21MAR200523282374 INTERNATIONAL BANCSHARES CORPORATION ALL BANKS MEMBER FDIC MEMBER BANKS: International Bank Of Commerce 1200 San Bernardo Avenue (956) 722-7611 Laredo 7002 San Bernardo Ave. (956) 728-0060 1002 Matamoros (956) 726-6622 1300 Guadalupe (956) 726-6601 2418 Jacaman Rd. (956) 764-6161 5300 San Dario Ste. 440D (956) 728-0063 5300 San Dario Ste. 202 (956) 790-6500 9710 Mines Road (956) 728-0092 4501 San Bernardo (956) 722-0485 7909 McPherson Ave. (956) 728-0064 2442 San Isidro Pkwy (956) 726-6611 2415 S. Zapata Hwy. (956) 728-0061 1320 San Dario Ave. (956) 790-6511 5610 San Bernardo (956) 726-6688 2320 Bob Bullock Lp 20 (956) 728-0062 4401 Highway 83 South (956) 794-8140 Administration Center 2418 Jacaman Rd. (Rear) (956) 722-7611 San Antonio 130 East Travis (210) 518-2500 5029 Broadway (210) 518-2523 6630 Callaghan (210) 369-2960 6301 NW Lp. 410 Ste. Q14 (210) 369-2910 2201 NW Military Dr. (210) 366-0617 12400 Hwy. 281 North (210) 369-2900 16339 Huebner Rd. (210) 369-2974 7400 San Pedro, Ste. 608 (210) 369-2940 1500 NE Lp. 410 (210) 281-2400 18750 Stone Oak Pkwy Ste. 100 (210) 496-6111 5300 Walzem Rd. (210) 564-2300 10200 San Pedro Ave. (210) 366-5400 11831 Bandera Rd. (210) 369-2980 15900 La Cantera Parkway Ste 10005 (210)354-6984 6909 N. Loop 1604 E Ste. E-01 (210) 369-2922 3119 SE Military Drive (210) 354-6980 327 SW Loop 410 (210) 930-9825 2310 SW Military Dr. Ste #216 (210) 518-2558 999 E. Basse Rd. Ste. 150 (210) 369-2920 12018 Perrin Beitel Rd. (210) 369-2916 938 SE Military Dr. (210) 930-9815 735 SW Military (210) 930-9835 11002 Culebra (210) 930-9850 8503 NW Military Hwy (210) 369-2918 20935 Hwy 281 N., Ste 121 (210) 369-2914 4100 S. New Braunfels Ave. (210) 883-1415 Service Center 2416 Cee Gee (210) 821-4700 8770 Tesoro (210) 821-4700 Luling 200 S. Pecan St. (830) 875-2445 Marble Falls 2401 Hwy. 281 North (830) 693-4301 San Marcos 1081 Wonder World (512) 353-1011 New Braunfels 955 N. Walnut Ave. (830) 608-9665 Shertz 3800 Hwy 3009 (210) 354-6982 McAllen One S. Broadway (956) 686-0263 7124 N. 23rd. (956) 630-9310 301 S. 10th St. (956) 688-3610 3600 N. 10th. St. (956) 688-3690 2200 S. 10th St. (La Plaza East) (956) 688-3670 2200 S. 10th St. (La Plaza West) (956) 688-3660 2225 Nolana (956) 688-3600 1200 E. Jackson (956) 688-3685 2800 Nolana (956) 688-3620 2900 W. Exp 83 (956) 630-9350 Alamo 1421 West Frontage Rd. (956) 688-3645 Edinburg 400 S. Closner (956) 630-9337 1724 W. University Dr. Ste. B (956) 688-3680 2205 W. University Dr. (956) 630-9340 Mission 900 N. Bryan Rd. (956) 688-3630 200 E. Griffin Pkwy (956) 632-3512 2410 E. Expressway 83 (956) 688-3625 Pharr 401 South Cage (956) 688-3635 1007 North I Rd. (956) 688-3655 Weslaco 606 S. Texas Blvd. (956) 688-3605 1310 N. Texas (956) 937-9500 Hidalgo 1023 S. Bridge (956) 688-3665 San Juan 108 E. FM 495 (956) 630-9320 Palmhurst 215 E. Mile 3 Rd. (956) 688-3675 Penitas 1705 Expressway 83 (956) 630-9347 Corpus Christi 221 S. Shoreline (361) 888-4000 6130 S. Staples (361) 991-4000 4622 Everhart (361) 903-7265 14066 Northwest Blvd. (361) 903-7285 Flour Bluff 1317 Waldron Road (361) 886-9950 Sinton 301 West Sinton (361) 364-1230 Rockport 2701 Hwy. 35 N. (361) 729-0500 2431 Hwy. 35 (361) 729-0500 Aransas Pass 2501 W. Wheeler (361) 729-0500 Portland 1800 US Hwy 181 (361) 886-9910 Port Lavaca 311 N. Virginia St. (361) 552-9771 Bay City 1916 7th Street (979) 245-5781 Victoria 6411 N. Navarro (361) 575-8394 Houston 5615 Kirby Dr. (713) 526-1211 8203 S. Kirkwood (713) 285-2165 1001 McKinney Ste. 150 (713) 285-2140 5250 FM 1640 (832) 595-0920 1777 Sage Rd. (713) 285-2133 3200 Woodridge, Ste. 1350 (713) 285-2266 3939 Montrose Ste. W (713) 285-2195 5085 Westheimer Ste. 4640 (713) 285-2296 1545 Eldridge Parkway (713) 285-2042 12400 FM 1960 W. (713) 285-2212 7747 Kirby Dr. (713) 285-2118 1630 Spencer Highway (713) 535-8344 9710 Katy Freeway (713) 535-8335 Sugarland 11565 State Hwy 6 (713) 285-2200 10570 State Hwy 6 (713) 285-2199 Friendswood 3135 FM 528 (713) 285-2233 Galveston 500 Seawall Blvd., Ste. 200 (409) 763-2254 Pearland 2805 Business Center Drive (713) 535-8380 Katy 544 West Grand Parkway (713) 285-2037 Lake Jackson 212 That Way (979) 297-2466 Angleton 200 East Mulberry (979) 849-7711 Freeport 1208 N. Brazosport Blvd. (979) 233-2677 Dickinson 2301 West FM 646 (713) 285-2021 Eagle Pass 2395 E. Main Street (830) 773-2313 2538 E. Main Street (830) 773-2313 439 Main Street (830) 773-2313 2305 Del Rio Blvd. (830) 773-2313 455 S. Bibb Ave. Ste. 502 (830) 773-2313 2135 East Main Street (830) 773-2313 Del Rio 2410 Dodson St. (830) 775-4265 1507 Veteran’s Blvd (830) 775-4265 2205 Veterans Blvd, Suite E9 (830) 775-4265 Uvalde 3100 E. Hwy. 90 (830) 278-8045 2065 E. Main St. (830) 278-8045 Austin 816 Congress Ave., Ste. 100 (512) 338-3900 10405 FM 2222 (512) 397-4584 2817 E. Cesar Chavez (512) 320-9650 6001 Airport Blvd. Ste. 2390 (512) 397-4542 12625 North IH 35 Bldg. D (512) 397-4570 11400 Burnett Road Bldg. 46 (512) 397-4595 9900 South IH 35 Southbound Svc Rd (512) 397-4530 Bastrop 701 W. Hwy 71 (512) 308-9412 Cedar Park 301 W. Whitestone Blvd (512) 397-4552 11200 Lakeline Mall Dr. (512) 397-4559 Round Rock 1850 Gattis School Rd. (512) 320-9530 Leander 1695 US Hwy 183 (512) 320-9089 Oklahoma Ardmore 2302 12th Ave. (580) 223-0345 Broken Arrow 6412 S. Elm Pl. (918) 497-2492 8112 Garnett Rd. (918) 497-2840 Chickasha 628 Grand Ave. (405) 775-8052 Claremore 1050 N. Lynn Riggs Blvd. (918) 497-2456 Clinton 1002 W. Frisco Ave. (580) 323-0730 Duncan 1006 Main (580) 255-8187 2311 N. Hwy 81 (580) 255-9055 Edmond 1812 SE 15th St. (405) 775-8061 421 S. Santa Fe Ave. (405) 841-8055 Grove 100 E. 3rd St. (918)786-4438 Guthrie 120 N. Division St. (405) 775-8064 Tulsa 2808 E. 101st St. (918) 497-2810 1951 S. Yale Ave. (918) 497-2452 4202 S. Garnett (918) 497-2880 2250 E. 73rd St (918) 497-2400 1 E. 5th St. (918) 497-2449 8202 E. 71st St (918) 497-2454 5302 E. Skelly Dr. (918) 497-2453 Chandler 3108 E. First St. (405) 258-2351 Oklahoma City 3817 NW Expressway (405) 841-2100 100 W. Park Ave. (405) 775-8093 5701 N. May Ave. (405) 841-2241 10500 S. Pennsylvania Ave (405) 775-8058 2301 N. Portland Ave. (405) 775-8068 12241 N. May Ave. (405) 775-8059 4902 N. Western Ave. (405) 775-8054 14001 N. McArthur Blvd (405) 775-1710 Lawton 2101 W. Gore (580) 355-0253 6425 NW Cache Rd. (580) 250-4311 200 SW C. Ave., Ste 10 (580) 248-2265 Miami 2520 N. Main (918) 542-4411 2120 Saunders (956) 724-1616 International Bank Of Commerce 1200 San Bernardo Avenue (956) 722-7611 Midwest City 414 N. Air Depot Blvd. (405) 775-8092 2200 S. Douglas Blvd. (405) 775-8057 3402 State Hwy. 97 (918) 497-2459 Sapulpa 911 E. Taft St. (918) 497-2458 Moore 513 NE 12th (405) 775-8066 901 SW 19th (405) 775-1720 Pauls Valley 700 W. Grant Ave. (405) 238-7318 Purcell 430 Lincoln St. (405) 775-8094 Sand Springs 800 E. Charles Page Blvd. (918) 497-2457 Commerce Bank 5800 San Dario Laredo, Texas 78041 (956) 724-1616 2302 Blaine St. (956) 724-1616 Shawnee 2512 N. Harrison Ave. (405) 775-8067 Sulphur 2009 W. Broadway Ave. (580) 622-3118 Weatherford 109 E. Franklin Ave. (580) 772-7441 Yukon 1203 Cornwell Dr. (405) 775-1711 Stillwater 1900 N. Perkins (405) 372-0889 1200 Welby Court (956) 724-1616 International Bank of Commerce, Brownsville 1600 Ruben Torres Blvd Brownsville, TX 78522-1831 (956) 547-1000 7480 S. HWY 48 (956) 547-1370 2721 Boca Chica Blvd (956) 547-1260 2370 N. Expressway (956) 547-1380 3600 W. Alton Gloor Blvd. (956) 547-1390 79 E. Alton Gloor Blvd (956) 547-1360 Harlingen 501 S. Dixieland Rd. (956) 428-6902 321 S. 77th Sunshine Strip (956) 428-6454 1801 W. Lincoln (956) 428-4559 International Bank of Commerce, Zapata U.S Hwy. 83 @ 10th Ave. Zapata, TX 78076 (956) 765-8361 4031 E. Hwy 83 (956) 487-5535 Rio Grande City 4015 E. Hwy. 83 (956) 487-5531 4534 E. Hwy. 83 (956) 488-6367 Hebbronville 401 N. Smith Ave. (361) 527-2645 Kingsville 1320 General Cavazos Blvd (361) 516-1040 715 W. Santa Gertrudis (361) 516-1040 1623 Central Blvd. (956) 547-1323 4520 E. 14th St. (956) 547-1300 630 E. Elizabeth St. (956) 547-1350 Roma 1702 Grant St. (956) 849-1047 Alice 2001 E. Main St. (361) 661-1211 Owasso 9350 N. Garnett (918) 497-2835 Elk City 1504 W. 3rd St. (580) 225-7200 Norman 2403 W. Main St. (405) 775-8069 Lindsey 211 E. Cherokee (405) 756-4494 Muskogee 3143 Azalea Park Drive (918) 682-2300 Bixby 11886 S. Memorial (918) 497-2855 Bethany 7723 NW 23rd St. (405) 775-8063 South Padre Island 911 Padre Blvd. (956) 547-1471 Port Isabel 1401 W. Hwy. 100 (956) 943-2108 Freer 405 S. Norton (361) 661-1211 Beeville 802 E. Houston St. (361) 358-8700 302 N. St. Mary’s Street (361) 358-8700 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, 2011. 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. SELECTED FINANCIAL DATA AS OF OR FOR THE YEARS ENDED DECEMBER 31, 2011 2010 2009 2008 2007 (Dollars in Thousands, Except Per Share Data) STATEMENT OF CONDITION Assets . . . . . . . . . . . . . . . . . . Net loans . . . . . . . . . . . . . . . Deposits . . . . . . . . . . . . . . . . Other borrowed funds . . . . . . Junior subordinated deferrable interest debentures . . . . . . . Shareholders’ equity . . . . . . . . $11,739,649 4,969,283 7,946,092 494,161 $11,943,469 5,325,521 7,599,558 1,026,780 $11,762,543 5,571,869 7,178,007 1,347,625 $12,439,341 5,799,372 6,858,784 2,522,986 $11,167,161 5,474,902 7,157,606 1,456,936 190,726 1,600,165 201,117 1,459,217 201,082 1,407,470 201,048 1,257,297 200,929 935,905 INCOME STATEMENT Interest income . . . . . . . . . . . Interest expense . . . . . . . . . . . $ Net interest income . . . . . . . . Provision (credit) for probable loan losses . . . . . . . . . . . . . Non-interest income . . . . . . . . Non-interest expense . . . . . . . Income before income taxes . . Income taxes . . . . . . . . . . . . . Net income . . . . . . . . . . . . . . Preferred stock dividends and $ $ 418,124 94,298 323,826 17,318 201,493 316,774 191,227 64,078 127,149 $ 458,769 114,036 344,733 22,812 218,784 339,725 200,980 70,957 130,023 527,377 139,796 387,581 58,833 201,013 309,031 220,730 77,988 142,742 564,603 231,731 332,872 19,813 189,809 301,226 201,642 69,530 132,112 $ 643,573 333,340 310,233 (1,762) 165,363 300,282 177,076 55,764 121,312 discount accretion . . . . . . . . 13,280 13,126 12,984 — — Net income available to common shareholders . . . . . Per common share (Note 1): Basic . . . . . . . . . . . . . . . . . Diluted . . . . . . . . . . . . . . . $ $ $ 113,869 1.69 1.69 $ $ $ 116,897 1.72 1.72 $ $ $ 129,758 1.90 1.90 $ $ $ 132,112 1.93 1.92 $ $ $ 121,312 1.76 1.75 Note 1: 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, 2011. The following discussion should be read in conjunction with the Company’s Annual Report on Form 10-K for the year ended December 31, 2011, 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 International Bancshares Corporation (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. Risk 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: (cid:129) Local, regional, national and international economic business conditions and the impact they may have on the Company, the Company’s customers, and such customers’ 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. (cid:129) Volatility and disruption in national and international financial markets. (cid:129) Government intervention in the U.S. financial system. (cid:129) The Company relies, in part, on external financing to fund the Company’s operations and the unavailability of such funds in the future could adversely impact the Company’s growth strategy and prospects. (cid:129) Changes in consumer spending, borrowings and savings habits. (cid:129) Changes in interest rates and market prices, which could reduce the Company’s net interest margins, asset valuations and expense expectations, including, without limitation, the repeal of federal prohibitions on the payment of interest on demand deposits. (cid:129) Changes in the capital markets utilized by the Company and its subsidiaries, including changes in the interest rate environment that may reduce margins. (cid:129) 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, the impact of the Consumer Financial Protection Bureau as a new regulator of financial institutions, changes in the accounting, tax and regulatory treatment of trust preferred securities, as well as changes in banking, tax, securities, insurance and employment, environmental and immigration laws and regulations and the risk of litigation that may follow. 2 (cid:129) 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. (cid:129) The loss of senior management or operating personnel. (cid:129) Increased competition from both within and outside the banking industry. (cid:129) The timing, impact and other uncertainties of the Company’s potential future acquisitions including the Company’s ability to identify suitable potential future acquisition candidates, the success or failure in the integration of their operations and the Company’s ability to maintain its current branch network and to enter new markets successfully and capitalize on growth opportunities. (cid:129) Changes in the Company’s ability to pay dividends on its Preferred Stock or Common Stock. (cid:129) 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, including, without limitation, lower real estate values or environmental liability risks associated with foreclosed properties. (cid:129) Greater than expected costs or difficulties related to the development and integration of new products and lines of business. (cid:129) Impairment of carrying value of goodwill could negatively impact our earnings and capital. (cid:129) Changes in the soundness of other financial institutions with which the Company interacts. (cid:129) Political instability in the United States or Mexico. (cid:129) Technological changes or system failure or breaches of our network security could subject us to increased operating costs as well as litigation and other liabilities. (cid:129) Acts of war or terrorism. (cid:129) Natural disasters. (cid:129) Reduced earnings resulting from the write down of the carrying value of securities held in our the securities are following a determination that securities available-for-sale portfolio other-than-temporarily impaired. (cid:129) 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. (cid:129) The costs and effects of regulatory developments, including the resolution of regulatory or other governmental inquiries and the results of regulatory examinations or reviews. (cid:129) The effect of final rules amending Regulation E that prohibit financial institutions from charging consumer fees for paying overdrafts on ATM and one-time debit card transactions, unless the consumer consents or opts-in to the overdraft service for those types of transactions, as well as the effect of any other regulatory or legal developments that limit overdraft services. (cid:129) The reduction of income and possible increase in required capital levels related to the adoption of new legislation, including, without limitation, the Dodd-Frank Regulatory Reform Act and the implementing rules and regulations, including the Federal Reserve’s new interim final rule that establishes debit card interchange fee standards and prohibits network exclusivity arrangements and routing restrictions that is negatively affecting interchange revenue from debit card transactions as well as revenue from consumer services. 3 (cid:129) The enhanced due diligence burden imposed on banks under the proposed rules of the banking agencies related to the banks’ inability to rely on credit ratings under Dodd-Frank which may result in a limitation on the types of securities certain banks will be able to purchase as a result of the due diligence burden. (cid:129) The Company may be adversely affected by its continued participation in the Capital Purchase Program (the ‘‘CPP’’). (cid:129) The Company’s success at managing the risks involved in the foregoing items, or a failure or circumvention of the Company’s internal controls and risk management, policies and procedures. Forward-looking statements speak only as of the date on which such statements are made. 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. Summary of Recent Legislation On July 21, 2010, sweeping financial regulatory reform legislation entitled the ‘‘Dodd-Frank Wall Street Reform and Consumer Protection Act’’ (the ‘‘Dodd-Frank Act’’) was signed into law. The Dodd-Frank Act implements far-reaching changes across the financial regulatory landscape, including provisions that, among other things, will: (cid:129) Centralize responsibility for consumer financial protection by creating a new agency, the Bureau of Consumer Financial Protection (the ‘‘CFPB’’), responsible for implementing, examining and enforcing compliance with federal consumer financial laws. (cid:129) Restrict the preemption of state law by federal law and disallow subsidiaries and affiliates of banks from availing themselves of such preemption. (cid:129) Apply the same leverage and risk-based capital requirements that apply to insured depository institutions to most bank holding companies. (cid:129) Require each federal bank regulatory agency to seek to make its capital requirement for banks countercyclical so that capital requirements increase in times of economic expansion and decrease in times of economic contraction. (cid:129) Require financial holding companies, such as the Company, to be well-capitalized and well-managed. Bank holding companies and banks must also be well-capitalized and well-managed in order to acquire banks located outside their home state. (cid:129) Change the assessment base for federal deposit insurance from the amount of insured deposits to consolidated assets less tangible capital, eliminate the ceiling on the size of the Deposit Insurance Fund (‘‘DIF’’) and increase the floor of the size of the DIF. (cid:129) Impose comprehensive regulation of over-the-counter derivatives market, which would include certain provisions that would effectively prohibit insured depository institutions from conducting certain derivatives businesses in the institution itself. (cid:129) Require publicly-traded bank holding companies with $10 billion in assets or more, like the Company, to create a risk committee responsible for the oversight of risk management of the enterprise. (cid:129) Require stress testing of certain financial institutions. On June 15, 2011, the FRB published for comment proposed guidance (‘‘Stress Testing Guidance Proposal’’) that would require bank holding companies with over $10 billion in total consolidated assets to conduct stress testing as a part of overall institution risk management. The Stress Testing Guidance Proposal includes stress testing 4 capital and non-capital related aspects of financial condition, provides an overview of how a banking organization should develop a structure for stress testing, outlines general principles for a satisfactory stress testing framework, and describes how stress testing should be used at various levels within a banking organization. The Stress Testing Guidance Proposal also discusses the importance of stress testing in liquidity planning and the importance of strong internal governance and controls in an effective stress-testing framework. The Company does currently have total consolidated assets in excess of $10 billion and the Company would be required to conduct the stress testing described in the Stress Testing Guidance Proposal when it is effective. On January 17, 2012, the FDIC issued a similar proposal that would require state nonmember banks with over $10 billion in assets to conduct annual stress tests, report the results to the FDIC, and make the results available to the public. At this time, none of the subsidiary banks of the Company would meet the $10 billion asset threshold to be required to conduct the bank stress tests under the FDIC Proposal. (cid:129) Implement corporate governance revisions, including executive compensation and proxy access by shareholders that apply to all public companies, not just financial institutions. (cid:129) Make permanent the $250,000 limit for federal deposit insurance and increase the cash limit of Securities Investor Protection Corporation protection from $100,000 to $250,000 and provide unlimited federal deposit insurance until December 31, 2012 for non-interest bearing demand transaction accounts at all insured depository institutions. (cid:129) Repeal the federal prohibitions on the payment of interest on demand deposits, thereby permitting depository institutions to pay interest on business transaction and other accounts. In July 2011, the FRB issued a final rule, effective July 21, 2011, repealing Regulation Q, which had prohibited the payment of interest on demand deposits. (cid:129) Amend the Electronic Fund Transfer Act (‘‘EFTA’’) to, among other things, give the FRB the authority to establish rules regarding interchange fees charged for electronic debit transactions by payment card issuers having assets over $10 billion and to enforce a new statutory requirement that such fees be reasonable and proportional to the actual cost of a transaction to the issuer. In June 2011,the FRB issued a final rule, effective October 1, 2011, which established the maximum permissible interchange fee that an issuer may receive for an electronic debit transaction at 21 cents per transaction and 5 basis points multiplied by the value of the transaction. The FRB also approved an interim final rule that allows for an upward adjustment of no more than 1 cent to an issuer’s debit card interchange fee if the issuer develops and implements appropriate fraud- prevention policies and procedures. (cid:129) Increase the authority of the FRB to examine the Company and its non-bank subsidiaries. (cid:129) Permit interstate de novo branching without the need to acquire an existing bank. (cid:129) Require extensive new restrictions and requirements relating to residential mortgage transactions. (cid:129) Eliminate the use of credit ratings in bank regulations, including capital regulations. On November 18, 2011, the OCC proposed guidance on due diligence requirements in determining whether investment securities are eligible for investment and on January 11, 2012, the FDIC and the other Federal bank agencies proposed a rule to modify the agencies’ market risk capital rules by incorporating into the rules various alternatives and complex methodologies for calculating specific risk capital requirements for debt and securitization positions that do not rely on credit ratings. (cid:129) Establish a Whistleblower Incentives and Protection Program for public company employees. On May 25, 2011, the SEC approved final rules whereby whistleblowers may receive 10% to 30% of the SEC-levied sanctions when a whistleblower voluntarily provides original information to the SEC and the sanctions levied against the culpable party exceed $1 million in an enforcement proceeding. 