INTERNATIONAL BANCSHARES CORPORATION AND SUBSIDIARIES
(Consolidated)
The following consolidated selected financial data is derived from the Corporation’s audited financial statements as of and for the
five years ended December 31, 2006. The following consolidated financial data should be read in conjunction with Management’s
Discussion and Analysis of Financial Condition and Results of Operations and the Consolidated Financial Statements and related
notes in this report.
Exhibit 13
SELECTED FINANCIAL DATA
STATEMENT OF CONDITION
Assets
Net loans
Deposits
Other borrowed funds
Junior subordinated deferrable interest
Debentures (Note 1)
Shareholders’ equity
INCOME STATEMENT
Interest income
Interest expense
Net interest income
Provision for possible loan losses
Non-interest income
Non-interest expense
Income before income taxes and cumulative
change in accounting principle
Minority interest in consolidated subsidiary
Income taxes
Cumulative effect of a change in accounting
principle, net of taxes
Net income
Adjusted net income
Per common share (Note 2):
Basic
Diluted
$
$
$
$
$
2006
AS OF OR FOR THE YEARS ENDED DECEMBER 31,
(Dollars in Thousands, Except Per Share Data)
2003
2005
2004
2002
10,911,454
4,970,273
6,989,918
2,095,576
$ 10,391,853
4,547,896
6,656,426
1,870,075
$ 9,921,505
4,807,623
6,571,104
1,670,199
210,908
842,056
609,073
319,588
289,485
3,849
176,971
288,677
236,391
792,867
235,395
753,090
$
$
508,705
206,830
301,875
960
167,222
255,988
$
352,378
108,602
243,776
5,196
134,816
196,484
173,930
212,149
176,912
—
71,370
—
57,880
$ 6,497,638
2,725,349
4,239,899
1,185,857
$ 6,580,560
2,700,354
4,435,699
845,276
172,254
577,383
—
547,264
353,928
116,415
237,513
8,253
85,645
155,131
159,774
—
54,013
$
318,051
94,725
223,326
8,044
127,273
160,001
182,554
—
60,426
40
56,889
—
117,001
117,001
1.85
1.83
$
$
$
$
—
140,779
140,779
—
$
119,032
$ 119,032
—
122,128
$
$ 122,128
(5,130 )
100,631
$
$ 100,631
2.21
2.18
$
$
1.92
1.88
$
$
2.02
1.98
$
$
1.61
1.58
Note 1: See note 1 of notes to the consolidated financial statements regarding the adoption of FIN 46, as revised. The Company early-adopted
the provisions of FIN 46, as revised, as of December 31, 2003 and thus deconsolidated its investment in eight special purpose business trusts
established for the issuance of trust preferred securities.
Note 2: Per share information has been re-stated giving retroactive effect to stock dividends distributed.
1
MANAGEMENT’S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Management’s discussion and analysis represents an explanation of significant changes in the financial position and results of
operations of International Bancshares Corporation and subsidiaries (the “Company” or the “Corporation”) on a consolidated basis for
the three-year period ended December 31, 2006. The following discussion should be read in conjunction with the Company’s Annual
Report on Form 10-K for the year ended December 31, 2006, and the Selected Financial Data and Consolidated Financial Statements
included elsewhere herein.
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 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
2
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 in the United States or Mexico.
• 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 230 facilities and more than 360 ATMs, provides
banking services for commercial, consumer and international customers of South, Central and Southeast Texas and the State of
Oklahoma. The Company is one of the largest independent commercial bank holding companies headquartered in 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 offered to commercial, consumer and international customers.
A primary goal of the Company is to grow net interest income and non-interest income while adequately managing credit risk,
interest rate risk and expenses. Effective management of capital is a critical objective of the Company. A key measure of the
performance of a banking institution is the return on average common equity (“ROE”). The Company’s ROE for the year ended
December 31, 2006 was 14.02% as compared to 17.97% for the year ended December 31, 2005.
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 except 2006, which the Company’s review indicates is
better than average compared to its national peer group. The Company’s efficiency ratio has increased over the last few years because
of the Company’s aggressive branch expansion which has added 64 branches during 2006 and 2005. The efficiency
3
ratio during 2006 was negatively affected by the $8.9 million, net of tax, expense recognized in connection with the tax litigation.
During rapid expansion periods, the Company’s efficiency ratio will suffer but the long term benefits of the expansion should be
realized in future periods and benefits should positively impact the efficiency ratio in future periods. The Company believes that the
de novo branching will help in attracting new low cost deposits and loans and also help with the retention of current customers as
more out of market banks expand their branching activities in Texas; however, the Company realizes that there is a certain amount of
time before each branch becomes profitable and thus negatively impacts earnings in the short term. The Company has continued to
foster the growth of loans to improve net interest income; however, this process of expanding quality loan balances takes a certain
amount of time and also increases the provision for loan losses in periods of expansion. The Company believes the de novo branch
expansion is important to the future long term expansion of the Company.
Results of Operations
Summary
Consolidated Statements of Condition Information
Assets
Net loans
Deposits
Other borrowed funds
Junior subordinated deferrable interest debentures
Shareholders’ equity
Consolidated Statements of Income Information
December 31, 2006
10,911,454
4,970,273
6,989,918
2,095,576
210,908
842,056
December 31, 2005
(Dollars in Thousands)
$ 10,391,853
4,547,896
6,656,426
1,870,075
236,391
792,867
Percent Increase
(Decrease)
5.0%
9.3
5.0
12.1
(10.8)
6.2
Interest income
Interest expense
Net interest income
Provision for possible loan losses
Non-interest income
Non-interest expense
Net income
Per common share:
Basic
Diluted
Year Ended
December 31,
2006
Year Ended
December 31,
2005
Percent
Increase
(Decrease)
2006 vs. 2005
(Dollars in Thousands)
$ 609,073
319,588
289,485
3,849
176,971
288,677
117,001
$ 508,705
206,830
301,875
960
167,222
255,988
140,779
19.7%
54.5
(4.1)
300.9
5.8
12.8
(16.9)
$
1.85
1.83
$
2.21
2.18
(16.3)%
(16.1)
Year ended
December 31,
2004
$ 352,378
108,602
243,776
5,196
134,816
196,484
119,032
$
1.92
1.88
Percent
Increase
(Decrease)
2005 vs. 2004
44.4%
90.4
23.8
(81.5)
24.0
30.3
18.3
15.1%
16.0
4
Net Income
Net income decreased for the year ended December 31, 2006 as compared to the year ended December 31, 2005 due in part, to a
$8.9 million, net of tax, charge to operations as a result of the loss of a tax lawsuit with the Internal Revenue Service that was litigated
during the third quarter of 2005 in the Federal District Court in San Antonio, Texas and that relates to certain leasing transactions
previously discussed in Note 17 of the Notes to Consolidated Financial Statements. Because of the trial court judgment issued on
March 31, 2006, the uncertainty of the outcome at the appellate level and the similarity between the litigated lawsuit and the other tax
case that is pending, the Company took the $8.9 million charge, net of tax. Additionally, net income for the year ended December 31,
2006 was negatively impacted due to the inverted yield curve, increasing competition for deposits, and strategic decisions to reduce
certain loan and deposit categories acquired from Local Financial Corporation (“LFIN”). As a result of the inverted yield curve, the
Company’s interest revenue coming from its securities portfolio has been negatively affected. Because the Company faces the
challenges of an inverted yield, the Company has placed greater emphasis on growing its loan portfolio and potentially improving the
volume of interest income derived from loans. However, the greater emphasis on increasing loan balances comes with more risk and
takes time to produce quality loans and does not guarantee the Company will achieve its goal.
Net income increased for the year ended December 31, 2005 as compared to the year ended December 31, 2004 primarily
because of the full integration of the Company’s acquisition of LFIN, improved results in its Texas operations, and the efficiencies
created by the operations of the combined companies. Net income was positively impacted by $5,613,000, net of tax, of distributions
received in the first and second quarter of 2005 from the January 2005 merger of the PULSE EFT Association with Discover Financial
Services, a business unit of Morgan Stanley. Members of the PULSE EFT Association received these distributions based in part upon
their volume of transactions through the PULSE network. Net income for 2006, 2005 and 2004 has been negatively affected by the
aggressive de novo branching activity by the Company. The Company has added 32, 32, and 17 new branches in 2006, 2005 and
2004, respectively. The new branches do not include the 52 branches the Company acquired as a result of the LFIN acquisition. The
Company believes that the de novo branching will help in attracting new low cost deposits and loans and also help with the retention
of current customers as more out of market banks expand their branching activities in Texas; however, the Company realizes that there
is a certain amount of time before each branch becomes profitable and thus de novo branching negatively impacts earnings in the
short term. As part of the LFIN acquisition, the Company decided to exit certain national lending strategies that LFIN employed. As
a result, the Company’s total loans have decreased from 2004 to 2005. During the fourth quarter of 2003, the Company reduced its
assets by approximately $1 billion in anticipation of the LFIN acquisition. The Company also increased its overnight liquidity in the
form of fed funds sold to prepare for the cash payment required as part of the transaction. On June 18, 2004, the Company completed
its acquisition of LFIN. As a result of the strategic management of earning assets, net interest income for the first, second and third
quarters of 2004 was negatively affected.
5
Net Interest Income
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 has decreased over the period
from 2005 to 2006 because of the inverted yield curve and the enormous competition for deposits.
Interest earning assets:
Loan, net of unearned discounts:
Assets
Domestic
Foreign
Investment securities:
Taxable
Tax-exempt
Federal funds sold
Other
Total interest-earning assets
Interest bearing liabilities:
Liabilities
Savings and interest bearing demand deposits
Time deposits:
Domestic
Foreign
Securities sold under repurchase agreements
Other borrowings
Junior subordinated deferrable interest debentures
Senior notes
Total interest bearing liabilities
For the years ended December 31,
2004
2005
2006
Average
Average
Average
Rate/Cost
Rate/Cost
Rate/Cost
8.42%
7.16
4.58
4.88
4.79
6.82
6.51%
1.91%
3.81
3.77
4.50
5.07
9.72
—
3.84%
7.12 %
5.44
3.98
4.84
2.77
6.12
5.59 %
1.23 %
2.29
2.42
3.65
3.21
7.88
—
2.53 %
5.99%
4.91
3.64
4.54
1.22
4.81
4.87%
.75%
1.44
1.85
3.64
1.55
6.38
11.47
1.69%
For the three years ended December 31, 2006, as short term interest rates increased and stabilized, the Company accordingly
increased interest rates on loans and deposits. The level of interest rates and the volume and mix of earning assets and interest-bearing
liabilities impact net income and net interest margin. The yield on average interest-earning assets increased 16.5% from 5.59% in 2005
to 6.51% in 2006, and the rates paid on average interest-bearing liabilities increased 51.8% from 2.53% in 2005 to 3.84% in 2006. The
yield on average interest-earning assets increased 14.8% from 4.87% in 2004 to 5.59% in 2005, and the rates paid on average interest-
bearing liabilities increased 49.7% from 1.69% in 2004 to 2.53% in 2005. The majority of the Company’s taxable investment
securities are invested in mortgage backed securities and during rapid increases or reduction in interest rates, the yield on these
securities do not re-price as quickly as the loans.
The Company has strategically reduced loans acquired in the LFIN acquisition. LFIN had a national real estate group that loaned
funds throughout the United States and after extensive review by the Company, the Company concluded the national real estate group
goals were not consistent with the Company’s loan origination goals that emphasize risk, pricing and the desire to lend primarily in the
markets that the Company occupies. This strategic reduction negatively impacted the interest recognized on loans. The decrease in
interest income arising from this strategic reduction was offset by continued
6
growth in the Company’s Texas branches. The Company has continued to grow deposits through its internal sales program. The
Company strategically reduced certain deposit categories of LFIN such as brokered deposits and certain public fund deposits. The
Company decided not to continue the recruitment of brokered deposits and certain public funds because of the high expense associated
with those types of funding sources and the lack of relationships those deposits carry. The strategic reduction in loans and deposits
acquired with LFIN has negatively impacted net interest income.
The following table analyzes the changes in net interest income during 2006 and 2005 and the relative effect of changes in
interest rates and volumes for each major classification of interest-earning assets and interest-bearing liabilities. Non-accrual loans
have been included in assets for the purpose of this analysis, which reduces the resulting yields:
Interest earned on:
Loans, net of unearned discounts:
Domestic
Foreign
Investment securities:
Taxable
Tax-exempt
Federal funds sold
Other
Total interest income
2006 compared to 2005
Net increase (decrease) due to
Rate(1)
(Dollars in Thousands)
Total
Volume(1)
2005 compared to 2004
Net increase (decrease) due to
Volume(1) Rate(1)
Total
(Dollars in Thousands)
$ (4,700) $ 58,593 $ 53,893
1,723
4,954
6,677
13,920
(322 )
(1,586 )
(187 )
$ 8,848
40,299
26,379
37
1,514
43
(285)
(72)
(144)
$ 91,520 $ 100,368
1,556
$ 48,906 $ 51,539 $ 100,445
1,370
2,926
37,615 13,468
301
2,061
142
51,083
(209)
2,091
(9)
$ 87,446 $ 68,881 $ 156,327
(510 )
30
(151 )
Interest incurred on:
Savings and interest bearing demand
deposits
Time deposits:
Domestic
Foreign
Securities sold under repurchase
agreements
Other borrowings
Junior subordinated deferrable interest
debentures
Senior notes
Total interest expense
Net interest income
$
(729) $ 14,237 $ 13,508
$ 2,624 $ 10,515 $ 13,139
261
2,842
(2,958 )
4,804
26,233
20,507
5,711
37,869
26,494
23,349
2,753
42,673
1,731 14,494
8,069
4,281
30
7,489
12,488 31,455
16,225
12,350
7,519
43,943
4,269
—
(288 )
—
$ 108,826 $ 112,758
$ 3,932
$ 12,780 $ (17,306) $ (12,390) $ 57,540
5,435
(383)
$ 30,119 $ 68,109 $ 98,228
559 $ 58,099
3,981
—
1,889
(383 )
3,546
—
$
(Note 1) The change in interest due to both rate and volume has been allocated to volume and rate changes in proportion to the
relationship of the absolute dollar amounts of the change in each.
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
7
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. The
Investment Committee is comprised of certain senior managers of the various Company bank subsidiaries along with consultants.
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.
At December 31, 2006, based on these simulations, a rate shift of 200 basis points in interest rates up or a rate shift of 200 basis
points down will not vary net interest income by more than 2.7% of projected 2007 net interest income. The basis point shift in
interest rates is a hypothetical rate scenario used to calibrate risk, and does not necessarily represent management’s current view of
future market developments. The Company believes that it is properly positioned for a potential interest rate increase or decrease.
Allowance for Possible Loan Loss
The following table presents information concerning the aggregate amount of non-accrual, past due and restructured domestic
loans; certain loans may be classified in one or more category:
Loans accounted for on a non-accrual basis
Loans contractually past due ninety days or more as to
interest or principal payments
Loans accounted for as “troubled debt restructuring”
2006
December 31,
(Dollars in Thousands)
$ 13,490 $ 17,129 $ 16,998 $ 20,874 $ 3,649
2004
2003
2005
2002
7,476
—
4,475
—
7,833
—
7,666
213
5,241
165
The allowance for possible loan losses decreased 17.0% to $64,537,000 at December 31, 2006 from $77,796,000 at
December 31, 2005. The provision for possible loan losses charged to expense increased $2,889,000 to $3,849,000 for the year ended
December 31, 2006 from $960,000 for the same period in 2005. The decrease in the allowance for possible loan losses can be
attributed to the charge off of loans acquired as part of the LFIN acquisition. The increase in the provision for possible loan losses
charged to expense can be attributed to the growth in the loan portfolio. The allowance for possible loan losses was 1.3% of total
loans, net of unearned income at December 31, 2006 and 1.7% at December 31, 2005.
The following table presents information concerning the aggregate amount of non-accrual and past due foreign loans extended to
persons or entities in foreign countries. Certain loans may be classified in one or more category:
Loans accounted for on a non-accrual basis
Loans contractually past due ninety days or more as to interest or principal
payments
$
4,298 $
228
2006
2005
December 31,
2004
(Dollars in Thousands)
12,946 $
608
104
13,741 $
2003
2002
85 $ 254
597
21
The increase in non-accrual loans from 2003 to 2004 can be attributed to certain non-accrual loans acquired as a result of the
LFIN acquisition. The gross income that would have been recorded during 2006 and 2005 on non-accrual and restructured loans in
accordance with their original contract terms was $1,074,000 and $1,144,000 on domestic loans and $798,000 and $1,185,000 on
foreign loans, respectively. The amount of interest income on such loans that was recognized in 2006 and 2005 was $289,000 and
$252,000 on domestic loans and $18,000 and $46,000 for foreign loans, respectively.
8
The non-accrual loan policy of the bank subsidiaries is to discontinue the accrual of interest on loans when management
determines that it is probable that future interest accruals will be uncollectible. Interest income on non-accrual loans is recognized only
to the extent payments are received or when, in management’s opinion, the creditor’s financial condition warrants reestablishment of
interest accruals. Under special circumstances, a loan may be more than 90 days delinquent as to interest or principal and not be
placed on non-accrual status. This situation generally results when a bank subsidiary has a borrower who is experiencing financial
difficulties, but not to the extent that requires a restructuring of indebtedness. The majority of this category is composed of loans that
are considered to be adequately secured and/or for which there has been a recent history of payments. When a loan is placed on non-
accrual status, any interest accrued, not paid is reversed and charged to operations against interest income.
Loan commitments, consisting of unused commitments to lend, letters of credit, credit card lines and other approved loans, that
have not been funded, were $2,043,213,000 and $1,542,272,000 at December 31, 2006 and 2005, respectively. See Note 19 to the
Consolidated Financial Statements.
9
The following table summarizes loan balances at the end of each year and average loans outstanding during the year; changes in
the allowance for possible loan losses arising from loans charged-off and recoveries on loans previously charged-off by loan category;
and additions to the allowance which have been charged to expense:
Loans, net of unearned discounts,
outstanding at December 31
Average loans outstanding during the
year (Note 1)
Balance of allowance at January 1
Provision charged to expense
Loans charged off:
Domestic:
2006
2005
2004
(Dollars in Thousands)
2003
2002
$ 5,034,810
$4,796,489
$
77,796
3,849
$
$
$
4,625,692
4,830,881
81,351
960
$
$
$
4,888,974
3,982,580
46,396
5,196
$
$
$
2,749,000
2,756,003
42,210
8,044
$
$
$
2,769,562
2,664,856
38,350
8,253
Commercial, financial and
agricultural
Real estate—mortgage
Real estate—construction
Consumer
Foreign
Total loans charged off:
Recoveries credited to allowance:
Domestic:
Commercial, financial and
agricultural
Real estate—mortgage
Real estate—construction
Consumer
Foreign
Total recoveries
Net loans charged off
Allowance acquired (disposed) in
purchase or sale transactions
Balance of allowance at December 31
Ratio of net loans charged-off during
(7,302)
(554)
(99)
(2,056)
(8,377)
(18,388)
625
130
53
448
24
1,280
(17,108)
(2,703)
(806)
(41)
(2,948)
(73)
(6,571)
1,436
69
24
511
16
2,056
(4,515)
(5,732)
(1,179)
(295)
(2,034)
(273)
(9,513)
4,841
93
17
451
5
5,407
(4,106)
(2,174 )
(489 )
—
(2,173 )
(107 )
(4,943 )
313
41
—
287
444
1,085
(3,858 )
—
64,537
$
—
77,796
$
33,865
81,351
$
$
—
46,396
$
the year to average loans
outstanding during the year (Note 1)
Ratio of allowance to loans, net of
unearned discounts, outstanding at
December 31
.36%
.09%
.10%
1.28%
1.68%
1.66%
.14 %
1.69 %
(2,490)
(240)
—
(2,412)
(115)
(5,257)
495
247
—
553
34
1,329
(3,928)
(465)
42,210
.15%
1.52%
(Note 1) The average balances for purposes of the above table are calculated on the basis of month-end balances for the years ended
2005, 2004, 2003 and 2002.
The loan balances increased despite the decline of loans as a result of the Company’s strategy to reduce the exposure to certain
loan categories that LFIN employed prior to the acquisition by the
10
Company. LFIN had a national real estate group that loaned funds throughout the United States and after extensive review by the
Company, the Company concluded the national real estate group goals were not consistent with the Company’s loan origination goals
that emphasize risk, pricing and the desire to lend primarily in the markets that the Company occupies.
