International Bancshares (IBOC) 10-Q 2005 Q3 Quarterly report

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

ý QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF

THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended September 30, 2005

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)

Texas	74-2157138
(State or other jurisdiction of incorporation or organization)	(I.R.S. Employer Identification No.)

1200 San Bernardo Avenue, Laredo, Texas 78042-1359

(Address of principal executive offices)

(Zip Code)

(956) 722-7611

(Registrant’s telephone number, including area code)

None

(Former name, former address and former fiscal year, if changed since last report)

                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 the filing requirements for at least 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    No o

                Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act)   Yes o    No ý

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

Class	Shares Issued and Outstanding
Common Stock, $1.00 par value	63,704,232 shares outstanding at
	October 31, 2005

PART I - FINANCIAL INFORMATION

Item 1. Financial Statements

INTERNATIONAL BANCSHARES CORPORATION AND SUBSIDIARIES

Consolidated Statements of Condition (Unaudited)

(Dollars in Thousands)

	September 30,				December 31,
	2005				2004
Assets
Cash and due from banks	$	209,387			$	174,770
Federal funds sold	143,000				21,000
Total cash and cash equivalents	352,387				195,770
Time deposits with banks	396				396
Investment securities:
Held-to-maturity (Market value of $2,385 on September 30, 2005 and December 31, 2004)	2,385				2,385
Available-for-sale (Amortized cost of $4,245,842 on September 30, 2005 and $3,851,741 on December 31, 2004)	4,225,196				3,874,833
Total investment securities	4,227,581				3,877,218
Loans, net of unearned discounts	4,714,117				4,888,974
Less allowance for possible loan losses	(80,799			)	(81,351		)
Net loans	4,633,318				4,807,623
Bank premises and equipment, net	339,299				302,230
Accrued interest receivable	46,325				41,140
Other investments	326,173				301,578
Identified intangible assets, net	40,505				44,400
Goodwill, net	289,262				289,262
Other assets	55,190				61,888
Total assets	$		10,310,436		$	9,921,505

1

INTERNATIONAL BANCSHARES CORPORATION AND SUBSIDIARIES

Consolidated Statements of Condition, continued (Unaudited)

(Dollars in Thousands)

	September 30,			December 31,
	2005			2004
Liabilities and Shareholders’ Equity
Liabilities:
Deposits:
Demand — non-interest bearing	$	1,298,250		$		1,150,999
Savings and interest bearing demand	2,123,076			2,232,102
Time	3,069,301			3,188,003
Total deposits	6,490,627			6,571,104
Securities sold under repurchase agreements	764,550			619,806
Other borrowed funds	1,925,076			1,670,199
Junior subordinated deferrable interest debentures	236,164			235,395
Other liabilities	87,224			71,911
Total liabilities	9,503,641			9,168,415
Shareholders’ equity:
Common shares of $1.00 par value. Authorized 275,000,000 shares; issued 86,024,758 shares on September 30, 2005 and 68,431,225 shares on December 31, 2004	86,025			68,431
Surplus	134,845			130,597
Retained earnings	774,522			705,642
Accumulated other comprehensive income (loss)	(13,423		)	15,010
	981,969			919,680
Less cost of shares in treasury, 22,327,658 shares on September 30, 2005 and 17,610,126 shares on December 31, 2004	(175,174		)	(166,590			)
Total shareholders’ equity	806,795			753,090
Total liabilities and shareholders’ equity	$	10,310,436		$	9,921,505

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 September 30,					Nine Months Ended September 30,
	2005			2004		2005			2004
Interest income:
Loans, including fees	$	86,304		$	72,486	$	250,974		$	161,508
Time deposits with banks	2			67		5			87
Federal funds sold	1,079			249		2,433			1,151
Investment securities:
Taxable	41,274			27,616		116,965			78,317
Tax-exempt	1,209			1,278		3,646			3,834
Other interest income	100			91		424			364
Total interest income	129,968			101,787		374,447			245,261
Interest expense:
Savings deposits	7,335			4,284		18,970			9,005
Time deposits	18,959			12,463		50,041			31,349
Securities sold under repurchase agreements	7,219			4,989		19,758			14,529
Other borrowings	16,403			4,546		41,836			9,190
Junior subordinated interest deferrable debentures	4,829			3,781		13,547			8,906
Senior notes	—			299		—			384
Total interest expense	54,745			30,362		144,152			73,363
Net interest income	75,223			71,425		230,295			171,898
Provision (credit) for possible loan losses	(196		)	2,066		2,635			4,783
Net interest income after provision (credit) for possible loan losses	75,419			69,359		227,660			167,115
Non-interest income:
Service charges on deposit accounts	21,857			21,611		62,761			51,931
Other service charges, commissions and fees
Banking	6,094			5,313		18,372			13,599
Non-banking	3,241			1,797		7,352			4,345
Gain (loss) on investment securities transactions, net	—			383		(181		)	8,844
Other investments, net	3,802			4,133		11,665			9,958
Other income	5,889			2,714		20,644			6,678
Total non-interest income	40,883			35,951		120,613			95,355

3

INTERNATIONAL BANCSHARES CORPORATION AND SUBSIDIARIES

Consolidated Statements of Income — continued (Unaudited)

(Dollars in Thousands, except per share data)

