Examining The Books of International Bancshares Corp.: A Cautionary Tale

In a recent Sept. 22, 2011, 8K filing with the SEC, IBOC announced it is shuttering 55 branches. To that regard the following statements were made:

The closing of 55 branches will result in the elimination of approximately 500 permanent job positions associated with these branches. During the next 90 days, employees will be reduced by attrition or absorbed in other branches. Nixon emphasizes that IBC customers will continue to experience superior customer service.

“We want to remind our customers that in addition to our strong network of 219 remaining branches, they can continue to access their accounts through IBC debit cards, IBC Voice, IBC Bank Online, IBC Bill Pay, IBC Mobile Banking, direct deposit services, and our network of over 375 IBC ATMs. This is what our customers asked for and this is what we intend to deliver. Our customers have told us, reduce expenses and close branches instead of eliminating our free checking products and services, so we are responding to that recommendation,” said Nixon.

At first glance, shuttering 55 branches would seem a prudent move based on the current U.S. economic situation. But let’s take a gander under the hood.

IBOC is headquartered in Laredo, Texas, a border town of 236,000 people with a dynamic and complex economy that is defined by its geographical location along the bank of the Rio Grande River. Situated more or less 150 miles from San Antonio, Monterrey Mexico, Corpus Christi, and McAllen, this once isolated town has become one of the largest trucking hubs in America since the passing of NAFTA. Its location, for better or for worse, also makes Laredo somewhat interdependent upon the politics and economy of Mexico.

This can be good and bad. During times of Peso devaluations, the streets of Laredo-- normally bustling with Mexican shoppers-- can appear eerily empty. Lately however, the streets are becoming crowded but not because business is booming. Rather, this is due to the influx of Mexican citizens seeking to leave the violence of Northern Mexico. And when one spends their last dollar relocating a family across the river, less money is available to spend in the economy.

I have a few friends who are currently trying to sell their homes here. They complain that Mexican nationals moving in are not going through realtors but instead looking for foreclosures being offered for sale through the banks’ REO (Real Estate Owned) departments, thus ensuring that houses being marketed at full value remain unsold on the local market. However, when the foreclosure supply dries up, the real estate market in Laredo should recover nicely if things don’t change in Mexico.

For example, this link is to the REO department of Falcon Bank, one of IBOC’s local competitors.

According to available government data, Single Family Home building permits have declined in Laredo for the past four years: 2011- 383, 2010 – 403, 2009 – 519, 2008 – 565.

Laredo’s economic stratification is lopsided. According to the 2010 census, 29% of Laredoans live below the poverty line. Seventy-seven thousand Laredoans are on food stamps, and Laredo receives nearly $1 Billion in welfare transfer payments from various government entities. This works out to nearly $4200 per person. Although a middle class has slowly been forming, the median family income remains at $36,784, or about $11,000 less than the national average. On the other end of the spectrum there is a small cadre of multi-millionaires, and one or two half-billionaires that derive their primary income from the Oil & Gas Economy, Freight Forwarding and Banking.

Thus, the average consumer has little in the way of savings, and much of Laredo’s business is conducted in cash. The local grocery stores not only cash payroll checks, but also accept cash payments for utilities and cable, and on paydays lines form down the aisle that can be daunting should one wish to conduct their personal business in this manner.

Economically, IBOC's decision to close down 55 branches appears sound. One may assume the closed branches were initially opened for the convenience of customers to cash checks and pay bills, and collect deposits of small business owners. Even with the closures, IBOC is the most visible bank with highest number of branches in the community.

IBOC only has one competitor that has branches established to cover the City, that being Wells Fargo (NYSE:WFC). Bank of America (NYSE:BAC) and Chase have both opened up single branches, but have nowhere near the customer base of Wells Fargo or IBOC. Wells Fargo is the most competitive of the three as it bought out an existing bank, Wachovia, which already had an established client base. Wells Fargo has five branch locations. Other competitors include locally owned Falcon International Bank with two branches, BBVA Compass Bank (NYSE:BBVA)—which merged with the Laredo National Bank (Laredo’s oldest bank founded in 1892) and has five branches, and newcomer Texas Community Bank. To round out the lot, there are two credit unions, the first of which is highly competitive with the local banks: Laredo Federal Credit Union has four branches, and the Tex-Mex Railroad Federal Credit Union has two.