The allowance for possible loan losses has been allocated based on the amount management has deemed to be reasonably
necessary to provide for the probable losses incurred within the following categories of loans at the dates indicated and the percentage
of loans to total loans in each category:
2006
2005
Allowance Percent
of total Allowance
Percent
of total
At December 31,
2004
Percent
Allowance
of total
(Dollars in Thousands)
2003
2002
Allowance
Percent
of total
Allowance
Percent
of total
Commercial,
Financial and
Agricultural
Real estate—
Mortgage
Real estate—
Construction
Consumer
Foreign
12,228
$ 28,158 46.5 % $ 34,283
9,461 15.6
16,914 27.9
2,392 3.9
7,612 6.1
100.0 %
$ 64,537
13,007
3,154
15,124
$ 77,796
51.4%
$ 46,061
55.5%
$ 25,112
18.3
16,325
19.6
8,887
19.5
4.7
6.1
100.0%
12,741
3,897
2,327
$ 81,351
15.3
4.7
4.9
100.0%
8,828
2,511
1,058
$ 46,396
50.9 % $ 25,767
8,203
18.0
4,468
17.9
2,593
5.1
1,179
8.1
$ 42,210
100.0 %
57.5%
18.3
10.0
5.8
8.4
100.0 %
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 decrease in the allowance for possible loan losses can be attributed to the decrease in total
loans, which is the result of the strategies employed after the consummation of the LFIN acquisition and the charging off of certain
loans acquired as part of the LFIN acquisition.
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, financial and agricultural or real estate loans are
generally considered by management to represent a loss, in whole or part, (i) when an exposure beyond any collateral coverage is
apparent, (ii) when no further collection of the portion of the loan so exposed is anticipated based on actual results, (iii) when the
credit enhancements, if any, are not adequate, and (iv) when the borrower’s financial condition would indicate so. 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 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 December 31, 2006 was
adequate to absorb probable losses from loans in the portfolio at that date. See Critical Accounting Policies on page 24.
11
Non-Interest Income
Service charges on deposit accounts
Other service charges, commissions and
fees
Banking
Non-banking
Investment securities transactions, net
Other investments, net
Other income
Total non-interest income
Year Ended
December 31,
2006
Year Ended
December 31,
2005
Percent
Increase
(Decrease)
2006 vs. 2005
(Dollars in Thousands)
Year Ended
December 31,
2004
Percent
Increase
(Decrease)
2005 vs. 2004
$
84,770
$
83,917
1.0% $
73,877
13.6%
29,523
21,605
(930)
20,035
21,968
176,971
$
25,212
12,248
(181)
20,629
25,397
167,222
17.1
76.4
413.8
(2.9)
(13.5)
5.8%
$
$
19,320
7,083
8,884
13,012
12,640
134,816
30.5
72.9
(102.0)
58.5
100.9
24.0%
Non-interest income increased in 2006 as compared to 2005 primarily because of income recognized by the Company’s
investment services unit. Non-interest income increased in 2005 as compared to 2004 primarily because of the full integration of the
Company’s acquisition of LFIN. The increase in other income from 2005 to 2004 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. Members of the PULSE EFT Association received these distributions based in part upon their
volume of transactions through the PULSE network.
Non-Interest Expense
Employee compensation and
benefits
Occupancy
Depreciation of bank premises and
equipment
Professional fees
Stationery and supplies
Amortization of identified
intangible assets
Advertising
Other
Total non-interest expense
Year Ended
December 31,
2006
Year Ended
December 31,
2005
Percent
Increase
(Decrease)
2006 vs. 2005
(Dollars in Thousands)
Year Ended
December 31,
2004
Percent
Increase
(Decrease)
2005 vs. 2004
$ 124,359
27,886
$ 113,620
25,053
9.5%
11.3
$ 83,631
18,403
35.9%
36.1
28,251
11,050
6,490
4,866
12,052
73,723
$ 288,677
25,538
12,497
5,809
5,176
10,596
57,699
$ 255,988
10.6
(11.6)
11.7
(6.0)
13.7
27.8
12.8%
18,975
6,513
5,075
3,681
10,082
50,124
$ 196,484
34.6
91.9
14.5
40.6
5.1
15.1
30.3%
Expense control is an essential element in the Company’s profitability. This is achieved through maintaining optimum staffing
levels, an effective budgeting process, and internal consolidation of bank functions. The increase in other expense in 2006 compared
to 2005 can be attributed to the $13,640,000 in connection with the tax lawsuits (see Note 17 to the consolidated financial statements)
expensed in the first quarter 2006. The increase in employee compensation and benefits in 2006 compared to 2005 can be
12
attributed to increased fees paid by the Company’s investment banking unit, the GulfStar Group and the growth experienced with the
de novo branch activity. The increase in non-interest expense for the three years ended 2006 can be attributed primarily to the
expanded operations of the Company’s bank subsidiaries, which added 81 branches in the three year period ended December 31, 2006
(excluding the acquisition of LFIN in June 2004, which added approximately 700 employees, 52 branches and $42,188,000 in
identified intangible assets), the amount expensed in connection with the tax lawsuits and increased fees paid by the Company’s
investment banking unit, the GulfStar Group, in 2006.
Effects of Inflation
The principal component of earnings is net interest income, which is affected by changes in the level of interest rates. Changes in
rates of inflation affect interest rates. It is difficult to precisely measure the impact of inflation on net interest income because it is not
possible to accurately differentiate between increases in net interest income resulting from inflation and increases resulting from
increased business activity. Inflation also raises costs of operations, primarily those of employment and services.
Financial Condition
Investment Securities
The following table sets forth the carrying value of investment securities as of December 31, 2006, 2005 and 2004:
U.S. Treasury and Government Securities
Available for sale
Mortgage-backed securities
Available for sale
Obligations of states and political subdivisions
Available for sale
Equity securities
Available for sale
Other securities
Held to maturity
Available for sale
Total
2006
December 31,
2005
(Dollars in Thousands)
2004
$
$
1,268 $
1,283 $
9,276
4,376,284
4,148,859
3,743,225
95,897
14,629
2,375
2,079
4,492,532 $
99,557
14,654
2,375
2,599
4,269,327 $
104,317
13,235
2,385
4,780
3,877,218
The following tables set forth the contractual maturities of investment securities, based on amortized cost, at December 31, 2006
and the average yields of such securities, except for the totals, which reflect the weighted average yields. Actual maturities will differ
from contractual maturities because borrowers may have the right to prepay obligations with or without prepayment penalties.
13
Available for Sale
Maturing
Within one year
Adjusted
Cost
Yield
After one but
within five years
Adjusted
Cost
Yield
After five but
within ten years
Adjusted
Cost
Yield
After ten years
Adjusted
Cost
Yield
(Dollars in Thousands)
$ 1,268
516
5.09% $
7.53
—
136,437
—% $
4.76
—
68,267
—
325
—
$ 2,109
—
—
—
4.89%
750
—
—
$ 137,187
4.45
—
—
4.75%
85,169
—
—
$ 153,436
—%
4.79
% $
—
4,235,045
5.34
4.78
—
—
5.03 % $ 4,260,134
4.91
6,959
13,500
4.41
4,630 13.00
4.80%
U.S. Treasury and obligations of U.S.
Government agencies
Mortgage-backed securities
Obligations of states and political
subdivisions
Equity securities
Other securities
Total
Other securities
Total
Within one year
Adjusted
Cost
Yield
$ 75
$ 75
5.72%
5.72%
Held to Maturity
Maturing
After one but
within five years
Adjusted
Cost
Cost
Yield
(Dollars in Thousands)
5.14%
5.14%
$ —
$ —
$ 2,300
$ 2,300
After five but
within ten years
Adjusted
After ten years
Adjusted
Yield Cost
Yield
—
—
$ —
$ —
—
—
Mortgage-backed securities are securities primarily issued by the Federal Home Loan Mortgage Corporation (“Freddie Mac”),
Federal National Mortgage Association (“Fannie Mae”), and the Government National Mortgage Association (“Ginnie Mae”).
Loans
The amounts of loans outstanding, by classification, at December 31, 2006, 2005, 2004, 2003 and 2002 are shown in the
following table:
Commercial, financial and agricultural $ 2,337,573
Real estate-mortgage
785,401
Real estate—construction
1,404,186
Consumer
198,580
Foreign
309,144
5,034,884
(74)
$ 5,034,810
Total loans
Unearned discount
Loans, net of unearned discount
2006
2005
December 31,
2004
(Dollars in Thousands)
$ 2,710,270
960,599
749,689
229,302
239,622
4,889,482
(508)
$ 4,888,974
$ 2,376,276
847,512
901,518
218,607
281,947
4,625,860
(168)
$ 4,625,692
2003
2002
$ 1,400,173
495,481
492,208
139,987
222,797
2,750,646
(1,646 )
$ 2,749,000
$ 1,595,140
507,837
276,595
160,546
233,276
2,773,394
(3,832)
$ 2,769,562
14
The following table shows the amounts of loans (excluding real estate mortgages and consumer loans) outstanding as of
December 31, 2006, which based on remaining scheduled repayments of principal are due in the years indicated. Also, the amounts
due after one year are classified according to the sensitivity to changes in interest rates:
Maturing
Commercial, financial and agricultural
Real estate—construction
Foreign
Total
Within
one year
$ 713,711
779,399
190,915
$ 1,684,025
Due after one but within five years
Due after five years
Total
Total
$ 2,337,573
1,404,186
309,144
$ 4,050,903
$ 1,401,687
583,278
115,967
$ 2,100,932
After one
After
but within
five years
five years
(Dollars in Thousands)
$ 222,175
41,509
2,262
$ 265,946
Interest sensitivity
(Dollars in Thousands)
Fixed Rate
Variable Rate
$ 1,802,188
223,815
$ 2,026,003
$ 298,744
42,131
$ 340,875
Total loan balances as of December 31, 2006 as compared to December 31, 2005 have increased because of the Company’s
desire to grow loans organically. This increase occurred despite the Company’s strategy to reduce the exposure to certain loan
categories that LFIN employed prior to the acquisition by the Company. LFIN had a national real estate group that loaned funds
throughout the United States and after extensive review by the Company, the Company concluded the national real estate group goals
were not consistent with the Company’s loan origination goals that emphasize risk, pricing and the desire to lend primarily in the
markets that the Company occupies.
International Operations
On December 31, 2006, the Company had $309,144,000 (2.8% of total assets) in loans outstanding to borrowers domiciled in
foreign countries. The loan policies of the Company’s bank subsidiaries generally require that loans to borrowers domiciled in foreign
countries be primarily secured by assets located in the United States or have credit enhancements, in the form of guarantees, from
significant United States corporations. The composition of such loans and the related amounts of allocated allowance for possible loan
losses as of December 31, 2006 is presented below.
Secured by certificates of deposits in United States banks
Secured by United States real estate
Secured by other United States collateral (securities, gold, silver, etc.)
Foreign real estate guaranteed under lease obligations primarily by U.S. companies
Direct unsecured Mexican sovereign debt (principally former FICORCA debt)
Other (principally Mexico real estate)
15
Amount
of Loans
Related
Allowance for
Possible Losses
$
$ 177,435
40,518
21,378
689
2,249
66,875
$ 309,144
(Dollars in Thousands)
89
421
2,453
121
22
4,506
$ 7,612
The transactions for the year ended December 31, 2006, in that portion of the allowance for possible loan losses related to foreign
debt were as follows:
Balance at December 31, 2005
Charge-offs
Recoveries
Net charge-offs
Provision charged to expense
Balance at December 31, 2006
Deposits
Deposits:
Demand—non-interest bearing
Domestic
Foreign
Total demand non-interest bearing
Savings and interest bearing demand
Domestic
Foreign
Total savings and interest bearing demand
Time certificates of deposit
$100,000 or more:
Less than $100,000:
Domestic
Foreign
Domestic
Foreign
Total time, certificates of deposit
Total deposits
16
(Dollars in Thousands)
$ 15,138
(8,537 )
84
(8,453 )
927
$ 7,612
2006
Average Balance
(Dollars in Thousands)
2005
Average Balance
$ 1,240,419
124,192
1,364,611
1,810,759
311,543
2,122,302
823,145
1,147,864
897,597
380,094
3,248,700
$ 6,735,613
$ 1,139,614
114,080
1,253,694
1,848,257
333,046
2,181,303
810,358
1,050,166
898,917
360,299
3,119,740
$ 6,554,737
Interest expense:
Savings and interest bearing demand
Domestic
Foreign
Total savings and interest bearing demand
Time, certificates of deposit
$100,000 or more
Less than $100,000
Domestic
Foreign
Domestic
Foreign
Total time, certificates of deposit
Total interest expense on deposits
2006
2005
(Dollars in Thousands)
2004
$ 36,606
3,838
40,444
$ 24,583
2,353
26,936
$ 11,991
1,806
13,797
32,851
44,143
18,705
26,710
10,483
17,327
33,225
12,858
123,077
$ 163,521
20,399
7,420
73,234
$ 100,170
12,396
4,453
44,659
$ 58,456
The Company offers a variety of deposit accounts having a wide range of interest rates and terms. The Company relies primarily
on its high quality customer service, sales programs, customer referrals and advertising to attract and retain these deposits. Deposits
provide the primary source of funding for the Company’s lending and investment activities, and the interest paid for deposits must be
managed carefully to control the level of interest expense. Deposits at December 31, 2006 were $6,989,918,000, an increase of 5.0%
from $6,656,426,000 at December 31, 2005. The increase in deposits from 2005 to 2006 is primarily the result of the Company’s
internal sales programs to organically grow deposits, despite the Company strategically reducing certain deposit categories of LFIN
such as brokered deposits and certain public funds. The Company decided not to continue the recruitment of brokered deposits and
certain public funds because of the high expense associated with those types of funding sources and the lack of relationships those
deposits carry.
Return on Equity and Assets
Certain key ratios for the Company for the years ended December 31, 2006, 2005 and 2004 follows (Note 1):
Percentage of net income to:
Average shareholders’ equity
Average total assets
Percentage of average shareholders’ equity to average total
assets
Percentage of cash dividends per share to net income per
share
Years ended December 31,
2005
2006
2004
14.02% 17.97 % 18.17 %
1.46
1.37
1.10
7.82
37.64
7.62
8.04
32.58
38.42
(Note 1) The average balances for purposes of the above table are calculated on the basis of month-end balances for 2005 and 2004.
17
Liquidity and Capital Resources
Liquidity
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 stable portion of the deposit base of the Company’s bank
subsidiaries. Historically, the Mexico based deposits of the Company’s bank subsidiaries have been a stable source of funding. Such
deposits comprised approximately 30%, 28% and 28% of the Company’s bank subsidiaries’ total deposits as of December 31, 2006,
2005 and 2004, respectively. Other important funding sources for the Company’s bank subsidiaries have been borrowings from the
Federal Home Loan Bank (“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 repurchase agreements. 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.
Asset/Liability Management
The Company’s fund management policy has as its primary focus the measurement and management of the banks’ earnings at
risk in the face of rising or falling interest rate forecasts. The earliest and most simplistic concept of earnings at risk measurement is
the gap report, which is used to generate a rough estimate of the vulnerability of net interest income to changes in market rates as
implied by the relative re-pricings of assets and liabilities. The gap report calculates the difference between the amounts of assets and
liabilities re-pricing across a series of intervals in time, with emphasis typically placed on the one-year period. This difference, or gap,
is usually expressed as a percentage of total assets.
If an excess of liabilities over assets matures or re-prices within the one-year period, the statement of condition is said to be
negatively gapped. This condition is sometimes interpreted to suggest that an institution is liability-sensitive, indicating that earnings
would suffer from rising rates and benefit from falling rates. If a surplus of assets over liabilities occurs in the one-year time frame, the
statement of condition is said to be positively gapped, suggesting a condition of asset sensitivity in which earnings would benefit from
rising rates and suffer from falling rates.
The gap report thus consists of an inventory of dollar amounts of assets and liabilities that have the potential to mature or re-price
within a particular period. The flaw in drawing conclusions about interest rate risk from the gap report is that it takes no account of the
probability that potential maturities or re-pricings of interest-rate-sensitive accounts will occur, or at what relative magnitudes.
Because simplicity, rather than utility, is the only virtue of gap analysis, financial institutions increasingly have either abandoned gap
analysis or accorded it a distinctly secondary role in managing their interest-rate risk exposure.
The net interest rate sensitivity at December 31, 2006, is illustrated in the following table. This information reflects the balances
of assets and liabilities whose rates are subject to change. As indicated in the table on the following page, the Company is liability-
sensitive during the early time periods and is asset-sensitive in the longer periods. The table shows the sensitivity of the statement of
condition at one point in time and is not necessarily indicative of the position at future dates.
18
December 31, 2006
Rate sensitive assets
Federal funds sold
Time deposits with banks
Investment securities
Loans, net of non-accruals
Total earning assets
Cumulative earning assets
Rate sensitive liabilities
Time deposits
Other interest bearing deposits
Securities sold under repurchase
agreements
Other borrowed funds
Junior subordinated deferrable interest
debentures
Total interest bearing liabilities
Cumulative sensitive liabilities
Repricing gap
Cumulative repricing gap
Ratio of interest-sensitive assets to
liabilities
Ratio of cumulative, interest- sensitive
assets to liabilities
INTEREST RATE SENSITIVITY
(Dollars in Thousands)
3 Months or
Less
Rate/Maturity
Over 3
Months
to 1 Year
Over 1
Year to 5
Years
(Dollars in Thousands)
Over 5
Years
Total
$
$
29,000
396
27,155
3,664,838
— $
—
216,524
319,527
— $
—
4,027,992
460,461
$ 3,721,389
$ 3,721,389
$
536,051
$ 4,488,453
$ 4,257,440
$ 8,745,893
—
—
220,861
572,270
$ 793,131
$ 9,539,024
$
29,000
396
4,492,532
5,017,095
$ 9,539,024
$ 1,441,173
2,204,451
$ 1,517,241
—
$ 372,482
—
$
1,095
—
$ 3,331,991
2,204,451
268,183
2,095,505
135,974
—
202,178
—
177,975
22,681
—
$ 574,660
$ 1,675,896
$ 6,187,287
$ 6,187,287
$ (2,465,898) $ (1,139,845) $ 3,913,793
308,050
$ 7,863,183
$ 8,437,843
(3,605,743)
(2,465,898)
100,000
71
706,335
2,095,576
10,252
$ 111,418
$ 8,549,261
$ 681,713
989,763
210,908
$ 8,549,261
$ 989,763
.601
.601
.320
.541
7.811
1.037
1.116
7.119
1.116
The detailed inventory of statement of condition items contained in gap reports is the starting point of income simulation
analysis. Income simulation analysis also focuses on the variability of net interest income and net income, but without the limitations
of gap analysis. In particular, the fundamental, but often unstated, assumption of the gap approach that every statement of condition
item that can re-price will do so to the full extent of any movement in market interest rates is taken into consideration in income
simulation analysis.
Accordingly, income simulation analysis captures not only the potential of assets and liabilities to mature or re-price, but also the
probability that they will do so. Moreover, income simulation analysis focuses on the relative sensitivities of these balance sheet items
and projects their behavior over an extended period of time in a motion picture rather than snapshot fashion. Finally, income
simulation analysis permits management to assess the probable effects on balance sheet items not only of changes in market interest
rates, but also of proposed strategies for responding to such changes. The Company and many other institutions rely primarily upon
income simulation analysis in measuring and managing exposure to interest rate risk.
19
At December 31, 2006, based on these simulations, a rate shift of 200 basis points in interest rates up or a rate shift of 200 basis
points down will not vary net interest income by more than 2.7% of projected 2007 net interest income. The basis point shift in
interest rates is a hypothetical rate scenario used to calibrate risk, and does not necessarily represent management’s current view of
future market developments. The Company believes that it is properly positioned for a potential interest rate increase or decrease.
All the measurements of risk described above are made based upon the Company’s business mix and interest rate exposures at
the particular point in time. The exposure changes continuously as a result of the Company’s ongoing business and its risk
management initiatives. While management believes these measures provide a meaningful representation of the Company’s interest
rate sensitivity, they do not necessarily take into account all business developments that have an effect on net income, such as changes
in credit quality or the size and composition of the statement of condition.