	Three Months Ended September 30,				Nine Months Ended September 30,
	2005		2004		2005		2004
Non-interest expense:
Employee compensation and benefits	$	28,518	$	23,562	$	84,288	$	57,126
Occupancy	6,269		5,000		17,655		11,899
Depreciation of bank premises and equipment	6,657		5,184		18,464		13,650
Professional fees	2,869		2,000		9,088		4,882
Stationery and supplies	1,297		1,534		4,048		3,423
Amortization of identified intangible assets	1,298		1,595		3,895		2,087
Advertising	2,996		2,796		8,404		6,889
Other	14,716		15,242		43,791		35,533
Total non-interest expense	64,620		56,913		189,633		135,489
Income before income taxes	51,682		48,397		158,640		126,981
Provision for income taxes	16,214		15,226		52,140		41,062
Net income	$	35,468	$	33,171	$	106,500	$	85,919
Basic earnings per common share:
Weighted average number of shares outstanding:	63,689,160		63,402,184		63,689,914		61,678,187
Net income	$	.56	$	.52	$	1.67	$	1.39
Fully diluted earnings per common share:
Weighted average number of shares outstanding:	64,419,413		64,538,370		64,502,333		62,971,003
Net income	$	.55	$	.51	$	1.65	$	1.36

See accompanying notes to consolidated financial statements.

4

INTERNATIONAL BANCSHARES CORPORATION AND SUBSIDIARIES

Consolidated Statements of Comprehensive Income (Unaudited)

(Dollars in Thousands)

	Three Months Ended September 30,							Nine Months Ended September 30,
	2005				2004			2005			2004
Net income	$	35,468			$	33,171		$	106,500		$	85,919
Other comprehensive gain (loss), net of tax
Unrealized holding gains (losses) on securities arising during period, net of reclassification adjustment for gains and losses included in net income	(8,166			)	32,296			(28,433		)	(2,929		)
Comprehensive income	$		27,302		$		65,467	$	78,067		$	82,990

See accompanying notes to consolidated financial statements.

5

INTERNATIONAL BANCSHARES CORPORATION AND SUBSIDIARIES

Consolidated Statements of Cash Flows (Unaudited)

(Dollars in Thousands)

	Nine Months Ended September 30,
	2005			2004
Operating activities:
Net income	$	106,500		$	85,919
Adjustments to reconcile net income to net cash provided by operating activities:
Provision for possible loan losses	2,635			4,783
Depreciation of bank premises and equipment	18,464			13,650
Gain on sale of bank premises and equipment	(158		)	(94		)
Depreciation and amortization of leased assets	1,425			1,265
Accretion of investment securities discounts	(461		)	(996		)
Amortization of investment securities premiums	19,307			22,383
Investment securities transactions, net	181			(8,844		)
Accretion of junior subordinated debenture discounts	769			769
Amortization of identified intangible assets	3,895			2,087
Earnings from affiliates and other investments	(8,733		)	(9,529		)
Deferred tax expense	5,341			5,202
(Increase) decrease in accrued interest receivable	(5,185		)	376
Net decrease in other assets	5,270			20,531
Net increase (decrease) in other liabilities	25,280			(17,246		)
Net cash provided by operating activities	174,530			120,256
Investing activities:
Proceeds from maturities of securities	4,366			28,346
Proceeds from sales of available for sale securities	189,187			877,658
Purchases of available for sale securities	(1,273,486		)	(1,308,676		)
Principal collected on mortgage-backed securities	666,805			598,930
Proceeds from matured time deposits with banks	—			87,400
Purchases of time deposits with banks	—			(296		)
Net decrease (increase) in loans	171,670			(68,792		)
Purchases of other investments	(24,870		)	(703		)
Distributions from other investments	9,008			62,617
Purchases of bank premises and equipment	(55,879		)	(34,990		)
Proceeds from sale of bank premises and equipment	504			173
Cash paid in purchase transaction	—			(276,555		)
Cash acquired in purchase transaction	—			66,009
Net cash (used in) provided by investing activities	(312,695		)	31,121

6

INTERNATIONAL BANCSHARES CORPORATION AND SUBSIDIARIES

Consolidated Statements of Cash Flows, continued (Unaudited)

(Dollars in Thousands)

	Nine Months Ended September 30,
	2005			2004
Financing activities:
Net increase in non-interest bearing demand deposits	$	147,251		$	81,201
Net (decrease) increase in savings and interest bearing demand deposits	(109,026		)	24,594
Net (decrease) increase in time deposits	(118,702		)	22,099
Net increase in securities sold under repurchase agreements	144,744			38,193
Proceeds from issuance of other borrowed funds	3,105,000			1,150,000
Principal payments on other borrowed funds	(2,850,123		)	(1,304,452		)
Principal payments on senior notes	—			(21,295		)
Purchase of treasury stock	(8,584		)	(682		)
Proceeds from stock transactions	4,670			5,388
Payment of cash dividends	(20,423		)	(19,419		)
Payment of cash dividends in lieu of fractional shares	(25		)	(38		)
Net cash provided by (used in) financing activities	294,782			(24,411		)
Increase in cash and cash equivalents	156,617			126,966
Cash and cash equivalents at beginning of period	195,770			215,729
Cash and cash equivalents at end of period	$	352,387		$	342,695
Supplemental cash flow information:
Interest paid	$	136,742		$	63,756
Income taxes paid	39,017			27,578

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, and IBC Capital Corporation, 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, 2004 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.

The Company operates as one segment.  The operating information used by the Company’s chief executive officer for purposes of assessing performance and making operating decisions about the Company is the consolidated statements presented in this report.  The Company has four active operating subsidiaries, namely, the bank subsidiaries, otherwise known as International Bank of Commerce, Laredo, Commerce Bank, International Bank of Commerce, Zapata and International Bank of Commerce, Brownsville.  The Company applies the provisions of SFAS No. 131, “Disclosures about Segments of an Enterprise and Related Information,” in determining its reportable segments and related disclosures.  None of the Company’s other operating segments meets the 10% threshold for disclosure under SFAS No. 131.

