of each matter and make appropriate revisions to the accrued amount as deemed necessary.

 

Item 2 - Management’s Discussion and Analysis of Financial Condition and Results of Operations

 

Special Cautionary Notice Regarding Forward Looking Information

 

Certain matters discussed in this report, excluding historical information, include forward-looking statements.  Although the Company believes such forward-looking statements are based on reasonable assumptions, no assurance can be given that every objective will be reached.  The words “estimate,” “expect,” “intend,” and “project,” as well as other words or expressions of a similar meaning are intended to identify forward-looking statements.  Readers are cautioned not to place undue reliance on forward-looking statements, which speak only as of the date of this report.  Such statements are based on current expectations, are inherently uncertain, are subject to risks and should be viewed with caution.  Actual results and experience may differ materially from the forward-looking statements as a result of many factors.

 

Factors that could cause actual results to differ materially from any results that are projected, forecasted, estimated or budgeted by the Company in forward-looking statements include, among others the following possibilities:  (I) changes in interest rates and market prices, which could reduce the Company’s net interest margins, asset valuations and expense expectations, (II) changes in the capital markets utilized by the Company and its subsidiaries, including changes in the interest rate environment that may reduce margins, (III) changes in state and/or federal laws and regulations to which the Company and its subsidiaries, as well as their customers, competitors and potential competitors, are subject, including, without limitation, banking, tax, securities, insurance and employment laws and regulations, (IV) the loss of senior management or operating personnel, (V) increased competition from both within and outside the banking industry, (VI) changes in local, national and international economic business conditions which adversely affect the Company’s customers and their ability to transact profitable business with the Company, including the ability of its borrowers to repay their loans according to their terms or a change in the value of the related collateral, (VII) the timing, impact and other uncertainties of the Company’s potential future acquisitions including the Company’s ability to identify suitable potential future acquisition candidates, the success or failure in the integration of their operations, and the Company’s ability to maintain its current branch network and to enter new markets successfully and capitalize on growth opportunities, (VIII) changes in the Company’s ability to pay dividends on its Common Stock, (IX) the effects of the litigation and proceedings pending with the Internal Revenue Service regarding the Company’s lease financing transactions, and (X) additions to the Company’s loan loss reserves as the result of changes in local, national or international conditions which adversely affect the Company’s customers.  It is not possible to foresee or identify all such factors.  The Company makes no commitment to update any forward-looking statement, or to disclose any facts, events or circumstances after the date hereof that may affect the accuracy of any forward-looking statement, unless required by law.

 

Results of Operations

 

Overview

 

Net income for the first quarter of 2003 was $31.3 million or $1.01 per share - basic ($.99 per share - diluted) compared to $17.4 million or $.53 per share - basic ($.53 per share - diluted) in the corresponding 2002 period. The first quarter earnings represent an 86.8% increase in diluted earnings per share and a 79.7% increase in net income over the corresponding period of 2002. The increase in net income can be partially attributed to an impairment charge taken by the Company on its investment services unit in the first quarter of 2002 due to the adoption of Statement of Financial Accounting Standards Board No. 142, "Goodwill and Other Intangible Assets." The impairment charge totaled $5.1 million, net of tax, and is reported as a cumulative effect of a change in accounting principle. Also reflected in the first quarter of 2002 is the Company's share of losses in the amount of $3.7 million, net of tax, recorded by the Aircraft Finance Trust, in which the Company holds a 20% interest.

 

12

 

Total assets at March 31, 2003, were $6,386,499,000, which represents a 1.7% decrease from total assets of $6,495,635,000 at December 31, 2002.  The decrease in total assets was primarily due to a decrease in investment securities arising from high level of principal re-payments, which have been used to pay down the Company's Federal Home Loan Bank ("FHLB") certificates of indebtedness.  Deposits at March 31, 2003 were $4,326,996,000, which represents an increase of 2.1% over the $4,239,899,000 reported at December 31, 2002.  Total loans at March 31, 2003 of $2,744,776,000 decreased 1.0% from the $2,773,394,000 reported at December 31, 2002.  The aggregate amount of FHLB certificates of indebtedness and trust preferred securities decreased to $945,653,000 at March 31, 2003, from the $1,185,857,000 at December 31, 2002.  On April 10, 2003, additional long-term debt in the form of trust-preferred securities in the amount of $10,000,000 was issued.  Trust preferred securities, certificates of indebtedness and deposits are used to fund the earning asset base of the Company.