Principal sources of liquidity and funding for the Company are dividends from subsidiaries and borrowed funds, with such funds
being used to finance the Company’s cash flow requirements. The Company closely monitors the dividend restrictions and availability
from the bank subsidiaries as disclosed in Note 20 to the Consolidated Financial Statements. At December 31, 2006, the aggregate
amount legally available to be distributed to the Company from bank subsidiaries as dividends was approximately $140,250,000,
assuming that each bank subsidiary continues to be classified as “well capitalized” under the applicable regulations and excluding
certified surplus. Pursuant to Texas law, a Texas state bank’s lending limit is twenty-five percent of the bank’s capital and certified
surplus. The board of directors of the bank determines how much surplus will be certified. Except to absorb losses in excess of
undivided profits and uncertified surplus, certified surplus may not be reduced without the prior written approval of the Texas banking
commissioner. The restricted capital (capital, surplus and certified surplus) of the bank subsidiaries was approximately $908,783,000
as of December 31, 2006. The undivided profits of the bank subsidiaries were approximately $536,740,000 as of December 31, 2006.
At December 31, 2006, the Company has outstanding $2,095,576,000 in other borrowed funds and $210,908,000 in junior
subordinated deferrable interest debentures. In addition to borrowed funds and dividends, the Company has a number of other
available alternatives to finance the growth of its existing banks as well as future growth and expansion.
Capital
The Company maintains an adequate level of capital as a margin of safety for its depositors and shareholders. At December 31,
2006, shareholders’ equity was $842,056,000 compared to $792,867,000 at December 31, 2005, an increase of $49,189,000, or 6.2%.
Shareholders’ equity increased due to the retention of earnings offset by the payment of cash dividends to shareholders. The
accumulated other comprehensive loss is not included in the calculation of regulatory capital ratios.
During 1990, the Federal Reserve Board (“FRB”) adopted a minimum leverage ratio of 3% for the most highly rated bank
holding companies and at least 4% to 5% for all other bank holding companies. The Company’s leverage ratio (defined as
shareholders’ equity plus eligible trust preferred securities issued and outstanding less goodwill and certain other intangibles divided
by average quarterly assets) was 7.36% at December 31, 2006 and 7.26% at December 31, 2005. The core deposit intangibles and
goodwill of $316,604,000 as of December 31, 2006, recorded in connection with financial institution acquisitions of the Company
after February 1992, are deducted from the sum of core capital elements when determining the capital ratios of the Company. The
substantial increase in core deposit intangibles and goodwill and the resulting decrease in the Company’s leverage ratio can be
attributed to the LFIN acquisition.
The FRB has adopted risk-based capital guidelines which assign risk weightings to assets and off-balance sheet items. The
guidelines also define and set minimum capital requirements (risk-based capital
20
ratios). Under the final 1992 rules, all banks are required to have Tier 1 capital of at least 4.0% of risk-weighted assets and total capital
of 8.0% of risk-weighted assets. Tier 1 capital consists principally of shareholders’ equity plus trust preferred securities issued and
outstanding less goodwill and certain other intangibles, while total capital consists of Tier 1 capital, certain debt instruments and a
portion of the reserve for loan losses. In order to be deemed well capitalized pursuant to the regulations, an institution must have a
total risk-weighted capital ratio of 10%, a Tier 1 risk-weighted ratio of 6% and a Tier 1 leverage ratio of 5%. The Company had risk-
weighted Tier 1 capital ratios of 12.49% and 12.97% and risk weighted total capital ratios of 13.61% and 14.22% as of December 31,
2006 and 2005, respectively, which are well above the minimum regulatory requirements and exceed the well capitalized ratios (see
Note 20 to Notes to Consolidated Financial Statements).
During the past few years the Company has expanded its banking facilities. Among the activities and commitments the Company
funded during 2006 and 2005 were certain capital expenditures relating to the modernization and improvement of several existing
bank facilities and the expansion of the bank branch network.
Junior Subordinated Deferrable Interest Debentures
The Company has formed ten statutory business trusts under the laws of the State of Delaware, for the purpose of issuing trust
preferred securities. As part of the LFIN acquisition, the Company acquired three additional statutory business trusts previously
formed by LFIN for the purpose of issuing trust preferred securities. The ten 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 $20,620,000. 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 December 31, 2006, the
principal amount of debentures outstanding totaled $210,908,000.
On July 25, 2006, pursuant to the Indenture dated as of July 16, 2001, between the Company and The Bank of New York, as
Trustee, the Company redeemed all of its Floating Rate Junior Subordinated Debt Securities (the “Debt Securities”), issued to
International Bancshares Capital Trust II (“Trust II”) at a redemption price equal to approximately $27,998,000, which includes
accrued interest to, but not including, the redemption date.
In accordance with the Amended and Restated Declaration of Trust dated as of July 16, 2001 between the Company and The
Bank of New York as Institutional Trustee, the proceeds from the redemption of the Debt Securities were used to simultaneously
redeem an equal amount of Trust II Floating Capital Securities and the Trust II Floating Rate Common Securities issued by Trust II.
On September 30, 2006, pursuant to the Indenture dated as of September 20, 2001, between Local Financial Corporation and The
Bank of New York, as Trustee, the Company redeemed all of its Fixed Rate Junior Subordinated Debt Securities (the “Debt
Securities”), issued to Local Financial Capital Trust I (“LFIN Trust I”) at a redemption price equal to approximately $41,155,625,
which includes accrued interest to, but not including, the redemption date.
In accordance with the Amended and Restated Declaration of Trust dated as of September 20, 2001 between Local Financial
Capital Corporation and The Bank of New York as Institutional Trustee, the proceeds from the redemption of the Debt Securities were
used to simultaneously redeem an equal
21
amount of LFIN Trust I Fixed Rate Capital Securities and the LFIN Trust I Fixed Rate Common Securities issued by LFIN Trust I.
On December 8, 2006, pursuant to the Indenture dated as of November 28, 2001, between the Company and Wilmington Trust
company, as Trustee, the Company redeemed all of its Floating Rate Junior Subordinated Debt Securities (the “Debt Securities”)
issued to International Bancshares Capital Trust III (“Trust III”) at a redemption price equal to approximately $34,538,000, which
includes accrued interest to, but not including, the redemption date.
In accordance with the Amended and Restated Declaration of Trust dated as of November 28, 2001, between the Company and
Wilmington Trust Company, as the Institutional Trustee and Delaware Trustee and the Administrators named therein, the proceeds
from the redemption of the Debt Securities were used to simultaneously redeem an equal amount of Trust III floating rate Capital
Securities and the Trust III floating rate Common Securities issued by Trust III.
On June 9, 2006, the Company formed International Bancshares Corporation Capital Trust IX (“Trust IX”), its ninth statutory
business trust formed under the laws of the State of Delaware, for the purpose of issuing trust preferred securities. On July 27, 2006,
Trust IX issued $40,000,000 of Capital Securities. The Capital Securities accrue interest for the first five years at a fixed rate of
7.10%, and subsequently at a floating rate of 1.62% over the London Interbank Offered Rate (“LIBOR”), and interest is payable
quarterly beginning October 1, 2006. The Trust IX Capital Securities will mature on October 1, 2036; 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 October 1, 2011, or
(b) in whole or in part within 90 days upon the occurrence 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 IX 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 twenty consecutive
quarterly 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.
On November 8, 2006, the Company formed International Bancshares Corporation Capital Trust X (“Trust X”), its tenth
statutory business trust formed under the laws of the State of Delaware, for the purpose of issuing trust preferred securities. On
November 15, 2006, Trust X issued $33,000,000 of Capital Securities. The Capital Securities accrue interest for the first five years at a
fixed rate of 6.66% and subsequently at a floating rate of 1.65% over the three month LIBOR, and interest is payable quarterly
beginning February 1, 2007. The Trust X Capital Securities will mature on February 1, 2037; 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 February 1, 2012, or (b) in
whole or in part within 90 days upon the occurrence 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 X 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 twenty consecutive
quarterly 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.
22
The Debentures are subordinated and junior in right of payment to all present and future senior indebtedness (as defined in the
respective indentures) of the Company, and are pari passu with one another. The interest rate payable on, and the payment terms of
the Debentures are the same as the distribution rate and payment terms of the respective issues of Capital and Common Securities
issued by the Trusts. The Company has fully and unconditionally guaranteed the obligations of each of the Trusts with respect to the
Capital and Common Securities. The Company has the right, unless an Event of Default (as defined in the Indentures) has occurred
and is continuing, to defer payment of interest on the Debentures for up to ten consecutive semi-annual periods on Trusts I and IV and
LFIN Trust II and for up to twenty consecutive quarterly periods on Trusts V, VI, VII, VIII, IX and X and LFIN Trust III. If interest
payments on any of the Debentures are deferred, distributions on both the Capital and Common Securities related to that Debenture
would also be deferred. The redemption prior to maturity of any of the Debentures may require the prior approval of the Federal
Reserve and/or other regulatory bodies.
For financial reporting purposes, the Trusts are treated as investments of the Company and not consolidated in the consolidated
financial statements. Although the Capital Securities issued by each of the Trusts are not included as a component of shareholders’
equity on the consolidated statement of condition, the Capital Securities are treated as capital for regulatory purposes. Specifically,
under applicable regulatory guidelines, the Capital Securities issued by the Trusts qualify as Tier 1 capital up to a maximum of 25% of
Tier 1 capital on an aggregate basis. Any amount that exceeds the 25% threshold would qualify as Tier 2 capital. For December 31,
2006, the total $210,908,000 of the Capital Securities outstanding qualified as Tier 1 capital.
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 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
current trust preferred securities will be included in Tier 1 capital after the five-year transition period ending March 31, 2009.
The following table illustrates key information about each of the Debentures and their interest rates at December 31, 2006:
Junior
Subordinated
Deferrable
Interest
Debentures
(in thousands)
$ 10,252
$ 22,681
$ 20,558
$ 25,662
$ 10,310
$ 25,566
$ 41,238
$ 34,021
$ 10,310
$ 10,310
$ 210,908
Trust I
Trust IV
Trust V
Trust VI
Trust VII
Trust VIII
Trust IX
Trust X
LFIN Trust II
LFIN Trust III
Repricing
Frequency
Interest
Rate
Interest
Rate Index(1)
Maturity Date
Optional
Redemption Date
Fixed
Semi-Annually
Quarterly
Quarterly
Quarterly
Quarterly
Quarterly
Quarterly
Quarterly
Semi-Annually
10.18 %
9.09 %
9.02 %
8.82 %
8.62 %
8.42 %
7.10 %
6.66 %
9.17 %
8.82 %
Fixed
LIBOR + 3.70
LIBOR + 3.65
LIBOR + 3.45
LIBOR + 3.25
LIBOR + 3.05
Fixed
Fixed
LIBOR + 3.625
LIBOR + 3.45
June 2031
April 2032
July 2032
November 2032
April 2033
October 2033
October 2036
February 2037
July 2032
November 2032
June 2011
April 2007
July 2007
November 2007
April 2008
October 2008
October 2011
February 2012
July 2007
November 2007
(1) Trust IX and Trust X accrue interest at a fixed rate for the first five years, then floating at LIBOR+1.62 and LIBOR+1.65
thereafter, respectively.
23
Contractual Obligations and Commercial Commitments
The following table presents contractual cash obligations of the Company (other than deposit liabilities) as of December 31,
2006:
Payments due by Period
Contractual Cash Obligations
Securities sold under repurchase agreements
Federal Home Loan Bank borrowings
Junior subordinated deferrable interest
debentures
Total Contractual Cash Obligations
Total
$ 706,335
$ 2,095,576
Less than
One Year
One to
Three Years
(Dollars in Thousands)
$ 2,178
—
$ 419,157
2,095,505
Three to
Five Years
$ —
—
After
Five Years
$ 285,000
71
$ 210,908
$ 3,012,819
—
$ 2,514,662
—
$ 2,178
—
$ —
210,908
$ 495,979
The following table presents contractual commercial commitments of the Company (other than deposit liabilities) as of
December 31, 2006:
Commercial Commitments
Total
Financial and Performance Standby
Letters of Credit
Commercial Letters of Credit
Credit Card Lines
Other Commercial Commitments
Total Commercial Commitments
Amount of Commitment Expiration Per Period
Three to
One to
Three Years
Less than
One Year
Five Years
(Dollars in Thousands)
$ 124,113
22,314
$
$
36,404
$ 1,860,382
$ 2,043,213
$ 117,199
22,314
36,404
1,159,433
$ 1,335,350
$
6,814
—
—
555,884
$ 562,698
$
100
—
—
101,325
$ 101,425
After
Five Years
$ —
—
—
43,740
$ 43,740
Due to the nature of the Company’s commercial commitments, including unfunded loan commitments and lines of credit, the
amounts presented above do not necessarily reflect the amounts the Company anticipates funding in the periods presented above.
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. The significant accounting policies are described in the Notes to the
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
24
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.
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 a loan has any potential problem and if a loan should be placed on the
Company’s internal classified report. Additionally, the Company’s credit department reviews the majority of the loans regardless of
whether they are past due and segregates any loans with potential problems for further review. The credit department will discuss the
potential problem 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. After
the above analysis is completed, the Company will determine if a 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.
The Company’s internal classified report is segregated into the following categories: (i) “Pass Credits,” (ii) “Special Review
Credits,” (iii) “Watch List Credits-Pass Credits,” or (iv) “Watch List Credits-Substandard and Doubtful 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” or the
“Watch List Credits-Pass 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” or the “Watch List Credits-Pass 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-Substandard and Doubtful
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-Substandard and Doubtful Credits” are potentially 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. Substantially all of the Company’s loans evaluated under SFAS
No. 114 are measured using the fair value of collateral method. In limited cases, the Company may use other methods to determine the
specific reserve of a loan under SFAS No. 114 if such loan is not collateral dependent.
The allowance, based on historical loss experience on the Company’s remaining loan portfolio, which includes the “Pass
Credits,” “Special Review Credits,” “Watch List Credits-Pass Credits,” and “Watch List Credits-Substandard and Doubtful Credits” is
determined by segregating the remaining loan portfolio into certain categories such as commercial loans, installment loans,
international loans, loan concentrations and overdrafts. Installment loans are then further segregated by number of days past due. A
historical loss percentage, adjusted for (i) management’s evaluation of changes in lending policies and procedures, (ii) current
economic conditions in the market area served by the Company, (iii) other risk factors, (iv) the effectiveness of the internal loan
review function, (v) changes in loan portfolios, and (vi) the composition and concentration of credit volume is applied to each
category. Each category is then added together to determine the allowance allocated under Statement of Financial Accounting
Standards No. 5.
The Company’s management continually reviews the allowance for loan loss 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 allowance for loan loss. If the bases of the
Company’s assumptions
25
change, the allowance for loan loss would either decrease or increase and the Company would increase or decrease the provision for
loan loss charged to operations accordingly.
Through December 31, 2005, the Company accounted for stock-based employee compensation plans based on the intrinsic value
method provided in Accounting Principles Board Opinion No. 25 “Accounting for Stock Issued to Employees,” (“APB No. 25”), and
related interpretations. Because the exercise price of the Company’s employee stock options equals the market price of the underlying
stock on the measurement date, which is generally the date of grant, no compensation expense was recognized on options granted.
Compensation expense for stock awards is based on the market price of the stock on the measurement date, which is generally the date
of grant, and is recognized ratably over the service period of the award.
Statement of Financial Accounting Standards No. 123 (“SFAS No. 123”), “Accounting for Stock-Based Compensation,” as
amended by 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,” requires pro forma disclosures of net income and earnings per
share for companies not adopting its fair value accounting method for stock-based employee compensation. The pro forma disclosures
presented in Note 3 in the accompanying Notes to Consolidated Financial Statements included elsewhere in this report use the fair
value method of SFAS No. 123 to measure compensation expense for stock-based employee compensation plans. The fair value of
stock options granted was estimated as the measurement date, which is generally the date of grant, using the Black-Sholes-Merton
option-pricing model. This model was developed for use in estimating the fair value of publicly traded options that have no vesting
restrictions and are fully transferable. Additionally, the model requires the input of highly subjective assumptions. Because the
Company’s employee stock options have characteristics significantly different from those of publicly traded options, and because
changes in the subjective input assumptions can materially affect the fair value estimate, in management’s opinion, the Black-Sholes-
Merton option-pricing model does not necessarily provide a reliable single measure of the fair value of the Company’s stock options.
In December 2004, the Financial Accounting Standards Board (“FASB”) issued Statement of Financial Accounting Standards
No. 123R (“SFAS No. 123R”), “Share-Based Payment (Revised 2004).” Among other things, SFAS No. 123R eliminates the ability
to account for stock-based compensation using APB No. 25 and requires that such transactions be recognized as compensation cost in
the income statement based on their fair values on the date of the grant. SFAS No. 123R was adopted by the Company on January 1,
2006.
Recent Accounting Standards Issued
See Note 1—Summary of Significant Accounting Policies in the accompanying Notes to the Consolidated Financial Statements
for details of recently issued and recently adopted accounting standards and their impact on the Company’s consolidated financial
statements.
Common Stock and Dividends
The Company had issued and outstanding 63,015,435 shares of $1.00 par value Common Stock held by approximately 2,563
holders of record at February 22, 2007. The book value of the stock at December 31, 2006 was $14.41 per share compared with
$13.66 per share at December 31, 2005.
26
The Common Stock is traded on the NASDAQ National Market under the symbol “IBOC.” The following table sets forth the
approximate high and low bid prices in the Company’s Common Stock during 2005 and 2006, as quoted on the NASDAQ National
Market for each of the quarters in the two year period ended December 31, 2006. Some of the quotations reflect inter-dealer prices,
without retail mark-up, mark-down or commission and may not necessarily represent actual transactions. The closing sales price of the
Company’s Common Stock was $31.37 per share at February 22, 2007.
2006: First quarter
Second quarter
Third quarter
Fourth quarter
2005: First quarter
Second quarter
Third quarter
Fourth quarter
High
$ 29.69
30.12
30.23
31.87
High
$ 31.89
30.06
30.49
30.49
Low
$ 28.49
27.48
27.52
29.20
Low
$ 27.52
26.80
28.01
29.15
The Company paid cash dividends to the shareholders in 2006 of $.35 and $.35 per share on May 1, 2006 and November 1, 2006,
respectively to all holders of record on April 17, 2006 and October 16, 2006, respectively, or $44,166,000 in the aggregate during
2006. In 2005, the Company paid cash dividends of $.40 ($.32 adjusted for the effect of the May 2, 2005 stock dividend) and $.32 per
share on April 30, and November 1, 2005, respectively, or $40,833,000 in the aggregate during 2005. The Company has no set
schedule for paying cash or stock dividends and the amount paid in previous periods is not necessarily indicative of amounts that may
be paid or available to be paid in future periods. In addition, the Company has issued stock dividends during the last five-year period
as follows:
Date
May 20, 2002
May 19, 2003
May 3, 2004
May 2, 2005
May 2006
Stock Dividend
25%
25%
25%
25%
0%
The Company’s principal source of funds to pay cash dividends on its Common Stock is cash dividends from its bank
subsidiaries. There are certain statutory limitations on the payment of dividends from the subsidiary banks. For a discussion of the
limitations, please see Note 20 of Notes to Consolidated Financial Statements.
Stock Repurchase Program
The Company expanded its formal stock repurchase program on November 2, 2006. Under the expanded stock repurchase
program, the Company is authorized to repurchase up to $200,000,000 of its common stock through December 2007. 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 February 22, 2007, a
total of 5,012,258 shares had been repurchased under this program at a cost of $183,971,000. 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 $220,973,000. In the
27
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 $220,973,000 cap will occur in the future. As of February 22, 2007, the Company has approximately $204,944,000
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 December 31, 2006.
October 1 – October 31, 2006
November 1 – November 30, 2006
December 1 – December 31, 2006
Total Number
of Shares
Purchased
—
110,067
8,898
118,965
Average
Price Paid
Per Share
—
31.00
30.34
$ 30.95
Shares Purchased as
Part of a Publicly
Announced Program
—
110,067
8,168
118,235
Approximate Dollar
Value of Shares
Available for
Repurchase(1)
$ 21,379,000
17,967,000
17,697,000
(1) The formal stock repurchase program was initiated in 1999 and has been expanded periodically with the most recent expansion
occurring in November 2006. The current program allows for the repurchase of up to $200,000,000 of treasury stock through
December 2007 of which $17,697,000 remains.
Equity Compensation Plan Information
The following table sets forth information as of December 31, 2006, with respect to the Company’s equity compensation plans:
Plan Category
Equity Compensation plans approved by
security holders
Equity Compensation plans not approved
by security holders(1)
Total
(A)
Number of securities to
be issued upon exercise
of outstanding options,
warrants and rights
(B)
Weighted average
exercise price of
outstanding options,
warrants and rights
1,237,768
140,382
1,378,150
$ 17.96
$ 10.66
$ 17.22
(C)
Number of securities
remaining available for
future issuance under
equity compensation plans
(excluding securities
reflected in column A)
130,200
—
130,200
(1) The Company granted non-qualified stock options exercisable for a total of 140,382 shares, adjusted for stock dividends, of
Common Stock to certain employees of the GulfStar Group. The grants were not made under any of the shareholder approved
Stock Option Plans. The options are exercisable for a period of seven years and vest in equal increments over a period of five
years. All options granted to the GulfStar Group employees had an option price of not less than the fair market value of the
Common Stock on the date of grant.