5 (cid:129) Requires the federal financial regulatory agencies to adopt rules that prohibit banks and their affiliates from engaging in proprietary trading and investing in and sponsoring certain unregistered investment companies (defined as hedge funds and private equity funds). The statutory provision is commonly called the ‘‘Volcker Rule.’’ In October 2011, federal regulators proposed rules to implement the Volcker Rule that included an extensive request for comments on the proposal, which are due by February 13, 2012. The proposed rules are highly complex, and many aspects of their application remain uncertain. Based on the proposed rules, the Company does not currently anticipate that the Volcker Rule will have a material effect on the operations of the Company and its subsidiaries, as the Company does not engage in the businesses prohibited by the Volcker Rule. Until a final rule is adopted, the actual financial impact of the rule on the Company, its customers or the financial industry more generally, cannot be determined. (cid:129) Authorizes the Federal Reserve Board to adopt enhanced supervision and prudential standards generally for bank holding companies with total consolidated assets of $50 billion or more (often referred to as ‘‘systemically important financial institutions’’ or ‘‘SIFI’’), and authorizes the FRB to establish such standards either on its own or upon the recommendations of the Financial Stability Oversight Council (‘‘FSOC’’), a new systemic risk oversight body created by Dodd-Frank. The FSOC has the authority to veto a financial rule of the CFPB if the rule would threaten the safety and soundness of the entire U.S. banking system. In December 2011, the FRB issued for public comment a notice of proposed rulemaking establishing such enhanced supervision and prudential standards. Most of the proposed SIFI rules will not apply to the Company because the Company has total consolidated assets in an amount less than $50 billion. Two aspects of the proposed SIFI rules—requirements for annual stress testing of capital and certain corporate governance provisions requiring, among other things, that each bank holding company establish a risk committee of its board of directors, apply to bank holding companies with total consolidated assets of $10 billion or more, including the Company. Many aspects of the Dodd-Frank Act are subject to rulemaking and will take effect over several years making it difficult to anticipate the overall financial impact on the Company, its customers or the financial industry more generally. Provisions in the legislation that affect deposit insurance assessments, payment of interest on demand deposits and interchange fees are likely to increase the costs associated with deposits as well as place limitations on certain revenues those deposits may generate. Provisions in the legislation that require revisions to the capital requirements of the Company could require the Company to seek other sources of capital in the future. Some of the rules that have been adopted or proposed to comply with the Dodd-Frank Act are discussed further below. Overview The Company, which is headquartered in Laredo, Texas, with 217 facilities and 378 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 liquidating subsidiary, a broker/ dealer and a fifty percent 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 6 on average common equity (‘‘ROE’’). The Company’s ROE for the year ended December 31, 2011 was 8.71% as compared to 9.43% for the year ended December 31, 2010. 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, the Company monitors the efficiency ratio, which is a measure of non-interest expense to net interest income plus non-interest income closely. As the Company adjusts to regulatory changes related to the adoption of the Dodd-Frank Regulatory Reform Act, the Company’s efficiency ratio may suffer because the additional regulatory compliance costs are expected to increase non-interest expense. The Company monitors this ratio over time to assess the Company’s efficiency relative to its peers. The Company uses this measure as one factor in determining if the Company is accomplishing its long-term goals of providing superior returns to the Company’s shareholders. On September 22, 2011, the Company announced the approval of a restructuring plan that resulted in the closing of fifty-five (55) in store branches by December 31, 2011. The branch closures are a result of reduced levels of revenue resulting from regulatory changes related to interchange fee income. The branches were closed in order to align the Company’s expenses with reduced levels of revenue, protecting the Company’s financial strength while preserving IBC’s free products program. Results of Operations Summary Consolidated Statements of Condition Information Assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Net loans . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Deposits . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Other borrowed funds . . . . . . . . . . . . . . . . . . . . . . Junior subordinated deferrable interest debentures . Shareholders’ equity . . . . . . . . . . . . . . . . . . . . . . . December 31, 2011 December 31, 2010 $11,739,649 4,969,283 7,946,092 494,161 190,726 1,600,165 (Dollars in Thousands) $11,943,469 5,325,521 7,599,558 1,026,780 201,117 1,459,217 Percent Increase (Decrease) (1.7)% (6.7) 4.6 (51.9) (5.2) 9.7 7 Consolidated Statements of Income Information Year Ended December 31, 2011 Year Ended December 31, 2010 Percent Increase (Decrease) 2011 vs. 2010 Year Ended December 31, 2009 Percent Increase (Decrease) 2010 vs. 2009 (Dollars in Thousands) $418,124 94,298 323,826 17,318 201,493 316,774 127,149 $458,769 114,036 344,733 22,812 218,784 339,725 130,023 (8.9)% $527,377 139,796 (17.3) 387,581 (6.1) 58,833 (24.1) 201,013 (7.9) 309,031 (6.8) 142,742 (2.2) (13.0)% (18.4) (11.1) (61.2) 8.8 9.9 (8.9) Interest income . . . . . . . . . . . . . . . Interest expense . . . . . . . . . . . . . . . Net interest income . . . . . . . . . . . . Provision for probable loan losses . . Non-interest income . . . . . . . . . . . . Non-interest expense . . . . . . . . . . . Net income . . . . . . . . . . . . . . . . . . Net income available to common shareholders . . . . . . . . . . . . . . . . 113,869 116,897 (2.6) 129,758 (9.9) Per common share: Basic . . . . . . . . . . . . . . . . . . . . . Diluted . . . . . . . . . . . . . . . . . . . $ 1.69 1.69 $ 1.72 1.72 (1.7)% $ (1.7) 1.90 1.90 (9.5)% (9.5) Net Income Net income available to common shareholders for the year ended December 31, 2011 decreased by 2.6% as compared to the same period in 2010. Net income for the years ended December 31, 2011 and December 31, 2010 was positively affected by gains on investment securities sales totaling $11.2 million and $21.6 million, net of tax, respectively. The sales of the securities were to facilitate a re-positioning of the Company’s investment portfolio. Net income for the year ended December 31, 2010 was negatively affected by an additional reserve of $21.8 million that the Company recorded during the first quarter of 2010 in connection with a dispute related to certain tax matters that were inherited by the Company in its 2004 acquisition of LFIN. See Note 17 to the Consolidated Financial Statements. The provision for probable loan losses charged to expense decreased $23.4 million, after tax to $14.8 million, after tax for the year ended December 31, 2010 from $38.2 million, after tax for the same period of 2009. The decrease was mainly due to a decrease in required reserves for impaired loans analyzed on an individual basis. The impaired loans were measured based on the fair value of collateral. The majority of these loans showed a fair value greater than carrying value. 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 8 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. For the years ended December 31, 2011 Average Rate/Cost 2010 Average Rate/Cost 2009 Average Rate/Cost Assets Interest earning assets: Loan, net of unearned discounts: Domestic . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Foreign . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5.63% 4.13 5.72% 4.62 5.88% 4.96 Investment securities: Taxable . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Tax-exempt Other . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2.40 5.29 1.55 3.30 5.02 2.23 4.34 4.87 .87 Total interest-earning assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4.06% 4.64% 5.17% Liabilities Interest bearing liabilities: Savings and interest bearing demand deposits . . . . . . . . . . . . . . . . . . Time deposits: Domestic . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Foreign . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Securities sold under repurchase agreements . . . . . . . . . . . . . . . . . . . Other borrowings . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Junior subordinated deferrable interest debentures . . . . . . . . . . . . . . .30% .39% .51% 1.03 .84 2.99 .22 5.66 1.46 1.24 2.99 .19 6.07 1.96 1.78 3.06 .57 6.23 Total interest bearing liabilities . . . . . . . . . . . . . . . . . . . . . . . . . 1.13% 1.39% 1.59% 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 decreased 12.5% from 4.64% in 2010 to 4.06% in 2011, and the rates paid on average interest-bearing liabilities decreased 18.7% from 1.39% in 2010 to 1.13% in 2011. The yield on average interest-earning assets decreased 10.3% from 5.17% in 2009 to 4.64% in 2010, and the rates paid on average interest-bearing liabilities decreased 12.6% from 1.59% in 2009 to 1.39% in 2010. 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. 9 The following table analyzes the changes in net interest income during 2011 and 2010 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: 2011 compared to 2010 Net increase (decrease) due to 2010 compared to 2009 Net increase (decrease) due to Volume(1) Rate(1) Total Volume(1) Rate(1) Total (Dollars in Thousands) (Dollars in Thousands) Interest earned on: Loans, net of unearned discounts: Domestic . . . . . . . . . . . . . . . . . Foreign . . . . . . . . . . . . . . . . . . . Investment securities: $(15,564) $ (4,571) $(20,135) $(10,557) $ (8,807) $(19,364) (2,203) (1,553) (1,162) (1,347) (391) (856) Taxable . . . . . . . . . . . . . . . . . . . Tax-exempt . . . . . . . . . . . . . . . . Other . . . . . . . . . . . . . . . . . . . . . . 20,976 2,346 471 (42,432) 505 (823) (21,456) 2,851 (352) (8,061) 1,950 260 (42,764) 220 1,354 (50,825) 2,170 1,614 Total interest income . . . . . . . . . . $ 7,838 $(48,483) $(40,645) $(17,755) $(50,853) $(68,608) Interest incurred on: Savings and interest bearing demand deposits . . . . . . . . . . . . $ 928 $ (2,528) $ (1,600) $ 1,291 $ (2,740) $ (1,449) Time deposits: Domestic . . . . . . . . . . . . . . . . . Foreign . . . . . . . . . . . . . . . . . . . (1,077) (332) (7,411) (6,591) (8,488) (6,923) 1,673 1,173 (9,109) (9,025) (7,436) (7,852) Securities sold under repurchase agreements . . . . . . . . . . . . . . . . Other borrowings . . . . . . . . . . . . . Junior subordinated deferrable (1,912) 162 (41) 192 (1,953) 354 543 (5,719) (1,050) (2,463) (507) (8,182) interest debentures . . . . . . . . . . (337) (791) (1,128) 2 (336) (334) Total interest expense . . . . . . . . . . $ (2,568) $(17,170) $(19,738) $ (1,037) $(24,723) $(25,760) Net interest income . . . . . . . . . . . . . $ 10,406 $(31,313) $(20,907) $(16,718) $(26,130) $(42,848) (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 the strategy to manage interest rate risk, the Company strives to manage both assets and liabilities so that interest sensitivities match. One method of calculating interest rate sensitivity is through gap analysis. A gap is the difference between the amount of interest rate sensitive assets and interest rate sensitive liabilities that re-price or mature in a given time period. Positive gaps occur when interest rate sensitive assets exceed interest rate sensitive liabilities, and negative gaps occur when interest rate sensitive liabilities exceed interest rate sensitive assets. A positive gap position in a period of rising interest rates should have a positive effect on net interest income as assets will re-price faster than liabilities. Conversely, net interest income should contract somewhat in a period of falling interest rates. Management can quickly change the Company’s interest rate position at any given point in time as market conditions dictate. Additionally, interest rate changes do not affect all categories of assets and liabilities equally or at the same time. Analytical techniques employed by the Company to supplement gap analysis include simulation analysis to quantify interest rate risk exposure. The gap analysis prepared by management is reviewed by the Investment Committee of the Company twice a year. 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 10 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, 2011, based on these simulations, a rate shift of 300 basis points in interest rates up will vary net interest income by 5.53%, while a rate shift of 150 basis points up will not vary net interest income by more than 5.42% of projected 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 Probable 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 categories: 2011 2010 2009 2008 2007 December 31, Loans accounted for on a non-accrual basis . . . . Accruing loans contractually past due ninety days or more as to interest or principal payments . . $118,505 (Dollars in Thousands) $68,314 $108,023 $163,700 $32,900 14,268 19,347 11,986 6,208 21,330 The allowance for probable loan losses decreased .3% to $84,192,000 at December 31, 2011 from $84,482,000 at December 31, 2010. The allowance was 1.67% of total loans, net of unearned income at December 31, 2011 and 1.56% at December 31, 2010. The provision for probable loan losses charged to expense decreased $5,494,000 to $17,318,000 for the year ended December 31, 2011 from $22,812,000 for the same period in 2010. The Company’s provision for probable loan losses decreased for the year ended December 31, 2011 mainly due to a decrease in the Company’s charge-off experience and a decrease in the loan portfolio. The Company’s provision for probable loan losses decreased for the year ended December 31, 2010 mainly due to the decrease in the required reserves for impaired loans analyzed on an individual basis. The impaired loans have been measured based on the fair value of collateral. The majority of these loans show a fair value greater than the carrying value. The Company’s provision for probable loan losses increased for the years ended December 31, 2009 and 2008, prompted by the analysis of management regarding the weakness in the overall economy and the impact of that weakness in the Company’s loan portfolio and the related allowance for probable loan losses. Although the Texas and Oklahoma economies are performing better and appear to be recovering faster than other parts of the country, the long term weak economic environment may continue to reveal new problems within these markets. Loans accounted for as ‘‘troubled debt restructuring’’ were not significant. 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: December 31, 2011 2010 2009 2008 2007 Loans accounted for on a non-accrual basis . . . . . . . . . . . . . . . . . . Accruing loans contractually past due ninety days or more as to (Dollars in Thousands) $530 $ 24 7 $— $ $722 interest or principal payments . . . . . . . . . . . . . . . . . . . . . . . . . . 20 501 103 66 510 The gross income that would have been recorded during 2011 and 2010 on non-accrual loans in accordance with their original contract terms was $4,114,000 and $3,748,000 on domestic loans and $0 and $2,000 on foreign loans, respectively. The amount of interest income on such loans that was recognized in 2011 and 2010 was $31,000 and $32,000 on domestic loans and $0 and $0 for foreign loans, respectively. 11 Generally, loans are placed on non-accrual status if principal or interest payments become 90 days past due and/or management deem the collectability of the principal and/or interest to be in question, as well as when required by applicable regulatory guidelines. 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 $1,235,699,000 and $1,309,921,000 at December 31, 2011 and 2010, respectively. See Note 19 to the Consolidated Financial Statements. 12 The following table summarizes loan balances at the end of each year and average loans outstanding during the year; changes in the allowance for probable 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: 2011 2010 2009 2008 2007 (Dollars in Thousands) Loans, net of unearned discounts, outstanding at December 31 . . . . . . $5,053,475 $5,410,003 $5,667,262 $5,872,833 $5,536,628 Average loans outstanding during the year (Note 1) . . . . . . . . . . . . . . . . . $5,261,601 $5,542,230 $5,748,789 $5,683,130 $5,215,435 Balance of allowance at January 1 . . . Provision (credit) charged to expense . $ 84,482 17,318 $ 95,393 22,812 $ 73,461 58,833 $ 61,726 19,813 $ 64,537 (1,762) Loans charged off: Domestic: 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 in purchase transactions . . . . . . . . . . . . . . . . . . (18,085) (2,109) (1,467) (1,067) (171) (22,899) (7,702) (2,973) (22,186) (2,152) (227) (35,240) (14,565) (2,500) (17,953) (2,690) (831) (38,539) 4,422 328 171 211 159 5,291 626 517 16 256 102 519 128 19 937 35 1,517 1,638 (17,608) (33,723) (36,901) (5,754) (1,400) (202) (1,770) (8) (9,134) 576 94 21 361 4 1,056 (8,078) (3,606) (800) (202) (1,741) (102) (6,451) 810 58 89 306 3,085 4,348 (2,103) — — — — 1,054 Balance of allowance at December 31 . $ 84,192 $ 84,482 $ 95,393 $ 73,461 $ 61,726 Ratio of net loans charged-off during the year to average loans outstanding during the year (Note 1) . . . . . . . . . . . . . . . . . . . . Ratio of allowance to loans, net of unearned discounts, outstanding at December 31 . . . . . . . . . . . . . . . . . .33% .61% .64% .14% .04% 1.67% 1.56% 1.68% 1.25% 1.11% (Note 1) The average balances for purposes of the above table are calculated on the basis of daily balances. 