 

Net Interest Income

 

As part of its strategy to manage interest rate risk, the Company strives to manage both assets and liabilities so that interest sensitivities match. One method of calculating interest rate sensitivity is through gap analysis.  A gap is the difference between the amount of interest rate sensitive assets and interest rate sensitive liabilities that re-price or mature in a given time period.  Positive gaps occur when interest rate sensitive assets exceed interest rate sensitive liabilities, and negative gaps occur when interest rate sensitive liabilities exceed interest rate sensitive assets.  A positive gap position in a period of rising interest rates should have a positive effect on net interest income as assets will re-price faster than liabilities.  Conversely, net interest income should contract somewhat in a period of falling interest rates.  Management can quickly change the Company’s interest rate position at any given point in time as market conditions dictate.  Additionally, interest rate changes do not affect all categories of assets and liabilities equally or at the same time.  Analytical techniques employed by the Company to supplement gap analysis include simulation analysis to quantify interest rate risk exposure.  The gap analysis prepared by management is reviewed by the Investment Committee of the Company twice a year (see table on page 17 for the March 31, 2003 gap analysis).  Management currently believes that the Company is properly positioned for interest rate changes; however if management determines at any time that the Company is not properly positioned, it will strive to adjust the interest rate sensitive assets and liabilities in order to manage the effect of interest rate changes.  Net interest income for the first quarter of 2003 increased $1,284,000, or 2.3% over the same period in 2002 and the increase is the result of the Company’s efforts to manage interest rate risk.

 

Interest and fees on loans decreased $1,120,000, or 2.4%, for the quarter ended March 31, 2003 from the same quarter in 2002.  Interest income on taxable and tax-exempt investment securities decreased $3,929,000, or 9.8%, for the quarter ended March 31, 2003 from the same quarter in 2002.  Interest income on federal funds sold for the first quarter in 2003 decreased $88,000, or 40.2%, from the same quarter in 2002.  Overall, total interest income from loans, time deposits, federal funds sold, investment securities and other interest income decreased $5,020,000, or 5.8%, for the quarter ended March 31, 2003, from the same quarter in 2002.  The decrease in total interest income was primarily due to decreased rates on the Company’s loan portfolio and a decrease in investment securities arising from high level of principal re-payments, which have been used to pay down the Company’s FHLB certificates of indebtedness.

 

Interest expense on savings deposits for the first quarter in 2003 decreased $670,000, or 18.5%, compared to the same period in 2002.  Interest expense on time deposits for the first quarter in 2003 decreased $5,623,000, or 33.3%, compared to the same period in 2002.  Interest expense on federal funds purchased and securities sold under repurchase agreements for the first quarter of 2003 decreased $535,000, or 10.4%, compared to the same period in 2002.  Interest expense on other borrowings and long-term debt for the first quarter of 2003 increased $524,000, or 11.3%, compared to the same period in 2002.  Overall, total interest expense on savings deposits, time deposits, federal funds purchased, securities sold under repurchase agreements, other borrowings and long term debt decreased $6,304,000, or 20.8%, for the first quarter of 2003 from the same quarter in 2002. The decrease in total interest expense was primarily due to lower interest rates paid on interest bearing liabilities.