28
Stock Performance
Total Return To Shareholders
(Includes reinvestment of dividends)
Company / Index
INTERNATIONAL BANCSHARES CORP
S&P 500 INDEX
S&P 500 BANKS
Base Period
2001
100
100
100
2002
119.18
77.90
98.98
2003
182.18
100.25
125.37
29
INDEXED RETURNS
December 31,
2004
194.06
111.15
143.44
2005
184.82
116.61
141.35
2006
199.21
135.03
164.11
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
The Board of Directors and Shareholders
International Bancshares Corporation:
We have audited the accompanying consolidated statements of condition of International Bancshares Corporation and subsidiaries (the
“Company”) as of December 31, 2006 and 2005, and the related consolidated statements of income, comprehensive income,
shareholders’ equity, and cash flows for each of the years in the three-year period ended December 31, 2006. These consolidated
financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these
consolidated financial statements based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those
standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of
material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as
evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of
International Bancshares Corporation and subsidiaries as of December 31, 2006 and 2005, and the results of their operations and their
cash flows for each of the years in the three-year period ended December 31, 2006, in conformity with U.S. generally accepted
accounting principles.
As discussed in Note 1 to the Consolidated Financial Statements, effective January 1, 2006, the Company adopted Statement of
Financial Accounting Standards No. 123R, Share-based Payment, to account for stock-based compensation.
We also have audited in accordance with the standards of the Public Company Accounting Oversight Board (United States), the
effectiveness of International Bancshares Corporation’s internal control over financial reporting as of December 31, 2006, based on
criteria established in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway
Commission (COSO), and our report dated February 28, 2007 expressed an unqualified opinion on management’s assessment of, and
the effective operation of, internal control over financial reporting.
/s/ KPMG LLP
San Antonio, Texas
February 28, 2007
30
INTERNATIONAL BANCSHARES CORPORATION AND SUBSIDIARIES
Consolidated Statements of Condition
December 31, 2006 and 2005
(Dollars in Thousands, Except Per Share Amounts)
Cash and due from banks
Federal funds sold
Assets
Total cash and cash equivalents
Time deposits with banks
Investment securities:
Held to maturity (Market value of $2,375 on December 31, 2006 and $2,375
on December 31, 2005)
Available for sale (Amortized cost of $4,552,866 on December 31, 2006 and
$4,331,517 on December 31, 2005)
Total investment securities
Loans, net of unearned discounts
Less allowance for possible loan losses
Net loans
Bank premises and equipment, net
Accrued interest receivable
Other investments
Identified intangible assets, net
Goodwill, net
Other assets
Total assets
2006
2005
$
$
268,207
29,000
297,207
396
216,118
242,000
458,118
396
2,375
2,375
4,490,157
4,492,532
5,034,810
(64,537 )
4,970,273
390,323
57,288
343,909
34,358
282,246
42,922
$ 10,911,454
4,266,952
4,269,327
4,625,692
(77,796)
4,547,896
351,986
48,647
332,675
39,224
289,262
54,322
$ 10,391,853
See accompanying notes to consolidated financial statements.
31
INTERNATIONAL BANCSHARES CORPORATION AND SUBSIDIARIES
Consolidated Statements of Condition (Continued)
December 31, 2006 and 2005
(Dollars in Thousands, Except Per Share Amounts)
Liabilities and Shareholders’ Equity:
Liabilities:
Deposits:
Demand—non-interest bearing
Savings and interest bearing demand
Time
Total deposits
Securities sold under repurchase agreements
Other borrowed funds
Junior subordinated deferrable interest debentures
Other liabilities
Total liabilities
Commitments, Contingent Liabilities and Other Tax Matters (Note 17)
Shareholders’ equity:
Common shares of $1.00 par value. Authorized 275,000,000 shares; issued
86,224,046 shares on December 31, 2006 and 86,059,121 shares on
December 31, 2005
Surplus
Retained earnings
Accumulated other comprehensive loss
Less cost of shares in treasury, 23,312,331 shares on December 31, 2006 and
22,330,354 shares on December 31, 2005
Total shareholders’ equity
Total liabilities and shareholders’ equity
2006
2005
$ 1,453,476
2,204,451
3,331,991
6,989,918
706,335
2,095,576
210,908
66,661
10,069,398
$ 1,339,380
2,156,234
3,160,812
6,656,426
760,762
1,870,075
236,391
75,332
9,598,986
86,224
138,247
861,251
(40,390 )
1,045,332
(203,276 )
842,056
$ 10,911,454
86,059
135,619
788,416
(41,968)
968,126
(175,259)
792,867
$ 10,391,853
See accompanying notes to consolidated financial statements.
32
INTERNATIONAL BANCSHARES CORPORATION AND SUBSIDIARIES
Consolidated Statements of Income
Years ended December 31, 2006, 2005 and 2004
(Dollars in Thousands, Except Per Share Amounts)
Interest income:
Loans, including fees
Federal funds sold
Investment securities:
Taxable
Tax-exempt
Other interest income
Total interest income
Interest expense:
Savings and interest bearing demand deposits
Time deposits
Securities sold under repurchase agreements
Other borrowings
Junior subordinated deferrable interest debentures
Senior notes
Total interest expense
Net interest income
Provision for possible loan losses
Net interest income after provision for possible loan losses
Non-interest income:
Service charges on deposit accounts
Other service charges, commissions and fees
Banking
Non-banking
Investment securities transactions, net
Other investments, net
Other income
Total non-interest income
2006
2005
2004
$ 400,020
3,596
$ 339,450
3,668
$ 236,079
1,577
200,474
4,577
406
609,073
40,444
123,077
30,137
103,362
22,568
—
319,588
289,485
3,849
285,636
160,175
4,862
550
508,705
26,936
73,234
27,384
60,689
18,587
—
206,830
301,875
960
300,915
84,770
83,917
29,523
21,605
(930)
20,035
21,968
176,971
25,212
12,248
(181 )
20,629
25,397
167,222
109,092
5,071
559
352,378
13,797
44,659
19,865
16,746
13,152
383
108,602
243,776
5,196
238,580
73,877
19,320
7,083
8,884
13,012
12,640
134,816
See accompanying notes to consolidated financial statements.
33
INTERNATIONAL BANCSHARES CORPORATION AND SUBSIDIARIES
Consolidated Statements of Income (Continued)
Years ended December 31, 2006, 2005 and 2004
(Dollars in Thousands, Except Per Share Amounts)
Non-interest expense:
Employee compensation and benefits
Occupancy
Depreciation of bank premises and equipment
Professional fees
Stationery and supplies
Amortization of identified intangible assets
Advertising
Other
Total non-interest expense
Income before income taxes
Minority interest in consolidated subsidiaries
Provision for income taxes
Net income
Basic earnings per common share:
Weighted average number of shares outstanding
Net income
Fully diluted earnings per common share:
Weighted average number of shares outstanding
Net income
2006
2005
2004
$
$
124,359
27,886
28,251
11,050
6,490
4,866
12,052
73,723
288,677
173,930
40
56,889
$
117,001
$
113,620
25,053
25,538
12,497
5,809
5,176
10,596
57,699
255,988
212,149
—
71,370
140,779
63,133,522
1.85
$
63,695,017
2.21
$
63,776,888
1.83
$
64,485,167
2.18
$
$
83,631
18,403
18,975
6,513
5,075
3,681
10,082
50,124
196,484
176,912
—
57,880
$
119,032
62,134,149
1.92
$
63,380,556
$
1.88
See accompanying notes to consolidated financial statements.
34
INTERNATIONAL BANCSHARES CORPORATION AND SUBSIDIARIES
Consolidated Statements of Comprehensive Income
Years ended December 31, 2006, 2005, and 2004
(Dollars in Thousands)
Net income
Other comprehensive income, net of tax:
Net unrealized gains (losses) on securities available for sale arising
during the year
Reclassification adjustment for (losses) gains on securities available
for sale included in net income
Comprehensive income
2006
$117,001
2005
$ 140,779
2004
$119,032
2,798
(58,397 )
(6,361 )
(1,220 )
$118,579
1,419
$ 83,801
8,529
$121,200
See accompanying notes to consolidated financial statements.
35
INTERNATIONAL BANCSHARES CORPORATION AND SUBSIDIARIES
Consolidated Statements of Shareholders’ Equity
Years ended December 31, 2006, 2005 and 2004
(in Thousands)
Balance at December 31, 2003
Net income
Dividends:
Shares issued
Cash
Purchase of treasury stock
Exercise of stock options
Tax benefit for exercise of stock options
Stock issued in acquisition
Other comprehensive income, net of
tax:
Net change in unrealized gains and
losses on available for sale
securities, net of reclassification
adjustment
Balance at December 31, 2004
Net income
Dividends:
Shares issued
Cash
Purchase of treasury stock
Exercise of stock options
Tax benefit for exercise of stock options
Other comprehensive income, net of
tax:
Net change in unrealized gains and
losses on available for sale
securities, net of reclassification
adjustment
Balance at December 31, 2005
Net income
Dividends:
Shares issued
Cash
Purchase of treasury stock
Exercise of stock options
Stock based compensation expense
recognized in earnings
Other comprehensive income, net of
tax:
Net change in unrealized gains and
losses on available for sale
securities, net of reclassification
adjustment
Balance at December 31, 2006
Number
of Shares
52,774
—
13,229
—
—
313
—
2,115
Common
Stock
52,774
—
13,229
—
—
313
—
2,115
Surplus
37,777
—
—
—
—
3,761
1,192
87,867
Accumulated
Other
Income (Loss) Treasury
Comprehensive
Stock
12,842
(165,616 )
—
—
—
—
—
—
—
—
—
—
(974 )
—
—
—
Retained
Earnings
639,606
119,032
(13,229)
(39,767)
—
—
—
—
Total
577,383
119,032
—
(39,767)
(974)
4,074
1,192
89,982
68,431
—
17,172
—
—
456
—
—
86,059
—
—
—
—
165
—
68,431
—
130,597
—
705,642
140,779
17,172
—
—
456
—
—
—
—
4,785
237
(17,172)
(40,833)
—
—
—
—
86,059
—
—
135,619
—
—
788,416
117,001
—
—
—
165
—
—
—
—
1,754
—
(44,166)
—
—
874
—
2,168
15,010
—
—
—
—
—
—
(56,978 )
(41,968 )
—
—
—
—
—
—
(166,590 )
—
—
—
(8,669 )
—
—
2,168
753,090
140,779
—
(40,833)
(8,669)
5,241
237
—
(175,259 )
—
(56,978)
792,867
117,001
—
—
(28,017 )
—
—
(44,166)
(28,017)
1,919
—
874
—
86,224
—
$ 86,224
—
$ 138,247
—
$ 861,251
1,578
$ (40,390 )
1,578
—
$ (203,276) $ 842,056
See accompanying notes to consolidated financial statements.
36
INTERNATIONAL BANCSHARES CORPORATION AND SUBSIDIARIES
Consolidated Statements of Cash Flows
Years ended December 31, 2006, 2005 and 2004
(Dollars in Thousands)
Operating activities:
Net income:
Adjustments to reconcile net income to net cash provided by
operating activities:
Provision for possible loan losses
Amortization of loan premiums
Accretion of time deposit discounts
Depreciation of bank premises and equipment
Loss (gain) on sale of bank premises and equipment
Depreciation and amortization of leased assets
Accretion of investment securities discounts
Amortization of investment securities premiums
Investment securities transactions, net
Accretion of junior subordinated debenture discounts
Amortization of identified intangible assets
Stock based compensation expense
Earnings from affiliates and other investments
Deferred tax (benefit) expense
(Increase) decrease in accrued interest receivable
Decrease in other assets
Net increase (decrease) in other liabilities
Net cash provided by operating activities
Investing activities:
Proceeds from maturities of securities
Proceeds from sales of available for sale securities
Purchases of available for sale securities
Principal collected on mortgage backed securities
Principal collected on other securities
Proceeds from matured time deposits with banks
Purchases of time deposits with banks
Net (increase) decrease in loans
Purchases of other investments
Distributions from other investments
Purchases of bank premises and equipment
Proceeds from sales of bank premises and equipment
Cash paid in purchase transaction
Cash acquired in purchase transaction
Net cash used in investing activities
2006
2005
2004
$
117,001
$
140,779
$ 119,032
3,849
1,190
—
28,251
2,096
2,169
(416)
4,097
930
548
4,866
874
(12,204)
(15,686)
(8,641)
9,423
13,561
151,908
960
2,813
(5,391 )
25,538
(2,244 )
1,967
(572 )
24,042
181
996
5,176
—
(15,495 )
22,752
(7,507 )
5,598
11,349
210,942
5,196
451
(3,600)
18,975
(3,230)
1,687
(611)
29,215
(8,884)
1,026
3,681
—
(11,993)
11,353
(3,983)
20,341
(20,558)
158,098
7,720
60,447
(1,159,306)
864,611
568
—
—
(427,416)
(15,294)
16,264
(85,363)
16,679
—
—
(721,090)
4,366
189,902
(1,616,504 )
918,819
—
—
—
255,954
(25,053 )
9,451
(76,162 )
3,112
—
—
(336,115 )
29,558
875,816
(2,223,915)
791,425
—
87,400
(296)
51,692
(5,161)
53,227
(51,866)
4,648
(276,555)
66,009
(598,018)
See accompanying notes to consolidated financial statements.
37
INTERNATIONAL BANCSHARES CORPORATION AND SUBSIDIARIES
Consolidated Statements of Cash Flows (Continued)
Years ended December 31, 2006, 2005 and 2004
(Dollars in Thousands)
Financing activities:
Net increase in non-interest bearing demand deposits
Net increase (decrease) in savings and interest bearing
demand deposits
Net increase (decrease) in time deposits
Net (decrease) increase in securities sold under repurchase
agreements
Other borrowed funds, net
Principal payments on senior notes
Principal payments of long-term debt
Proceeds from issuance of long-term debt
Purchase of treasury stock
Proceeds from stock transactions
Payments of cash dividends
Payments of cash dividends in lieu of fractional shares
Net cash provided by financing activities
Increase (decrease) in cash and cash equivalents
Cash and cash equivalents at beginning of year
Cash and cash equivalents at end of year
Supplemental cash flow information:
Interest paid
Income taxes paid
Adjustment to goodwill arising from acquisition
2006
114,096
48,217
171,179
(54,427)
225,501
—
(101,290)
75,259
(28,017)
1,919
(44,166)
—
408,271
(160, 911)
458,118
297,207
312,018
67,421
7,016
$
$
$
$
2005
188,381
(75,868 )
(21,800 )
140,956
199,876
—
—
—
(8,669 )
5,478
(40,808 )
(25 )
387,521
262,348
195,770
458,118
2004
103,547
70,306
27,961
74,372
200,545
(21,295)
—
—
(974)
5,266
(39,729)
(38)
419,961
(19,959)
215,729
$ 195,770
$
197,023
39,040
—
93,337
36,277
—
See accompanying notes to consolidated financial statements.
38
INTERNATIONAL BANCSHARES CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(1) Summary of Significant Accounting Policies
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 following is a description of the more significant of those
policies.
Consolidation and Basis of Presentation
The consolidated financial statements include the accounts of the Corporation and its wholly-owned bank 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. All significant inter-company balances and transactions
have been eliminated in consolidation.
The Company, through its subsidiaries, is primarily engaged in the business of banking, including the acceptance of checking and
savings deposits and the making of commercial, real estate, personal, home improvement, automobile and other installment and term
loans. The primary markets of the Company are South, Central, and Southeast Texas and the state of Oklahoma. Each bank subsidiary
is very active in facilitating international trade along the United States border with Mexico and elsewhere. Although the Company’s
loan portfolio is diversified, the ability of the Company’s debtors to honor their contracts is primarily dependent upon the economic
conditions in the Company’s trade area. In addition, the investment portfolio is directly impacted by fluctuations in market interest
rates. The Company and its bank subsidiaries are subject to the regulations of certain Federal agencies as well as the Texas
Department of Banking and undergo periodic examinations by those regulatory authorities. Such agencies may require certain
standards or impose certain limitations based on their judgments or changes in law and regulations.
The preparation of the consolidated financial statements in conformity with accounting policies generally accepted in the United
States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities as
of the dates of the statement of condition and income and expenses for the periods. Actual results could differ significantly from those
estimates. Material estimates that are particularly susceptible to significant changes in the near-term relate to the determination of the
allowance for possible loan losses.
Per Share Data
All share and per share information has been restated giving retroactive effect to stock dividends distributed.
Investment Securities
The Company classifies debt and equity securities into one of these categories: held-to-maturity, available-for-sale, or trading.
Such classifications are reassessed for appropriate classification at each reporting date. Securities that are intended and expected to be
held until maturity are classified as “held-to-maturity” and are carried at amortized cost for financial statement reporting. Securities
that are not positively expected to be held until maturity, but are intended to be held for an indefinite period of time
39
INTERNATIONAL BANCSHARES CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements (Continued)
(1) Summary of Significant Accounting Policies (Continued)
are classified as “available-for-sale” or “trading” and 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 in shareholders’
equity as accumulated other comprehensive income until realized. The Company did not maintain any trading securities during the
three year period ended December 31, 2006.
Mortgage-backed securities held at December 31, 2006 and 2005 represent participating interests in pools of long-term first
mortgage loans originated and serviced by the issuers of the securities. Premiums and discounts are amortized using the level yield or
“interest method.” Mortgage-backed securities are either issued or guaranteed by the U.S. Government or its agencies. Market interest
rate fluctuations can affect the prepayment speed of principal and the yield on the security.
Unearned Discounts
Consumer loans are frequently made on a discount basis. The amount of the discount is subsequently included in interest income
ratably over the term of the related loans to approximate the effective interest method.
Provision and Allowance for Possible Loan Losses
The allowance for possible loan losses is maintained at a level considered adequate by management to provide for probable loan
losses. The allowance is increased by provisions charged to operating expense and reduced by net charge-offs. The provision for
possible loan losses is the amount, which, in the judgment of management, is necessary to establish the allowance for probable loan
losses at a level that is adequate to absorb known and inherent risks in the loan portfolio.
Management believes that the allowance for possible loan losses is adequate. While management uses available information to
recognize losses on loans, future additions to the allowance may be necessary based on changes in economic conditions. In addition,
various regulatory agencies, as an integral part of their examination process, periodically review the Company’s bank subsidiaries’
allowances for possible loan losses. Such agencies may require the Company’s bank subsidiaries to make additions or reductions to
their GAAP allowances based on their judgments of information available to them at the time of their examination.
Loans
Loans are reported at the principal balance outstanding, net of unearned discounts. Interest income on loans is reported on an
accrual basis. Loan fees and costs associated with originating the loans are amortized over the life of the loan using the interest
method.
Non-Accrual Loans
The non-accrual loan policy of the Company’s bank subsidiaries is to discontinue the accrual of interest on loans when
management determines that it is probable that future interest accruals will be un-collectible. Interest income on non-accrual loans is
recognized only to the extent payments are received or when, in management’s opinion, the debtor’s financial condition warrants
reestablishment of interest accruals.
40
INTERNATIONAL BANCSHARES CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements (Continued)
(1) Summary of Significant Accounting Policies (Continued)
Other Real Estate Owned
Other real estate owned is comprised of real estate acquired by foreclosure and deeds in lieu of foreclosure. Other real estate is
carried at the lower of the recorded investment in the property or its fair value less estimated costs to sell such property (as determined
by independent appraisal). Prior to foreclosure, the value of the underlying loan is written down to the fair value of the real estate to be
acquired by a charge to the allowance for loan possible losses, if necessary. Any subsequent write-downs are charged against other
non-interest expense. Operating expenses of such properties and gains and losses on their disposition are included in other non-interest
expense.
Bank Premises and Equipment
Bank premises and equipment are stated at cost less accumulated depreciation. Depreciation is computed on straight-line and
accelerated methods over the estimated useful lives of the assets. Repairs and maintenance are charged to operations as incurred and
expenditures for renewals and betterments are capitalized.
Income Taxes
Deferred income tax assets and liabilities are determined using the asset and liability method. Under this method, the net deferred
tax asset or liability is determined based on the tax effects of the differences between the book and tax basis of the various balance
sheet assets and liabilities and gives current recognition to changes in tax rates and laws. The Company files a consolidated federal
income tax return with its subsidiaries.