13 The allowance for probable 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: Commercial, Financial and Agricultural . . . . . . . . . . Real estate—Mortgage . . . . . Real estate—Construction . . Consumer . . . . . . . . . . . . . Foreign . . . . . . . . . . . . . . At December 31, 2011 2010 2009 2008 2007 Percent Allowance of total Percent Allowance of total Percent Allowance of total Percent Allowance of total Percent Allowance of total (Dollars in Thousands) $51,847 9,322 19,940 1,724 1,359 50.6% $38,439 12,670 17.7 26,695 25.2 6,241 1.9 437 4.6 48.5% $47,676 16,825 17.5 27,918 27.2 2,581 2.3 393 4.5 47.8% $33,737 11,639 16.8 25,058 27.9 2,223 2.6 804 4.9 43.8% $28,117 9,256 15.1 21,277 32.6 2,212 2.9 864 5.6 43.9% 14.4 33.2 3.4 5.1 $84,192 100.0% $84,482 100.0% $95,393 100.0% $73,461 100.0% $61,726 100.0% The allowance for probable loan losses primarily 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 probable loan losses. 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. The allowance for probable loan losses is a reserve established through a provision for probable loan losses charged to expense, which represents management’s best estimate of probable loan losses within the existing portfolio of loans. The Company’s allowance for probable loan loss methodology is based on guidance provided in Securities and Exchange Commission Staff Accounting Bulletin No. 102, ‘‘Selected Loan Loss Allowance Methodology and Documentation Issues’’ and includes allowance allocations calculated in accordance with ASC 310, ‘‘Receivables’’ and ASC 450, ‘‘Contingencies.’’ The reserve allocated to all categories of loans decreased approximately $10.9 million from 2009 to 2010. The decrease in the reserve from 2009 to 2010 is mainly due to a decrease in the required reserves for impaired loans analyzed on an individual basis. The impaired loans have been measured based on the fair value of collateral. The majority of these loans show a fair value, after considering selling costs, greater than the carrying value. The increase in the reserve from 2008 to 2009 occurred as the result of the deterioration of economic conditions in 2008 that continued to occur in 2009. Please refer to Note 4—Allowance for Probable Loan Losses in the accompanying Notes to the consolidated Financial Statements. 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 probable loan losses can be made only on a subjective basis. It is the judgment of the Company’s management that the allowance for probable loan losses at December 31, 2011 was adequate to absorb probable losses from loans in the portfolio at that date. See Critical Accounting Policies on page 26. Should any of the factors considered by management in evaluating the adequacy of the allowance for probable loan losses change, the Company’s estimate of probable loan losses could also change, which could affect the level of future provisions for probable loan losses. 14 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 . . . . . . . . . . . . . . . . . Year Ended December 31, 2011 Year Ended December 31, 2010 Percent Increase (Decrease) 2011 vs. 2010 Year Ended December 31, 2009 Percent Increase (Decrease) 2010 vs. 2009 $ 97,968 $ 99,644 (1.7)% $ 99,642 —% (Dollars in Thousands) 50,686 7,304 17,285 16,041 12,209 47,930 8,439 33,209 17,696 11,866 5.8 (13.4) (48.0) (9.4) 2.9 42,861 12,697 11,956 19,773 14,084 11.8 (33.5) 177.8 (10.5) (15.7) Total non-interest income . . . . . . $201,493 $218,784 (7.9)% $201,013 8.8% The investment securities transactions for the years ended December 31, 2011 and December 31, 2010 can be attributed to the sale of investment securities to facilitate the re-positioning of the Company’s investment portfolio. Non-Interest Expense Employee compensation and benefits . . . . . . . . . . . . . . . . . . . Occupancy . . . . . . . . . . . . . . . . . . . Depreciation of bank premises and equipment . . . . . . . . . . . . . . . . . Professional fees . . . . . . . . . . . . . . . . . . Deposit insurance assessments Net expense, other real estate owned . . . . . . . . . . . . . . . . . . . . Amortization of identified intangible assets . . . . . . . . . . . . . . . . . . . . . Advertising . . . . . . . . . . . . . . . . . . Litigation expense . . . . . . . . . . . . . Impairment charges (Total other-than-temporary impairment charges, $(1,003) less loss of $26 for 2011, and $(19,070) less loss of $10,654 for 2010, included in other comprehensive income) . . . Other . . . . . . . . . . . . . . . . . . . . . . Year Ended December 31, 2011 Year Ended December 31, 2010 Percent Increase (Decrease) 2011 vs. 2010 Year Ended December 31, 2009 Percent Increase (Decrease) 2010 vs. 2009 (Dollars in Thousands) $126,004 38,722 $127,469 36,631 (1.1)% $130,849 35,374 5.7 (2.6)% 3.6 34,935 12,998 9,047 35,395 15,625 10,253 (1.3) (16.8) (11.8) 35,879 12,640 10,249 (1.3) 23.6 — 14,817 6,055 144.7 2,557 136.8 5,293 5,807 — 5,284 7,716 21,837 .2 (24.7) — 5,286 9,149 — — (15.7) — 977 68,174 8,416 65,044 (88.4) 4.8 — 67,048 100.0 (3.0) Total non-interest expense . . . . . . $316,774 $339,725 (6.8)% $309,031 9.9% Non-interest expense decreased 6.8% for the year ended December 31, 2011 compared to the same period of 2010. Non-interest expense for 2011 was negatively impacted by a valuation allowance taken for a 15 foreclosed real estate project, included in ‘‘net expense, other real estate owned,’’ in the table above. After evaluation of the carrying value of the foreclosed real estate, the Company determined that the property required a valuation allowance. Included in litigation expense for the year ended December 31, 2010, is a reserve of $21.8 million for a dispute related to certain tax deductions that were inherited by the Company’s 2004 acquisition of LFIN. The dispute involves claims by the former controlling shareholders of LFIN related to tax refunds received by the Company based on deductions taken in 2003 by LFIN in connection with losses on loans acquired from a failed thrift and a dispute LFIN had with the FDIC regarding tax benefits related to the failed thrift acquisition, which originated in 1988. For more information about the LFIN dispute, please refer to Note 17—Commitments, Contingent Liabilities and Other Matters in the accompanying Notes to the Consolidated Financial Statements. The Company recorded other-than-temporary impairment charges of $977 thousand and $8.4 million on non-agency mortgage-backed securities, representing the credit related impairment on the securities in during 2011 and 2010. During the fourth quarter of 2011, the Company also recognized charges of $5.36 million, before tax, related to the closing of fifty-five (55) in-store branches by December 31, 2011. The charges are included in ‘‘Depreciation of bank premises and equipment’’ and ‘‘Other’’ in the table above. 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, 2011, 2010 and 2009: December 31, 2011 2010 2009 (Dollars in Thousands) U.S. Treasury Securities Available for sale . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ — $ 1,327 $ 1,327 Residential mortgage-backed securities Available for sale . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4,969,263 4,924,468 4,491,764 Obligations of states and political subdivisions Available for sale . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 224,761 145,997 136,866 Equity securities Available for sale . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 19,891 14,665 14,126 Other securities Held to maturity . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2,450 2,450 2,450 Total . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $5,216,365 $5,088,907 $4,646,533 16 The following tables set forth the contractual maturities of investment securities, based on amortized cost, at December 31, 2011 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. Available for Sale Maturing Within one year Adjusted After one but within five years After five but within ten years Adjusted Adjusted After ten years Adjusted Cost Yield Cost Yield Cost Yield Cost Yield (Dollars in Thousands) Residential mortgage-backed securities . . . . . . . . . . . . . . . . $ — —% $5,569 5.54% $654,841 3.80% $4,191,337 2.43% Obligations of states and political subdivisions . . . . . . . Equity securities . . . . . . . . . . . . Other securities . . . . . . . . . . . . . — 325 — — — — 636 — — 4.68 — — 4,068 — — 4.98 — — 206,819 18,500 5.80 2.99 — — Total . . . . . . . . . . . . . . . . . . . $325 —% $6,205 5.45% $658,909 3.81% $4,416,656 2.59% Held to Maturity Maturing After one but within five years After five but within ten years Within one year Adjusted Adjusted Adjusted After ten years Adjusted Cost Yield Cost Yield Cost Yield Cost Yield (Dollars in Thousands) Other securities . . . . . . . . . . . . . . . . . . . . . $1,125 1.41% $1,325 1.30% $— —% $— % Total . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $1,125 1.41% $1,325 1.30% $— —% $— —% 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’’). Investments in mortgage-backed securities issued by Ginnie Mae are fully guaranteed by the U.S. Government. Investments in mortgage-backed securities issued by Freddie Mac and Fannie Mae are not fully guaranteed by the U.S. Government, however, the Company believes that the quality of the bonds is similar to other AAA rated bonds with limited credit risk, particularly given the placement of Fannie Mae and Freddie Mac into conservatorship by the federal government in early September 2008. 17 Loans The amounts of loans outstanding, by classification, at December 31, 2011, 2010, 2009, 2008 and 2007 are shown in the following table: 2011 2010 2009 2008 2007 December 31, Commercial, financial and agricultural Real estate—mortgage . . . . . . . . . . . . Real estate—construction . . . . . . . . . . Consumer . . . . . . . . . . . . . . . . . . . . . Foreign . . . . . . . . . . . . . . . . . . . . . . . $2,560,102 895,870 1,273,389 94,109 230,005 $2,615,878 948,982 1,473,471 126,047 245,625 (Dollars in Thousands) $2,703,379 954,010 1,583,057 146,331 280,485 $2,574,247 888,095 1,911,954 169,589 328,948 $2,426,063 798,708 1,835,950 190,899 285,008 Loans . . . . . . . . . . . . . . . . . . . . . . $5,053,475 $5,410,003 $5,667,262 $5,872,833 $5,536,628 The following table shows the amounts of loans (excluding real estate mortgages and consumer loans) outstanding as of December 31, 2011, 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 Within one year After one but within five years After five years Total (Dollars in Thousands) Commercial, financial and agricultural . . . . . . . . . . . Real estate—construction . . . . . . . . . . . . . . . . . . . . Foreign . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 927,308 811,216 157,482 $1,525,478 452,425 67,211 $107,316 9,748 5,312 $2,560,102 1,273,389 230,005 Total . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $1,896,006 $2,045,114 $122,376 $4,063,496 Due after one but within five years . . . . . . . . . . . . . . . . . . . Due after five years . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $134,068 31,916 $1,911,046 90,460 Total . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $165,984 $2,001,506 Interest sensitivity Fixed Rate Variable Rate (Dollars in Thousands) International Operations On December 31, 2011, the Company had $230,005,000 (2.0% of total assets) in loans outstanding to borrowers domiciled in foreign countries, which included primarily borrowers domiciled in Mexico. 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 18 the related amounts of allocated allowance for probable loan losses as of December 31, 2011 is presented below. Secured by certificates of deposit in United States banks . . . . . . . . . . . Secured by United States real estate . . . . . . . . . . . . . . . . . . . . . . . . . . Secured by other United States collateral (securities, gold, silver, etc.) . Unsecured . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Other (principally Mexico real estate) . . . . . . . . . . . . . . . . . . . . . . . . . Amount of Loans Related Allowance for Probable Losses (Dollars in Thousands) $156,623 18,775 25,463 824 28,320 $230,005 $ 669 201 251 11 227 $1,359 The transactions for the year ended December 31, 2011, in that portion of the allowance for probable loan losses related to foreign debt were as follows: (Dollars in Thousands) Balance at December 31, 2010 . . . . . . . . . . . . . . . . . . . . . . . . . Charge-offs . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Recoveries . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Net charge-offs . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Provision charged to expense . . . . . . . . . . . . . . . . . . . . . . . . $ 437 (171) 159 (12) 934 Balance at December 31, 2011 . . . . . . . . . . . . . . . . . . . . . . . . . $1,359 Deposits Deposits: Demand—non-interest bearing 2011 Average Balance 2010 Average Balance (Dollars in Thousands) Domestic . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Foreign . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $1,612,039 205,742 $1,471,034 168,085 Total demand non-interest bearing . . . . . . . . . . . . . . . . . . . . . . . . . . 1,817,781 1,639,119 Savings and interest bearing demand Domestic . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Foreign . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2,138,297 487,661 Total savings and interest bearing demand . . . . . . . . . . . . . . . . . . . . 2,625,958 1,949,389 440,310 2,389,699 Time certificates of deposit $100,000 or more: Domestic . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Foreign . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1,024,335 1,253,365 1,038,031 1,270,513 Less than $100,000: Domestic . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Foreign . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 705,681 393,254 766,075 402,913 Total time, certificates of deposit . . . . . . . . . . . . . . . . . . . . . . . . . 3,376,635 3,477,532 Total deposits . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $7,820,374 $7,506,350 19 2011 2010 2009 (Dollars in Thousands) Interest expense: Savings and interest bearing demand Domestic . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Foreign . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 6,549 1,234 $ 7,771 1,612 $ 9,267 1,565 Total savings and interest bearing demand . . . . . . . . . . . . . . . . . . . . . 7,783 9,383 10,832 Time, certificates of deposit $100,000 or more Domestic . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Foreign . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 10,299 11,512 14,839 17,084 18,091 23,315 Less than $100,000 Domestic . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Foreign . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 7,468 2,277 Total time, certificates of deposit . . . . . . . . . . . . . . . . . . . . . . . . . . . . 31,556 11,416 3,628 46,967 15,600 5,249 62,255 Total interest expense on deposits . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $39,339 $56,350 $73,087 Scheduled maturities of time deposits in amounts of $100,000 or more at December 31, 2011, 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 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 871,022 545,993 608,270 241,183 $2,266,468 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, 2011 were $7,946,092,000, an increase of 4.6% from $7,599,558,000 at December 31, 2010. Return on Equity and Assets Certain key ratios for the Company for the years ended December 31, 2011, 2010 and 2009 follows (Note 1): Years ended December 31, 2011 2010 2009 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 . . . . . . . . . . . . 8.71% 9.43% 11.10% 1.15 1.08 12.24 12.42 20.81 22.49 1.23 11.07 17.89 (Note 1) The average balances for purposes of the above table are calculated on the basis of daily balances. 20 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 29%, 30%, and 31% of the Company’s bank subsidiaries’ total deposits at each of the years ended December 31, 2011, 2010 and 2009, 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 anticipate 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, 2011, 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. 21 INTEREST RATE SENSITIVITY (Dollars in Thousands) Rate/Maturity 3 Months or Less Over 3 Months to 1 Year Over 1 Year to 5 Years Over 5 Years Total (Dollars in Thousands) December 31, 2011 Rate sensitive assets Investment securities . . . . . . . . . . . Loans, net of non-accruals . . . . . . . $ 360,721 3,676,960 $ 1,010,317 311,450 $3,621,202 258,558 Total earning assets . . . . . . . . . . . . $4,037,681 $ 1,321,767 $3,879,760 $ $ 224,125 688,002 $ 5,216,365 4,934,970 912,127 $10,151,335 Cumulative earning assets . . . . . . . $4,037,681 $ 5,359,448 $9,239,208 $10,151,335 Rate sensitive liabilities Time deposits . . . . . . . . . . . . . . . . Other interest bearing deposits . . . Securities sold under repurchase agreements . . . . . . . . . . . . . . . . Other borrowed funds . . . . . . . . . . Junior subordinated deferrable $1,342,107 2,707,693 $ 1,597,491 — $ 371,161 — $ 622 — $ 3,311,381 2,707,693 285,384 387,500 59,347 100,000 3,898 — — 1,000,000 6,661 1,348,629 494,161 — 190,726 interest debentures . . . . . . . . . . 137,117 53,609 Total interest bearing liabilities . . . $4,859,801 $ 1,810,447 $ 375,059 $ 1,007,283 $ 8,052,590 Cumulative sensitive liabilities . . . . $4,859,801 $ 6,670,248 $7,045,307 $ 8,052,590 Repricing gap . . . . . . . . . . . . . . . . Cumulative repricing gap . . . . . . . . Ratio of interest-sensitive assets to liabilities . . . . . . . . . . . . . . . . . . Ratio of cumulative, interest- sensitive assets to liabilities . . . . . $ (822,120) $ (488,680) $3,504,701 2,193,901 (1,310,800) (822,120) $ (95,156) $ 2,098,745 2,098,745 .83 .83 .73 .80 10.34 1.31 .91 1.26 1.26 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. At December 31, 2011, based on these simulations, a rate shift of 300 basis points in interest rates up will vary projected 2012 net interest income by 5.53%, while a rate shift of 150 basis points up will not vary net interest income by more than 5.42% of projected 2012 net interest income. The basis point shift in interest rates is a hypothetical rate scenario used to calibrate risk, and does not necessarily represent 22 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, 2011, the aggregate amount legally available to be distributed to the Company from bank subsidiaries as dividends was approximately $585,000,000, assuming that each bank subsidiary continues to be classified as ‘‘well capitalized’’ under the applicable regulations. The restricted capital (capital and surplus) of the bank subsidiaries was approximately $908,097,000 as of December 31, 2011. The undivided profits of the bank subsidiaries were approximately $902,123,000 as of December 31, 2011. Additionally, as a result of the Company’s participation in the TARP Capital Purchase Program, the Company was restricted in the payment of dividends and was not allowed without the Treasury Department’s consent, to declare or pay any dividend on the Company Common Stock other than a regular semi-annual cash dividend of not more than $.33 per share, as adjusted for any stock dividend or stock split. The restriction ceased to exist on December 23, 2011. At December 31, 2011, the Company has outstanding $494,161,000 in other borrowed funds and $190,726,000 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, 2011, shareholders’ equity was $1,600,165,000 compared to $1,459,217,000 at December 31, 2010, an increase of $140,948,000, or 9.7%. Shareholders’ equity increased primarily due to the retention of earnings offset by the payment of cash dividends to shareholders and the repurchase of common stock under the Company’s publicly announced stock purchase program. The accumulated other comprehensive income 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 12.74% at December 31, 2011 and 11.58% at December 31, 2010. The core deposit intangibles and goodwill of $294,722,000 as of December 31, 2011, are deducted from the sum of core capital elements when determining the capital ratios of the Company. 