 

Non-Interest Income

 

Non-interest income increased $13,932,000, or 91.6%, to $29,145,000 in the first quarter of 2003 as compared to $15,213,000 for the quarter ended March 31, 2002.  Non-interest income includes income on other investments.  Income on other investments increased by 155.5% for the first quarter of 2003 to $1,983,000 from $(3,570,000) for the corresponding period of 2002.  The decrease in 2002 can be attributed to the Company’s share of losses recorded by AFT.  The Company’s share of such losses during the first quarter of 2002 totaled $3,742,000, net of tax.  Investment securities gains of $2,763,000 were recorded in the first quarter of 2003 compared to gains of $102,000 for the same period in 2002.  The gains for the first quarter of both 2003 and 2002 occurred due to the repositioning of a portion of the Company’s bond portfolio to take advantage of higher bond yields.

 

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Non-Interest Expense

 

Non-interest expense increased $2,865,000, or 8.1%, for the quarter ended March 31, 2003 when compared to the same period of 2002.  Non-interest expense increased primarily due to increased salaries and commissions paid to employees of the Company’s investment services unit for income produced during the first quarter of 2003.

 

The efficiency ratio, a measure of non-interest expense to net interest income plus non-interest income, was 44% for the quarter ended March 31, 2003, compared to 49% for the quarter ended March 31, 2002.

 

Financial Condition

 

Allowance for Possible Loan Losses

 

The allowance for possible loan losses increased 3.5% to $45,753,000 at March 31, 2003 from $44,213,000 at December 31, 2002.  The increase in the allowance for possible loan losses can be attributed to a decrease in losses charged to the allowance for the first quarter 2003.  The provision for possible loan losses charged to expense decreased 4.1% to $1,989,000 for the quarter ended March 31, 2003 from $2,074,000 for the same quarter in 2002.  The allowance for possible loan losses was 1.7% of total loans, net of unearned income, at March 31, 2003, compared to 1.6% at December 31, 2002.

 

Investment Securities

 

Investment securities decreased 4.5% to $2,934,740,000 at March 31, 2003, from investment securities of $3,072,771,000 at December 31, 2002.  Total federal funds sold increased 373.1% to $61,500,000 at March 31, 2003 as compared to $13,000,000 at December 31, 2002.  The changes reflected during the first quarter of 2003 were primarily from the results of continued contraction of the consolidated statement of condition affected through the pay down of bank borrowings.

 

Foreign Operations

 

On March 31, 2003, the Company had $6,386,499,000 of consolidated assets, of which approximately $227,843,000, or 3.6%, was related to loans outstanding to borrowers domiciled in Mexico, compared to $233,277,000, or 3.6%, at December 31, 2002.  Of the $227,843,000, 76% is directly or indirectly secured by U.S. assets, certificates of deposits and real estate; 20.6% is secured by Mexican real estate; 1.2% is secured by Mexican real estate, related to maquiladora plants, guaranteed under lease obligations primarily by U.S. companies, many of which are on the Fortune 500 list of companies; 1.7% is unsecured; and .5% represents accrued interest receivable on the portfolio.

 

Critical Accounting Policies

 

The Company considers its Allowance for Possible Loan Losses policy as a policy critical to the sound operations of the Banks.  The allowance for possible loan losses consists of the aggregate loan loss allowances of the bank subsidiaries.  The allowances are established through charges to operations in the form of provisions for possible loan losses.  Loan losses or recoveries are charged or credited directly to the allowances.  The allowance for possible loan losses of each bank subsidiary is maintained at a level considered appropriate by management, based on estimated probable losses in the loan portfolio.  The allowance is derived from the following elements:  (i) allowances established on specific loans, and (ii) allowances based on historical loss experience on the Company’s remaining loan portfolio.

 

The specific loan loss provision is determined using the following methods.  On a weekly basis, loan past due reports are reviewed by the servicing loan officer to determine if the loan has any potential problem and if the loan should be placed on the Company’s internal classified report.  The Company’s credit department reviews the majority of the loans regardless of past due status and determines if the loan should be placed on an internal classified report because of issues related to the analysis of the credit, credit documents, collateral and/or payment history.  As part of its review process, the credit department will discuss the loans with the servicing loan officers to determine any relevant issues that were not discovered in the evaluation.  Also, any analysis on loans that is provided through examinations by regulatory authorities is considered in the review process.