                All per share data presented has been restated to reflect the stock splits effected through stock dividends, see Note 8.

Note 2 — Loans

A summary of net loans, by loan type at September 30, 2005 and December 31, 2004 is as follows:

	September 30,			December 31,
	2005			2004
	(Dollars in thousands)
Commercial, financial and agricultural	$	2,485,271		$		2,710,270
Real estate-mortgage	835,578			960,599
Real estate — construction	905,895			749,689
Consumer	220,203			229,302
Foreign	267,382			239,622
Total loans	4,714,329			4,889,482
Unearned discount	(212		)	(508			)
Loans, net of unearned discount	$	4,714,117		$	4,888,974

8

Note 3 — Stock Options

In December 2002, the Financial Accounting Standards Board (“FASB”) issued Statement of Financial Accounting Standards No. 148 (“SFAS No. 148”), “Accounting for Stock-Based Compensation — Transition and Disclosure, an amendment of FASB Statement No. 123.”  SFAS No. 148 amends Statement of Financial Accounting Standards No. 123 (“SFAS No. 123”), “Accounting for Stock-Based Compensation,” to provide alternative methods of transition for a voluntary change to the fair value based method of accounting for stock-based employee compensation.  In addition, SFAS No. 148 amends the disclosure requirement of SFAS No. 123 to require prominent disclosures in both annual and interim financial statements about the fair value based method of accounting for stock-based employee compensation for those companies that have elected to continue to apply Accounting Principles Board Opinion No. 25 (“APB 25”), “Accounting for Stock Issued to Employees.”   In December 2004, the FASB issued Statement of Financial Accounting Standards No. 123R (“SFAS No. 123R”), “Share-Based Payment (Revised 2004).” SFAS 123R eliminates the ability to account for stock-based compensation using APB 25 and requires that such transactions be recognized as compensation expense in the consolidated statement of income based on their fair values on the date of the grant.  The Company will be required to adopt the provisions of SFAS No. 123R on January 1, 2006.

At September 30, 2005, the Company had one stock-based employee compensation plan under which options are outstanding and certain options granted outside the plan.  An additional stock-based employee compensation plan has been adopted by the Company, but no options have been granted under such plan.  The Company accounts for options under the recognition and measurement principles of APB 25, and related interpretations.  No stock-based employee cost is reflected in net income, as all options granted 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 SFAS No. 148, illustrates the effect on net income and earnings per share if the Company had applied the fair value recognition provisions of SFAS No. 123 to stock based employee compensation.

	Three Months Ended September 30,									Nine Months Ended September 30,
	2005				2004					2005				2004
	(Dollars in Thousands, except per share data)
Net income, as reported	$	35,468			$			33,171		$	106,500			$		85,919
Deduct: Total stock-based compensation expense determined under the fair value based method for all awards, net of tax related tax effects	(68			)	(109				)	(247			)	(395			)
Pro forma net income	$	35,400			$	33,062				$	106,253			$	85,524
Earnings per share:
Basic earnings
As reported	$		.56		$		.52			$		1.67		$	1.39
Pro forma	.56				.52					1.67				1.39
Diluted earnings
As reported	$		.55		$		.51			$		1.65		$	1.36
Pro forma	.55				.51					1.65				1.36

Note 4 — 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 (loss) income and accumulated other comprehensive (loss) 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:

	September 30,		December 31,
	2005		2004
	(Dollars in Thousands)
U.S. Treasury and federal agencies
Available for sale	$	4,104,838	$	3,752,501
States and political subdivisions
Available for sale	102,745		104,317
Other
Held to maturity	2,385		2,385
Available for sale	17,613		18,015
Total investment securities	$	4,227,581	$	3,877,218

Note 5 — Allowance for Possible Loan Losses

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

	September 30,			September 30,
	2005			2004
	(Dollars in Thousands)
Balance at December 31,	$	81,351		$	48,646
Losses charged to allowance	(5,062		)	(3,513		)
Recoveries credited to allowance	1,875			1,654
Net losses charged to allowance	(3,187		)	(1,859		)
Provision charged to operations	2,635			4,783
Net allowance acquired in purchase transaction	—			33,865
Balance at September 30,	$	80,799		$	85,435

                Impaired loans are 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 are measured 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.  Substantially all of the Company’s impaired loans are measured at 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.

The following table details key information regarding the Company’s impaired loans:

	September 30,		December 31,
	2005		2004
	(Dollars in Thousands)
Balance of impaired loans where there is a related allowance for loan loss	$	24,705	$	37,037
Balance of impaired loans where there is no related allowance for loan loss	—		—
Total impaired loans	$	24,705	$	37,037
Allowance allocated to impaired loans	$	15,696	$	15,666

10

The impaired loans included in the table above were primarily comprised of collateral dependent commercial loans, which have not been fully charged off. The average recorded investment in impaired loans was $30,469,000 and $34,226,000 for the nine months ended September 30, 2005 and for the year ended December 31, 2004, respectively. The interest recognized on impaired loans was 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 bank subsidiaries charge off that portion of any loan which management considers to represent a loss as well as that portion of any other loan which 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.

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 un-collectible 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 September 30, 2005 was adequate to absorb probable losses from loans in the portfolio at that date.

Note 6 — Other Borrowed Funds

   Other borrowed funds include Federal Home Loan Bank borrowings, which are short or long term, variable or fixed borrowings issued by the Federal Home Loan Bank of Dallas at the market price offered at the time of funding.  These borrowings are secured by mortgage-backed investment securities and a portion of the Company’s loan portfolio.  At September 30, 2005, other borrowed funds totaled $1,925,076,000, an increase of 15.3% from $1,670,199,000 at December 31, 2004.  The increase in other borrowed funds can be attributed to the additional funding requirements of the combined Company.