Recognition of deferred tax assets is based on management’s belief that the benefit related to certain temporary differences, tax
operating loss carryforwards, and tax credits are more likely than not to be realized. A valuation allowance is recorded for the amount
of the deferred tax items for which it is more likely than not that the tax benefits will not be realized.
Stock Options
Through December 31, 2005, the Company accounted for stock-based employee compensation plans based on the intrinsic value
method provided in Accounting Principles Board Opinion No. 25 “Accounting for Stock Issued to Employees,” (“APB No. 25”), and
related interpretations. Because the exercise price of the Company’s employee stock options equals the market price of the underlying
stock on the measurement date, which is generally the date of grant, no compensation expense was recognized on options granted.
Compensation expense for stock awards is based on the market price of the stock on the measurement date, which is generally the date
of grant, and is recognized ratably over the service period of the award.
Statement of Financial Accounting Standards No. 123 (“SFAS No. 123”), “Accounting for Stock-Based Compensation,” as
amended by 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,” requires pro forma disclosures of net income and earnings per
share for companies not adopting its fair value accounting method for stock-based employee compensation. The pro forma disclosures
presented in Note 16 in the accompanying Notes to Consolidated Financial Statements
41
INTERNATIONAL BANCSHARES CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements (Continued)
(1) Summary of Significant Accounting Policies (Continued)
included elsewhere in this report use the fair value method of SFAS No. 123 to measure compensation expense for stock-based
employee compensation plans. The fair value of stock options granted was estimated as the measurement date, which is generally the
date of grant, using the Black-Sholes-Merton option-pricing model. This model was developed for use in estimating the fair value of
publicly traded options that have no vesting restrictions and are fully transferable. Additionally, the model requires the input of highly
subjective assumptions. Because the Company’s employee stock options have characteristics significantly different from those of
publicly traded options, and because changes in the subjective input assumptions can materially affect the fair value estimate, in
management’s opinion, the Black-Sholes-Merton option-pricing model does not necessarily provide a reliable single measure of the
fair value of the Company’s stock options.
In December 2004, the Financial Accounting Standards Board (“FASB”) issued Statement of Financial Accounting Standards
No. 123R (“SFAS No. 123R”), “Share-Based Payment (Revised 2004).” Among other things, SFAS No. 123R eliminates the ability
to account for stock-based compensation using APB No. 25 and requires that such transactions be recognized as compensation cost in
the income statement based on their fair values on the date of the grant. SFAS No. 123R was adopted by the Company on January 1,
2006.
Net Income Per Share
Basic Earnings Per Share (“EPS”) is calculated by dividing net income by the weighted average number of common shares
outstanding. The computation of diluted EPS assumes the issuance of common shares for all dilutive potential common shares
outstanding during the reporting period. The dilutive effect of stock options is considered in earnings per share calculations, if dilutive,
using the treasury stock method.
Goodwill and Identified Intangible Assets
Goodwill represents the excess of costs over fair value of assets of businesses acquired. Prior to 2002, goodwill was amortized
over its estimated useful life using the straight-line method or an accelerated basis (as appropriate) over periods generally not
exceeding 25 years. On January 1, 2002, in accordance with a new accounting standard, the Company stopped amortizing goodwill
and adopted a new policy for measuring goodwill for impairment. Under the new policy, goodwill is assigned to reporting units.
Goodwill is then tested for impairment at least annually or on an interim basis if an event occurs or circumstances change that would
more likely than not reduce the fair value of the reporting unit below its carrying value.
Identified intangible assets are acquired assets that lack physical substance but can be distinguished from goodwill because of
contractual or other legal rights or because the asset is capable of being sold or exchanged either on its own or in combination with a
related contract, asset, or liability. The Company’s identified intangible assets relate to core deposits. Identified intangible assets with
definite useful lives are amortized on an accelerated basis over their estimated life. Identified intangible assets, premises and
equipment and other long lived assets are tested for impairment whenever events or changes in circumstances indicate the carrying
amount of the assets may not be recoverable from future undiscounted cash flow. If impaired, the assets are recorded at fair value. See
Note 7—Goodwill and Other Intangible Assets.
42
INTERNATIONAL BANCSHARES CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements (Continued)
(1) Summary of Significant Accounting Policies (Continued)
Impairment of Long-Lived Assets
Long-lived assets, such as property, plant and equipment, and purchased intangibles subject to amortization, are reviewed for
impairment whenever events or changes in circumstances indicate that the carrying value of an asset may not be recoverable.
Recoverability of assets to be held and used is measured by a comparison of the carrying value of the asset to the estimated
undiscounted future cash flows expected to be generated by the asset. If the carrying value of an asset exceeds its estimated future
cash flows, an impairment charge is recognized by the amount by which the carrying value of the asset exceeds the fair value of the
asset. Assets to be disposed of would be separately presented in the statement of condition and reported at the lower of the carrying
value or fair value less costs to sell, and are no longer depreciated. The assets and liabilities of a disposed group classified as held for
sale would be presented separately in the appropriate asset and liability sections of the statement of condition.
Consolidated Statements of Cash Flows
For purposes of the consolidated statements of cash flows, the Company considers all short-term investments with a maturity at
date of purchase of three months or less to be cash equivalents. Also, the Company reports transactions related to deposits loans to
customers on a net basis.
Accounting for Transfers and Servicing of Financial Assets
The Company accounts for transfers and servicing of financial assets and extinguishments of liabilities based on the application
of a financial-components approach that focuses on control. After a transfer of financial assets, the Company recognizes the financial
and servicing assets it controls and liabilities it has incurred, derecognizes financial assets when control has been surrendered and
derecognizes liabilities when extinguished. The Company has retained mortgage servicing rights in connection with the sale of
mortgage loans. The value of the mortgage servicing rights are reviewed periodically for impairment and are amortized in proportion
to and over the period of estimated net servicing income or net servicing losses.
Segments of an Enterprise and Related Information
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 financial 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 subsidiaries meets the 10% threshold for
disclosure under SFAS No. 131.
Derivative Instruments
The Company currently does not directly engage in hedging activities and does not directly hold any derivative instruments or
embedded derivatives.
43
INTERNATIONAL BANCSHARES CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements (Continued)
(1) Summary of Significant Accounting Policies (Continued)
Guarantor’s Accounting and Disclosure Requirements for Guarantees
In November 2002, the FASB issued FASB Interpretation No. 45 (“FIN 45”), “Guarantor’s Accounting and Disclosure
Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others, an interpretation of FASB Statements No. 5,
57 and 107 and rescission of FASB Interpretation No. 34.” FIN 45 elaborates on the disclosures to be made by a guarantor in its
interim and annual financial statements about its obligations under certain guarantees that it has issued. This Interpretation also
incorporates, without change, the guidance in Financial Accounting Standards Board Interpretation No. 34 (“FIN 34”), “Disclosure of
Indirect Guarantees of Indebtedness of Others,” which has been superceded. FIN 45 also clarifies that a guarantor is required to
recognize, at the inception of a guarantee, a liability for the obligations it has undertaken in issuing the guarantee, including its
ongoing obligations to stand ready to perform over the term of the guarantee in the event that the specified triggering events or
conditions occur. The initial recognition and initial measurement provisions of FIN 45 were applicable on a prospective basis to
guarantees issued or modified after December 31, 2002, irrespective of the guarantor’s fiscal year-end. The disclosure requirements
were effective for financial statements of interim or annual periods ending after December 15, 2002, and are included in the notes to
the Company’s consolidated financial statements. The adoption of FIN 45 did not have a significant impact on the Company’s
consolidated financial statements.
Reclassifications
Certain amounts in the prior year’s presentations have been reclassified to conform to the current presentation. These
reclassifications had no effect on previously reported net income.
New Accounting Standards
In May 2005, The Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 154, (“SFAS
No. 154”), “Accounting Changes and Error Corrections, a Replacement of APB Opinion No. 20 and FASB Statement No. 3.” SFAS
No. 154 establishes, unless impracticable, retrospective application as the required method for reporting a change in accounting
principle in the absence of explicit transitional requirements specific to a newly adopted accounting principle. Previously, most
changes in accounting principle were recognized by reporting a cumulative change in accounting principle to the net income of the
period of the change. Under SFAS No. 154, retrospective application requires that (i) the cumulative effect of the change to the new
accounting principle on periods prior to those presented be reflected in the carrying amounts of asset and liabilities as of the beginning
of the first period presented, (ii) an offsetting adjustment, if any, be made to the opening balance of retained earnings or other
appropriate components of equity for that period, and (iii) financial statements for each prior period presented be adjusted to reflect
the direct period specific effects of applying the new accounting principle. Special retroactive application rules apply in certain
situations where it is impracticable to determine either the period specific effects or the cumulative effect of the change. Indirect
effects of a change in accounting principle are required to be reported in the period in which the accounting change is made. SFAS
No. 154 carries forward the guidance in APB Opinion No. 20 “Accounting Changes,” requiring justification of a change in accounting
principle on the basis of preferability. SFAS No. 154 also carries forward, without change, the guidance in APB Opinion 20, for
reporting the correction of an error in previously issued financial statements and for a change in accounting estimate. SFAS No. 154 is
effective for accounting changes and corrections of errors made in fiscal years beginning after December 15, 2005.
44
INTERNATIONAL BANCSHARES CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements (Continued)
(1) Summary of Significant Accounting Policies (Continued)
The adoption of this new accounting standard did not have an impact on the Company’s consolidated financial statements.
In November 2005, the Financial Accounting Standards Board issued FASB Staff Position No 115-1 (“FSP 115-1”), “The
Meaning of Other-Than-Temporary Impairment and Its Application to Certain Investments.” FSP 115-1 provides guidance for
determining when an investment is considered impaired, whether impairment is other-than-temporary, and measurement of an
impairment loss. An investment is considered impaired if the fair value of the investment is less than its cost. If, after consideration of
all available evidence to evaluate the realizable value of its investment, impairment is determined to be other-thank-temporary, then an
impairment loss should be recognized equal to the difference between the investments’ cost and its fair value. FSB 115-1 nullifies
certain provision of Emerging Issues Task Force (“EITF”) Issue No 01-1, “The Meaning of Other-Than-Temporary Impairment and
Its Application to Certain Investments,” while retaining the disclosure requirements of EITF 01-1 which were adopted in 2003. FSP
115-1 is effective for reporting periods beginning after December 15, 2005. The company adopted FSP 115-1 on January 1, 2006. The
adoption did not have a significant impact on the consolidated financial statements.
In December 2004, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 123R,
(“SFAS No. 123R”), “Share-Based Payment, an Amendment of Statements No. 123 and 95.” The revision to the existing SFAS
No. 123 eliminates the ability of public companies to account for stock-based compensation using Accounting Principles Board
Opinion No. 25 (“APB 25”), “Accounting for Stock Issues to Employees” and requires such transactions be recognized as
compensation expense in the Company’s consolidated financial statements based on the fair value of the options issued as of their
grant date. SFAS No. 123R was to be effective for the Company for interim and reporting periods after December 31, 2005. The
Company adopted the provisions of SFAS No. 123R on January 1, 2006. “Details related to the adoption of SFAS No. 123R and the
impact to the Consolidated Financial Statements are discussed in Note 1b—Stock Options.”
In February 2006, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 155,
(“SFAS No. 155”), “Accounting for Certain Hybrid Financial Instruments—an amendment of FASB Statements No. 133 and 140.”
SFAS No. 155 amends SFAS No. 133, “Accounting for Derivative Instruments and Hedging Activities,” and SFAS No. 140,
“Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities.” SFAS No. 155 permits fair value
measurements for any hybrid financial instrument that contains an embedded derivative and that otherwise would require bifurcation,
clarifies which interest-only strips and principal-only strips are not subject to the requirements of SFAS No. 133, establishes a
requirement to evaluate interests in securitized financial assets to identify interests that are freestanding derivatives or that are hybrid
financial instruments that contain an embedded derivative requiring bifurcation, clarifies that concentrations of credit risk in the form
of subordination are not embedded derivatives, and amends SFAS No. 140 to eliminate the prohibition on a qualifying special purpose
entity from holding a derivative financial nstrument that pertains to a beneficial interest other than another derivative financial interest.
SFAS No. 155 is effective for all financial instruments acquired, issued, or subject to a re-measurement event occurring after the
beginning of an entity’s first fiscal year that begins after September 15, 2006. The adoption of this new standard at January 1, 2007 did
not have an impact on the Company’s financial statements.
45
INTERNATIONAL BANCSHARES CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements (Continued)
(1) Summary of Significant Accounting Policies (Continued)
In March 2006, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 156, (“SFAS
No. 156”), “Accounting for Servicing of Financial Assets—an amendment of FASB Statement No. 140.” SFAS No. 156 amends
SFAS No. 140, “Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities—a replacement of
FASB Statement No. 125,” by requiring, in certain situations, an entity to recognize a servicing asset or servicing liability each time it
undertakes an obligation to service a financial asset by entering into a servicing contract. All separately recognized servicing assets
and servicing liabilities are required to be initially measured at fair value. Subsequent measurement methods include the amortization
method, whereby servicing assets or servicing liabilities are amortized in proportion to an over the period of estimated net servicing
income or net servicing loss or the fair value method, whereby servicing assets or servicing liabilities are measured at fair value at
each reporting date and changes in fair value are reported in earnings in the period in which they occur. If the amortization method is
used, an entity must assess servicing assets or servicing liabilities for impairment or increased obligation based on the fair value at
each reporting date. SFAS No. 156 is effective as of the beginning of an entity’s first fiscal year that begins after September 15, 2006.
The adoption of this new standard at January 1, 2007 did not have a significant impact on the Company’s consolidated financial
statements.
In September 2006, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 157
(“SFAS No. 157”), “Fair Value Measurements.” SFAS No. 157 defines fair value, establishes a framework for measuring fair value
in generally accepted accounting principles, and expands disclosures about fair value measurements. SFAS No. 157 is effective for
fiscal years beginning after November 15, 2007. The Company does not anticipate a significant impact to the financial statements
upon the adoption of this new standard.
In December 2006, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 158
(“SFAS No. 158”), “Employers’ Accounting for Defined Benefit Pension and Other Postretirement Plans, an amendment of FASB
Statements No. 87, 88, 106 and 132(R).” SFAS No 158 requires an employer to recognize the over-funded or under-funded status of
defined benefit post-retirement benefit plans as an asset or liability in its financial statements. The funded status is measured as the
difference between plan assets at fair value and the benefit obligation (the projected benefit obligation for pension plans or the
accumulated benefit obligation for other post-retirement benefit plans). An employer is also required to measure the funded status of a
plan as of the date of its year-end financial statements with changes in the funded status recognized through comprehensive income.
SFAS No. 158 also requires certain disclosures regarding the effects on net periodic benefit cost for the next fiscal year that arise from
delayed recognition of gains or losses, prior service costs or credits, and the transition asset or obligation. Publicly traded companies
are to apply the disclosure requirements of SFAS No. 158 for fiscal years ending after December 15, 2006, with full adoption for
fiscal years ending after December 15, 2008. The adoption of this new standard is not expected to have an impact on the Company’s
financial statements.
46
INTERNATIONAL BANCSHARES CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements (Continued)
(1) Summary of Significant Accounting Policies (Continued)
In June 2006, the Financial Accounting Standards Board issued FASB Interpretation No. 48 (“FIN 48”), “ Accounting for
Uncertainty in Income Taxes, an interpretation of FASB Statement 109.” FIN 48 prescribes a recognition threshold and a
measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax
return. Benefits from tax positions should be recognized in the financial statements only when it is more likely than not that the tax
position will be sustained upon examination by the appropriate taxing authority that would have full knowledge of all relevant
information. A tax position that meets the more likely than not recognition threshold is measured at the largest amount of benefit that
is greater than fifty percent likely of being realized upon ultimate settlement. Tax positions that previously failed to meet the more
likely than not recognition threshold should be recognized in the first subsequent financial reporting period in which that threshold is
met. Previously recognized tax positions that no longer meet the more likely than not recognition threshold should be derecognized in
the first subsequent financial reporting period in which that threshold is no longer met. FIN 48 also provides guidance on the
accounting for and disclosure of unrecognized tax benefits, interest and penalties. FIN 48 is effective for fiscal years beginning after
December 15, 2006. The adoption of this new standard is not expected to have an impact on the Company’s financial statements.
In September 2006, the Securities and Exchange Commission issued Staff Accounting Bulletin No. 108 (“SAB No. 108”),
“Considering the Effects of a Prior Year Misstatements when Quantifying Misstatements in Current Year Financial Statements.” SAB
No.108 addresses how the effects of prior year uncorrected errors must be considered in quantifying misstatements in the current year
financial statements. The effects of prior year uncorrected errors include the potential accumulation of improper amounts that may
result in a material misstatement on the balance sheet or the reversal of prior period errors in the current period that result in a material
misstatement of the current period income statement amounts. Adjustments to current or prior period financial statements would be
required in the event that after application of various approaches for assessing materiality of misstatement in current period financial
statements and consideration of all relevant quantitative and qualitative factors, a misstatement is determined to be material. SAB
No. 108 is effective for fiscal years ending after November 15, 2006.
(2) Potential and Completed Acquisitions
On December 1, 2006, the Company signed a definitive agreement pursuant to which the Company will acquire Southwest First
Community, Inc. (“Southwest Community”), a bank holding company with approximately $129 million in assets that owns State
Bank & Trust in Beeville, Texas and Commercial State Bank in Sinton, Texas. The transaction is expected to close in the spring of
2007 and is subject to various closing conditions, including receipt of all requisite regulatory approvals. The Board of Directors of
both the Company and Southwest Community and the shareholders of Southwest Community have approved the transaction.
On June 18, 2004, the Company acquired Local Financial Corporation (“LFIN”), an Oklahoma based bank holding company
with approximately $3.0 billion in assets. The acquisition was effected pursuant to the Agreement and Plan of Merger dated as of
January 22, 2004 (the “Merger Agreement”). The Company paid consideration totaling approximately $276.6 million in cash and 2.11
million shares of Company common stock. The aggregate purchase price was $367.4 million. Under the terms of the Merger
Agreement, LFIN shareholders were entitled to elect to receive either cash or Company common stock in
47
INTERNATIONAL BANCSHARES CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements (Continued)
(2) Potential and Completed Acquisitions (Continued)
the merger, subject to the requirement that 75% of LFIN’s shares be exchanged for cash and 25% be exchanged for Company
common stock. Based on the elections of LFIN shareholders and the terms of the Merger Agreement, LFIN shares held by LFIN
shareholders who elected to receive shares of Company common stock in the Merger and LFIN shareholders who did not timely make
a cash/stock election were exchanged entirely for shares of Company common stock. As to those LFIN shares for which an election to
receive cash was timely made, each such share was exchanged for approximately $20.59 in cash and 0.033 shares of Company
common stock. The exchange rate for those LFIN shareholders receiving Company common stock in the Merger was 0.5170 shares of
Company common stock for each share of LFIN.
The following table summarizes the estimated fair value of the assets acquired and liabilities assumed at the date of the
acquisition, in thousands.
Assets
Cash and cash equivalents
Time deposits with banks
Investment securities
Net loans
Bank premises and equipment
Accrued interest receivable
Other investments
Identified intangible asset
Goodwill
Other assets
Total assets acquired
Liabilities
Demand deposits
Savings deposits
Time deposits
Securities sold under repurchase agreements
Other borrowed funds
Senior notes
Other liabilities
Total liabilities assumed
Net assets acquired
48
As of
June 18, 2004
(Dollars in
thousands)
$
66,009
87,400
331,656
2,152,912
50,155
8,266
93,538
42,188
221,814
30,230
3,084,168
232,982
766,178
938,031
44,138
624,382
21,295
89,764
2,716,770
$ 367,398
INTERNATIONAL BANCSHARES CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements (Continued)
(2) Potential and Completed Acquisitions (Continued)
The following table reflects the pro forma results of operations for the year ended December 31, 2004 as though the acquisition
had been completed as of January 1, 2004 (dollars in thousands, except per share data):
Interest income
Interest expense
Net interest income
Provision for possible loan losses
Non-interest income
Non-interest expense
Income before income taxes
Income taxes
Net income
Per common share:
Basic
Diluted
Year Ended
December 31, 2004
$ 417,945
136,886
281,059
18,000
150,917
267,923
146,053
47,962
$ 98,091
$
$
1.58
1.55
Included in the non-interest expense of the combined operations for the year ended December 31, 2004 are certain costs
associated with contractual obligations related to the closing of the transaction.