 

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The Company’s internal classified report is segregated into the following categories:  (i) “Pass Credits,” (ii) “Special Review Credits,” or (iii) “Watch List Credits.”  The loans placed in the “Pass Credits” category reflect the Company’s opinion that the loan conforms to the bank’s lending policies, which includes the borrower’s ability to repay, the value of the underlying collateral, if any, as it relates to the outstanding indebtedness of the loan, and the economic environment and industry in which the borrower operates.  The loans placed in the “Special Review Credits” category reflect the Company’s opinion that the loans reflect potential weakness which require monitoring on a more frequent basis; however, the “Special Review Credits” are not considered to need a specific reserve at the time, but are reviewed and discussed on a regular basis with the credit department and the lending staff to determine if a change in category is warranted.  The loans placed in the “Watch List Credits” category reflect the Company’s opinion that the loans contain clearly pronounced credit weaknesses and/or inherent financial weaknesses of the borrower.  Credits classified as “Watch List Credits” are evaluated under Statement of Financial Accounting Standards No. 114, “Accounting by Creditors for Impairment of a Loan,” criteria and, if deemed necessary a specific reserve is allocated to the credit.  The specific reserve allocated under SFAS No. 114, is based on (1) the present value of expected future cash flows discounted at the loan’s effective interest rate; (2) the loan’s observable market price; or (3) the fair value of the collateral if the loan is collateral dependent.

 

The allowances based on historical loss experience on the Company’s remaining loan portfolio is determined by segregating the remaining loan portfolio into similar categories such as commercial loans, installment loans, international loans and overdrafts.  Installment loans are then further segregated by number of days past due.  A historical loss percentage, adjusted for management’s evaluation of changes in lending policies and procedures and current economic conditions in the market area served by the Company is applied to each category.

 

The Company’s management continually reviews the loan loss allowance of the bank subsidiaries using the amounts determined from the allowances established on specific loans, the allowance established based on historical percentages and the loans charged off and recoveries to establish an appropriate amount to maintain in the Company’s loan loss allowance.  If the basis of the Company’s assumptions change, the loan loss allowance would either decrease or increase and the Company would increase or decrease the provision for loan loss charged to operations accordingly.

 

Liquidity and Capital Resources

 

The maintenance of adequate liquidity provides the Company’s bank subsidiaries with the ability to meet potential depositor withdrawals, provide for customer credit needs, maintain adequate statutory reserve levels and take full advantage of high-yield investment opportunities as they arise.  Liquidity is afforded by access to financial markets and by holding appropriate amounts of liquid assets.  The Company’s bank subsidiaries derive their liquidity largely from deposits of individuals and business entities.  Deposits from persons and entities domiciled in Mexico comprise a significant and stable portion of the deposit base of the Company’s bank subsidiaries. Other important funding sources for the Company’s bank subsidiaries during 2003 and 2002 have been borrowings from FHLB, securities sold under repurchase agreements and large certificates of deposit, requiring management to closely monitor its asset/liability mix in terms of both rate sensitivity and maturity distribution.  Primary liquidity of the Company and its subsidiaries has been maintained by means of increased investment in shorter-term securities, certificates of deposit and loans.  As in the past, the Company will continue to monitor the volatility and cost of funds in an attempt to match maturities of rate-sensitive assets and liabilities and respond accordingly to anticipated fluctuations in interest rates over reasonable periods of time.

 

The Company maintains an adequate level of capital as a margin of safety for its depositors and shareholders.  At March 31, 2003, shareholders’ equity was $549,757,000 compared to $547,264,000 at December 31, 2002, an increase of $2,493,000, or .5%.  The change in shareholders' equity can be attributed to the retention of earnings, an increase in the unrealized gain on available for sale investment securities and the declaration of a forty-three cents per share cash dividend to all shareholders of record as of March 31, 2003, payable on April 15, 2003.