23 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 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 22.73% and 19.47% and risk weighted total capital ratios of 23.99% and 20.72% as of December 31, 2011 and 2010, respectively, which are well above the minimum regulatory requirements and exceed the well capitalized ratios (see Note 20 to Notes to Consolidated Financial Statements). Junior Subordinated Deferrable Interest Debentures The Company has formed eight statutory business trusts under the laws of the State of Delaware, for the purpose of issuing trust preferred securities. The eight statutory business trusts formed by the Company (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. As of December 31, 2011 and December 31, 2010, the principal amount of debentures outstanding totaled $190,726,000 and $201,117,000, respectively. As a result of the participation in the TARP Capital Purchase Program, the Company was not permitted, without the consent of the Treasury Department, to redeem any of the Debentures. This restriction ceased to exist on December 23, 2011. On March 14, 2011, upon the request of the Company, the Treasury consented to the repurchase by the Company of the $10.4 million in trust preferred securities of Trust I, as well as related costs for a total payment of approximately $11 million, provided that the aggregate amount of the Company’s (i) semi-annual cash dividend, (ii) common stock repurchases and (iii) trust preferred securities redemptions for a given semi-annual period would not exceed the originally permitted semi-annual cash dividend aggregate amount of $.33 per share. One half of the Trust I securities were redeemed on June 8, 2011 and the remaining one half of the Trust I securities were redeemed on July 1, 2011. 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 twenty consecutive quarterly periods on Trusts VI, VII, VIII, IX, X, XI and XII. 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. At December 31, 2011 and December 31, 2010, the total $190,726,000 and $201,117,000 of the Capital Securities outstanding qualified as Tier 1 capital. 24 The following table illustrates key information about each of the Debentures and their interest rates at December 31, 2011: Junior Subordinated Deferrable Interest Debentures (in thousands) Repricing Frequency Interest Rate Interest Rate Index Maturity Date Optional Redemption Date Trust VI . . . . Trust VII . . . . Trust VIII . . . Trust IX . . . . Trust X . . . . . Trust XI . . . . Trust XII . . . . $ 25,774 Quarterly 10,310 Quarterly 25,774 Quarterly 41,238 Quarterly 34,021 32,990 20,619 Fixed Fixed Fixed $190,726 3.91% LIBOR + 3.45 November 2032 May 2012 April 2012 3.68 April 2012 3.45 1.99 April 2012 February 2037 May 2012 6.66 July 2012 July 2037 6.82 September 2037 September 2012 6.85 LIBOR + 3.25 April 2033 LIBOR + 3.05 October 2033 LIBOR + 1.62 October 2036 Fixed Fixed Fixed (1) Trust X, XI and XII accrue interest at a fixed rate for the first five years, then floating at LIBOR + 1.65%, 1.62% and 1.45% thereafter, respectively. Contractual Obligations and Commercial Commitments The following table presents contractual cash obligations of the Company (other than deposit liabilities) as of December 31, 2011: Payments due by Period Contractual Cash Obligations Total Less than One Year (Dollars in Thousands) One to Three Years Three to Five Years After Five Years Securities sold under repurchase agreements . . . . . . . . . . . . . . . . . . . . . Federal Home Loan Bank borrowings . . . Junior subordinated deferrable interest debentures . . . . . . . . . . . . . . . . . . . . . Operating leases . . . . . . . . . . . . . . . . . . . $1,348,629 494,161 $344,731 487,634 $ 3,898 283 $ — $1,000,000 5,941 303 190,726 23,472 — 6,670 — 9,097 — 4,964 190,726 2,741 Total Contractual Cash Obligations . . . . . $2,056,988 $839,035 $13,278 $5,267 $1,199,408 The following table presents contractual commercial commitments of the Company (other than deposit liabilities) as of December 31, 2011: Commercial Commitments Financial and Performance Standby Letters of Credit . . . . . . . . . . . . . . . . . . . . . . . . Commercial Letters of Credit . . . . . . . . . . . Credit Card Lines . . . . . . . . . . . . . . . . . . . Other Commercial Commitments . . . . . . . . Amount of Commitment Expiration Per Period (Dollars in Thousands) Total Less than One Year One to Three Years Three to Five Years After Five Years $ 112,343 20,224 60,895 1,042,237 $ 82,045 20,224 60,895 763,528 $ 30,193 — — 143,040 $ — $ — — 117,280 105 — — 18,389 Total Commercial Commitments . . . . . . . $1,235,699 $926,692 $173,233 $117,280 $18,494 25 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 Probable Loan Losses as a policy critical to the sound operations of the bank subsidiaries. The allowance for probable loan losses primarily 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 probable loan losses. Loan losses or recoveries are charged or credited directly to the allowances. The allowance for probable 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, (ii) allowances based on quantitative historical loss experience on the Company’s loan portfolio, and (iii) allowances based on qualitative data, which includes general economic conditions and other risk factors both internal and external to the Company. See also discussion regarding the allowance for probable loan losses and provision for probable loan losses included in the results of operations and ‘‘Provision and Allowance for Probable Loan Losses’’ included in Notes 1 and 4 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 problems 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 Company’s 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) ‘‘Special Review Credits,’’ (ii) ‘‘Watch List—Pass Credits,’’ or (iii) ‘‘Watch List—Substandard Credits.’’ The loans placed in the ‘‘Special Review Credits’’ category reflect the Company’s opinion that the loans reflect potential weakness which require monitoring on a more frequent basis. The ‘‘Special Review Credits’’ 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—Pass Credits’’ category reflect the Company’s opinion that the credit contains weaknesses which represent a greater degree of risk, which warrant ‘‘extra attention.’’ The ‘‘Watch List—Pass Credits’’ 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—Substandard Credits’’ classification are considered to be potentially inadequately protected by the current sound worth and debt service capacity of the borrower or of any pledged collateral. These credit obligations, even if apparently protected by collateral value, have shown defined weaknesses related to adverse financial, managerial, economic, market or political conditions which may jeopardize repayment of principal and interest. Furthermore, there is the possibility that some future loss could be sustained by the bank if such weaknesses are not corrected. For loans that are 26 classified as impaired, management evaluates these credits under Statement of Financial Accounting Standards No. 114, ‘‘Accounting by Creditors for Impairment of a Loan,’’ now included as part of ASC 310-10, ‘‘Receivables,’’ criteria and, if deemed necessary, a specific reserve is allocated to the credit. The specific reserve allocated under ASC 310-10, 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 as impaired under ASC 310-10 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 ASC 310-10 if such loan is not collateral dependent. The allowance based on historical loss experience on the Company’s remaining loan portfolio, which includes the ‘‘Special Review Credits,’’ ‘‘Watch List—Pass Credits,’’ and ‘‘Watch List—Substandard Credits’’ is determined by segregating the remaining loan portfolio into certain categories such as commercial loans, installment loans, international loans, loan concentrations and overdrafts. Management determined in 2010 that the allowance should be further segmented for commercial and consumer mortgage loans by the type of loans in order to better analyze the portfolio. Management determined in 2011 that the one year historical loss experience used in the calculation should represent the long term economic environment that began in 2008. The further segmentation in 2010 and the change in the 2011 calculation did not have a significant impact on the allowance or provision for probable loan losses. 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 ASC 450-20. The Company’s management continually reviews the allowance for loan losses of the bank subsidiaries using the amounts determined from the allowances established on specific loans, the allowance established on quantitative historical loss percentages, and the allowance based on qualitative data, to establish an appropriate amount to maintain in the Company’s allowance for loan loss. Should any of the factors considered by management in evaluating the adequacy of the allowance for probable loan losses change, the Company’s estimate of probable loan losses could also change, which could affect the level of future provisions for probable loan losses. 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. Preferred Stock, Common Stock and Dividends The Company had issued and outstanding 67,278,237 shares of $1.00 par value Common Stock held by approximately 2,368 holders of record at February 21, 2012. The book value of the Common Stock at December 31, 2011 was $21.83 per share compared with $19.61 per share at December 31, 2010. The Company has issued and outstanding 216,000 shares of Fixed Rate Cumulative Perpetual Preferred Stock, Series A, par value $0.01 per share, having a liquidation preference of $1,000 per share, as of February 21, 2012. The book value of the Series A Preferred at December 31, 2011 was $1,000 per share. 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 2011 and 2010, as quoted on the NASDAQ National Market for each of the quarters in the two year period ended December 31, 2011. Some of the quotations reflect inter-dealer prices, without retail mark-up, 27 mark-down or commission and may not necessarily represent actual transactions. The closing sales price of the Company’s Common Stock was $19.55 per share at February 21, 2012. 2011: First quarter . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Second quarter . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Third quarter . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Fourth quarter . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $20.92 18.99 17.70 19.84 $17.33 15.53 12.62 12.41 High Low 2010: First quarter . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Second quarter . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Third quarter . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Fourth quarter . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $25.14 25.04 18.61 21.20 $18.93 16.69 15.11 15.97 High Low The Company paid cash dividends to the common shareholders of $.19 per share on April 18, 2011 to all holders of record on March 28, 2011 and $.19 per share on October 17, 2011 to all holders of record on September 30, 2011, or $25,648,000 in the aggregate. The Company paid cash dividends to the common shareholders of $.17 per share on April 19, 2010 to all holders of record on April 1, 2010 and $.19 per share on October 18, 2010 to all holders of record on September 30, 2010, or $24,444,000 in the aggregate during 2010. Additionally, as a result of the Company’s participation in the TARP Capital Purchase Program, the Company was restricted in the payment of dividends and was not allowed, without the Treasury Department’s consent, to declare or pay any dividend on the Company Common Stock other than a regular semi-annual cash dividend of not more than $.33 per share, as adjusted for any stock dividend or stock split. On April 7, 2009, the Company gained consent from the Treasury Department (the ‘‘Treasury Consent’’) to use the regular semi-annual cash dividend funds of not more than $.33 per share, as adjusted for any stock dividend or stock split, to pay quarterly dividends and to repurchase common stock. The restrictions ceased to exist on December 23, 2011. While the IBC Board is inclined to continue to declare regular semi-annual cash dividends, there can be no assurance as to future dividends because they are dependent upon the Company’s future earnings, capital requirements, financial condition, acquisition opportunities and general business conditions at the time. In addition, the Company has issued common stock dividends during the last five-year period as follows: Date Stock Dividend May 2007 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . May 2008 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . May 2009 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . May 2010 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . May 2011 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 10% —% —% —% —% The Company’s principal source of funds to pay cash dividends on its Common Stock and Series A Preferred Stock is cash dividends from its bank subsidiaries. For a discussion of the limitations, please see Note 20 of Notes to Consolidated Financial Statements. 28 Stock Repurchase Program The Company terminated its stock repurchase program on December 19, 2008, in connection with participating in the TARP Capital Purchase Program, which program prohibited stock repurchases, except for repurchases made in connection with the administration of an employee benefit plan in the ordinary course of business and consistent with past practices, which restrictions ceased to exist on December 23, 2011. On April 7, 2009, the Company obtained consent from the Treasury to repurchase shares of the Company’s common stock; provided, however, that in no event will the aggregate amount of cash dividends and common stock repurchases for a given semi-annual period exceed the aggregate amount that would be used to pay the originally permitted semi-annual cash dividend of $.33 per share. The Company also received consent from the Treasury to pay quarterly dividends. Following receipt of the Treasury Department’s consent, the Board of Directors established a formal stock repurchase program that authorized the repurchase of up to $40 million of common stock within the following twelve months and on March 10, 2011, the Board of Directors extended the repurchase program and again authorized the repurchase of up to $40 million of common stock during the twelve month period expiring on April 10, 2012, which repurchase cap the Board is inclined to increase over time. 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 21, 2012, a total of 7,747,827 shares had been repurchased under all programs at a cost of $235,819,000. The Company will determine on an ongoing basis the best use of the funds and whether a more frequent dividend program and expanded repurchase program are warranted and beneficial to its shareholders. Except for repurchases in connection with the administration of an employee benefit plan in the ordinary course of business and consistent with past practices, common stock repurchases are only conducted under publicly announced repurchase programs approved by the Board of Directors. The following table includes information about common stock share repurchases for the quarter ended December 31, 2011. Total Number of Shares Purchased Average Price Paid Per Share Total Number of Shares Purchased as Part of a Publicly- Announced Program October 1—October 31, 2011 . . . . . . . . . . . . . . November 1—November 30, 2011 . . . . . . . . . . December 1—December 31, 2011 . . . . . . . . . . Total . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 8,000 — — 8,000 12.65 — — $12.65 8,000 — — 8,000 Approximate Dollar Value of Shares Available for Repurchase(1) $33,565,000 33,565,000 33,565,000 (1) The repurchase program was extended on March 10, 2011 and allows for the repurchase of up to an additional $40,000,000 of treasury stock through April 9, 2012. 29 Equity Compensation Plan Information The following table sets forth information as of December 31, 2011, with respect to the Company’s equity compensation plans: (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 (C) Number of securities remaining available for future issuance under equity compensation plans (excluding securities reflected in column A) 844,721 844,721 $19.08 $19.08 14,161 14,161 Plan Category Equity Compensation plans approved by security holders . . . . . . . . . . . . . . . . . Total . . . . . . . . . . . . . . . . . . . . . . . . . Stock Performance $150 $100 $50 $0 2006 2007 2008 2009 2010 2011 International Bancshares Corporation S&P 500 Index S&P 500 Banks 10FEB201202421787 Total Return To Shareholders (Includes reinvestment of dividends) Company / Index International Bancshares Corporation . . . . . . . . . . . . . S&P 500 Index . . . . . . . . . . . . . . . . . . . . . . . . . . . . . S&P 500 Banks . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Base Period 2006 100 100 100 INDEXED RETURNS December 31, 2007 2008 2009 2010 2011 76.57 105.49 70.22 81.98 66.46 36.87 72.73 84.05 34.44 78.48 96.71 41.27 73.63 98.76 36.85 30 INTERNATIONAL BANCSHARES CORPORATION AND SUBSIDIARIES Consolidated Statements of Condition December 31, 2011 and 2010 (Dollars in Thousands, Except Per Share Amounts) 2011 2010 Assets Cash and due from banks . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 261,885 $ 197,814 Total cash and due from banks—cash and cash equivalents . . . . . . . . . 261,885 197,814 Investment securities: Held to maturity (Market value of $2,450 on December 31, 2011 and $2,450 on December 31, 2010) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2,450 2,450 Available for sale (Amortized cost of $5,082,095 on December 31, 2011 and $5,041,847 on December 31, 2010) . . . . . . . . . . . . . . . . . . . . . . . 5,213,915 5,086,457 Total investment securities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5,216,365 5,088,907 Loans . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Less allowance for probable loan losses . . . . . . . . . . . . . . . . . . . . . . . . . 5,053,475 (84,192) 5,410,003 (84,482) Net loans . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4,969,283 5,325,521 Bank premises and equipment, net . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Accrued interest receivable . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Other investments . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Identified intangible assets, net . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Goodwill, net . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Other assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 453,050 32,002 351,209 12,190 282,532 161,133 468,950 35,660 360,955 17,309 282,532 165,821 Total assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $11,739,649 $11,943,469 See accompanying notes to consolidated financial statements. 32 INTERNATIONAL BANCSHARES CORPORATION AND SUBSIDIARIES Consolidated Statements of Condition (Continued) December 31, 2011 and 2010 (Dollars in Thousands, Except Per Share Amounts) 2011 2010 Liabilities and Shareholders’ Equity Liabilities: Deposits: Demand—non-interest bearing . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Savings and interest bearing demand . . . . . . . . . . . . . . . . . . . . . . . . . . . Time . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 1,927,018 2,707,693 3,311,381 $ 1,639,076 2,522,842 3,437,640 Total deposits . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 7,946,092 7,599,558 Securities sold under repurchase agreements . . . . . . . . . . . . . . . . . . . . . . . Other borrowed funds . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Junior subordinated deferrable interest debentures . . . . . . . . . . . . . . . . . . Other liabilities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1,348,629 494,161 190,726 159,876 1,433,270 1,026,780 201,117 223,527 Total liabilities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 10,139,484 10,484,252 Commitments, Contingent Liabilities and Other Matters (Note 17) Shareholders’ equity: Series A cumulative perpetual preferred shares, $.01 par value, $1,000 per share liquidation value. Authorized 25,000,000 shares; issued 216,000 shares on December 31, 2011, net of discount of $5,452 and 216,000 shares on December 31, 2010 net of discount of $7,932 . . . . . . Common shares of $1.00 par value. Authorized 275,000,000 shares; issued 95,719,652 shares on December 31, 2011 and 95,711,285 shares on December 31, 2010 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Surplus . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Retained earnings . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Accumulated other comprehensive income (including $(6,889) and $(6,870) of comprehensive loss related to other-than-temporary impairment for non-credit related issues) . . . . . . . . . . . . . . . . . . . . . . 