Note 7 — Junior Subordinated Deferrable Interest Debentures

The Company has formed eight statutory business trusts under the laws of the State of Delaware, for the purpose of issuing trust preferred securities.  As part of the Local Financial Corporation (“LFIN”) acquisition, the Company acquired three additional statutory business trusts previously formed by LFIN for the purpose of issuing trust preferred securities.  The eight statutory business trusts formed by the Company and the three business trusts acquired in the LFIN transaction (the “Trusts”) have each issued Capital and Common Securities and invested the proceeds thereof in an equivalent amount of junior subordinated debentures (the “Debentures”) issued by the Company or LFIN, as appropriate.  The Company has succeeded to the obligations of LFIN under the LFIN Debentures, which have an outstanding principal balance of $62,115,000.  The Debentures will mature on various dates; however the Debentures may be redeemed at specified prepayment prices, in whole or in part after the optional redemption dates specified in the respective indentures or in whole upon the occurrence of any one of certain legal, regulatory or tax events specified in respective indentures.  As of September 30, 2005, the principal amount of debentures outstanding totaled $236,164,000.

In March 2005, the Federal Reserve Board issued a final rule that would continue to allow the inclusion of trust preferred securities in Tier 1 capital, but with stricter quantitative limits.  Under the final rule, after a five-year transition period ending March 31, 2009, the aggregate amount of trust preferred securities and certain other capital elements would be limited to 25% of Tier 1 capital elements, net of goodwill, less any associated deferred tax liability.  The amount of trust preferred securities and certain other elements in excess of the limit could be included in Tier 2 capital, subject to restrictions.  Bank holding companies with significant international operations will be expected to limit trust preferred securities to 15% of Tier 1 capital elements, net of goodwill; however, they may include qualifying mandatory convertible preferred securities up to the 25% limit.  The Company believes that substantially all of the $236,164,000 will be included in Tier 1 capital after the five-year transition period ending March 31, 2009.

11

The following table illustrates key information about each of the Capital and Common Securities and their interest rate at September 30, 2005:

	Junior Subordinated Deferrable Interest Debentures		Repricing Frequency	Interest Rate		Interest Rate Index	Maturity Date	Optional Redemption Date
	(in thousands)
Trust I	$	10,209	Fixed	10	.18%	Fixed	June 2031	June 2011
Trust II	$	25,730	Semi-Annually	7	.67%	LIBOR + 3.75	July 2031	July 2006
Trust III	$	33,985	Semi-Annually	7	.37%	LIBOR + 3.75	December 2031	December 2006
Trust IV	$	22,523	Semi-Annually	7	.11%	LIBOR + 3.70	April 2032	April 2007
Trust V	$	20,409	Quarterly	7	.25%	LIBOR + 3.65	July 2032	July 2007
Trust VI	$	25,474	Quarterly	7	.24%	LIBOR + 3.45	November 2032	November 2007
Trust VII	$	10,310	Quarterly	6	.94%	LIBOR + 3.25	April 2033	April 2008
Trust VIII	$	25,409	Quarterly	6	.65%	LIBOR + 3.05	October 2033	October 2008
LFIN Trust I	$	41,495	Fixed	9	.00%	Fixed	September 2031	September 2006
LFIN Trust II	$	10,310	Semi-Annually	7	.55%	LIBOR + 3.625	July 2032	July 2007
LFIN Trust III	$	10,310	Quarterly	7	.24%	LIBOR + 3.45	November 2032	November 2007
	$	236,164

Note 8 — 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 2, 2005 and May 3, 2004 and were paid on May 31, 2005 and May 28, 2004, respectively.  Cash dividends of $.32 per share, adjusted for stock dividends, were paid on April 29, 2005 to all holders of record on April 15, 2005.  Cash dividends of $.32 per share, were paid on November 1, 2005 to all holders of record on October 14, 2005.

The Company expanded its formal stock repurchase program on December 16, 2004.  Under the expanded stock repurchase program, the Company is authorized to repurchase up to $175,000,000 of its common stock through December 2005.  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 October 31, 2005, a total of 3,974,327 shares had been repurchased under this program at a cost of $154,231,000.  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 $195,973,000.  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 $195,973,000 cap will occur in the future.  As of October 31, 2005, the Company has approximately $175,204,000 invested in treasury shares, which amount has been accumulated since the inception of the Company.

On May 16, 2005, the Corporation’s shareholders adopted the 2005 International Bancshares Corporation Stock Option Plan (the “2005 Plan”).  The 2005 Plan became effective on April 1, 2005, the date it was approved and adopted by the Corporation’s Board of Directors, upon such shareholder approval.  The Plan replaces the 1996 International Bancshares Corporation Stock Option Plan (the “1996 Plan”), which will be terminated for purposes of granting further options.  The 2005 Plan provides for the grant of incentive stock options and non-statutory stock options.  The Stock Option Plan committee of the Board of Directors administers the 2005 Plan and determines the terms and conditions under which the options of common stock of the Corporation may be awarded.  The aggregate number of shares of common stock of the Corporation that may be issued pursuant to the 2005 Plan is 380,000 shares, subject to adjustment as provided in the 2005 Plan.  Further, the maximum number of shares of common stock covered by options which may be granted to any one person in any fiscal year is 75,000, also subject to adjustment as provided in the 2005 Plan.  Neither the 380,000 aggregate shares limitation nor the 75,000 individual annual limitation described above reflects the adjustment for the May 2, 2005 stock dividend.