 

The Company had a leverage ratio of 8.58% and 8.71%, risk-weighted Tier 1 capital ratio of 15.92% and 15.95% and risk-weighted total capital ratio of 17.47% and 17.21% at March 31, 2003 and December 31, 2002, respectively.  The identified intangibles and goodwill of $74,292,000 as of March 31, 2003, recorded in connection with the acquisitions of the Company, are deducted from the sum of core capital elements when determining the capital ratios of the Company.

 

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On March 28, 2003, the Company formed International Bancshares Capital Trust VII (“Trust VII”), a statutory business trust formed under the laws of the State of Delaware, for the purpose of issuing trust preferred securities.  On April 10, 2003, Trust VII issued $10,000,000 of Capital Securities.  The Capital Securities accrue interest at a floating rate of 3.25% over the London Interbank Offer Rate (“LIBOR”), and interest is payable quarterly beginning October 24, 2003.  The Capital Securities will mature April 24, 2033; however, the Capital Securities may be redeemed at specified prepayment prices (a) in whole or in part on any interest payment date on or after April 24, 2008, or (b) in whole within 90 days upon the occurrence of any of certain legal, regulatory, or tax events.  The Capital Securities are subordinated and junior in right of payment to all present and future senior indebtedness of the Company.  The Company has fully and unconditionally guaranteed the obligation of Trust VII with respect to the Capital Securities.  The Company has the right, unless an Event of Default has occurred and is continuing, to defer payment of interest on the Capital Securities for up to ten consecutive semi-annual periods.  The redemption prior to maturity of any of the Capital Securities may require the prior approval of the Federal Reserve and/or other regulatory agencies.

 

After taking into account the $10,000,000 in Capital Securities issued on April 10, 2003, the Company has a total of $145,000,000 of trust preferred securities issued by statutory business trusts formed by the Company.

 

As in the past, the Company will continue to monitor the volatility and cost of funds in an attempt to match maturities of rate-sensitive assets and liabilities, and respond accordingly to anticipate fluctuations in interest rates by adjusting the balance between sources and uses of funds as deemed appropriate.  The net-interest rate sensitivity as of March 31, 2003 is illustrated in the table on page 17.  This information reflects the balances of assets and liabilities for which rates are subject to change.  A mix of assets and liabilities that are roughly equal in volume and re-pricing characteristics represents a matched interest rate sensitivity position.  Any excess of assets or liabilities results in an interest rate sensitivity gap.

 

The Company undertakes an interest rate sensitivity analysis to monitor the potential risk on future earnings resulting from the impact of possible future changes in interest rates on currently existing net asset or net liability positions.  However, this type of analysis is as of a point-in-time position, when in fact that position can quickly change as market conditions, customer needs, and management strategies change. Thus, interest rate changes do not affect all categories of asset and liabilities equally or at the same time.  As indicated in the table, the Company is liability sensitive during the early time periods and asset sensitive in the longer periods.  The Company’s Asset and Liability Committee semi-annually reviews the consolidated position along with simulation and duration models, and makes adjustments as needed to control the Company’s interest rate risk position.  The Company uses modeling of future events as a primary tool for monitoring interest rate risk.

 

16

 

INTEREST RATE SENSITIVITY

(Dollars in Thousands)

 