210,548 208,068 95,720 162,767 1,302,964 95,711 162,276 1,214,743 84,959 28,777 1,856,958 1,709,575 Less cost of shares in treasury, 28,441,714 shares on December 31, 2011 and 28,016,059 shares on December 31, 2010 . . . . . . . . . . . . . . . . . . . (256,793) (250,358) Total shareholders’ equity . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1,600,165 1,459,217 Total liabilities and shareholders’ equity . . . . . . . . . . . . . . . . . . . . . . . $11,739,649 $11,943,469 See accompanying notes to consolidated financial statements. 33 INTERNATIONAL BANCSHARES CORPORATION AND SUBSIDIARIES Consolidated Statements of Income Years ended December 31, 2011, 2010 and 2009 (Dollars in Thousands, Except Per Share Amounts) 2011 2010 2009 Interest income: Loans, including fees . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Investment securities: $292,514 $314,202 $335,769 Taxable . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Tax-exempt . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Other interest income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 113,650 10,091 1,869 135,106 7,240 2,221 185,931 5,070 607 Total interest income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 418,124 458,769 527,377 Interest expense: Savings and interest bearing demand deposits . . . . . . . . . . . . . . . . Time deposits . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Securities sold under repurchase agreements . . . . . . . . . . . . . . . . . Other borrowings . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Junior subordinated deferrable interest debentures . . . . . . . . . . . . Other interest expense . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Total interest expense . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 7,783 31,556 42,263 1,623 11,073 — 94,298 9,383 46,967 44,216 1,269 12,201 — 10,832 62,255 44,723 9,451 12,535 — 114,036 139,796 Net interest income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 323,826 344,733 387,581 Provision for probable loan losses . . . . . . . . . . . . . . . . . . . . . . . . . . 17,318 22,812 58,833 Net interest income after provision for probable loan losses . . . . 306,508 321,921 328,748 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 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 97,968 99,644 99,642 50,686 7,304 17,285 16,041 12,209 47,930 8,439 33,209 17,696 11,866 42,861 12,697 11,956 19,773 14,084 Total non-interest income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 201,493 218,784 201,013 See accompanying notes to consolidated financial statements. 34 INTERNATIONAL BANCSHARES CORPORATION AND SUBSIDIARIES Consolidated Statements of Income (Continued) Years ended December 31, 2011, 2010 and 2009 (Dollars in Thousands, Except Per Share Amounts) Non-interest expense: Employee compensation and benefits . . . . . . . . . . . . . . . . Occupancy . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Depreciation of bank premises and equipment . . . . . . . . . Professional fees . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Deposit insurance assessments . . . . . . . . . . . . . . . . . . . . . Net expense, other real estate owned . . . . . . . . . . . . . . . . Amortization of identified intangible assets . . . . . . . . . . . . Advertising . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Litigation expense . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Impairment charges (Total other-than-temporary impairment charges, $(1,003) less loss of $26 for 2011, and $(19,070) less loss of $10,654 for 2010, included in other comprehensive income) . . . . . . . . . . . . . . . . . . . . Other . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Total non-interest expense . . . . . . . . . . . . . . . . . . . . . . Income before income taxes . . . . . . . . . . . . . . . . . . . . . Provision for income taxes . . . . . . . . . . . . . . . . . . . . . . . . . . Net income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Preferred stock dividends and discount accretion . . . . . . . . . Net income available to common shareholders . . . . . . . . Basic earnings per common share: 2011 2010 2009 $ $ $ 126,004 38,722 34,935 12,998 9,047 14,817 5,293 5,807 — 977 68,174 316,774 191,227 64,078 127,149 13,280 113,869 $ $ $ 127,469 36,631 35,395 15,625 10,253 6,055 5,284 7,716 21,837 8,416 65,044 339,725 200,980 70,957 130,023 13,126 116,897 $ $ $ 130,849 35,374 35,879 12,640 10,249 2,557 5,286 9,149 — — 67,048 309,031 220,730 77,988 142,742 12,984 129,758 Weighted average number of shares outstanding . . . . . . . . 67,506,554 67,921,353 68,373,732 Net income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 1.69 $ 1.72 $ 1.90 Fully diluted earnings per common share: Weighted average number of shares outstanding . . . . . . . . 67,569,468 68,004,441 68,394,624 Net income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 1.69 $ 1.72 $ 1.90 See accompanying notes to consolidated financial statements. 35 INTERNATIONAL BANCSHARES CORPORATION AND SUBSIDIARIES Consolidated Statements of Comprehensive Income Years ended December 31, 2011, 2010, and 2009 (Dollars in Thousands) Net income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $127,149 $130,023 $142,742 2011 2010 2009 Other comprehensive income, net of tax: Net unrealized holding gains (losses) on securities available for sale arising during period (tax effects of $35,960, $(11,300), and $29,863) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Reclassification adjustment for gains on securities available for sale included in net income (tax effects of $(6,050), $(11,623), and $(4,185)) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Reclassification adjustment for impairment charges on available for sale securities included in net income (tax effects of $342, $2,946, and $0) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 66,782 (20,985) 55,460 (11,235) (21,586) (7,771) 635 5,470 — Comprehensive income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $183,331 $ 92,922 $190,431 See accompanying notes to consolidated financial statements. 36 INTERNATIONAL BANCSHARES CORPORATION AND SUBSIDIARIES Consolidated Statements of Shareholders’ Equity Years ended December 31, 2011, 2010 and 2009 (in Thousands) Preferred Stock Number of Shares Common Stock Other Retained Comprehensive Treasury Income (Loss) Stock Surplus Earnings Total Balance at December 31, 2008 . . . $203,558 — Net Income . . . . . . . . . . . . . . Dividends: Cash ($.34 per share) . . . . . . — Preferred stock (5%) including discount accretion . . . . . . . . . 2,184 95,499 — $95,499 — $158,110 $1,016,004 142,742 — $ 18,189 — $(234,063) $1,257,297 142,742 — — — — 212 — — — — 212 — — — — 2,493 655 (23,262) (13,194) — — — — — — — — — — (23,262) (11,010) (9,346) — (9,346) 2,705 — 655 Purchase of treasury (708,925 shares) . . . . . . . . . . . . . . . . Exercise of stock options . . . . . . Stock compensation expense recognized in earnings . . . . . . Other comprehensive income, net of tax: Net change in unrealized gains and losses on available for sale securities, net of reclassification adjustment . . Balance at December 31, 2009 . . . Net Income . . . . . . . . . . . . . . Dividends: Purchase of treasury stock (408,888 shares) . . . . . . . . . . Exercise of stock options . . . . . . . Stock compensation expense recognized in earnings . . . . . . . Other comprehensive income, net of tax: Net change in unrealized gains and losses on available for sale securities, net of reclassification adjustment . . Balance at December 31, 2010 . . . Net Income . . . . . . . . . . . . . . Dividends: Purchase of treasury stock (425,655 shares) . . . . . . . . . . Exercise of stock options . . . . . . . Stock compensation expense recognized in earnings . . . . . . . Other comprehensive loss, net of tax: Net change in unrealized gains and losses on available for sale securities, net of reclassification adjustments . — — — — — — — — — . . . . . . Cash ($.36 per share) Preferred stock (5%) including discount accretion . . . . . . . — 2,326 — — — — — 205,742 — 95,711 — 95,711 — 161,258 — 1,122,290 130,023 47,689 65,878 — — 47,689 (243,409) 1,407,470 130,023 — — — — — — — — — — — — — — 484 534 (24,444) (13,126) — — — — — — — — — — (24,444) (10,800) (6,949) — (6,949) 484 — 534 . . . . . . Cash ($.38 per share) Preferred stock (5%) including discount accretion . . . . . . . — 2,480 — — — — — (37,101) — (37,101) 208,068 — 95,711 — 95,711 — 162,276 — 1,214,743 127,149 28,777 — (250,358) 1,459,217 127,149 — — — — 9 — — — — 9 — — — — 104 387 (25,648) (13,280) — — — — — — — — — — (25,648) (10,800) (6,435) — (6,435) 113 — 387 — — — — — 56,182 — 56,182 Balance at December 31, 2011 . . . $210,548 95,720 $95,720 $162,767 $1,302,964 $ 84,959 $(256,793) $1,600,165 See accompanying notes to consolidated financial statements. 37 INTERNATIONAL BANCSHARES CORPORATION AND SUBSIDIARIES Consolidated Statements of Cash Flows Years ended December 31, 2011, 2010 and 2009 (Dollars in Thousands) Operating activities: Net income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Adjustments to reconcile net income to net cash provided $ 127,149 $ 130,023 $ 142,742 2011 2010 2009 by operating activities: Provision for probable loan losses . . . . . . . . . . . . . . . . . Specific reserve, other real estate owned . . . . . . . . . . . . . Accretion of time deposit discounts . . . . . . . . . . . . . . . . Depreciation of bank premises and equipment . . . . . . . . (Gain) loss on sale of bank premises and equipment . . . . Gain on sale of other real estate owned . . . . . . . . . . . . . Depreciation and amortization of leased assets . . . . . . . . Accretion of investment securities discounts . . . . . . . . . . Amortization of investment securities premiums . . . . . . . Investment securities transactions, net . . . . . . . . . . . . . . Impairment charges on available for sale securities . . . . . Accretion of junior subordinated debenture discounts . . . Amortization of identified intangible assets . . . . . . . . . . . Stock based compensation expense . . . . . . . . . . . . . . . . . Earnings from affiliates and other investments . . . . . . . . Deferred tax benefit . . . . . . . . . . . . . . . . . . . . . . . . . . . Decrease in accrued interest receivable . . . . . . . . . . . . . . Decrease (increase) in other assets . . . . . . . . . . . . . . . . . (Decrease) increase in other liabilities . . . . . . . . . . . . . . 17,318 9,806 (11) 34,935 (361) (738) — (2,081) 18,362 (17,285) 977 9 5,293 387 (11,633) (2,299) 3,658 2,303 (4,966) 22,812 657 (14) 35,395 (22) (266) — (1,693) 13,211 (33,209) 8,416 35 5,284 534 (15,023) (3,532) 6,071 7,824 1,652 58,833 44 (14) 35,879 80 (291) 300 (1,940) 6,911 (11,956) — 34 5,286 655 (16,891) (3,035) 6,981 (62,308) (12,253) Net cash provided by operating activities . . . . . . . . . . . 180,823 178,155 149,057 Investing activities: Proceeds from maturities of securities Proceeds from sales and calls of available for sale . . . . . . . . . . . . . . securities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Purchases of available for sale securities . . . . . . . . . . . . . Principal collected on mortgage backed securities . . . . . . Proceeds from matured time deposits with banks . . . . . . Net 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 . . . Proceeds from sales of other real estate owned . . . . . . . . . . . . . Purchase, adjustment of identified intangible asset 1,425 4,423 1,637 1,102,849 (2,231,330) 999,419 — 306,915 (11,941) 33,320 (20,393) 1,719 25,324 (174) 1,149,021 (2,666,596) 1,085,817 — 164,241 (7,438) 20,910 (15,953) 2,005 8,362 (235) 579,099 (1,280,925) 1,224,938 396 138,340 (11,430) 56,988 (61,015) 1,052 23,041 (259) Net cash provided by (used in) investing activities . . . . 207,133 (255,443) 671,862 See accompanying notes to consolidated financial statements. 38 INTERNATIONAL BANCSHARES CORPORATION AND SUBSIDIARIES Consolidated Statements of Cash Flows (Continued) Years ended December 31, 2011, 2010 and 2009 (Dollars in Thousands) Financing activities: Net increase in non-interest bearing demand deposits . . . Net increase in savings and interest bearing demand deposits . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Net (decrease) increase in time deposits . . . . . . . . . . . . . Net (decrease) increase in securities sold under repurchase agreements . . . . . . . . . . . . . . . . . . . . . . . . Other borrowed funds, net . . . . . . . . . . . . . . . . . . . . . . . Repayment of long-term debt . . . . . . . . . . . . . . . . . . . . . Purchase of treasury stock . . . . . . . . . . . . . . . . . . . . . . . Proceeds from stock transactions . . . . . . . . . . . . . . . . . . Payments of cash dividends—common . . . . . . . . . . . . . . Payments of cash dividends—preferred . . . . . . . . . . . . . . Net cash (used in) 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 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Purchases of available-for-sale securities not yet settled . . Net transfers from loans to other real estate owned . . . . Accrued dividends, preferred shares . . . . . . . . . . . . . . . . 2011 2010 2009 $ 287,942 $ 122,277 $ 57,129 184,851 (126,248) 260,290 38,998 180,950 81,158 (84,641) (532,619) (10,400) (6,435) 113 (25,648) (10,800) (323,885) 64,071 197,814 261,885 97,699 60,922 72,538 32,005 1,350 $ $ (8,547) (320,845) — (6,949) 484 (24,444) (10,800) 686 (1,175,361) — (9,346) 2,705 (23,262) (9,660) 50,464 (895,001) $ $ (26,824) 224,638 197,814 116,037 78,435 160,216 59,429 1,350 (74,082) 298,720 224,638 146,778 83,830 100,829 30,331 1,350 $ $ See accompanying notes to consolidated financial statements. 39 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, Premier Tierra Holdings, Inc. 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 Company owns two insurance-related subsidiaries, IBC Life Insurance Company and IBC Insurance Agency, Inc., a wholly owned subsidiary of IBC, the bank subsidiary. Neither of the insurance- related subsidiaries conducts underwriting activities. The IBC Life Insurance Company is in the business of reinsuring credit life and credit accident and health insurance. The business is assumed from an unaffiliated insurer and the only business written is generated by the bank subsidiaries of the Company. The risk assumed on each of the policies is not significant to the consolidated financial statements. The preparation of the consolidated financial statements in conformity with accounting principles 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 probable loan losses. Subsequent Events The Company has evaluated all events or transactions that occurred through the date the Company issued these financial statements. During this period, the Company did not have any material recognizable or non-recognizable subsequent events. 40 INTERNATIONAL BANCSHARES CORPORATION AND SUBSIDIARIES Notes to Consolidated Financial Statements (Continued) (1) Summary of Significant Accounting Policies (Continued) 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 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, 2011. Mortgage-backed securities held at December 31, 2011 and 2010 represent participating interests in pools of long-term first mortgage loans originated and serviced by the issuers of the securities. Mortgage- backed securities are either issued or guaranteed by the U.S. Government or its agencies including the Federal Home Loan Mortgage Corporation (‘‘Freddie Mac’’), the Federal National Mortgage Association (‘‘Fannie Mae’’), the Government National Mortgage Association (‘‘Ginnie Mae’’) or other non-government entities. Investments in mortgage-backed securities issued by Ginnie Mae are fully guaranteed by the U. S. Government. Investments in mortgage-backed securities issued by Freddie Mac and Fannie Mae are not fully guaranteed by the U.S. Government, however, the Company believes that the quality of the bonds is similar to other AAA rated bonds with limited credit risk, particularly given the placement of Fannie Mae and Freddie Mac into conservatorship by the federal government in early September 2008. Market interest rate fluctuations can affect the prepayment speed of principal and the yield on the security. Premiums and discounts are amortized using the level yield or ‘‘interest method’’ over the terms of the securities. Declines in the fair value of held-to-maturity and available-for sale-securities below their cost that are deemed to be other than temporary are reflected in earnings as realized losses. In determining whether other-than-temporary impairment exists, management considers many factors, including (1) the length of time and the extent to which the fair value has been less than cost, (2) the financial condition and near-term prospects of the issuer, and (3) the intent of the Company to hold and the determination of whether the Company will more likely than not be required to sell the security prior to a recovery in fair value. If the Company determines that (1) it intends to sell the security or (2) it is more likely than not that it will be required to sell the security before it’s anticipated recovery, the other-than-temporary impairment that is recognized in earnings is equal to the difference between the fair value of the security and the Company’s amortized cost in the security. If the Company determines that it (1) does not intend to sell the security and (2) it will not be more likely than not required to sell the security before it’s anticipated recovery, the other-than-temporary impairment is segregated into its two components (1) the amount of impairment related to credit loss and (2) the amount of impairment related to other factors. The difference between the present value of the cash flows expected to be collected and the amortized cost is the credit loss recognized through earnings and an adjustment to the cost basis of the security. The amount of impairment related to other factors is included in other comprehensive income (loss). Gains and losses on the sale of securities are recorded on the trade date and are determined using the specific identification method. 41 INTERNATIONAL BANCSHARES CORPORATION AND SUBSIDIARIES Notes to Consolidated Financial Statements (Continued) (1) Summary of Significant Accounting Policies (Continued) Provision and Allowance for Probable Loan Losses The allowance for probable 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 probable 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 probable 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 probable 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. The Company originates mortgage loans that may subsequently be sold to an unaffiliated third party. The loans are not securitized and if sold, are sold without recourse. Loans held for sale are carried at cost and the principal amount outstanding is not significant to the consolidated financial statements. Impaired Loans 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. 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. 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. As it relates to consumer loans, management charges off those loans when the loan is contractually 90 days past due. Under special circumstances, a consumer or non-consumer 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 are expected future payments. When a loan is placed on non-accrual status, any interest accrued, not paid is reversed and charged to operations against interest income. As it relates to non-consumer loans that are not 90 days past due, management will evaluate each of these loans to determine if placing the loan on non-accrual status is 42 INTERNATIONAL BANCSHARES CORPORATION AND SUBSIDIARIES Notes to Consolidated Financial Statements (Continued) (1) Summary of Significant Accounting Policies (Continued) warranted. 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. Other Real Estate Owned Other real estate owned is comprised of real estate acquired by foreclosure and deeds in lieu of foreclosure. Real estate acquired by foreclosure and deeds in lieu of foreclosure is initially recorded at fair value less estimated selling costs (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 probable loan losses, if necessary. Any subsequent write-downs are charged against other non-interest expense. Other real estate owned totaled $86,626,000 and $87,192,000 at December 31, 2011 and 2010, respectively. Other real estate owned is included in other assets. 