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Note 9 — Commitments, Contingent Liabilities and Tax Matters

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 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 was 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 lawsuits 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 were unfavorable, on March 7, 2003, the Company submitted to the IRS a total of $13,640,797, which constitutes the interest that would have accrued based on the adjustments proposed in the FPAAs related to both of the lease-financing transactions.  If it is determined that the amount of interest due, if any, related to the lease-financing transactions is less than the $13,640,797, the remaining amount of the prepaid interest will be refunded to the Company, plus interest thereon.

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.  The Company has accrued approximately $12 million at September 30, 2005 in connection with the lawsuits.  Management intends to continue to evaluate the merits of each matter and make appropriate revisions to the accrued amount as deemed necessary.

As part of the LFIN acquisition, the Company acquired two tax matters. The first relates to deductions taken on amended returns filed by LFIN during 2003 for the tax years ended June 30, 1999 through December 31, 2001. The refunds requested on the amended returns amounted to approximately $7,000,000. At December 31, 2003, LFIN had received approximately $2,000,000 of the total refund requested. Because all the refunds are under review by the IRS, LFIN had established a reserve equal to the $2,000,000 received and did not recognize any benefit for the remaining $5,000,000. The second tax contingency, which is also approximately $7,000,000, relates to permanent differences applicable to prior periods taken as deductions in 2002 and was received by LFIN during 2003. LFIN had recorded a reserve equal to the amounts received pending final resolution with the IRS. Both reserves are included in the current income taxes payable of the Company.  The Company will continue to monitor the IRS reviews.

Note 10 — Capital Ratios

The Company had a leverage ratio of 7.14% and 6.91%, risk-weighted Tier 1 capital ratio of 12.60% and 10.74% and risk-weighted total capital ratio of 13.86% and 11.99% at September 30, 2005 and December 31, 2004, respectively.  The net identified intangibles and goodwill of $329,767,000 as of September 30, 2005, recorded in connection with the acquisitions made by the Company, are deducted from the sum of core capital elements when determining the capital ratios of the Company.  The Company actively monitors the regulatory capital ratios to ensure that the Company’s bank subsidiaries are well capitalized under the regulatory framework.

In March 2005, the Federal Reserve Board issued a final rule that would continue to allow the inclusion of trust preferred securities in Tier 1 capital, but with stricter quantitative limits.  Under the final rule, after a five-year transition period ending March 31, 2009, the aggregate amount of trust preferred securities and certain other capital elements would be limited to 25% of Tier 1 capital elements, net of goodwill, less any associated deferred tax liability.  The amount of trust preferred securities and certain other elements in excess of the limit could be included in Tier 2 capital, subject to restrictions.  Bank holding companies with significant international operations will be expected to limit trust preferred securities to 15% of Tier 1 capital elements, net of goodwill; however, they may include qualifying mandatory convertible preferred securities up to the 25% limit.

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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, within the meaning of Section 27A of the Securities Exchange Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended, and are subject to the safe harbor created by these sections.  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,” “believe” 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:

•Changes in interest rates and market prices, which could reduce the Company’s net interest margins, asset valuations and expense expectations.

•Changes in the capital markets utilized by the Company and its subsidiaries, including changes in the interest rate environment that may reduce margins.

•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, changes in the accounting, tax and regulatory treatment of trust preferred securities, as well as changes in banking, tax, securities, insurance and employment laws and regulations.

•Changes in U.S. — Mexico trade, including, without limitation, reductions in border crossings and commerce resulting from the Homeland Security Programs called “US-VISIT,” which is derived from Section 110 of the Illegal Immigration Reform and Immigrant Responsibility Act of 1996.

•The loss of senior management or operating personnel.

•Increased competition from both within and outside the banking industry.

•Changes in local, national and international economic business conditions that 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.

•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.

•Changes in the Company’s ability to pay dividends on its Common Stock.

•The effects of the litigation and proceedings pending with the Internal Revenue Service regarding the Company’s lease financing transactions.

•Additions to the Company’s loan loss allowance as a result of changes in local, national or international conditions which adversely affect the Company’s customers.

•Political instability.

•Technological changes.

•Acts of war or terrorism.

•The effect of changes in accounting policies and practices as may be adopted by the regulatory agencies, as well as the Public Company Accounting Oversight Board, the Financial Accounting Standards Board and other accounting standards setters.

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.

Overview

The Company, which is headquartered in Laredo, Texas, with more than 195 facilities and more than 300 ATMs, provides banking services for commercial, consumer and international customers of South, Central and Southeast Texas and the State of Oklahoma.  The Company is the one of the largest independent commercial bank holding companies headquartered in

14

Texas.  The Company, through its bank subsidiaries, is in the business of gathering funds from various sources and investing those funds in order to earn a return.  The Company either directly or through a bank subsidiary owns two insurance agencies, a broker/dealer and a majority interest in an investment banking unit that owns a broker/dealer.  The Company’s primary earnings come from the spread between the interest earned on interest-bearing assets and the interest paid on interest-bearing liabilities.  In addition, the Company generates income from fees on products and services offered to commercial, consumer and international customers.

The Company is very active in facilitating trade along the United States border with Mexico.  The Company does a large amount of business with customers domiciled in Mexico.  Deposits from persons and entities domiciled in Mexico comprise a large and stable portion of the deposit base of the Company’s bank subsidiaries.  The Company also serves the growing Hispanic population through the Company’s facilities located throughout South, Central and Southeast Texas and the State of Oklahoma.

Expense control is an essential element in the Company’s long-term profitability.  As a result, one of the key ratios the Company monitors is the efficiency ratio, which is a measure of non-interest expense to net-interest income plus non-interest income.  The Company’s efficiency ratio has been under 55% for each of the last five years, which the Company believes is better than average compared to its national peer group.  One of the benefits derived from such operating efficiencies is that the Company is not subject to undue pressure to generate interest income from high-risk loans.