March 31, 2003		3 MONTHS OR LESS			OVER 3 MONTHS TO 1 YEAR			OVER 1 YEAR TO 5 YEARS			OVER 5 YEARS			TOTAL
SECTION A
RATE SENSITIVE ASSETS
FEDERAL FUNDS SOLD		$	61,500		$	—		$	—		$	—		$	61,500
DUE FROM BANK INTEREST EARNING		100			99			—			—			199
INVESTMENT SECURITIES		234,451			533,855			1,508,258			658,176			2,934,740
LOANS, NET OF NON-ACCRUALS		1,908,881			184,300			323,421			317,553			2,734,155
TOTAL EARNING ASSETS		$	2,204,932		$	718,254		$	1,831,679		$	975,729		$	5,730,594
CUMULATIVE EARNING ASSETS		$	2,204,932		$	2,923,186		$	4,754,865		$	5,730,594
SECTION B
RATE SENSITIVE LIABILITIES
TIME DEPOSITS		$	1,099,907		$	911,072		$	250,102		$	327		$	2,261,408
OTHER INTEREST BEARING DEPOSITS		1,310,725			—			—			—			1,310,725
FED FUNDS PURCHASED AND REPOS		113,494			56,422			4,742			300,000			474,658
OTHER BORROWINGS AND LONG TERM DEBT		910,000			25,434			133			10,086			945,653
TOTAL INTEREST BEARING LIABILITIES		$	3,434,126		$	992,928		$	254,977		$	310,413		$	4,992,444
CUMULATIVE SENSITIVE LIABILITIES		$	3,434,126		$	4,427,054		$	4,682,031		$	4,992,444
SECTION C
REPRICING GAP		$	(1,229,194	)	$	(274,674	)	$	1,576,702		$	665,316		$	738,150
CUMULATIVE REPRICING GAP		(1,229,194		)	(1,503,868		)	72,834			738,150
RATIO OF INTEREST-SENSITIVE ASSETS TO LIABILITIES		.64			.72			7.18			3.14			1.15
RATIO OF CUMULATIVE, INTEREST-SENSITIVE ASSETS TO LIABILITIES		.64			.66			1.02			1.15

 

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Item 3.  Quantitative and Qualitative Disclosure about Market Risk

 

During the first quarter of 2003, there were no material changes in market risk exposures that affected the quantitative and qualitative disclosures regarding market risk presented in the Company’s Form 10-K for the year ended December 31, 2002.

 

Item 4.  Controls and Procedures

 

 

Evaluation of Disclosure Controls and Procedures.  Within 90 days before the filing date of this quarterly report, an evaluation (the “Evaluation”) was performed under the supervision and with the participation of the Company’s management, including the Chief Executive Officer (“CEO”) and Chief Financial Officer (“CFO”), of the effectiveness of the design and operation of the Company’s disclosure controls and procedures.  Rules adopted by the SEC require that in this section of this quarterly report we present the conclusions of the CEO and CFO about the effectiveness of our disclosure controls and procedures.

 

Limitations of Controls and Procedures.  Our management, including the CEO and CFO, does not expect that our disclosure controls and procedures and our internal controls and procedures over financial reporting will prevent all error and fraud.  A control system, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the control systems are met.  Further, the design of a control system must reflect the fact that there are resource constraints, and the benefits of controls must be considered relative to their costs.  Because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, within our Company have been detected.  These inherent limitations include the realities that judgments in decision-making can be faulty, and that breakdowns can occur because of simple errors or mistakes.  Additionally, controls can be circumvented by the individual acts of some persons, by collusion of two or more people, or by management override of the controls.  The design of any system of controls also is based in part upon certain assumptions about the likelihood of future events, and we cannot assure that any design will succeed in achieving its stated goals under all potential future conditions.  Over time, controls may become inadequate because of changes in conditions, or the degree of compliance with the policies or procedures may deteriorate.  Because of the inherent limitations in a cost-effective control system, misstatements due to error or fraud may occur and not be detected.

 

Conclusions.  Based upon the Evaluation, our CEO and CFO concluded that, subject to the limitations noted above, as of the date of the Evaluation, our disclosure controls and procedures were effective to provide reasonable assurance that information required to be disclosed in the Company’s reports under the Securities Exchange Act of 1934 is recorded, processed, summarized, and reported within the time periods specified in the SEC’s rules and forms, and that such information is accumulated and communicated to the Company’s management, including the CEO and CFO, as appropriate, to allow timely decisions regarding disclosure.  There have been no significant changes in the Company’s internal controls or in other factors that could significantly affect such internal controls subsequent to the date that the Company’s management conducted its evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses.