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. Other Investments Other investments include equity investments in non-financial companies, bank owned life insurance, as well as equity securities with no readily determinable fair market value. Equity investments are accounted for using the equity method of accounting. Equity securities with no readily determinable fair value are accounted for using the cost method. 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 carry forwards, 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. The Company evaluates uncertain tax positions at the end of each reporting period. The Company may recognize the tax benefit from an uncertain tax position only if it is more likely than not that the tax position will be sustained on examination by the taxing authorities, based on the technical merits of the position. The tax benefit recognized in the financial statements from any such a position is measured based on the largest benefit that has a greater than fifty percent likelihood of being realized upon ultimate settlement. As of December 31, 2011 and 2010, respectively, after evaluating all uncertain tax positions, the Company has recorded no liability for unrecognized tax benefits at the end of the reporting period. The 43 INTERNATIONAL BANCSHARES CORPORATION AND SUBSIDIARIES Notes to Consolidated Financial Statements (Continued) (1) Summary of Significant Accounting Policies (Continued) Company would recognize any interest accrued on unrecognized tax benefits as other interest expense and penalties as other non-interest expense. During the years ended December 31, 2011, 2010 and 2009, the Company recognized no interest expense or penalties related to uncertain tax positions. The Company files consolidated tax returns in the U.S. Federal jurisdiction and various state jurisdictions. The Company is no longer subject to U.S. federal or state income tax examinations by tax authorities for years before 2008. Stock Options 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. The fair value of stock options granted was estimated, 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-Scholes-Merton option- pricing model does not necessarily provide a reliable single measure of the fair value of the Company’s stock options. 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. Goodwill is tested for impairment at least annually or on an interim basis if an event triggering impairment may have occurred. As of October 1, 2011, after completing goodwill testing, the Company has determined that no goodwill impairment exists. 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 and contract rights. As of December 31, 2011, the Company has determined that no impairment of identified intangibles exists. Identified intangible assets with definite useful lives are amortized on an accelerated basis over their estimated life. See Note 6— Goodwill and Other Intangible Assets. 44 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 and 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. Because the Company may not initially identify loans as originated for resale, all loans are initially treated as held for investment. 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. The value of the mortgage servicing rights is not significant to the consolidated statements of condition. 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. Comprehensive Income Comprehensive income consists of net income and other comprehensive income (loss). Other comprehensive income (loss) includes unrealized gains and losses on securities available for sale. 45 INTERNATIONAL BANCSHARES CORPORATION AND SUBSIDIARIES Notes to Consolidated Financial Statements (Continued) (1) Summary of Significant Accounting Policies (Continued) Advertising Advertising costs are expensed as incurred. 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 or total assets. Additionally, subsequent to the filing of the Company’s annual report on Form 10-K for the year ended December 31, 2009, the Company identified that cash flows arising from the purchases of available-for-sale securities, not yet settled, had been presented at the end of the prior period in the consolidated statement of cash flows as part of cash flows from operating activities instead of investing activity. The change resulted in a reclassification of $84.8 million for the year ended December 31, 2009 from net cash provided by operating activities to net cash provided by investing activities, which did not alter the net change in cash and cash equivalents reported. The impact of this reclassification is not considered material to the financial statements previously presented on the Form 10-K for the year ended December 31, 2009. New Accounting Standards In January 2010, the Financial Accounting Standards Board issued Accounting Standards Update No. 2010-06, to ASC 820, ‘‘Fair Value Measurements and Disclosures.’’ The Update amends prior accounting guidance regarding fair value disclosures including required disclosure of (i) significant amounts of transfers of assets or liabilities between Levels 1 and 2 of the fair value hierarchy and the reasons for the transfers (ii) detailed gross information about activity related to assets or liabilities included in Level 3 of the fair value hierarchy for recurring fair value measurements, (iii) the policy for determining when transfers between the levels of the fair value hierarchy are recognized and (iv) the reasons for transfers of assets or liabilities in or out of Level 3 of the fair value hierarchy, with significant transfers disclosed separately. The Update further clarifies that (i) fair value disclosures should be provided for each class of assets and liabilities, where class would generally be a subset of assets or liabilities within a line item in the consolidated financial statements and (ii) disclosures about fair value inputs and techniques used for both recurring and nonrecurring fair value measurements included in Level 2 and 3 of the fair value hierarchy. The disclosures related to the detailed gross information about activity related to assets or liabilities included in Level 3 of the fair value hierarchy for recurring fair value measurements were required for the Company beginning on January 1, 2011. The remaining disclosure requirements became effective for the Company on January 1, 2010. The adoption of the update to existing accounting standards did not have a significant impact on the Company’s consolidated financial statements. In July 2010, the Financial Accounting Standards Board issued Accounting Standards Update No. 2010-20, to ASC 310, ‘‘Receivables.’’ The Update amends existing disclosure requirements regarding an entity’s financing receivables. The main objective of the Update is intended to provide users of financial statements with greater transparency regarding an entity’s allowance for credit losses and the quality of its financing receivables. The Update requires additional disclosures about (i) the credit risk inherent in the entity’s portfolio of financing receivables, (ii) how the inherent risk in the portfolio is analyzed and assessed in arriving at the allowance for credit loss, and (iii) the changes and reasons for changes in the allowance for credit loss. Additionally, the Update clarifies that disclosures should be made on a 46 INTERNATIONAL BANCSHARES CORPORATION AND SUBSIDIARIES Notes to Consolidated Financial Statements (Continued) (1) Summary of Significant Accounting Policies (Continued) disaggregated basis as defined in the Update—portfolio segment and class of financing receivable. Portfolio segment is defined as the level at which the entity develops and documents a systematic method for determining its allowance for credit loss and class of financing receivable is defined as a disaggregation of a portfolio segment. Existing disclosures are amended by the Update to include (i) a roll forward of the allowance for credit losses by portfolio segment with the ending balance disaggregated on the basis of impairment method, (ii) for each disaggregated balance, the related recorded investment in the financing receivable, (iii) the non-accrual status of financing receivable by class of financing receivable, and (iv) impaired financing receivables by class. Additional disclosures required by the Update include (i) credit quality indicators by class of financing receivable, (ii) the aging of past due financing receivables by class of financing receivable, (iii) the nature and extent of troubled debt restructuring that occurred during the reporting period and their effect on the allowance for credit losses, (iv) the nature and extent of troubled debt restructurings within the previous 12 months that defaulted during the reporting period, by class of financing receivable and their impact on the allowance for credit loss, and (v) significant purchases and sales of financing receivables during the reporting period disaggregated by portfolio segment. The Update was effective for the Company as of December 31, 2010, as it relates to disclosures required at the end of a reporting period. Disclosures that relate to activity during a reporting period were required for the Company for the fiscal year ending December 31, 2011. Please see Note 4—Allowance for Probable Loan Losses. In December 2010, the Financial Accounting Standards Board issued Accounting Standards Update No. 2010-28, to ASC 350, ‘‘Intangibles—Goodwill and Other.’’ The Update modifies Step 1 of the goodwill impairment test for reporting units that have zero or negative carrying amounts. For those reporting units, an entity is required to perform Step 2 of the goodwill impairment test if it is more likely than not that a goodwill impairment exists. The qualitative factors that should be evaluated in making the more likely than not determination are consistent with existing guidance in ASC 350. The Update will be effective for the Company for interim and fiscal years beginning after December 15, 2010. The adoption of the update to existing standards is not expected to have a significant impact to the Company’s consolidated financial statements. In April 2011, the Financial Accounting Standards Board issued Accounting Standards Update No. 2011-02, to ASC 310, ‘‘Receivables.’’ The Update clarifies which loan modifications are troubled debt restructurings and provides additional guidance to help creditors determine whether a modification of a loan meets the criteria to be considered a troubled debt restructuring. For modifications that are troubled debt restructurings, the Update requires that a creditor separately conclude that (i) the restructuring constitutes a concession, and (ii) the debtor is experiencing financial difficulties. The Update became effective for the first interim or annual period beginning on or after June 15, 2011 and was applied retrospectively for the 2011 annual reporting period. The adoption of the Update did not have a significant impact on the Company’s consolidated financial statements. In April 2011, the Financial Accounting Standards Board issued Accounting Standards Update No 2011-03, to ASC 860, ‘‘Transfers and Servicing.’’ The Update is intended to improve financial reporting of repurchase agreements and other agreements that both entitle and obligate a transferor to repurchase or redeem financial assets before their maturity. The Update removes the following from the assessment of effective control included in existing literature (i) the criteria requiring the transferor to have the ability to repurchase or redeem the financial assets on substantially the agreed terms, even in the event of default by the transferee, and (ii) the collateral maintenance guidance related to that criteria. The Update is effective for the first interim or annual period beginning on or after December 15, 2011 and is to 47 INTERNATIONAL BANCSHARES CORPORATION AND SUBSIDIARIES Notes to Consolidated Financial Statements (Continued) (1) Summary of Significant Accounting Policies (Continued) be applied prospectively to transactions or modifications of existing transactions that occur on or after the effective date. The adoption of the Update to existing standards is not expected to have a significant impact to the Company’s consolidated financial statements. In May 2011, the Financial Accounting Standards Board issued Accounting Standards Update No. 2011-04, to ASC 820, ‘‘Fair Value Measurement.’’ The Update is intended to converge the fair value measurement guidance in U.S. GAAP with International Financial Reporting Standards. The Update clarifies the application of existing fair value measurement requirements, changes certain principles in existing guidance and requires additional fair value disclosures. The Update is effective for interim and annual periods beginning after December 15, 2011. The provisions of the Update are to be applied prospectively and early adoption is not permitted. The adoption of the Update to existing standards is not expected to have a significant impact to the Company’s consolidated financial statements. In June 2011, the Financial Accounting Standards Board issued Accounting Standards Update No. 2011-05, to ASC 220, ‘‘Comprehensive Income.’’ The Update is an amendment to existing literature and requires that all non-owner changes in stockholders’ equity be presented in either a single continuous statement of comprehensive income or in two separate, but consecutive statements. The Update also requires entities to present, on the face of the financial statement, reclassification adjustments for items that are reclassified from other comprehensive income to net income in the statement or statements where the components of that net income and the components of other comprehensive income are presented. The option to present components of other comprehensive income as part of the statement of changes in stockholders’ equity was eliminated. The Update is effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2011. The adoption of the Update to existing standards is not expected to have a significant impact to the Company’s consolidated financial statements. In September 2011, the Financial Accounting Standards Board issued Accounting Standards Update No. 2011-08 to ASC 350, ‘‘Intangibles—Goodwill and Other.’’ The Update amends existing literature to give entities the option to first assess qualitative factors to determine whether the existence of events or circumstances leads to a determination that it is more likely than not that the fair value of a reporting unit is less than its carrying amount. If, after assessing the totality of events or circumstances, an entity determines it is not more likely than not that the fair value of a reporting unit is less than its carrying amount, then performing the two step impairment test is unnecessary. If an entity concludes otherwise, then it is required to perform the first step of the two step impairment test by calculating the fair value of the reporting unit and comparing the fair value with the carrying amount of the reporting unit. The Update is effective for annual and interim goodwill impairment tests performed for fiscal years beginning after December 15, 2011. The adoption of the Update to existing standards is not expected to have a significant impact to the Company’s consolidated financial statements. In December 2011, the Financial Accounting Standards Board issued Accounting Standards Update No. 2011-12 to ASC 220, ‘‘Comprehensive Income.’’ The Update defers the effective date for amendments to the presentation of reclassifications of items out of other accumulated comprehensive income, as required by Accounting Standards Update No. 2011-05. The deferment is intended to allow the Financial Accounting Standards Board adequate time to re-deliberate the proposed changes to present on the face of the financial statements the effects of reclassifications out of accumulated comprehensive income on the components of net income and other comprehensive income for all periods presented. 48 INTERNATIONAL BANCSHARES CORPORATION AND SUBSIDIARIES Notes to Consolidated Financial Statements (Continued) (2) Investment Securities The amortized cost and estimated fair value by type of investment security at December 31, 2011 are as follows: Held to Maturity Amortized cost Gross unrealized gains Gross unrealized losses Estimated fair value Carrying value Other securities . . . . . . . . . . . . . . . . . . . . . . . . . $2,450 (Dollars in Thousands) $— $— $2,450 Total investment securities . . . . . . . . . . . . . . . . . . $2,450 $— $— $2,450 $2,450 $2,450 Residential mortgage-backed securities . . . Obligations of states and political subdivisions . . . . . . . . . . . . . . . . . . . . . Equity securities . . . . . . . . . . . . . . . . . . . Available for Sale Amortized cost Gross unrealized gains Gross unrealized losses Estimated fair value Carrying value(1) $4,851,747 $128,196 $(10,680) $4,969,263 $4,969,263 (Dollars in Thousands) 211,523 18,825 14,449 1,115 (1,211) (49) 224,761 19,891 224,761 19,891 Total investment securities . . . . . . . . . . . . $5,082,095 $143,760 $(11,940) $5,213,915 $5,213,915 (1) Included in the carrying value of residential mortgage-backed securities are $3,008,935 of mortgage- backed securities issued by Ginnie Mae, $1,920,723 of mortgage-backed securities issued by Fannie Mae and Freddie Mac and $39,605 issued by non-government entities The amortized cost and estimated fair value of investment securities at December 31, 2011, 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 Amortized Cost Estimated fair value Amortized Cost Estimated fair value Due in one year or less . . . . . . . . . . . . . . . . . . . . . . . . Due after one year through five years . . . . . . . . . . . . . Due after five years through ten years . . . . . . . . . . . . . Due after ten years . . . . . . . . . . . . . . . . . . . . . . . . . . . Residential mortgage-backed securities . . . . . . . . . . . . . Equity securities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $1,125 1,325 — — — — $1,125 1,325 — — — — — $ 636 4,068 206,819 4,851,747 18,825 — 641 4,149 219,971 4,969,263 19,891 (Dollars in Thousands) $ Total investment securities . . . . . . . . . . . . . . . . . . . . . . $2,450 $2,450 $5,082,095 $5,213,915 49 INTERNATIONAL BANCSHARES CORPORATION AND SUBSIDIARIES Notes to Consolidated Financial Statements (Continued) (2) Investment Securities (Continued) The amortized cost and estimated fair value by type of investment security at December 31, 2010 are as follows: Held to Maturity Amortized cost Gross unrealized gains Gross unrealized losses Estimated fair value Carrying value Other securities . . . . . . . . . . . . . . . . . . . . . . . . . $2,450 (Dollars in Thousands) $— $— $2,450 Total investment securities . . . . . . . . . . . . . . . . . . $2,450 $— $— $2,450 $2,450 $2,450 U.S. Treasury securities . . . . . . . . . . . . . . Residential mortgage-backed securities . . . Obligations of states and political subdivisions . . . . . . . . . . . . . . . . . . . . . Equity securities . . . . . . . . . . . . . . . . . . . Available for Sale Amortized cost Gross unrealized gains Gross unrealized losses Estimated fair value Carrying value(1) (Dollars in Thousands) $ 1,327 4,876,573 $ — $ — $ 77,741 (29,846) 1,327 4,924,468 $ 1,327 4,924,468 150,122 13,825 636 864 (4,761) (24) 145,997 14,665 145,997 14,665 Total investment securities . . . . . . . . . . . . $5,041,847 $79,241 $(34,631) $5,086,457 $5,086,457 (1) Included in the carrying value of residential mortgage-backed securities are $2,326,378 of mortgage- backed securities issued by Ginnie Mae, $2,552,062 of mortgage-backed securities issued by Fannie Mae and Freddie Mac and $46,028 issued by non-government entities Residential mortgage-backed securities are securities issued by Freddie Mac, Fannie Mae, Ginnie Mae or non-government entities. Investments in residential mortgage-backed securities issued by Ginnie Mae are fully guaranteed by the U.S. Government. Investments in mortgage-backed securities issued by Freddie Mac and Fannie Mae are not fully guaranteed by the U.S. Government, however, the Company believes that the quality of the bonds is similar to other AAA rated bonds with limited credit risk, particularly given the placement of Fannie Mae and Freddie Mac into conservatorship by the federal government in early September 2008. 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 $2,624,520,000 and $2,717,496,000, respectively, at December 31, 2011. Proceeds from the sale and call of securities available-for-sale were $1,102,849,000, $1,149,021,000 and $579,099,000 during 2011, 2010 and 2009, respectively, which amounts included $1,095,815,000, $1,133,610,000 and $544,305,000 of mortgage-backed securities. Gross gains of $17,318,000, $33,223,000 and $11,980,000 and gross losses of $33,000, $14,000 and $24,000 were realized on the sales in 2011, 2010 and 2009, respectively. 