Results of Operations

Summary

Consolidated Statements of Condition Information

	September 30, 2005		December 31, 2004		Percent Increase (Decrease)
	(Dollars in Thousands)
Assets	$	10,310,436	$	9,921,505	3.9	%
Net loans	4,633,318		4,807,623		(3.6	)
Deposits	6,490,627		6,571,104		(1.2	)
Other borrowed funds	1,925,076		1,670,199		15.3
Junior subordinated deferrable interest debentures	236,164		235,395		.3
Shareholders’ equity	806,795		753,090		7.1

	Three Months Ended September 30,						Percent Increase (Decrease)		Nine Months Ended September 30,				Percent Increase (Decrease)
	(Dollars in Thousands)								(Dollars in Thousands)
	2005			2004					2005		2004
Interest income	$	129,968		$	101,787		27.7	%	$	374,447	$	245,261	52.7	%
Interest expense	54,745			30,362			80.3		144,152		73,363		96.5
Net interest income	75,223			71,425			5.3		230,295		171,898		34.0
Provision for possible loan losses	(196		)	2,066			(109.5	)	2,635		4,783		(44.9	)
Non-interest income	40,883			35,951			13.7		120,613		95,355		26.5
Non-interest expense	64,620			56,913			13.5		189,633		135,489		40.0
Net income	35,468			33,171			6.9		106,500		85,919		24.0
Per common share:
Basic	$	.56		$		.52	7.7	%	$	1.67	$	1.39	20.1	%
Diluted	.55			.51			7.8		1.65		1.36		21.3

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Net Income

Net income increased by 6.9% for the three months ended September 30, 2005 and 24.0% for the nine months ended September 30, 2005 from the same periods in 2004.   Net income was positively impacted by the acquisition of Local Financial Corporation (“LFIN”) in June 2004.  Net income was also positively impacted by $5,613,000, net of tax, of distributions from the January 2005 merger of the PULSE EFT Association with Discover Financial Services, a business unit of Morgan Stanley received in the first and second quarter 2005.  Members of the PULSE EFT Association received these distributions based in part upon their volume of transactions through the PULSE network.

Net Interest Income

	Three Months Ended September 30,				Percent Increase (Decrease)		Nine Months Ended September 30,						Percent Increase (Decrease)
	(in Thousands)						(in Thousands)
	2005		2004				2005			2004
Interest income:
Loans, including fees	$	86,304	$	72,486	19.1	%	$	250,974		$		161,508	55.4	%
Time deposits with banks	2		67		(97.0	)	5			87			(94.3	)
Federal funds sold	1,079		249		333.3		2,433			1,151			111.4
Investment securities:
Taxable	41,274		27,616		49.5		116,965			78,317			49.3
Tax-exempt	1,209		1,278		(5.4	)	3,646		%	3,834			(4.9	)
Other interest income	100		91		9.9		424			364			16.5
Total interest income	129,968		101,787		27.7		374,447			245,261			52.7
Interest expense:
Savings deposits	7,335		4,284		71.2		18,970			9,005			110.7
Time deposits	18,959		12,463		52.1		50,041			31,349			59.6
Securities sold under repurchase agreements	7,219		4,989		44.7		19,758			14,529			36.0
Other borrowings	16,403		4,546		260.8		41,836			9,190			355.2
Junior subordinated interest deferrable debentures	4,829		3,781		27.7		13,547			8,906			52.1
Senior notes	—		299		(100.0	)	—			384			(100.0	)
Total interest expense	54,745		30,362		80.3		144,152			73,363			96.5
Net interest income	$	75,223	$	71,425	5.3	%	$	230,295		$	171,898		34.0	%

Net interest income is the spread between income on interest earning assets, such as loans and securities, and the interest expense on liabilities used to fund those assets, such as deposits, repurchase agreements and funds borrowed.  Net interest income is the Company’s largest source of revenue.  Net interest income is affected by both changes in the level of interest rates and changes in the amount and composition of interest earning assets and interest bearing liabilities.  Net interest income was positively impacted by the acquisition of LFIN, as well as stable portfolio levels and increasing market rates on interest bearing asset and interest bearing liabilities.

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 20 for the September 30, 2005 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.

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Non-Interest Income

	Three Months Ended September 30,				Percent Increase (Decrease)		Nine Months Ended September 30,						Percent Increase (Decrease)
	(in Thousands)						(in Thousands)
	2005		2004				2005			2004
Service charges on deposit accounts	$	21,857	$	21,611	1.1	%	$	62,761		$		51,931	20.9	%
Other service charges, commissions and fees
Banking	6,094		5,313		14.7		18,372			13,599			35.1
Non-banking	3,241		1,797		80.4		7,352			4,345			69.2
Investment securities transactions, net	—		383		(100.0	)	(181		)	8,844			(102.0	)
Other investments, net	3,802		4,133		(8.0	)	11,665			9,958			17.1
Other income	5,889		2,714		117.0		20,644			6,678			209.1
Total non-interest income	$	40,883	$	35,951	13.7	%	$	120,613		$	95,355		26.5	%

The increase in non-banking service charges, commissions and fees can be attributed to the acquisition of LFIN.  The Company recorded investment securities losses of $181,000 for the nine months ended September 30, 2005 compared to gains of $8,844,000 for the same period of 2004.  The increase in other income can be attributed primarily to a gain of $8,636,000 from a distribution resulting from the January 2005 merger of the PULSE EFT Association with Discover Financial Services, a business unit of Morgan Stanley, of which $7,363,000 was received in the first quarter 2005 and $1,273,000 was received in the second quarter.  Members of the PULSE EFT Association received these distributions based in part upon their volume of transactions through the PULSE network.