(3) Investment Securities
The amortized cost and estimated fair value by type of investment security at December 31, 2006 are as follows:
Other securities
Total investment securities
Amortized
cost
$ 2,375
$ 2,375
Gross
unrealized
gains
Held to Maturity
Gross
unrealized
losses
(Dollars in Thousands)
$ —
$ —
$ —
$ —
Estimated
fair value
$ 2,375
$ 2,375
Carrying
value
$ 2,375
$ 2,375
U.S. Treasury securities
Mortgage-backed securities
Obligations of states and political
subdivisions
Other securities
Equity securities
Total investment securities
Amortized
cost
$
1,268
4,440,265
92,878
4,630
13,825
$ 4,552,866
49
Gross
unrealized
gains
$ —
1,025
Available for Sale
Gross
unrealized
losses
(Dollars in Thousands)
— $
$
(65,006 )
Estimated
fair value
1,268
4,376,284
3,019
—
804
$ 4,848
—
(2,551 )
—
95,897
2,079
14,629
$ (67,557) $ 4,490,157
Carrying
value
$
1,268
4,376,284
95,897
2,079
14,629
$ 4,490,157
INTERNATIONAL BANCSHARES CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements (Continued)
(3) Investment Securities (Continued)
The amortized cost and estimated fair value of investment securities at December 31, 2006, by contractual maturity, are shown
below. Expected maturities will differ from contractual maturities because borrowers may have the right to prepay obligations with or
without prepayment penalties.
Held to Maturity
Available for Sale
Due in one year or less
Due after one year through five years
Due after five years through ten years
Due after ten years
Mortgage-backed securities
Equity securities
Total investment securities
Amortized
Cost
$
75
2,300
—
—
—
—
$ 2,375
Estimated
fair value
Amortized
Cost
(Dollars in Thousands)
$
$
75
2,300
—
—
—
—
$ 2,375
1,268
—
8,199
89,309
4,440,265
13,825
$ 4,552,866
Estimated
fair value
$
1,268
—
8,304
89,672
4,376,284
14,629
$ 4,490,157
The amortized cost and estimated fair value by type of investment security at December 31, 2005 are as follows:
Other securities
Total investment securities
Amortized
cost
$ 2,375
$ 2,375
Gross
unrealized
gains
Held to Maturity
Gross
unrealized
losses
(Dollars in Thousands)
$ —
$ —
$ —
$ —
Estimated
fair value
$ 2,375
$ 2,375
Carrying
value
$ 2,375
$ 2,375
U.S. Treasury securities
Mortgage-backed securities
Obligations of states and political
subdivisions
Other securities
Equity securities
Total investment securities
Amortized
cost
$
1,283
4,214,461
96,750
5,198
13,825
$ 4,331,517
Gross
unrealized
gains
$ —
913
Available for Sale
Gross
unrealized
losses
(Dollars in Thousands)
— $
$
(66,515 )
Estimated
fair value
1,283
4,148,859
2,833
—
978
$ 4,724
(26 )
(2,599 )
(149 )
99,557
2,599
14,654
$ (69,289) $ 4,266,952
Carrying
value
$
1,283
4,148,859
99,557
2,599
14,654
$ 4,266,952
Mortgage-backed securities are primarily securities issued by the Federal Home Loan Mortgage Corporation (“Freddie Mac”),
the Federal National Mortgage Association (“Fannie Mae”) and the Government National Mortgage Association (“Ginnie Mae”).
The amortized cost and fair value of available for sale investment securities pledged to qualify for fiduciary powers, to secure
public monies as required by law, repurchase agreements and short-term fixed borrowings was $3,088,095,000 and $3,043,558,000,
respectively, at December 31, 2006.
50
INTERNATIONAL BANCSHARES CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements (Continued)
(3) Investment Securities (Continued)
Proceeds from the sale of securities available-for-sale were $60,447,000, $189,902,000 and $875,816,000 during 2006, 2005 and
2004, respectively. Gross gains of $412,000, $1,402,000 and $12,818,000 and gross losses of $1,342,000, $1,583,000 and $3,934,000
were realized on the sales in 2006, 2005 and 2004, respectively.
Gross unrealized losses on investment securities and the fair value of the related securities, aggregated by investment category
and length of time that individual securities have been in a continuous unrealized loss position, at December 31, 2006 were as follows:
Available for sale:
U.S. Treasury securities
Mortgage-backed securities
Obligations of states and political
subdivisions
Other securities
Less than 12 months
Fair Value
Unrealized
Losses
12 months or more
Fair Value
Unrealized
Losses
(Dollars in Thousands)
Total
Fair Value Unrealized
Losses
$
—
812,870
$ —
(4,511)
$
—
$
3,137,292
—
(60,495 )
$
— $
—
(65,006 )
3,950,162
—
—
$ 812,870
—
—
—
2,079
$ (4,511) $ 3,139,371
—
(2,551 )
—
2,079
$ (63,046) $ 3,952,241
—
(2,551 )
$ (67,557)
The unrealized losses on investments in mortgage-backed securities are caused by changes in market interest rates. The
contractual cash obligations of the securities are guaranteed by Freddie Mac, Fannie Mae, and Ginnie Mae. The decrease in fair value
is due to market interest rates and not other factors, and because the Company has the ability and intent to hold these investments until
a market price recovery or maturity of the securities, it is the conclusion of the Company that the investments are not considered other-
than-temporarily impaired.
The unrealized losses on investments in other securities are caused by fluctuations in market interest rates. The underlying cash
obligations of the securities are guaranteed by the entity underwriting the debt instrument. It is the belief of the Company that the
entity issuing the debt will honor its interest payment schedule, as well as the full debt at maturity. The securities are purchased by the
Company for their economic value. The decrease in fair value is primarily due to market interest rates and not other factors, and
because the Company has the ability and intent to hold these investments until a market price recovery or maturity of the securities, it
is the conclusion of the Company that the investments are not considered other-than-temporarily impaired.
51
INTERNATIONAL BANCSHARES CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements (Continued)
(4) Loans
A summary of net loans, by loan type at December 31, 2006 and 2005 is as follows:
Commercial, financial and agricultural
Real estate-mortgage
Real estate—construction
Consumer
Foreign
Total loans
Unearned discount
Loans, net of unearned discount
December 31,
2006
2005
(Dollars in thousands)
$ 2,337,573
785,401
1,404,186
198,580
309,144
5,034,884
(74 )
$ 5,034,810
$ 2,376,276
847,512
901,518
218,607
281,947
4,625,860
(168)
$ 4,625,692
(5) Allowance for Possible Loan Losses
A summary of the transactions in the allowance for possible loan losses for the years ended December 31, 2006, 2005 and 2004
is as follows:
Balance at January 1,
Losses charged to allowance
Recoveries credited to allowance
Net losses charged to allowance
Provision charged to operations
Acquired in purchase transactions
Balance at December 31,
2004
2006
2005
(Dollars in Thousands)
$ 81,351
(6,571 )
2,056
(4,515 )
960
—
$ 77,796
$ 77,796
(18,388 )
1,280
(17,108 )
3,849
—
$ 64,537
$ 46,396
(9,513 )
5,407
(4,106 )
5,196
33,865
$ 81,351
Loans accounted for on a non-accrual basis at December 31, 2006, 2005 and 2004 amounted to $17,788,000, $30,075,000 and
$30,773,000, respectively. The effect of such non-accrual loans reduced interest income by $1,868,000, $2,329,000 and $1,203,000
for the years ended December 31, 2006, 2005 and 2004, respectively. Amounts received on non-accruals are applied, for financial
accounting purposes, first to principal and then to interest after all principal has been collected.
The decrease in non-accrual loans from 2005 to 2006 can be attributed to the charge-off of loans acquired as part of the LFIN
acquisition.
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.
52
INTERNATIONAL BANCSHARES CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements (Continued)
(5) Allowance for Possible Loan Losses (Continued)
The following table details key information regarding the Company’s impaired loans:
Balance of impaired loans where there is a related allowance for loan loss
Balance of impaired loans where there is no related allowance for loan loss
Total impaired loans
Allowance allocated to impaired loans
2004
2006
2005
(Dollars in Thousands)
$ 22,909 $ 34,796 $ 37,037
—
—
$ 34,796 $ 37,037
$ 22,909
$ 7,171 $ 20,014 $ 15,666
—
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 $25,684,000, $29,909,000, and $34,226,000 for
the years ended December 31, 2006, 2005 and 2004, respectively.
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 December 31, 2006 was
adequate to absorb probable losses from loans in the portfolio at that date.
(6) Bank Premises and Equipment
A summary of bank premises and equipment, by asset classification, at December 31, 2006 and 2005 were as follows:
Bank buildings and improvements
Furniture, equipment and vehicles
Land
Real estate held for future expansion:
Land, building, furniture, fixture and equipment
Less: accumulated depreciation
Bank premises and equipment, net
Estimated
useful lives
5 - 40 years
1 - 20 years
7 - 27 years
53
2006
2005
(Dollars in Thousands)
$ 288,664
204,163
82,191
$ 261,787
185,465
65,632
868
(185,563 )
$ 390,323
919
(161,817)
$ 351,986
INTERNATIONAL BANCSHARES CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements (Continued)
(7) Goodwill and Other Intangible Assets
The Company’s identified intangibles are all in the form of amortizable core deposit premium. In 2004, the Company acquired
$42,188,000 in identified intangibles in the form of core deposit premium in the LFIN acquisition, which will be amortized over a ten
year period. Information on the Company’s identified intangible assets follows:
December 31, 2006:
Core deposit premium
December 31, 2005:
Core deposit premium
Carrying
Amount
Accumulated
Amortization
(Dollars in Thousands)
Net
$ 56,338
$ 21,980
$ 34,358
$ 56,338
$ 17,114
$ 39,224
Amortization expense of intangible assets for the years ended December 31, 2006, 2005 and 2004, was $4,866,000, $5,176,000
and $3,681,000, respectively. Estimated amortization expense for each of the five succeeding fiscal years, and thereafter, is as follows:
Fiscal year ending:
2007
2008
2009
2010
2011
Thereafter
Total
Total
(in thousands)
$ 4,837
4,837
4,837
4,837
4,794
10,216
$ 34,358
Changes in the carrying amount of goodwill for the year ended December 31, 2006 were as illustrated in the table below.
There were no changes in the carrying amount of goodwill for the year ended December 31, 2005.
Balance at December 31, 2005
Adjustment to goodwill related to acquisition (Note 17)
Balance as of December 31, 2006
$ 289,262
(7,016)
$ 282,246
54
INTERNATIONAL BANCSHARES CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements (Continued)
(8) Deposits
Deposits as of December 31, 2006 and 2005 and related interest expense for the years ended December 31, 2006, 2005 and 2004
were as follows:
Deposits:
Demand—non-interest bearing
Total demand non-interest bearing
Savings and interest bearing demand
Domestic
Foreign
Domestic
Foreign
Total savings and interest bearing demand
Time, certificates of deposit
$100,000 or more
Less than $100,000
Domestic
Foreign
Domestic
Foreign
Total time, certificates of deposit
Total deposits
Interest expense:
Savings and interest bearing demand
Domestic
Foreign
Total savings and interest bearing demand
Time, certificates of deposit
$100,000 or more
Less than $100,000
Domestic
Foreign
Domestic
Foreign
Total time, certificates of deposit
Total interest expense on deposits
2006
2005
(Dollars in Thousands)
$ 1,332,525
120,951
1,453,476
$ 1,222,888
116,492
1,339,380
1,838,229
366,222
2,204,451
1,839,829
316,405
2,156,234
846,185
1,200,412
814,267
1,091,284
892,656
392,738
3,331,991
$ 6,989,918
889,016
366,245
3,160,812
$ 6,656,426
2006
2005
(Dollars in Thousands)
2004
$ 36,606
3,838
40,444
$ 24,583
2,353
26,936
$ 11,991
1,806
13,797
32,851
44,143
18,705
26,710
10,483
17,327
33,225
12,858
123,077
$ 163,521
20,399
7,420
73,234
$ 100,170
12,396
4,453
44,659
$ 58,456
55
INTERNATIONAL BANCSHARES CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements (Continued)
(8) Deposits (Continued)
Scheduled maturities of time deposits in amounts of $100,000 or more at December 31, 2006, were as follows:
Due within 3 months or less
Due after 3 months and within 6 months
Due after 6 months and within 12 months
Due after 12 months
$ 876,841
506,135
477,336
186,285
$ 2,046,597
(9) Securities Sold Under Repurchase Agreements
The Company’s bank subsidiaries have entered into repurchase agreements with an investment banking firm and individual
customers of the bank subsidiaries. The purchasers have agreed to resell to the bank subsidiaries identical securities upon the
maturities of the agreements. Securities sold under repurchase agreements were mortgage-backed book entry securities and averaged
$670,063,000 and $746,389,000 during 2006 and 2005, respectively, and the maximum amount outstanding at any month end during
2006 and 2005 was $794,617,000 and $856,681,000, respectively.
Further information related to repurchase agreements at December 31, 2006 and 2005 is set forth in the following table:
Collateral Securities
Repurchase Borrowing
December 31, 2006 term:
Overnight agreements
1 to 29 days
30 to 90 days
Over 90 days
Total
December 31, 2005 term:
Overnight agreements
1 to 29 days
30 to 90 days
Over 90 days
Total
Book Value of
Securities Sold
$ 318,681
39,274
119,200
558,993
$ 1,036,148
$ 150,055
12,461
45,516
765,644
$ 973,676
Fair Value of
Securities Sold
Balance of
Liability
(Dollars in Thousands)
$ 314,225
39,048
118,346
553,223
$ 1,024,842
$ 147,175
12,296
44,884
756,145
$ 960,500
$ 180,139
27,181
60,863
438,152
$ 706,335
$ 128,886
3,931
33,851
594,094
$ 760,762
Weighted
Average Interest
Rate
4.00%
4.53
4.69
4.92
4.65%
2.79%
3.85
3.20
4.24
3.95%
The book value and fair value of securities sold includes the entire book value and fair value of securities partially or fully
pledged under repurchase agreements.
(10) Other Borrowed Funds
Other borrowed funds include Federal Home Loan Bank borrowings, which are short and long-term fixed borrowings issued by
the Federal Home Loan Bank of Dallas at the market price offered at the time
56
INTERNATIONAL BANCSHARES CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements (Continued)
(10) Other Borrowed Funds (Continued)
of funding. These borrowings are secured by mortgage-backed investment securities and a portion of the Company’s loan portfolio.
Further information regarding the Company’s other borrowed funds at December 31, 2006 and 2005 is set forth in the following
table:
December 31
2006
2005
(Dollars in Thousands)
Federal Home Loan Bank advances—short-term
Balance at year end
Rate on balance outstanding at year end
Average daily balance
Average rate
Maximum amount outstanding at any month end
Federal Home Loan Bank advances—long-term
Balance at year end
Rate on balance outstanding at year end
Average daily balance
Average rate
Maximum amount outstanding at any month end
$ 2,095,505
$ 1,870,000
5.29 %
5.07 %
$ 2,040,618
$ 1,863,096
$ 2,247,025
$ 2,035,119
4.25%
3.21%
$
$
$
71
5.15 %
73
5.15 %
75
$
$
$
75
5.15%
77
5.15%
79
(11) Junior Subordinated Deferrable Interest Debentures
The Company has formed ten statutory business trusts under the laws of the State of Delaware, for the purpose of issuing trust
preferred securities. As part of the LFIN acquisition, the Company acquired three additional statutory business trusts previously
formed by LFIN for the purpose of issuing trust preferred securities. The ten 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 $20,620,000. 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 December 31, 2006, the
principal amount of debentures outstanding totaled $210,908,000.
On July 25, 2006, pursuant to the Indenture dated as of July 16, 2001, between the Company and The Bank of New York, as
Trustee, the Company redeemed all of its Floating Rate Junior Subordinated Debt Securities (the “Debt Securities”), issued to
International Bancshares Capital Trust II (“Trust II”) at a redemption price equal to approximately $27,998,000, which includes
accrued interest to, but not including, the redemption date.
In accordance with the Amended and Restated Declaration of Trust dated as of July 16, 2001 between the Company and The
Bank of New York as Institutional Trustee, the proceeds from the redemption of
57
INTERNATIONAL BANCSHARES CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements (Continued)
(11) Junior Subordinated Deferrable Interest Debentures (Continued)
the Debt Securities were used to simultaneously redeem an equal amount of Trust II Floating Capital Securities and the Trust II
Floating Rate Common Securities issued by Trust II.
On September 30, 2006, pursuant to the Indenture dated as of September 20, 2001, between Local Financial Corporation and The
Bank of New York, as Trustee, the Company redeemed all of its Fixed Rate Junior Subordinated Debt Securities (the “Debt
Securities”), issued to Local Financial Capital Trust I (“LFIN Trust I”) at a redemption price equal to approximately $41,155,625,
which includes accrued interest to, but not including, the redemption date.
In accordance with the Amended and Restated Declaration of Trust dated as of September 20, 2001 between Local Financial
Capital Corporation and The Bank of New York as Institutional Trustee, the proceeds from the redemption of the Debt Securities were
used to simultaneously redeem an equal amount of LFIN Trust I Fixed Rate Capital Securities and the LFIN Trust I Fixed Rate
Common Securities issued by LFIN Trust I.
On December 8, 2006, pursuant to the Indenture dated as of November 28, 2001, between the Company and Wilmington Trust
company, as Trustee, the Company redeemed all of its Floating Rate Junior Subordinated Debt Securities (the “Debt Securities”)
issued to International Bancshares Capital Trust III (“Trust III”) at a redemption price equal to approximately $34,538,000, which
includes accrued interest to, but not including, the redemption date.
In accordance with the Amended and Restated Declaration of Trust dated as of November 28, 2001, between the Company and
Wilmington Trust Company, as the Institutional Trustee and Delaware Trustee and the Administrators named therein, the proceeds
from the redemption of the Debt Securities were used to simultaneously redeem an equal amount of Trust III floating rate Capital
Securities and the Trust III floating rate Common Securities issued by Trust III.
On June 9, 2006, the Company formed International Bancshares Corporation Capital Trust IX (“Trust IX”), its ninth statutory
business trust formed under the laws of the State of Delaware, for the purpose of issuing trust preferred securities. On July 27, 2006,
Trust IX issued $40,000,000 of Capital Securities. The Capital Securities accrue interest for the first five years at a fixed rate of
7.10%, and subsequently at a floating rate of 1.62% over the London Interbank Offered Rate (“LIBOR”), and interest is payable
quarterly beginning October 1, 2006. The Trust IX Capital Securities will mature on October 1, 2036; 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 October 1, 2011, or
(b) in whole or in part within 90 days upon the occurrence 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 IX 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 twenty consecutive
quarterly 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.
On November 8, 2006, the Company formed International Bancshares Corporation Capital Trust X (“Trust X”), its tenth
statutory business trust formed under the laws of the State of Delaware, for the purpose of issuing trust preferred securities. On
November 15, 2006, Trust X issued $33,000,000 of Capital Securities. The Capital Securities accrue interest for the first five years at a
fixed rate of 6.66% and
58
INTERNATIONAL BANCSHARES CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements (Continued)
(11) Junior Subordinated Deferrable Interest Debentures (Continued)
subsequently at a floating rate of 1.65% over the three month LIBOR, and interest is payable quarterly beginning February 1, 2007.
The Trust X Capital Securities will mature on February 1, 2037; 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 February 1, 2012, or (b) in whole or in part within
90 days upon the occurrence 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 X 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 twenty consecutive quarterly 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.
The Debentures are subordinated and junior in right of payment to all present and future senior indebtedness (as defined in the
respective indentures) of the Company, and are pari passu with one another. The interest rate payable on, and the payment terms of
the Debentures are the same as the distribution rate and payment terms of the respective issues of Capital and Common Securities
issued by the Trusts. The Company has fully and unconditionally guaranteed the obligations of each of the Trusts with respect to the
Capital and Common Securities. The Company has the right, unless an Event of Default (as defined in the Indentures) has occurred
and is continuing, to defer payment of interest on the Debentures for up to ten consecutive semi-annual periods on Trusts I, IV and
LFIN Trust II and for up to twenty consecutive quarterly periods on Trusts V, VI, VII, VIII, IX and X and LFIN Trust III. If interest
payments on any of the Debentures are deferred, distributions on both the Capital and Common Securities related to that Debenture
would also be deferred. The redemption prior to maturity of any of the Debentures may require the prior approval of the Federal
Reserve and/or other regulatory bodies.