50 INTERNATIONAL BANCSHARES CORPORATION AND SUBSIDIARIES Notes to Consolidated Financial Statements (Continued) (2) Investment Securities (Continued) 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, 2011 were as follows: Less than 12 months 12 months or more Total Fair Value Unrealized Losses Fair Value Unrealized Losses Fair Value Unrealized Losses (Dollars in Thousands) Available for sale: Residential mortgage-backed securities . . . . . . . . . . . . . . . . . $ — $ — $39,605 $(10,680) $39,605 $(10,680) Obligations of states and political subdivisions . . . . . . . . . . . . . . . Equity securities . . . . . . . . . . . . . 9,531 3,485 (315) (16) 3,398 42 (896) (33) 12,929 3,527 (1,211) (49) $13,016 $(331) $43,045 $(11,609) $56,061 $(11,940) 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 loss position, at December 31, 2010 were as follows: Less than 12 months 12 months or more Total Fair Value Unrealized Losses Fair Value Unrealized Losses Fair Value Unrealized Losses (Dollars in Thousands) Available for sale: Residential mortgage-backed securities . . . . . . . . . . . . . . $1,166,720 $(19,192) $46,028 $(10,654) $1,212,748 $(29,846) Obligations of states and political subdivisions . . . . . . Equity securities . . . . . . . . . . 97,701 4,988 (4,666) (12) 355 63 (95) (12) 98,056 5,051 (4,761) (24) $1,269,409 $(23,870) $46,446 $(10,761) $1,315,855 $(34,631) The unrealized losses on investments in residential mortgage-backed securities are primarily caused by changes in market interest rates. Residential mortgage-backed securities are primarily securities issued by Freddie Mac, Fannie Mae and Ginnie Mae. The contractual cash obligations of the securities issued by Ginnie Mae are fully guaranteed by the U.S. Government. The contractual cash obligations of the securities issued by Freddie Mac and Fannie Mae are not fully guaranteed by the U.S. Government; however, the Company believes that the quality of the bonds is similar to other AAA rated bonds with limited credit risk, particularly given the placement of Fannie Mae and Freddie Mac into conservatorship by the federal government in early September 2008. The decrease in fair value on residential mortgage- backed securities issued by Freddie Mac, Fannie Mae and Ginnie Mae is due to market interest rates. The Company has no intent to sell and will more than likely not be required to sell before a market price recovery or maturity of the securities; therefore, it is the conclusion of the Company that the investments in residential mortgage-backed securities issued by Freddie Mac, Fannie Mae and Ginnie Mae are not considered other-than-temporarily impaired. In addition, the Company has a small investment in non-agency residential mortgage-backed securities that have strong credit backgrounds and include 51 INTERNATIONAL BANCSHARES CORPORATION AND SUBSIDIARIES Notes to Consolidated Financial Statements (Continued) (2) Investment Securities (Continued) additional credit enhancements to protect the Company from losses arising from high foreclosure rates. These securities have additional market volatility beyond economically induced interest rate events. It is the conclusion of the Company that the investments in non-agency residential mortgage-backed securities are other-than-temporarily impaired due to both credit and other than credit issues. An impairment charge of $977,000 ($635,000, after tax), was recorded in 2011 on the non-agency residential mortgage backed securities. An impairment charge of $8,416,000 ($5,470,000, after tax), was recorded in 2010 on the non-agency residential mortgage backed securities. The impairment charges represent the credit related impairment on the securities. 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 no intent to sell and will more than likely not be required to sell before 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 following impairment charges on available-for-sale investments recognized in earnings for the twelve months ended December 31, 2011(in Thousands): table presents a reconciliation of credit-related Balance at December 31, 2010 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Impairment charges recognized during period . . . . . . . . . . . . . . . . . . . . . $8,416 977 Balance at December 31, 2011 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $9,393 The following impairment charges on available-for-sale investments recognized in earnings for the twelve months ended December 31, 2010 (in Thousands): table presents a reconciliation of credit-related Balance at December 31, 2009 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Impairment charges recognized during period . . . . . . . . . . . . . . . . . . . . . $ — 8,416 Balance at December 31, 2010 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $8,416 52 INTERNATIONAL BANCSHARES CORPORATION AND SUBSIDIARIES Notes to Consolidated Financial Statements (Continued) (3) Loans A summary of net loans, by loan type at December 31, 2011 and 2010 is as follows: December 31, 2011 2010 (Dollars in thousands) Commercial, financial and agricultural . . . . . . . . . . . . . . . . Real estate—mortgage . . . . . . . . . . . . . . . . . . . . . . . . . . . Real estate—construction . . . . . . . . . . . . . . . . . . . . . . . . . Consumer . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Foreign . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $2,560,102 895,870 1,273,389 94,109 230,005 $2,615,878 948,982 1,473,471 126,047 245,625 Total loans . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $5,053,475 $5,410,003 (4) Allowance for Probable Loan Losses The allowance for probable loan losses primarily 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 probable loan losses. Loan losses or recoveries are charged or credited directly to the allowances. The allowance for probable 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 for probable loan losses is derived from the following elements: (i) allowances established on specific loans, which are based on a review of the individual characteristics of each loan, including the customer’s ability to repay the loan, the underlying collateral values, and the industry the customer operates in, (ii) allowances based on actual historical loss experience for similar types of loans in the Company’s loan portfolio, and (iii) allowances based on general economic conditions, changes in the mix of loans, company resources, border risk and credit quality indicators, among other things. All segments of the loan portfolio continue to be impacted by the prolonged economic downturn. Loans secured by real estate could be impacted negatively by the continued economic environment and resulting decrease in collateral values. Consumer loans may be impacted by continued and prolonged unemployment rates. The Company’s management continually reviews the allowance for loan losses of the bank subsidiaries using the amounts determined from the allowances established on specific loans, the allowance established on quantitative historical loss percentages, and the allowance based on qualitative data to establish an appropriate amount to maintain in the Company’s allowance for loan loss. Should any of the factors considered by management in evaluating the adequacy of the allowance for probable loan losses change, the Company’s estimate of probable loan losses could also change, which could affect the level of future provisions for probable loan losses. While the calculation of the allowance for probable loan losses utilizes management’s best judgment and all information available, the adequacy of the allowance is dependent on a variety of factors beyond the Company’s control, including, among other things, the performance of the entire loan portfolio, the economy, changes in interest rates and the view of regulatory authorities towards loan classifications. 53 INTERNATIONAL BANCSHARES CORPORATION AND SUBSIDIARIES Notes to Consolidated Financial Statements (Continued) (4) Allowance for Probable Loan Losses (Continued) 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 problems 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 Company’s 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, an analysis of 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. While the Texas and Oklahoma economies are performing better and appear to be recovering faster than other parts of the country, Texas and Oklahoma are not completely immune to the problems associated with the U.S. economy. Thus, the risk of loss associated with all segments of the loan portfolio in these markets continues to be impacted by the prolonged economic downturn. The downturn in the economy and other risk factors are minimized by the underwriting standards of the bank subsidiaries. The general underwriting standards encompass the following principles: (i) the financial strength of the borrower including strong earnings, a high net worth, significant liquidity and an acceptable debt to worth ratio, (ii) managerial and business competence, (iii) the ability to repay, (iv) for a new business, projected cash flows, (v) loan to value, (vi) in the case of a secondary guarantor, a guarantor financial statement, and (vii) financial and/or other character references. Although the underwriting standards reduce the risk of loss, unique risk factors exist in each type of loan that the bank subsidiaries invest. Commercial and industrial loans are mostly secured by the collateral pledged by the borrower that are directly related to the business activities of the company such as accounts receivable and inventory. The ability of the borrower to collect accounts receivable, and to turn inventory into sales are risk factors in the repayment of the loan. Construction and land development loans can carry risk of repayment when projects incur cost overruns, have an increase in the price of building materials, encounter zoning and environmental issues, or encounter other factors that may affect the completion of a project on time and on budget. Additionally, repayment risk may be negatively impacted when the market experiences a deterioration in the value of real estate. Risks specifically related to 1-4 family development loans also include the practice by the mortgage industry of more restrictive underwriting standards, which inhibits the buyer from obtaining long term financing, and excessive housing and lot inventory in the market. Commercial real estate loans demonstrate a risk of repayment when market values deteriorate, the business experiences turnover in key management, the business has an inability to attract or keep occupancy levels stable, or when the market experiences an exit of a specific business industry that is significant to the local economy, such as a manufacturing plant. First and second lien residential 1-4 family mortgage and consumer loan repayments may be affected by unemployment or underemployment and deteriorating market values of real estate. 54 INTERNATIONAL BANCSHARES CORPORATION AND SUBSIDIARIES Notes to Consolidated Financial Statements (Continued) (4) Allowance for Probable Loan Losses (Continued) A summary of the transactions in the allowance for probable loan losses by loan class is as follows: December 31, 2011 Domestic Commercial real estate: other Commercial construction & real estate: Commercial Commercial land development farmland & real estate: Residential: Residential: commercial multifamily first lien junior lien Consumer Foreign Total Balance at December 31, . . . Losses charge to allowance . . Recoveries credited to allowance . . . . . . . $ 22,046 (16,130) 4,126 Net losses charged to allowance . (12,004) $26,695 (1,467) 171 (1,296) (Dollars in Thousands) 53 — — $10,059 (805) 28 $ $16,340 (1,955) 296 $ 2,611 (1,304) 300 $ 6,241 (1,067) 211 $ 437 $ 84,482 (22,899) 5,291 (171) 159 (1,659) — (777) (1,004) (856) (12) (17,608) Provision (credit) charged to . operations . . . . . . . . Balance at December 31, . . . . . . . . . . . . 16,575 (5,459) 9,546 950 (4,720) 3,153 (3,661) 934 17,318 $ 26,617 $19,940 $24,227 $1,003 $ 4,562 $ 4,760 $ 1,724 $1,359 $ 84,192 Balance at December 31, . . . . . . . . . . . . . . . . . . . . . . . . . . . . Losses charged to allowance . . . . . . . . . . . . . . . . . . . . . . . . Recoveries credited to allowance . . . . . . . . . . . . . . . . . . . . . Net losses charged to allowance . . . . . . . . . . . . . . . . . . . . . Provision charged to operations . . . . . . . . . . . . . . . . . . . . . . 2010 2009 (Dollars in Thousands) $ 73,461 $ 95,393 (35,240) 1,517 (33,723) 22,812 (38,539) 1,638 (36,901) 58,833 Balance at December 31, . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 84,482 $ 95,393 The allowance for probable loan losses is a reserve established through a provision for probable loan losses charged to expense, which represents management’s best estimate of probable loan losses when evaluating loans (i) individually or (ii) collectively. The Company’s provision for probable loan losses decreased for the year ended December 31, 2011 mainly due to a decrease in the Company’s charge-off experience and a decrease in the loan portfolio. The Company’s provision for probable loan losses decreased for the year ended December 31, 2010 mainly due to the decrease in the required reserves for impaired loans analyzed on an individual basis. The impaired loans have been measured based on the fair value of collateral. The majority of these loans show a fair value greater than the carrying value. The Company’s provision for probable loan losses increased for the year ended December 31, 2009, prompted by the analysis of management regarding the weakness in the overall economy and the impact of that weakness on the Company’s loan portfolio and the related allowance for probable loan losses. 55 INTERNATIONAL BANCSHARES CORPORATION AND SUBSIDIARIES Notes to Consolidated Financial Statements (Continued) (4) Allowance for Probable Loan Losses (Continued) The table below provides additional information on the balance of loans individually or collectively evaluated for impairment and their related allowance, by loan class: Domestic Commercial . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Commercial real estate: other construction & land development . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Commercial real estate: farmland & commercial . . . . . Commercial real estate: multifamily . . . . . . . . . . . . . . . Residential: first lien . . . . . . . . . . . . . . . . . . . . . . . . . Residential: junior lien . . . . . . . . . . . . . . . . . . . . . . . . Consumer . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Foreign . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . December 31, 2011 (Dollars in Thousands) Loans individually evaluated for impairment Loans collectively evaluated for impairment Recorded Investment Allowance Recorded Investment Allowance $ 27,603 $14,402 $ 746,213 $12,215 60,428 42,231 411 2,290 1,962 1,334 46 3,073 9,754 — 23 — — — 1,212,961 1,622,456 121,188 493,432 398,186 92,775 229,959 16,867 14,473 1,003 4,539 4,760 1,724 1,359 Total . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $136,305 $27,252 $4,917,170 $56,940 Domestic Commercial . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Commercial real estate: other construction & land development . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Commercial real estate: farmland & commercial Commercial real estate: multifamily . . . . . . . . . . . . . . . Residential: first lien . . . . . . . . . . . . . . . . . . . . . . . . . Residential: junior lien . . . . . . . . . . . . . . . . . . . . . . . . Consumer . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Foreign . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . December 31, 2010 (Dollars in Thousands) Loans individually evaluated for impairment Loans collectively evaluated for impairment Recorded Investment Allowance Recorded Investment Allowance $ 23,426 $ 8,138 $ 807,098 $13,908 77,207 21,844 473 2,015 199 29 7 592 3,441 — — — — — 1,396,264 1,666,719 96,318 531,440 415,328 126,018 245,618 26,103 12,899 53 10,059 2,611 6,241 437 Total . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $125,200 $12,171 $5,284,803 $72,311 Loans accounted for on a non-accrual basis at December 31, 2011, 2010 and 2009 amounted to $118,505,000, $108,030,000 and $68,338,000, respectively. The effect of such non-accrual loans reduced interest income by $4,114,000, $3,750,000 and $4,011,000 for the years ended December 31, 2011, 2010 and 2009, 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. Accruing loans contractually past 56 INTERNATIONAL BANCSHARES CORPORATION AND SUBSIDIARIES Notes to Consolidated Financial Statements (Continued) (4) Allowance for Probable Loan Losses (Continued) due 90 days or more as to principal or interest payments at December 31, 2011, 2010 and 2009 amounted to $14,288,000, $19,848,000 and $12,089,000, respectively. The table below provides additional information on loans accounted for on a non-accrual basis by loan class: Domestic Commercial . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Commercial real estate: other construction & land development . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Commercial real estate: farmland & commercial . . . . . . . . . Commercial real estate: multifamily . . . . . . . . . . . . . . . . . . Residential: first lien . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Residential: junior lien . . . . . . . . . . . . . . . . . . . . . . . . . . . . Consumer . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Foreign . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . December 31, 2011 2010 (Dollars in Thousands) $ 26,819 $ 22,614 54,336 34,910 411 1,848 135 46 — 77,207 5,486 473 2,015 199 29 7 Total non-accrual loans . . . . . . . . . . . . . . . . . . . . . . . . . . $118,505 $108,030 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. 57 INTERNATIONAL BANCSHARES CORPORATION AND SUBSIDIARIES Notes to Consolidated Financial Statements (Continued) (4) Allowance for Probable Loan Losses (Continued) The following tables detail key information regarding the Company’s impaired loans by loan class for the year ended December 31, 2011: Loans with Related Allowance Domestic Commercial . . . . . . . . . . . . . . . . . . . . . . . . . Commercial real estate: other construction & land development . . . . . . . . . . . . . . . . . . . Commercial real estate: farmland & December 31, 2011 Recorded Investment Unpaid Principal Balance Related Allowance Average Recorded Investment Interest Recognized (Dollars in Thousands) $24,108 $24,108 $14,402 $24,145 $ 41 34,417 34,432 3,073 34,709 — commercial . . . . . . . . . . . . . . . . . . . . . . . . Residential: first lien . . . . . . . . . . . . . . . . . . 28,636 208 28,671 208 9,754 23 28,883 214 Total impaired loans with related allowance $87,369 $87,419 $27,252 $87,951 817 — $858 Recorded Investment December 31, 2011 Unpaid Principal Balance Average Recorded Investment (Dollars in Thousands) Interest Recognized Loans with No Related Allowance Domestic Commercial . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Commercial real estate: other construction & land development . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Commercial real estate: farmland & commercial Commercial real estate: multifamily . . . . . . . . . . . . . . . Residential: first lien . . . . . . . . . . . . . . . . . . . . . . . . . . Residential: junior lien . . . . . . . . . . . . . . . . . . . . . . . . . Consumer . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Foreign . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 3,495 $ 3,932 $ 3,942 $ 20 26,011 13,595 411 2,082 1,962 1,334 46 26,112 15,394 411 2,220 1,970 1,338 46 27,722 16,271 439 2,230 1,980 1,729 46 128 102 — 27 118 — 4 Total impaired loans with no related allowance . . . . . . $48,936 $51,423 $54,359 $399 58 INTERNATIONAL BANCSHARES CORPORATION AND SUBSIDIARIES Notes to Consolidated Financial Statements (Continued) (4) Allowance for Probable Loan Losses (Continued) The following tables detail key information regarding the Company’s impaired loans by loan class for the year ended December 31, 2010: Loans with Related Allowance Domestic Commercial . . . . . . . . . . . . . . . . . . . . . . . . . Commercial real estate: other construction & land development . . . . . . . . . . . . . . . . . . . Commercial real estate: farmland & December 31, 2010 Recorded Investment Unpaid Principal Balance Related Allowance Average Recorded Investment Interest Recognized (Dollars in Thousands) $23,062 $23,071 $ 8,138 $23,096 $ 42 10,603 10,645 592 10,622 — commercial . . . . . . . . . . . . . . . . . . . . . . . . 