Non-Interest Expense

	Three Months Ended September 30,					Percent Increase (Decrease)		Nine Months Ended September 30,					Percent Increase (Decrease)
	(in Thousands)							(in Thousands)
	2005		2004					2005		2004
Employee compensation and benefits	$	28,518	$		23,562	21.0	%	$	84,288	$	57,126		47.5	%
Occupancy	6,269		5,000			25.4		17,655		11,899			48.4
Depreciation of bank premises and equipment	6,657		5,184			28.4		18,464		13,650			35.3
Professional fees	2,869		2,000			43.5		9,088		4,882			86.2
Stationery and supplies	1,297		1,534			(15.4	)	4,048		3,423			18.3
Amortization of identified intangible assets	1,298		1,595			(18.6	)	3,895		2,087			86.6
Advertising	2,996		2,796			7.2		8,404		6,889			22.0
Other	14,716		15,242			(3.5	)	43,791		35,533			23.2
Total non-interest expense	$	64,620	$	56,913		13.5	%	$	189,633	$		135,489	40.0	%

The increase in employee compensation and benefits expense for the quarter and nine months ended September 30, 2005 compared to the quarter and nine months ended September 30, 2004 can be attributed primarily to the expanded operations of the Company’s bank subsidiaries (including the acquisition of LFIN in June 2004, which added approximately 700 employees, 52 branches and $42,188,000 in identified intangible assets).

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Financial Condition

Allowance for Possible Loan Losses

The allowance for possible loan losses decreased .7% to $80,799,000 at September 30, 2005 from $81,351,000 at December 31, 2004. The provision for possible loan losses charged to expense decreased 44.9% to $2,635,000 for the nine months ended September 30, 2005 from $4,783,000 for the same period in 2004. The decrease in allowance for possible loan losses can be attributed to the decrease in the loan portfolio. The allowance for possible loan losses was 1.7% of total loans, net of unearned income, at September 30, 2005 and at December 31, 2004, respectively.

Investment Securities

Investment securities increased 9.0% to $4,227,581,000 at September 30, 2005, from $3,877,218,000 at December 31, 2004.

Foreign Operations

On September 30, 2005, the Company had $10,310,436,000 of consolidated assets, of which approximately $267,382,000, or 2.6%, was related to loans outstanding to borrowers domiciled in foreign countries compared to $239,622,000, or 2.4%, at December 31, 2004.  Of the $267,382,000, 79.8% is directly or indirectly secured by U.S. assets, certificates of deposits and real estate; 17.5% is secured by Mexican real estate; .4% is secured by Mexican real estate related to maquiladora plants and 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 .6% represents accrued interest receivable on the portfolio.

Critical Accounting Policies

The Company has established various accounting policies which govern the application of accounting principles in the preparation of the Company’s consolidated financial statements.  Certain accounting policies involve significant subjective judgments and assumptions by management which have a material impact on the carrying value of certain assets and liabilities; management considers such accounting policies to be critical accounting policies.

The Company considers its Allowance for Possible Loan Losses as a policy critical to the sound operations of the bank subsidiaries.  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, which includes general economic conditions and other qualitative risk factors both internal and external to the Company.  See also discussion regarding the allowance for possible loan losses and provision for possible loan losses included in the results of operations and “Provision and Allowance for Possible Loan Losses” included in Notes 1 and 5 of the notes to Consolidated Financial Statements in the Company’s latest Annual Report on Form 10K for further information regarding the Company’s provision and allowance for possible loan losses policy.

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 2005 and 2004 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.

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The Company maintains an adequate level of capital as a margin of safety for its depositors and shareholders.  At September 30, 2005, shareholders’ equity was $806,795,000 compared to $753,090,000 at December 31, 2004, an increase of $53,705,000, or 7.1%.  The change in shareholders’ equity can be attributed to the retention of earnings offset by a decrease in the unrealized gain on available for sale investments.

The Company had a leverage ratio of 7.14% and 6.91%, risk-weighted Tier 1 capital ratio of 12.60% and 10.74% and risk-weighted total capital ratio of 13.86% and 11.99% at September 30, 2005 and December 31, 2004, respectively.  The identified intangibles and goodwill of $329,767,000 as of September 30, 2005, recorded in connection with the Company’s acquisitions, are deducted from the sum of core capital elements when determining the capital ratios of 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 September 30, 2005 is illustrated in the table on the following page.  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.

19

Interest Rate Sensitivity

(Dollars in Thousands)

	Rate/Maturity
September 30, 2005	3 Months or Less							Over 3 Months to 1 Year			Over 1 Year to 5 Years			Over 5 Years		Total
Rate sensitive assets
Federal funds sold	$					143,000		$	—		$	—		$	—	$	143,000
Time deposits with banks	396							—			—			—		396
Investment securities	136,449							1,140,900			1,127,690			1,822,542		4,227,581
Loans, net of non-accruals	3,081,536							390,234			574,898			647,628		4,694,296
Total earning assets	$					3,361,381		$	1,531,134		$	1,702,588		$	2,470,170	$	9,065,273
Cumulative earning assets	$					3,361,381		$	4,892,515		$	6,595,103		$	9,065,273
Rate sensitive liabilities
Time deposits	$				1,347,527			$	1,223,987		$	496,502		$	1,285	$	3,069,301
Other interest bearing deposits	2,123,076							—			—			—		2,123,076
Securities sold under repurchase agreements	232,841							227,154			4,555			300,000		764,550
Other borrowed funds	1,925,000							—			—			76		1,925,076
Junior subordinated deferrable interest debentures	148,420							36,040			—			51,704		236,164
Total interest bearing liabilities	$			5,776,864				$	1,487,181		$	501,057		$	353,065	$	8,118,167
Cumulative sensitive liabilities	$		5,776,864					$	7,264,045		$	7,765,102		$	8,118,167
Repricing gap	$	(2,415,483					)	$	43,953		$	1,201,531		$	2,117,105	$	947,106
Cumulative repricing gap	(2,415,483						)	(2,371,530		)	(1,169,999		)	947,106
Ratio of interest-sensitive assets to liabilities	.58							1.03			3.40			7.00		1.12
Ratio of cumulative, interest-sensitive assets to liabilities	.58							.67			.85			1.12