For financial reporting purposes, the Trusts are treated as investments of the Company and not consolidated in the consolidated
financial statements. Although the Capital Securities issued by each of the Trusts are not included as a component of shareholders’
equity on the consolidated statement of condition, the Capital Securities are treated as capital for regulatory purposes. Specifically,
under applicable regulatory guidelines, the Capital Securities issued by the Trusts qualify as Tier 1 capital up to a maximum of 25% of
Tier 1 capital on an aggregate basis. Any amount that exceeds the 25% threshold would qualify as Tier 2 capital. For December 31,
2006, the total $210,908,000 of the Capital Securities outstanding qualified as Tier 1 capital.
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 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
current trust preferred securities will be included in Tier 1 capital after the five-year transition period ending March 31, 2009.
59
INTERNATIONAL BANCSHARES CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements (Continued)
(11) Junior Subordinated Deferrable Interest Debentures (Continued)
The following table illustrates key information about each of the Debentures and their interest rates at December 31, 2006:
Fixed
Repricing
Frequency
Junior
Subordinated
Deferrable
Interest
Debentures
(in thousands)
$ 10,252
$ 22,681 Semi-Annually
$ 20,558
$ 25,662
$ 10,310
$ 25,566
$ 41,238
$ 34,021
$ 10,310 Semi-Annually
$ 10,310
$ 210,908
Quarterly
Quarterly
Quarterly
Quarterly
Quarterly
Quarterly
Quarterly
Trust I
Trust IV
Trust V
Trust VI
Trust VII
Trust VIII
Trust IX
Trust X
LFIN Trust II
LFIN Trust III
Interest
Rate
Interest Rate
Index(1)
Maturity
Date
Optional
Redemption
Date
10.18% Fixed
9.09% LIBOR + 3.70
9.02% LIBOR + 3.65
8.82% LIBOR + 3.45
8.62% LIBOR + 3.25
8.42% LIBOR + 3.05
7.10% Fixed
6.66% Fixed
June 2011
April 2007
July 2007
June 2031
April 2032
July 2032
November 2032 November 2007
April 2033
October 2033
October 2036
February 2037
April 2008
October 2008
October 2011
February 2012
July 2007
November 2032 November 2007
9.17% LIBOR + 3.625 July 2032
8.82% LIBOR + 3.45
(1) Trust IX and Trust X accrue interest at a fixed rate for the first five years, then floating at LIBOR+1.62 and LIBOR+1.65 thereafter,
respectively.
(12) Earnings per Share (“EPS”)
Basic EPS is calculated by dividing net income by the weighted average number of common shares outstanding. The
computation of diluted EPS assumes the issuance of common shares for all dilutive potential common shares outstanding during the
reporting period. The calculation of the basic EPS and the diluted EPS for the years ended December 31, 2006, 2005, and 2004 is set
forth in the following table:
December 31, 2006:
Basic EPS
Net income
Potential dilutive common shares
Diluted EPS
December 31, 2005:
Basic EPS
Diluted EPS
December 31, 2004:
Basic EPS
Net income
Potential dilutive common shares
Net income
Potential dilutive common shares
Diluted EPS
Net
Income
(Numerator)
(Dollars in Thousands, Except Per Share Amounts)
Shares
(Denominator)
Per Share
Amount
$ 117,001
—
$ 117,001
$ 140,779
—
$ 140,779
$ 119,032
—
$ 119,032
63,133,522
643,366
63,776,888
63,695,017
790,150
64,485,167
62,134,149
1,246,407
63,380,556
$ 1.85
$ 1.83
$ 2.21
$ 2.18
$ 1.92
$ 1.88
60
INTERNATIONAL BANCSHARES CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements (Continued)
(13) Employees’ Profit Sharing Plan
The Company has a deferred profit sharing plan for full-time employees with a minimum of one year of continuous employment.
The Company’s annual contribution to the plan is based on a percentage, as determined by the Board of Directors, of income before
income taxes, as defined, for the year. Allocation of the contribution among officers and employees’ accounts is based on length of
service and amount of salary earned. Profit sharing costs of $4,685,000, $4,950,000 and $3,823,000 were charged to income for the
years ended December 31, 2006, 2005, and 2004, respectively.
(14) International Operations
The Company provides international banking services for its customers through its bank subsidiaries. Neither the Company nor
its bank subsidiaries have facilities located outside the United States. International operations are distinguished from domestic
operations based upon the domicile of the customer.
Because the resources employed by the Company are common to both international and domestic operations, it is not practical to
determine net income generated exclusively from international activities.
A summary of assets attributable to international operations at December 31, 2006 and 2005 are as follows:
Loans:
Commercial
Others
Less allowance for possible loan losses
Net loans
Accrued interest receivable
2006
(Dollars in Thousands)
2005
$ 246,352
62,792
309,144
(7,612 )
$ 301,532
$ 2,655
$ 219,877
62,070
281,947
(15,138)
$ 266,809
1,672
$
At December 31, 2006, the Company had $146,427,000 in outstanding standby and commercial letters of credit to facilitate trade
activities. The letters of credit are issued primarily in conjunction with credit facilities, which are available to various Mexican banks
doing business with the Company.
Revenues directly attributable to international operations were $20,344,000, $14,003,000 and $11,077,000 for the years ended
December 31, 2006, 2005 and 2004, respectively.
61
INTERNATIONAL BANCSHARES CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements (Continued)
(15) Income Taxes
The Company files a consolidated U.S. Federal and State income tax return. The current and deferred portions of net income tax
expense included in the consolidated statements of income are presented below for the years ended December 31:
Current
U.S.
State
Foreign
Deferred
U.S.
State
Total current taxes
Total deferred taxes
Total income taxes
2006
2005
(Dollars in Thousands)
2004
$ 70,701
1,838
36
72,575
(15,442 )
(244 )
(15,686 )
$ 56,889
$ 48,151
452
15
48,618
21,763
989
22,752
$ 71,370
$ 45,969
523
35
46,527
11,353
—
11,353
$ 57,880
Total income tax expense differs from the amount computed by applying the U.S. Federal income tax rate of 35% for 2006, 2005
and 2004 to income before income taxes. The reasons for the differences for the years ended December 31 are as follows:
Computed expected tax expense
Change in taxes resulting from:
Tax-exempt interest income
State tax, net of federal income taxes
Other investment income
Other
Actual tax expense
2006
2005
(Dollars in Thousands)
$ 74,252
$ 60,876
2004
$ 61,919
(1,681 )
1,037
(3,724 )
381
$ 56,889
(1,800 )
1,267
(2,965 )
616
$ 71,370
(1,847 )
340
(2,522 )
(10 )
$ 57,880
62
INTERNATIONAL BANCSHARES CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements (Continued)
(15) Income Taxes (Continued)
The tax effects of temporary differences that give rise to significant portions of the deferred tax assets and deferred tax liabilities
at December 31, 2006 and 2005 are reflected below:
Deferred tax assets:
Loans receivable, principally due to the allowance for possible loan losses
Net unrealized losses on available for sale investment securities
Other real estate owned
Goodwill
Accrued expenses
State net operating loss carryforwards
Other
Total deferred tax assets
Deferred tax liabilities:
Lease financing receivable
Bank premises and equipment, principally due to differences on depreciation
FHLB stock
Identified intangible assets
Other
Total deferred tax liabilities
Net deferred tax liability
2006
(Dollars in Thousands)
2005
$ 26,796
22,320
13
3,132
5,829
1,275
1,893
61,258
(8,328 )
(23,051 )
(5,975 )
(19,157 )
(4,536 )
(61,047 )
211
$
$ 26,865
22,598
152
3,147
1,255
1,633
1,776
57,426
(26,320 )
(20,365 )
(4,520 )
(19,015 )
(2,422 )
(72,642 )
$ (15,216)
The net deferred tax asset at $211,000 at December 31, 2006 is included in other assets in the consolidated statements of
condition. The net deferred tax liability of $15,216,000 at December 31, 2005 is included in other liabilities in the consolidated
statements of condition.
(16) Stock Options
On April 1, 2005, the Board of Directors adopted the 2005 International Bancshares Corporation Stock Option Plan (the “2005
Plan”). The 2005 Plan replaced the 1996 International Bancshares Corporation Key Contributor Stock Option Plan (the “1996 Plan”).
Under the 2005 Plan both qualified incentive stock options (“ISOs”) and nonqualified stock options (“NQSOs”) may be granted.
Options granted may be exercisable for a period of up to 10 years from the date of grant, excluding ISOs granted to 10% shareholders,
which may be exercisable for a period of up to only five years. As of December 31, 2006, 130,200 shares were available for future
grants under the 2005 Plan.
Through December 31, 2006 the Company has granted nonqualified stock options exercisable for a total of 140,382 shares,
adjusted for stock dividends, of Common Stock to certain employees of the GulfStar Group. The grants were not made under either
the 1996 Plan or the 2005 Plan. The options are exercisable for a period of seven years and vest in equal increments over a period of
five years. All options granted to the GulfStar Group employees had an option price of not less than the fair market value of the
Common Stock on the date of grant.
63
INTERNATIONAL BANCSHARES CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements (Continued)
(16) Stock Options (Continued)
On January 1, 2006, the Company adopted the provisions of Statement of Financial Accounting Standards No. 123R (“SFAS
No. 123R”), “Share-Based Payment, (Revised 2004).” SFAS No. 123R sets accounting requirements for “share-based” compensation
to employees and non-employee directors, including employee stock purchase plans, and requires companies to recognize in the
statement of operations the grant-date fair value of stock options and other equity-based compensation.
The Company chose the modified-prospective transition alternative in adopting SFAS No. 123R. Under the modified-prospective
transition method, compensation cost is recognized in financial statements issued subsequent to the date of adoption for all stock-
based payments granted, modified or settled after the date of adoption, as well as for any unvested awards that were granted prior to
the date of adoption.
The fair value of each option award is estimated on the date of grant using a Black-Sholes-Merton option valuation model that
uses the assumptions noted in the following table. Expected volatility is based on the historical volatility of the price of the Company’s
stock. The company uses historical data to estimate the expected dividend yield and employee termination rates within the valuation
model. The expected term of options is derived from the “simplified” method as prescribed by SEC Staff Accounting Bulletin
No. 107. The risk-free rate for periods within the contractual life of the option is based on the U.S. Treasury yield curve in effect at the
time of grant.
Expected Life (Years)
Dividend yield
Interest rate
Volatility
2005
5.99
2006
6.13
2.25% 2.50 %
4.94% 4.36 %
21.05% 24.00 %
A summary of option activity under the stock option plans for the twelve months ended December 31, 2006 is as follows:
Options outstanding at December 31, 2005
Plus: Options granted
Less:
Options exercised
Options expired
Options forfeited
Options outstanding at December 31, 2006
Options fully vested and exercisable at
December 31, 2006
Weighted
average
exercise
price
Weighted
average
remaining
contractual
term (years)
Aggregate
intrinsic
value ($)
Number of
options
1,626,155 $
23,750
164,925
—
106,830
1,378,150
$
16.55
29.70
11.63
—
18.41
17.22
1,029,299
$
13.45
3.02
1.84
$
$
18,917,000
18,017,000
Stock-based compensation expense included in the consolidated statements of income for the twelve months ended December 31,
2006 was approximately $874,000. As of December 31, 2006 there
64
INTERNATIONAL BANCSHARES CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements (Continued)
(16) Stock Options (Continued)
was approximately $1,799,000 of total unrecognized stock-based compensation cost related to non-vested options granted under the
Company plans that will be recognized over a weighted average period of 1.8 years.
A summary of the status of the Company’s non-vested options as of December 31, 2006, and changes during the twelve months
ended December 31, 2006, is presented below:
Non-vested Options
Non-vested options at December 31, 2005
Granted
Vested
Forfeited
Non-vested options at December 31, 2006
Options
549,131
23,750
117,200
106,830
348,851
Weighted average grant-
date fair value ($)
$ 7.52
7.08
11.11
8.54
$ 7.37
Other information pertaining to option activity during the twelve month period ending December 31, 2006 and December 31,
2005 is as follows:
Weighted average grant date fair value of stock
options granted
Total fair value of stock options vested
Total intrinsic value of stock options exercised
Twelve Months Ended
December 31,
2005
2006
7.08
$
$ 1,302,000
$ 2,907,000
$
7.37
$ 1,515,186
$ 8,053,000
Awards granted prior to the Company’s adoption of SFAS No. 123R were accounted for under the recognition and measurement
principles of APB Opinion 25, “Accounting for Stock Issued to Employees,” and related interpretations. Accordingly, no stock-based
employee compensation cost is reflected in net income in the accompanying unaudited consolidated statements of income for the
twelve months ended December 31, 2005 and 2004 because all options granted under the Company’s plans had exercise prices equal
to the market value of the underlying common stock on the date of grant.
65
INTERNATIONAL BANCSHARES CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements (Continued)
(16) Stock Options (Continued)
Pro forma net income and net income per share, as if the Company had applied the fair value recognition provisions of SFAS 123
to stock-based compensation for the period presented prior to the Company’s adoption of SFAS 123R is as follows:
Net income, as reported
Deduct: Total stock-based compensation expense determined under the fair value based method for
$
all awards, net of tax related tax effects
Pro forma net income
Earnings per share:
Basic earnings
As reported
Pro forma
Diluted earnings
As reported
Pro forma
2005
Twelve Months Ended
December 31,
2004
(Dollars in Thousands,
except per share data)
140,779 $
119,032
$
$
$
(345)
140,434
$
(334)
118,698
2.21 $
2.20
2.18 $
2.18
1.92
1.91
1.88
1.87
(17) Commitments, Contingent Liabilities and Other 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 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 leases portions of its banking premises and equipment under operating leases. Total rental expense for the years
ended December 31, 2006, 2005 and 2004 and non-cancellable lease commitments at December 31, 2006 were not significant.
Cash of approximately $57,272,000 and $50,625,000 at December 31, 2006 and 2005, respectively, was maintained to satisfy
regulatory reserve requirements.
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
66
INTERNATIONAL BANCSHARES CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements (Continued)
(17) Commitments, Contingent Liabilities and Other Tax Matters (Continued)
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 approximately $13.7 million, 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 approximate $13.7
million, the remaining amount of the prepaid interest would be refunded to the Company, plus interest thereon.
Beginning August 29, 2005, IBC proceeded to litigate one of the partnership tax cases in the Federal District Court in San
Antonio, Texas. The case was tried over nine days beginning August 29, 2005. On March 31, 2006, the trial court rendered a judgment
against the Company on the first FPAA. IBC timely filed its notice of appeal to the Fifth Circuit Court of Appeals. All appellate briefs
have been filed and the parties are awaiting a decision on oral argument. The other partnership tax case has been stayed by the same
Court during the pendency of the appeal.
The Company, through December 31, 2005, had previously expensed approximately $12,000,000 in connection with the
lawsuits. Because of the above-referenced trial court judgment against the Company on the first FPAA, the uncertainty of the outcome
at the appellate level, and the similarity between the two FPAAs, the Company, as of December 31, 2006 has expensed an additional
$13,700,000, approximately. The resultant approximately $25,700,000 expensed is the total of the tax adjustments due and the interest
due on such adjustments for both FPAAs. Management intends to appeal the judgment in the first case and will continue to evaluate
the merits of each lawsuit and make any appropriate revisions to the amounts, as deemed necessary.
As part of the LFIN acquisition, two tax matters were transferred to the Company. 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 reserve, of
$7,000,000 was resolved with the IRS in September 2006 and as a result, the second tax contingency reserve is no longer required.
The reserve was applied to the goodwill acquired as part of the LFIN acquisition. The Company will continue to monitor the IRS
review of the remaining tax matter and any adjustments will be reflected in goodwill.
(18) Transactions with Related Parties
In the ordinary course of business, the subsidiaries of the Company make loans to directors and executive officers of the
Corporation, including their affiliates, families and companies in which they are principal owners. In the opinion of management,
these loans are made on substantially the same terms, including interest rates and collateral, as those prevailing at the time for
comparable transactions with other persons and do not involve more than normal risk of collectibility or present other
67
INTERNATIONAL BANCSHARES CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements (Continued)
(18) Transactions with Related Parties (Continued)
unfavorable features. The aggregate amounts receivable from such related parties amounted to approximately $48,731,000 and
$42,605,000 at December 31, 2006 and 2005, respectively.
(19) Financial Instruments with Off-Statement of Condition Risk and Concentrations of Credit Risk
In the normal course of business, the bank subsidiaries are party to financial instruments with off-statement of condition risk to
meet the financing needs of their customers. These financial instruments include commitments to their customers. These financial
instruments involve, to varying degrees, elements of credit risk in excess of the amounts recognized in the consolidated statement of
condition. The contract amounts of these instruments reflect the extent of involvement the bank subsidiaries have in particular classes
of financial instruments. At December 31, 2006, the following financial amounts of instruments, whose contract amounts represent
credit risks, were outstanding:
Commitments to extend credit
Credit card lines
Standby letters of credit
Commercial letters of credit
$ 1,860,382,000
36,404,000
124,113,000
22,314,000
The Company enters into a standby letter of credit to guarantee performance of a customer to a third party. These guarantees are
primarily issued to support public and private borrowing arrangements. The credit risk involved is represented by the contractual
amounts of those instruments. Under the standby letters of credit, the Company is required to make payments to the beneficiary of the
letters of credit upon request by the beneficiary so long as all performance criteria have been met. At December 31, 2006, the
maximum potential amount of future payments is $124,113,000. At December 31, 2006, the fair value of these guarantees is not
significant.
The Company enters into commercial letters of credit on behalf of its customers which authorize a third party to draw drafts on
the Company up to a stipulated amount and with specific terms and conditions. A commercial letter of credit is a conditional
commitment on the part of the Company to provide payment on drafts drawn in accordance with the terms of the commercial letter of
credit.
The bank subsidiaries’ exposure to credit loss in the event of nonperformance by the other party to the above financial
instruments is represented by the contractual amounts of the instruments. The bank subsidiaries use the same credit policies in making
commitments and conditional obligations as they do for on-statement of condition instruments. The bank subsidiaries control the
credit risk of these transactions through credit approvals, limits and monitoring procedures. Commitments to extend credit are
agreements to lend to a customer as long as there is no violation of any condition established in the contract. Commitments generally
have fixed expiration dates normally less than one year or other termination clauses and may require the payment of a fee. Since many
of the commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent
future cash requirements. The bank subsidiaries evaluate each customer’s credit-worthiness on a case-by-case basis. The amount of
collateral obtained, if deemed necessary by the subsidiary banks upon extension of credit, is based on management’s credit evaluation
of the customer. Collateral held varies, but may include residential and commercial real estate, bank certificates of deposit, accounts
receivable and inventory.
68
INTERNATIONAL BANCSHARES CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements (Continued)
(19) Financial Instruments with Off-Statement of Condition Risk and Concentrations of Credit Risk (Continued)
The bank subsidiaries make commercial, real estate and consumer loans to customers principally located in South, Central and
Southeast Texas and the State of Oklahoma. Although the loan portfolio is diversified, a substantial portion of its debtors’ ability to
honor their contracts is dependent upon the economic conditions in these areas, especially in the real estate and commercial business
sectors.
(20) Dividend Restrictions and Capital Requirements
Bank regulatory agencies limit the amount of dividends, which the bank subsidiaries can pay the Corporation, through IBC
Subsidiary Corporation, without obtaining prior approval from such agencies. At December 31, 2006, the subsidiary banks could pay
dividends of up to $140,250,000 to the Company without prior regulatory approval and without adversely affecting their “well
capitalized” status. In addition to legal requirements, regulatory authorities also consider the adequacy of the bank subsidiaries’ total
capital in relation to their deposits and other factors. These capital adequacy considerations also limit amounts available for payment
of dividends. The Company historically has not allowed any subsidiary bank to pay dividends in such a manner as to impair its capital
adequacy.
The Company and the bank subsidiaries are subject to various regulatory capital requirements administered by the federal
banking agencies. Failure to meet minimum capital requirements can initiate certain mandatory and possibly additional discretionary
actions by regulators that, if undertaken, could have a direct material effect on the Company’s consolidated financial statements.
Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Company must meet specific capital
guidelines that involve quantitative measures of the Company’s assets, liabilities, and certain off-statement of condition items as
calculated under regulatory accounting practices. The Company’s capital amounts and classification are also subject to qualitative
judgments by the regulators about components, risk weightings, and other factors.
Quantitative measures established by regulation to ensure capital adequacy require the Company to maintain minimum amounts
and ratios (set forth in the table on the following page) of Total and Tier 1 capital to risk-weighted assets and of Tier 1 capital to
average assets. Management believes, as of December 31, 2006, that the Company and each of the bank subsidiaries met all capital
adequacy requirements to which it is subject.