 

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PART II - OTHER INFORMATION

 

Item 6.  Exhibits and Reports on Form 8-K

 

(a)           Exhibits

 

The following exhibits are filed as a part of this Report:

 

(99a) – Certification of Chief Executive Officer pursuant to 18 U.S.C. Section as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002

 

(99b) – Certification of Chief Financial Officer pursuant to 18 U.S.C. Section as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002

 

(b)           Reports on Form 8-K

 

Registrant filed a current report on Form 8-K on February 25, 2003 covering Item 5 – Other Events and Item 7 – Financial Statements and Exhibits in connection with the announcement of 2002 annual earnings.

 

Registrant filed a current report on Form 8-K on February 27, 2003 covering Item 5 – Other Events and Item 7 – Financial Statements and Exhibits in connection with the announcement of a forty-three cents per share cash dividend for all holders of Common Stock, $1.00 par value, of record as of March 31, 2003, payable on April 15, 2003.

 

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SIGNATURES

 

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

 

	INTERNATIONAL BANCSHARES CORPORATION
Date:  May 15, 2003	/s/ Dennis E. Nixon
	Dennis E. Nixon
	President
Date:  May 15, 2003	/s/ Imelda Navarro
	Imelda Navarro
	Treasurer

 

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Certification

 

I, Dennis E. Nixon, certify that:

 

1.               I have reviewed this quarterly report on form 10-Q of International Bancshares Corporation;

2.               Based on my knowledge, this quarterly report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this quarterly report;

3.               Based on my knowledge, the financial statements, and other financial information included in this quarterly report, fairly present in all material aspects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this quarterly report;

4.               The registrant’s other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:

a.               designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this quarterly report is being prepared;

b.              evaluated the effectiveness of the registrant’s disclosure controls and procedures as of a date within 90 days prior to the filing date of this quarterly report (the “Evaluation Date”); and

c.               presented in this quarterly report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date:

5.               The registrant’s other certifying officers and I have disclosed, based on our most recent evaluation, to the registrant’s auditors and the audit committee of registrant’s board of directors (or persons performing the equivalent function):

a.               all significant deficiencies in the design or operation of internal controls which could adversely affect the registrant’s ability to record, process, summarize and report financial data and have identified for the registrant’s auditors any material weakness in internal controls; and

b.              any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal controls; and

6.               The registrant’s other certifying officers and I have indicated in this quarterly report whether or not there were any significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses.

 

Date:  May 15, 2003
		/s/ Dennis E. Nixon
		Dennis E. Nixon
		President (Chief Executive Officer)

 

21

 

Certification

 

 

I, Imelda Navarro, certify that:

 

1.                I have reviewed this quarterly report on form 10-Q of International Bancshares Corporation;

2.                Based on my knowledge, this quarterly report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this quarterly report;

3.                Based on my knowledge, the financial statements, and other financial information included in this quarterly report, fairly present in all material aspects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this quarterly report;

4.                The registrant’s other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:

a.               designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this quarterly report is being prepared;

b.              evaluated the effectiveness of the registrant’s disclosure controls and procedures as of a date within 90 days prior to the filing date of this quarterly report (the “Evaluation Date”); and

c.               presented in this quarterly report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date:

5.                The registrant’s other certifying officers and I have disclosed, based on our most recent evaluation, to the registrant’s auditors and the audit committee of registrant’s board of directors (or persons performing the equivalent function):

a.               all significant deficiencies in the design or operation of internal controls which could adversely affect the registrant’s ability to record, process, summarize and report financial data and have identified for the registrant’s auditors any material weakness in internal controls; and

b.              any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal controls; and

6.                The registrant’s other certifying officers and I have indicated in this quarterly report whether or not there were any significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses.

 

Date:  May 15, 2003
		/s/ Imelda Navarro
		Imelda Navarro
		Treasurer (Chief Financial Officer)

 

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