Item 3.  Quantitative and Qualitative Disclosures about Market Risk

During the first nine months of 2005, there were no material changes in market risk exposures that affected the quantitative and qualitative disclosures regarding market risk presented under the caption “Liquidity & Capital Resources” located on pages 18 through 21 of the Company’s 2004 Annual Report as filed as an exhibit to the Company’s Form 10-K for the year ended December 31, 2004.

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Item 4.  Controls and Procedures

Disclosure Controls and Procedures

The Company maintains disclosure controls and procedures designed to ensure that information required to be disclosed in reports filed under the Securities Exchange Act of 1934, as amended, is recorded, processed, summarized and reported within specified time periods.  As of the end of the period covered by this Quarterly Report on Form 10-Q, the Company’s chief Executive Officer and Chief Financial Officer evaluated, with the participation of the Company’s management, the effectiveness of the Company’s disclosure controls and procedures (as defined in Exchange Act rules 13a-15(e) and 15d-15(e)).  Based on the evaluation, which disclosed no significant deficiencies or material weaknesses, the Company’s Chief Executive Officer and Chief Financial Officer concluded that the Company’s disclosure controls and procedures were effective as of the end of the period covered by this report.

Internal Control Over Financial Reporting

There were no significant changes in the Company’s internal control over financial reporting that occurred during the Company’s most recent fiscal quarter that have materially affected or are reasonably likely to materially affect the Company’s internal control over financial reporting.

PART II - - OTHER INFORMATION

Item 1.  Legal Proceedings

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 were unfavorable, on March 7, 2003, the Company submitted to the IRS a total of $13,640,797, which constitutes the interest that would have accrued based on the adjustments proposed in the FPAAs related to both of the lease-financing transactions.  If it is determined that the amount of interest due, if any, related to the lease-financing transactions is less than the $13,640,797, the remaining amount of the prepaid interest will be refunded to the Company, plus interest thereon.

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.  The Company has accrued approximately $12 million at September 30, 2005 in connection with the lawsuits.  Management intends to continue to evaluate the merits of each matter and make appropriate revisions to the accrued amount as deemed necessary.

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As part of the LFIN acquisition, the Company acquired two tax matters. The first relates to deductions taken on amended returns filed by LFIN during 2003 for the tax years ended June 30, 1999 through December 31, 2001. The refunds requested on the amended returns amounted to approximately $7,000,000. At December 31, 2003, LFIN had received approximately $2,000,000 of the total refund requested. Because all the refunds are under review by the IRS, LFIN had established a reserve equal to the $2,000,000 received and did not recognize any benefit for the remaining $5,000,000. The second tax contingency, which is also approximately $7,000,000, relates to permanent differences applicable to prior periods taken as deductions in 2002 and was received by LFIN during 2003. LFIN had recorded a reserve equal to the amounts received pending final resolution with the IRS. Both reserves are included in the current income taxes payable of the Company.  The Company will continue to monitor the IRS reviews.

Item 2.  Unregistered Sales of Equity Securities and Use of Proceeds

The Company expanded its formal stock repurchase program on December 16, 2004. Under the expanded stock repurchase program, the Company is authorized to repurchase up to $175,000,000 of its common stock through December 2005. 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 October 31, 2005, a total of 3,974,327 shares had been repurchased under this program at a cost of $154,231,000, which shares are now reflected as 10,845,024 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 $195,973,000. 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 $195,973,000 cap will occur in the future. As of October 31, 2005, the Company has approximately $175,204,000 invested in treasury shares, which amount has been accumulated since the inception of the Company.

Share repurchases are only conducted under publicly announced repurchase programs approved by the Board of Directors.  The following table includes information about share repurchases for the quarter ended September 30, 2005.

	Total Number of Shares Purchased	Average Price Paid Per Share (2)		Shares Purchased as Part of a Publicly- Announced Program	Approximate Dollar Value of Shares Available for Repurchase (1) (2)
July 1 — July 31, 2005	195	29.23		—	$	21,979,000
August 1 — August 31, 2005	39,104	30.19		39,103	20,798,000
September 1 — September 30, 2005	—	—		—	20,798,000
	39,299	$	30.19	39,103

(1)The formal stock repurchase program was initiated in 1999 and has been expanded periodically.  The current program allows for the repurchase of up to $175,000,000 of treasury stock through December 2005 of which $20,798,000 remains.

(2)The average price paid per share reflects the Company stock dividend paid on May 31, 2005.

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Item 6.  Exhibits

(a)           Exhibits

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

31(a) —Certification of Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002

31(b) —Certification of Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002

32(a) —Certification of Chief Executive Officer pursuant to 18 U.S.C. Section 1350 as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002

32(b) —Certification of Chief Financial Officer pursuant to 18 U.S.C. Section 1350 as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002

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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:	November 3, 2005	/s/ Dennis E. Nixon
		Dennis E. Nixon
		President
Date:	November 3, 2005	/s/ Imelda Navarro
		Imelda Navarro
		Treasurer

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