As of December 31, 2006, the most recent notification from the Federal Deposit Insurance Corporation categorized all the bank
subsidiaries as well capitalized under the regulatory framework for prompt corrective action. To be categorized as “well capitalized”
the Company and the bank subsidiaries must maintain minimum Total risk-based, Tier 1 risk based, and Tier 1 leverage ratios as set
forth in the table. There are no conditions or events since that notification that management believes have changed the categorization
of the Company or any of the bank subsidiaries as well capitalized.
69
INTERNATIONAL BANCSHARES CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements (Continued)
(20) Dividend Restrictions and Capital Requirements (Continued)
The Company’s and the bank subsidiaries’ actual capital amounts and ratios for 2006 are presented in the following table:
As of December 31, 2006:
Total Capital (to Risk Weighted Assets):
Consolidated
International Bank of Commerce, Laredo
International Bank of Commerce, Brownsville
International Bank of Commerce, Zapata
Commerce Bank
Tier 1 Capital (to Risk Weighted Assets):
Consolidated
International Bank of Commerce, Laredo
International Bank of Commerce, Brownsville
International Bank of Commerce, Zapata
Commerce Bank
Tier 1 Capital (to Average Assets):
Consolidated
International Bank of Commerce, Laredo
International Bank of Commerce, Brownsville
International Bank of Commerce, Zapata
Commerce Bank
Actual
Amount
Ratio
For Capital
Adequacy Purposes
Ratio
Amount
(greater
(greater
than or
than or
equal to)
equal to)
(Dollars in Thousands)
To Be Well
Capitalized Under
Prompt Corrective
Action Provisions
Amount Ratio
(greater
than or
equal to)
(greater
than or
equal to)
$ 845,827
13.61% $ 497,044 8.00 % $ 621,305 10.00%
8.00
8.00
8.00
8.00
544,990 10.00
38,850 10.00
13,711 10.00
20,498 10.00
435,992
31,080
10,968
16,398
639,892 11.74
80,168 20.64
37,345 27.24
46,198 22.54
$ 775,705
578,414 10.61
75,934 19.55
35,847 26.15
43,631 21.29
4.00
4.00
4.00
4.00
217,996
15,540
5,484
8,199
12.49% $ 248,522 4.00 % $ 372,783
326,994
23,310
8,226
12,299
7.36% $ 421,784 4.00 % $ 527,230
440,605
6.56
41,160
9.22
18,857
9.50
25,975
8.40
352,484
32,928
15,086
20,778
4.00
4.00
4.00
4.00
6.00%
6.00
6.00
6.00
6.00
5.00%
5.00
5.00
5.00
5.00
$ 775,705
578,414
75,934
35,847
43,631
70
INTERNATIONAL BANCSHARES CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements (Continued)
(20) Dividend Restrictions and Capital Requirements (Continued)
The Company’s and the bank subsidiaries’ actual capital amounts and ratios for 2005 are also presented in the following table:
Actual
Amount
Ratio
For Capital
Adequacy Purposes
Ratio
Amount
(greater
(greater
than or
than or
equal to)
equal to)
(Dollars in Thousands)
To Be Well
Capitalized Under
Prompt Corrective
Action Provisions
Amount Ratio
(greater
than or
equal to)
(greater
than or
equal to)
$ 814,021
14.22% $ 457,889 8.00 % $ 572,361 10.00%
8.00
8.00
8.00
8.00
503,267 10.00
34,118 10.00
12,683 10.00
19,394 10.00
402,614
27,294
10,146
15,515
628,370 12.49
71,038 20.82
33,584 26.48
40,445 20.85
$ 742,345
565,312 11.23
67,058 19.65
32,367 25.52
38,020 19.60
$ 742,345
565,312
67,058
32,367
38,020
4.00
4.00
4.00
4.00
201,307
13,647
5,073
7,757
12.97% $ 228,944 4.00 % $ 343,417
301,960
20,471
7,610
11,636
7.26% $ 408,952 4.00 % $ 511,190
431,648
6.55
37,028
9.06
17,566
9.21
23,373
8.13
345,319
29,622
14,053
18,698
4.00
4.00
4.00
4.00
6.00%
6.00
6.00
6.00
6.00
5.00%
5.00
5.00
5.00
5.00
As of December 31, 2005:
Total Capital (to Risk Weighted Assets):
Consolidated
International Bank of Commerce, Laredo
International Bank of Commerce, Brownsville
International Bank of Commerce, Zapata
Commerce Bank
Tier 1 Capital (to Risk Weighted Assets):
Consolidated
International Bank of Commerce, Laredo
International Bank of Commerce, Brownsville
International Bank of Commerce, Zapata
Commerce Bank
Tier 1 Capital (to Average Assets):
Consolidated
International Bank of Commerce, Laredo
International Bank of Commerce, Brownsville
International Bank of Commerce, Zapata
Commerce Bank
(21) Fair Value of Financial Instruments
The fair value estimates, methods, and assumptions for the Company’s financial instruments at December 31, 2006 and 2005 are
outlined below.
Cash and Due From Banks and Federal Funds Sold
For these short-term instruments, the carrying amount is a reasonable estimate of fair value.
71
INTERNATIONAL BANCSHARES CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements (Continued)
(21) Fair Value of Financial Instruments (Continued)
Investment Securities
For investment securities, which include U. S. Treasury securities, obligations of other U. S. government agencies, obligations of
states and political subdivisions and mortgage pass through and related securities, fair values are based on quoted market prices or
dealer quotes. Fair values are based on the value of one unit without regard to any premium or discount that may result from
concentrations of ownership of a financial instrument, possible tax ramifications, or estimated transaction costs. See disclosures of fair
value of investment securities in Note 3.
Loans
Fair values are estimated for portfolios of loans with similar financial characteristics. Loans are segregated by type such as
commercial, real estate and consumer loans as outlined by regulatory reporting guidelines. Each category is segmented into fixed and
variable interest rate terms and by performing and non-performing categories.
For variable rate performing loans, the carrying amount approximates the fair value. For fixed rate performing loans, except
residential mortgage loans, the fair value is calculated by discounting scheduled cash flows through the estimated maturity using
estimated market discount rates that reflect the credit and interest rate risk inherent in the loan. For performing residential mortgage
loans, fair value is estimated by discounting contractual cash flows adjusted for prepayment estimates using discount rates based on
secondary market sources or the primary origination market. At December 31, 2006 and 2005, the carrying amount of fixed rate
performing loans was $1,259,870,000 and $1,398,838,000 respectively, and the estimated fair value was $1,237,409,000 and
$1,382,409,000, respectively.
Fair value for significant impaired loans is based on recent external appraisals. If appraisals are not available, estimated cash
flows are discounted using a rate commensurate with the risk associated with the estimated cash flows. Assumptions regarding credit
risk, cash flows and discount rates are judgmentally determined using available market and specific borrower information. As of
December 31, 2006 and 2005, the net carrying amount of impaired loans was a reasonable estimate of the fair value.
Deposits
The fair value of deposits with no stated maturity, such as non-interest bearing demand deposit accounts, savings accounts and
interest bearing demand deposit accounts, was equal to the amount payable on demand as of December 31, 2006 and 2005. The fair
value of time deposits is based on the discounted value of contractual cash flows. The discount rate is based on currently offered rates.
At December 31, 2006 and 2005, the carrying amount of time deposits was $3,331,991,000 and $3,160,812,000, respectively, and the
estimated fair value was $3,337,399,000 and $3,175,624,000, respectively.
72
INTERNATIONAL BANCSHARES CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements (Continued)
(21) Fair Value of Financial Instruments (Continued)
Securities Sold Under Repurchase Agreements and Other Borrowed Funds
Due to the contractual terms of these financial instruments, the carrying amounts approximated fair value at December 31, 2006
and 2005.
Junior Subordinated Deferrable Interest Debentures
Due to the contractual terms of these financial instruments, the carrying amounts approximated fair value at December 31, 2006.
Commitments to Extend Credit and Letters of Credit
Commitments to extend credit and fund letters of credit are principally at current interest rates and therefore the carrying amount
approximates fair value.
Limitations
Fair value estimates are made at a point in time, based on relevant market information and information about the financial
instrument. These estimates do not reflect any premium or discount that could result from offering for sale at one time the Company’s
entire holdings of a particular financial instrument. Because no market exists for a significant portion of the Company’s financial
instruments, fair value estimates are based on judgments regarding future expected loss experience, current economic conditions, risk
characteristics of various financial instruments and other factors. These estimates are subjective in nature and involve uncertainties
and matters of significant judgment and therefore cannot be determined with precision. Changes in assumptions could significantly
affect the estimates.
Fair value estimates are based on existing on-and off-statement of condition financial instruments without attempting to estimate
the value of anticipated future business and the value of assets and liabilities that are not considered financial instruments. Other
significant assets and liabilities that are not considered financial assets or liabilities include the bank premises and equipment and core
deposit value. In addition, the tax ramifications related to the effect of fair value estimates have not been considered in the above
estimates.
73
INTERNATIONAL BANCSHARES CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements (Continued)
(22) International Bancshares Corporation (Parent Company Only) Financial Information
Statements of Condition
(Parent Company Only)
December 31, 2006 and 2005
(Dollars in Thousands)
ASSETS
Cash
Repurchase Agreements
Other investments
Notes receivable
Investment in subsidiaries
Other assets
Total assets
LIABILITIES AND SHAREHOLDERS’ EQUITY
Liabilities:
Junior subordinated deferrable interest debentures
Due to IBC Trading
Other liabilities
Total liabilities
Shareholders’ equity:
Common shares
Surplus
Retained earnings
Accumulated other comprehensive loss
Less cost of shares in treasury
Total shareholders’ equity
Total liabilities and shareholders’ equity
74
2006
2005
$
655
6,303
25,464
1,636
1,022,959
1,938
$ 1,058,955
$
1,562
2,600
21,937
2,536
1,003,878
1,277
$ 1,033,790
$ 210,908
21
5,970
216,899
$ 236,391
21
4,511
240,923
86,224
138,247
861,251
(40,390 )
1,045,332
(203,276 )
842,056
$ 1,058,955
86,059
135,619
788,416
(41,968)
968,126
(175,259)
792,867
$ 1,033,790
INTERNATIONAL BANCSHARES CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements (Continued)
(23) International Bancshares Corporation (Parent Company Only) Financial Information
Statements of Income
(Parent Company Only)
Years ended December 31, 2006, 2005 and 2004
(Dollars in Thousands)
Income:
Dividends from subsidiaries
Interest income on notes receivable
Interest income on other investments
Other interest income
Gain on sale of other securities
Gain on sale of assets
Other
Total income
Expenses:
Interest expense (Debentures)
Interest expense (Senior Notes)
Other
Total expenses
Income before federal income taxes and equity in undistributed net
income of subsidiaries
Income tax benefit
Income before equity in undistributed net income of subsidiaries
Equity in undistributed net income of subsidiaries
Net income
75
2006
2005
2004
$ 113,839
126
2,508
1,339
—
—
7
117,819
22,568
—
3,220
25,788
$ 51,450
180
1,351
498
—
67
4,047
57,593
18,587
—
946
19,533
$ 62,950
682
1,437
511
151
1,659
5,683
73,073
13,152
383
1,271
14,806
92,031
(7,918)
99,949
17,052
$ 117,001
38,060
(4,716 )
42,776
98,003
$ 140,779
58,267
(1,559)
59,826
59,206
$ 119,032
INTERNATIONAL BANCSHARES CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements (Continued)
(24) International Bancshares Corporation (Parent Company Only) Financial Information
Statements of Cash Flows
(Parent Company Only)
Years ended December 31, 2006, 2005 and 2004
(Dollars in Thousands)
Operating activities:
Net income
Adjustments to reconcile net income to net cash provided by operating
activities:
Gain on sale of other investments
Gain on sale of assets
Accretion of junior subordinated interest deferrable debentures
Depreciation of bank premises and equipment
Stock compensation expense
Increase in other liabilities
Equity in undistributed net income of subsidiaries
Net cash provided by operating activities
Investing activities:
Contributions to subsidiaries
(Repurchase) proceeds of repurchase agreement with banks
Purchase of available for sale other securities
Proceeds of sales of available for sale securities
Proceeds from sales of bank premises and equipment
Net decrease in notes receivable
(Increase) decrease in other assets
Net cash (used in) provided by investing activities
Financing activities:
Proceeds from issuance of subordinated debentures
Proceeds from payments of subordinated debentures
Principal payments on senior notes
Proceeds from stock transactions
Payments of cash dividends
Payments of cash dividends in lieu of fractional shares
Purchase of treasury stock
Net cash used in financing activities
(Decrease) increase in cash
Cash at beginning of year
Cash at end of year
76
$
2006
2005
2004
$ 117,001 $ 140,779 $ 119,032
—
—
548
—
874
1,459
(17,052 )
102,830
(424 )
(3,703 )
—
—
—
900
(4,215 )
(7,442 )
—
(67 )
996
93
—
1,220
(98,003 )
45,018
(4,034 )
(1,800 )
—
—
147
3,239
2,629
181
75,259
(101,290 )
—
1,919
(44,166 )
—
(28,017 )
(96,295 )
(907 )
1,562
655
—
—
—
5,478
(40,808 )
(25 )
(8,669 )
(44,024 )
1,175
387
$ 1,562
$
(151)
(1,659)
1,026
15
—
904
(59,206)
59,961
(9,581)
300
(5,068)
5,010
2,598
5,750
(2,982)
(3,973)
—
—
(21,295)
5,265
(39,729)
(38)
(974)
(56,771)
(783)
1,170
387
INTERNATIONAL BANCSHARES CORPORATION AND SUBSIDIARIES
Condensed Average Statements of Condition
(Dollars in Thousands, Except Per Share Amounts)
(Unaudited)
Distribution of Assets, Liabilities and Shareholders’ Equity
The following table sets forth a comparative summary of average interest earning assets and average interest bearing liabilities
and related interest yields for the years ended December 31, 2006, 2005, and 2004:
2006
2005
2004
Average
Balance
Interest
Average
Rate/Cost
Average
Balance
Interest
Average
Rate/Cost
(Dollars in Thousands)
Average
Balance
Interest
Average
Rate/Cost
Assets
Interest earning assets:
Loan, net of unearned
discounts:
Domestic
Foreign
Taxable
Tax-exempt
Federal funds sold
Other
Investment securities:
Total interest-earning
assets
Non-interest earning assets:
Cash and due from banks
Bank premises and
equipment, net
Other assets
Less allowance for possible
loan losses
Total
Liabilities and Shareholders’
Equity
Interest bearing liabilities:
Savings and interest bearing
demand deposits
Time deposits:
Domestic
Foreign
repurchase agreements
Securities sold under
Other borrowings
Junior subordinated interest
deferrable debentures
Senior notes
Total interest bearing
Non-interest bearing liabilities:
liabilities
Demand Deposits
Other liabilities
Shareholders’ equity
Total
Net interest income
Net yield on interest
earning assets
93,776
75,016
5,956
$ 4,507,583 $ 379,340
288,906
20,680
4,379,218 200,474
4,577
3,596
406
9,350,455 609,073
243,374
369,058
764,330
(68,673 )
$ 10,658,544
$ 2,122,302 $ 40,444
65,597
57,480
1,720,742
1,527,958
670,104
30,137
2,040,691 103,362
232,260
22,568
—
—
8,314,057 319,588
1,364,611
145,538
834,338
$ 10,658,544
$ 289,485
8.42 % $ 4,573,634 $ 325,447
14,003
257,247
7.16
4.58
4.88
4.79
6.82
4,029,077
100,441
132,192
8,992
160,175
4,862
3,668
550
6.51 %
9,101,583
508,705
205,008
323,946
749,044
(84,256 )
$ 10,295,325
1.91 % $ 2,181,303 $ 26,936
3.81
3.77
4.50
5.07
9.72
—
1,709,275
1,410,465
751,247
1,891,001
235,905
—
39,104
34,130
27,384
60,689
18,587
—
3.84 %
8,179,196
206,830
1,253,694
79,178
783,257
$ 10,295,325
$ 301,875
5.59 %
3.98
4.84
2.77
6.12
109,092
5,071
1,577
559
7.12 % $ 3,757,015 $ 225,002
225,565
11,077
5.44
2,996,046
111,671
129,731
11,612
7,231,640
162,278
260,671
552,880
(69,324 )
$ 8,138,145
352,378
3.65
3.21
19,865
16,746
1.23 % $ 1,832,714 $ 13,797
1,590,229
22,879
2.29
1,178,775
21,780
2.42
545,572
1,083,222
206,272
3,340
6,440,124
988,659
54,261
655,101
$ 8,138,145
13,152
383
7.88
—
2.53 %
108,602
$ 243,776
5.99 %
4.91
3.64
4.54
1.22
4.81
4.87 %
.75 %
1.44
1.85
3.64
1.55
6.38
11.47
1.69 %
3.10 %
3.32 %
3.37 %
(Note 1) The average balances for purposes of the above table are calculated on the basis of month-end balances for 2005 and 2004.
77
INTERNATIONAL BANCSHARES CORPORATION AND SUBSIDIARIES
Condensed Quarterly Income Statements
(Dollars in Thousands, Except Per Share Amounts)
(Unaudited)
2006
Interest income
Interest expense
Net interest income
(Recovery) provision for possible loan losses
Non-interest income
Non-interest expense
Income before income taxes
Minority interest in consolidated subsidiaries
Income taxes
Net income
Per common share:
Basic
Net income
Diluted
Net income
Fourth
Quarter(1)
Third
Quarter
Second
Quarter
First
Quarter
$ 160,829
87,658
73,171
1,216
49,272
73,070
48,157
40
16,342
$ 31,775
$ 156,552
86,600
69,952
1,954
40,058
69,028
39,028
—
12,435
$ 26,593
$ 149,374
77,325
72,049
82
47,022
67,721
51,268
—
16,610
$ 34,658
$ 142,318
68,005
74,313
597
40,619
78,858
35,477
—
11,502
$ 23,975
$
$
.50
.50
$
$
.42
.42
$
$
.55
.54
$
$
.38
.37
(1) Includes income related to corrections of the Company’s accounting for mortgage servicing rights. The after tax effect of the item
was $1.43 million, which is immaterial for the year to net earnings, cash flow and shareholders’ equity.
78
INTERNATIONAL BANCSHARES CORPORATION AND SUBSIDIARIES
Condensed Quarterly Income Statements
(Dollars in Thousands, Except Per Share Amounts)
(Unaudited)
2005
Interest income
Interest expense
Net interest income
Provision for possible loan losses
Non-interest income
Non-interest expense
Income before income taxes
Income taxes
Net income
Per common share:
Basic
Net income
Diluted
Net income
Fourth
Quarter
Third
Quarter
Second
Quarter
First
Quarter
$ 134,258
62,678
71,580
(1,675)
46,609
66,355
53,509
19,230
$ 34,279
$ 129,968
54,745
75,223
(196 )
40,883
64,620
51,682
16,214
$ 35,468
$ 126,160
48,201
77,959
221
37,307
64,989
50,056
16,684
$ 33,372
$ 118,319
41,206
77,113
2,610
42,423
60,024
56,902
19,242
$ 37,660
$
$
.54
.53
$
$
.56
.55
$
$
.52
.52
$
$
.59
.58
79
INTERNATIONAL BANCSHARES CORPORATION
OFFICERS AND DIRECTORS
OFFICERS
DIRECTORS
DENNIS E. NIXON
Chairman of the Board and President
DENNIS E. NIXON
President, International Bank of Commerce
R. DAVID GUERRA
Vice President
EDWARD J. FARIAS
Vice President
RICHARD CAPPS
Vice President
IMELDA NAVARRO
Treasurer
WILLIAM CUELLAR
Auditor
MARISA V. SANTOS
Secretary
HILDA V. TORRES
Assistant Secretary
LESTER AVIGAEL
Retail Merchant
Chairman of the Board
International Bank of Commerce
IRVING GREENBLUM
International Investments/Real Estate
R. DAVID GUERRA
President
International Bank of Commerce
Branch in McAllen, TX
DANIEL B. HASTINGS, JR.
Licensed U. S. Custom Broker
President
Daniel B. Hastings, Inc.
RICHARD E. HAYNES
Attorney at Law
Real Estate Investments
IMELDA NAVARRO
Senior Executive Vice President
International Bank of Commerce
SIOMA NEIMAN
International Entrepreneur
PEGGY J. NEWMAN
Investments
LEONARDO SALINAS
Investments
ANTONIO R. SANCHEZ, JR.
Chairman of the Board
Sanchez Oil & Gas Corporation
Investments
80