IBOC released its third quarter earnings report on September 30th, with a net income of $.40 per share, down from $.45 per share the previous year. Net Income for the quarter declined by $2.9 Million Dollars, and for the cumulative nine month period, Net Operating Cash declined by $6.5 Million Dollars.

IBOC has a banking peer group of 172 banks nationwide, banks similar in asset size and underlying capital. This is down from 187 banks four years ago as the Feds continue to shut down non-performing and undercapitalized banks.

The asset growth rate for IBOC’s peer group is 5.96%. IBOC’s asset growth rate has been steadily eroding and now sits at a negative growth rate of (-4.8) %, down from 12.7% in 2008 when the peer average was 11.44%. Interest and Fees on Loans have declined 6.6% over the past year and are down 41% from 2008. Some of the bank’s efficiency metrics are extremely low. Net assets per employee are a mere $3.05 Million Dollars per employee, as compared to $10.85 Million for its peer group.

Employees may wish to take note that at IBOC, the average expense per employee is $36,000 as compared with $79,000 at the 170 banks ranked higher than IBOC. Perhaps spending more on the employees in the way of training would produce a larger number in the Net assets per employee metric.

One possible red flag in IBOC’s operations comes under the heading of Fed Funds Purchased & Repos. Here we find IBOC borrowing overnight funds to meet daily financing needs at a rate of 3.04% of total assets. The average rate for the peer group is .82%. This puts IBOC in the 89th percentile of its peer group. The peer group appears to have weaned itself off of this type of borrowing, down from an average of 2.32% in 2008, while IBOC’s rate of borrowing has remained steady at 3.04%, down from a high of 3.49%. This number is a reflection of daily cash flow management and whether or not a bank is able to internally finance its daily activities.

Loan Assets declined in nearly all asset classes from Sept. 30th, 2010 through Sept. 30th, 2011:

  • Real Estate Loans down (2.34)%
  • Commercial Loans down (5.35)%
  • Individual Loans down (5.3)%
  • Agricultural Loans down (10.88)%

IBOC’s foreclosure portfolio continues to grow. As listed on its Uniform Bank Performance Reports (“UBPR”), other real estate owned has increased by 93.7% from 2010, with a portfolio value of $75 Million dollars in 2011 as compared to $19.7 Million in 2008.

Another possible red flag which I did not expect to find in IBOC’s UBPR is that IBOC is carrying a whopping $58 Million Dollars worth of Derivatives contracts on its books; $34 Million in Interest Rate contracts and $24.2 Million in OTC - written options in equity securities, and commodities. Derivatives have been known to sink financial institutions, and sovereign governments alike. I just hope for the sake of IBOC shareholders that IBOC is being well advised and has a sharp trader on hand. As jittery as the markets are these days, interest rates can change as quickly as European governments can change leaders.

IBOC’s OTC portfolio is larger than 98% of the banks in its peer group. IBOC’s OTC portfolio makes up 41.58% of its Derivatives portfolio compared to .89% of the group. Although interest rate hedging is common amongst banks, OTC options are not. This could be a one-off special situation which may warrant further investigation as this is the first year of the past four that IBOC has engaged in this type of trading behavior.

And finally, the key to IBOC’s success will ultimately be decided by local politics, and whether or not the Laredo City Council and Webb County can effectively govern and prevent trade from circumventing Laredo. Laredo squandered the opportunity to add a fifth international bridge a couple of years back, after spending millions of dollars on studies and being unable to overcome internal bickering based on self-interest politics. In the meantime, McAllen, Texas slipped in the back door, built a new bridge and began stealing business away from Laredo. It also remains to be seen what the impact will be on the Laredo's economy as Mexican trucking companies ramp up for transnational trucking runs through the United States.

Should the Laredo City Council and Webb County overcome their challenges and act together and facilitate trade with open arms, IBOC could be a bank to rise from the ashes. Long term investors willing to take on the risk may wish to consider share accumulation on dips in the market. Others may wish to use caution and watch for signs of improvement in to the bottom line.

On a positive note, IBOC treats its shareholders well when times are good. It has made many locals independently wealthy.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

Additional disclosure: I am considering buying IBOC shares in the near future as a long term investment and bet on the growth of the border economy.