17,841 17,878 3,441 18,475 Total impaired loans with related allowance $51,506 $51,594 $12,171 $52,193 860 $902 Recorded Investment December 31, 2010 Unpaid Principal Balance Average Recorded Investment (Dollars in Thousands) Interest Recognized Loans with No Related Allowance Domestic Commercial . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Commercial real estate: other construction & land development . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Commercial real estate: farmland & commercial . . . . . . Commercial real estate: multifamily . . . . . . . . . . . . . . . Residential: first lien . . . . . . . . . . . . . . . . . . . . . . . . . . Residential: junior lien . . . . . . . . . . . . . . . . . . . . . . . . . Consumer . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Foreign . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 364 $ 980 $ 993 $30 66,604 4,003 473 2,015 199 29 7 66,755 5,606 473 2,143 226 46 7 68,608 5,594 500 2,297 228 49 19 2 — — — — — — Total impaired loans with no related allowance . . . . . . $73,694 $76,236 $78,288 $32 59 INTERNATIONAL BANCSHARES CORPORATION AND SUBSIDIARIES Notes to Consolidated Financial Statements (Continued) (4) Allowance for Probable Loan Losses (Continued) The following table details key information regarding the Company’s impaired loans for the year ended December 31, 2009: 2009 (Dollars in Thousands) 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 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $106,780 11,494 Total impaired loans . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $118,274 Allowance allocated to impaired loans . . . . . . . . . . . . . . . . . . . . . . $ 30,555 The average recorded investment in impaired loans was $142,310,000, $130,481,000, and $149,528,000 for the years ended December 31, 2011, 2010 and 2009, respectively. Interest income recorded on impaired loans was $547,000 for the year ended December 31, 2009. A portion of the impaired loans have adequate collateral and credit enhancements not requiring a related allowance for loan loss. The level of impaired loans is reflective of the economic weakness that has been created by the financial crisis and the subsequent economic downturn. Management is confident the Company’s loss exposure regarding these credits will be significantly reduced due to the Company’s long-standing practices that emphasize secured lending with strong collateral positions and guarantor support. Management is likewise confident the reserve for probable loan losses is adequate. The Company has no direct exposure to sub-prime loans in its loan portfolio, but the sub-prime crisis has affected the credit markets on a national level, and as a result, the Company has experienced an increasing amount of impaired loans; however, management’s decision to place loans in this category does not necessarily mean that the Company will experience significant losses from these loans or significant increases in impaired loans from these levels. 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. In the current environment, troubled loan management can be protracted because of the legal and process problems that delay the collection of an otherwise collectable loan. Additionally, management believes that the collateral related to these impaired loans and/or the secondary support from guarantors mitigates the potential for losses from impaired loans. It is also important to note that even though the economic conditions in Texas and Oklahoma are weakened, we believe these markets are improving and better positioned to recover than many other areas of the country. Loans accounted for as ‘‘troubled debt restructuring’’ were not significant. 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. 60 INTERNATIONAL BANCSHARES CORPORATION AND SUBSIDIARIES Notes to Consolidated Financial Statements (Continued) (4) Allowance for Probable Loan Losses (Continued) The following table presents information regarding the aging of past due loans by loan class: December 31, 2011 90 Days or greater 30 - 59 Days 60 - 89 Days 90 Days or & still accruing Greater Total Past due Current Total Portfolio (Dollars in Thousands) Domestic Commercial Commercial real estate: other . . . . . . . . . . . . . . $ 5,180 $ 1,369 $ 1,842 $ 1,490 $ 8,391 $ 765,425 $ 773,816 construction & land development . . . . . . . . . . . . Commercial real estate: 23,426 4,360 49,887 979 77,673 1,195,716 1,273,389 farmland & commercial . . . . 9,467 10,269 7,879 1,231 27,615 1,637,072 1,664,687 Commercial real estate: multifamily . . . . . . . . . . . . . Residential: first lien . . . . . . . . Residential: junior lien . . . . . . . . . . . . . . . . . . . . . Consumer Foreign . . . . . . . . . . . . . . . . . . . 450 6,207 1,433 1,643 666 — 2,757 378 408 53 411 10,295 368 912 20 — 9,382 320 866 20 861 19,259 2,179 2,963 739 120,738 476,463 397,969 91,146 229,266 121,599 495,722 400,148 94,109 230,005 Total past due loans . . . . . . . $48,472 $19,594 $71,614 $14,288 $139,680 $4,913,795 $5,053,475 December 31, 2010 90 Days or greater 30 - 59 Days 60 - 89 90 Days or & still accruing Greater Days Total Past due Current Total Portfolio (Dollars in Thousands) Domestic Commercial . . . . . . . . . . . . . . . $ 3,734 $ 861 $23,239 $ 1,029 $ 27,834 $ 802,690 $ 830,524 Commercial real estate: other construction & land development . . . . . . . . . . . . . Commercial real estate: 2,685 2,896 50,618 11,507 56,199 1,417,272 1,473,471 farmland & commercial . . . . . 3,077 817 6,600 1,585 10,494 1,678,069 1,688,563 Commercial real estate: multifamily . . . . . . . . . . . . . . Residential: first lien . . . . . . . . . Residential: junior lien . . . . . . . Consumer . . . . . . . . . . . . . . . . Foreign . . . . . . . . . . . . . . . . . . . . 73 4,884 703 1,518 196 185 3,436 272 587 380 473 5,136 457 1,505 501 — 3,472 277 1,477 501 731 13,456 1,432 3,610 1,077 96,060 519,999 414,095 122,437 244,548 96,791 533,455 415,527 126,047 245,625 Total past due loans . . . . . . . $16,870 $9,434 $88,529 $19,848 $114,833 $5,295,170 $5,410,003 61 INTERNATIONAL BANCSHARES CORPORATION AND SUBSIDIARIES Notes to Consolidated Financial Statements (Continued) (4) Allowance for Probable Loan Losses (Continued) The Company’s internal classified report is segregated into the following categories: (i) ‘‘Special Review Credits,’’ (ii) ‘‘Watch List—Pass Credits,’’ or (iii) ‘‘Watch List—Substandard Credits.’’ The loans placed in the ‘‘Special Review Credits’’ category reflect the Company’s opinion that the loans reflect potential weakness which require monitoring on a more frequent basis. The ‘‘Special Review Credits’’ 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—Pass Credits’’ category reflect the Company’s opinion that the credit contains weaknesses which represent a greater degree of risk, which warrant ‘‘extra attention.’’ The ‘‘Watch List—Pass Credits’’ 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—Substandard Credits’’ classification are considered to be potentially inadequately protected by the current sound worth and debt service capacity of the borrower or of any pledged collateral. These credit obligations, even if apparently protected by collateral value, have shown defined weaknesses related to adverse financial, managerial, economic, market or political conditions which may jeopardize repayment of principal and interest. Furthermore, there is the possibility that some future loss could be sustained by the bank if such weaknesses are not corrected. For loans that are classified as impaired, management evaluates these credits under Statement of Financial Accounting Standards No. 114, ‘‘Accounting by Creditors for Impairment of a Loan,’’ now included as part of ASC 310-10, ‘‘Receivables,’’ criteria and, if deemed necessary, a specific reserve is allocated to the credit. The specific reserve allocated under ASC 310-10, 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 as impaired under ASC 310-10 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 ASC 310-10 if such loan is not collateral dependent. The allowance based on historical loss experience on the Company’s remaining loan portfolio, which includes the ‘‘Special Review Credits,’’ ‘‘Watch List—Pass Credits,’’ and ‘‘Watch List—Substandard 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 ASC 450-20. 62 INTERNATIONAL BANCSHARES CORPORATION AND SUBSIDIARIES Notes to Consolidated Financial Statements (Continued) (4) Allowance for Probable Loan Losses (Continued) A summary of the loan portfolio by credit quality indicator by loan class is as follows: December 31, 2011 Pass Special Review Watch Watch Watch List—Pass List—Substandard List—Impaired (Dollars in Thousands) Domestic Commercial . . . . . . . . . . . . . . . . . . . $ 655,154 $ Commercial real estate: other 5,279 $ 6,361 $ 79,419 $ 27,603 construction & land development . . 1,058,843 76,722 11,083 66,313 Commercial real estate: farmland & commercial . . . . . . . . . . . . . . . . . . Commercial real estate: multifamily . . Residential: first lien . . . . . . . . . . . . Residential: junior lien . . . . . . . . . . . Consumer . . . . . . . . . . . . . . . . . . . . Foreign . . . . . . . . . . . . . . . . . . . . . . . . 1,449,822 121,188 490,924 397,861 92,714 229,898 83,581 — 132 — — — 40,510 — 974 319 41 61 48,543 — 1,402 6 20 — 60,428 42,231 411 2,290 1,962 1,334 46 Total . . . . . . . . . . . . . . . . . . . . . . $4,496,404 $165,714 $59,349 $195,703 $136,305 December 31, 2010 Pass Special Review Watch Watch Watch List—Pass List—Substandard List—Impaired (Dollars in Thousands) Domestic Commercial . . . . . . . . . . . . . . . . . . . $ 741,006 $ 14,015 Commercial real estate: other $ 7,187 $ 44,890 $ 23,426 construction & land development . . 1,100,430 117,058 53,770 125,006 Commercial real estate: farmland & commercial . . . . . . . . . . . . . . . . . . Commercial real estate: multifamily . . Residential: first lien . . . . . . . . . . . . Residential: junior lien . . . . . . . . . . . Consumer . . . . . . . . . . . . . . . . . . . . Foreign . . . . . . . . . . . . . . . . . . . . . . . . 1,521,243 94,973 526,504 415,021 125,973 234,979 42,353 1,345 2,237 — 3 10,108 29,936 — 1,747 — — — 73,187 — 952 307 42 531 77,207 21,844 473 2,015 199 29 7 Total . . . . . . . . . . . . . . . . . . . . . . $4,760,129 $187,119 $92,640 $244,915 $125,200 63 INTERNATIONAL BANCSHARES CORPORATION AND SUBSIDIARIES Notes to Consolidated Financial Statements (Continued) (5) Bank Premises and Equipment A summary of bank premises and equipment, by asset classification, at December 31, 2011 and 2010 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 2011 2010 (Dollars in Thousands) $ 390,875 266,547 124,694 $ 388,847 268,590 123,988 614 (329,680) 664 (313,139) $ 453,050 $ 468,950 (6) Goodwill and Other Intangible Assets The majority of the Company’s identified intangibles are in the form of amortizable core deposit premium, with the exception of $1,147,000, which represents identified intangibles in the acquisition of the rights to the insurance agency contracts of InsCorp, Inc., acquired in 2008. Information on the Company’s identified intangible assets follows: Carrying Amount Accumulated Amortization Net (Dollars in Thousands) December 31, 2011: Core deposit premium . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Identified intangible (contract rights) . . . . . . . . . . . . . . . . . . . . . . . $58,675 1,742 $47,632 595 $11,043 1,147 Total identified intangibles . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $60,417 $48,227 $12,190 December 31, 2010: Core deposit premium . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Identified intangible (contract rights) . . . . . . . . . . . . . . . . . . . . . . . $58,675 1,568 $42,583 351 $16,092 1,217 Total identified intangibles . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $60,243 $42,934 $17,309 64 INTERNATIONAL BANCSHARES CORPORATION AND SUBSIDIARIES Notes to Consolidated Financial Statements (Continued) (6) Goodwill and Other Intangible Assets (Continued) Amortization expense of intangible assets for the years ended December 31, 2011, 2010 and 2009, was $5,293,000, $5,284,000 and $5,286,000, respectively. Estimated amortization expense for each of the five succeeding fiscal years, and thereafter, is as follows: Fiscal year ending: 2012 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2013 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2014 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2015 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2016 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Thereafter . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Total (in thousands) $ 4,630 4,611 2,368 429 128 24 Total . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $12,190 There were no changes in the carrying amount of goodwill for the years ended December 31, 2011 and 2010. (7) Deposits Deposits as of December 31, 2011 and 2010 and related interest expense for the years ended December 31, 2011, 2010 and 2009 were as follows: 2011 2010 (Dollars in Thousands) Deposits: Demand—non-interest bearing Domestic . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Foreign . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $1,717,286 209,732 $1,459,776 179,300 Total demand non-interest bearing . . . . . . . . . . . . . . . . . 1,927,018 1,639,076 Savings and interest bearing demand Domestic . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Foreign . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2,221,758 485,935 2,058,311 464,531 Total savings and interest bearing demand . . . . . . . . . . . 2,707,693 2,522,842 Time, certificates of deposit $100,000 or more Domestic . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Foreign . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1,022,450 1,244,018 1,054,649 1,242,524 Less than $100,000 Domestic . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Foreign . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 664,111 380,802 741,399 399,068 Total time, certificates of deposit . . . . . . . . . . . . . . . . . . 3,311,381 3,437,640 Total deposits . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $7,946,092 $7,599,558 65 INTERNATIONAL BANCSHARES CORPORATION AND SUBSIDIARIES Notes to Consolidated Financial Statements (Continued) (7) Deposits (Continued) 2011 2010 2009 (Dollars in Thousands) Interest expense: Savings and interest bearing demand Domestic . . . . . . . . . . . . . . . . . . . . . . . . . . . . Foreign . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 6,549 1,234 $ 7,771 1,612 $ 9,267 1,565 Total savings and interest bearing demand . . . . . . . . 7,783 9,383 10,832 Time, certificates of deposit $100,000 or more Domestic . . . . . . . . . . . . . . . . . . . . . . . . . . . . Foreign . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 10,299 11,512 14,839 17,084 18,091 23,315 Less than $100,000 Domestic . . . . . . . . . . . . . . . . . . . . . . . . . . . . Foreign . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 7,468 2,277 Total time, certificates of deposit . . . . . . . . . . . . . . . 31,556 11,416 3,628 46,967 15,600 5,249 62,255 Total interest expense on deposits . . . . . . . . . . . . . . . . $39,339 $56,350 $73,087 Scheduled maturities of time deposits as of December 31, 2011 were as follows (in thousands): 2012 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2013 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2014 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2015 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2016 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Thereafter . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Total (in thousands) $2,947,111 254,344 68,881 39,260 1,363 422 Total . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $3,311,381 Scheduled maturities of time deposits in amounts of $100,000 or more at December 31, 2011, 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 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 871,022 545,993 608,270 241,183 $2,266,468 (8) 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 66 INTERNATIONAL BANCSHARES CORPORATION AND SUBSIDIARIES Notes to Consolidated Financial Statements (Continued) (8) Securities Sold Under Repurchase Agreements (Continued) repurchase agreements were mortgage-backed book entry securities and averaged $1,415,769,000 and $1,479,734,000 during 2011 and 2010, respectively, and the maximum amount outstanding at any month end during 2011 and 2010 was $1,437,480,000 and $1,520,714,000, respectively. Further information related to repurchase agreements at December 31, 2011 and 2010 is set forth in the following table: Collateral Securities Repurchase Borrowing Book Value of Securities Sold Fair Value of Securities Sold Balance of Liability Weighted Average Interest Rate (Dollars in Thousands) December 31, 2011 term: Overnight agreements . . . . . . . . . . . . . . . 1 to 29 days . . . . . . . . . . . . . . . . . . . . . . 30 to 90 days . . . . . . . . . . . . . . . . . . . . . Over 90 days . . . . . . . . . . . . . . . . . . . . . $ 377,620 13,772 45,512 1,236,021 $ 388,304 14,227 48,177 1,285,811 $ 245,026 10,263 30,095 1,063,245 Total . . . . . . . . . . . . . . . . . . . . . . . . . . . $1,672,925 $1,736,519 $1,348,629 December 31, 2010 term: Overnight agreements . . . . . . . . . . . . . . . 1 to 29 days . . . . . . . . . . . . . . . . . . . . . . 30 to 90 days . . . . . . . . . . . . . . . . . . . . . Over 90 days . . . . . . . . . . . . . . . . . . . . . $ 432,252 26,714 44,443 1,243,634 $ 426,112 27,177 45,438 1,279,248 $ 311,333 16,308 30,167 1,075,462 Total . . . . . . . . . . . . . . . . . . . . . . . . . . . $1,747,043 $1,777,975 $1,433,270 .32% 1.13 1.12 3.72 3.02% .60% 1.15 1.69 3.71 2.97% 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. (9) 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 of funding. These borrowings are secured by mortgage-backed investment securities and a portion of the Company’s loan portfolio. 67 INTERNATIONAL BANCSHARES CORPORATION AND SUBSIDIARIES Notes to Consolidated Financial Statements (Continued) (9) Other Borrowed Funds (Continued) Further information regarding the Company’s other borrowed funds at December 31, 2011 and 2010 is set forth in the following table: December 31, 2011 2010 (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 . . . . . . $ 487,500 $1,020,000 .18% .18% $ 733,559 $ 656,365 .19% .19% $1,235,900 $1,307,875 Federal Home Loan Bank advances—long-term(1) Balance at year end . . . . . . . . . . . . . . . . . . . . . . . . . . . Rate on balance outstanding at year end . . . . . . . . . . . . Average daily balance . . . . . . . . . . . . . . . . . . . . . . . . . . Average rate . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Maximum amount outstanding at any month end . . . . . . $ $ $ 6,661 3.51% 6,721 3.51% 6,780 $ $ $ 6,780 3.51% 93 3.51% 6,780 (1) The amortization of the long-term advances is approximately $144 per year for each of the next five years and the final maturity date is January 3, 2028. (10) Junior Subordinated Deferrable Interest Debentures The Company has formed eight statutory business trusts under the laws of the State of Delaware, for the purpose of issuing trust preferred securities. The eight statutory business trusts formed by the Company (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. As of December 31, 2011 and December 31, 2010, the principal amount of debentures outstanding totaled $190,726,000 and $201,117,000, respectively. As a result of the participation in the TARP Capital Purchase Program, the Company was not permitted, without the consent of the Treasury Department, to redeem any of the Debentures. This restriction ceased to exist on December 23, 2011. On March 14, 2011, upon the request of the Company, the Treasury consented to the repurchase by the Company of the $10.4 million in trust preferred securities of Trust I, as well as related costs for a total payment of approximately $11 million, provided that the aggregate amount of the Company’s (i) semi-annual cash dividend, (ii) common stock repurchases and (iii) trust preferred securities redemptions for a given semi-annual period would not exceed the originally permitted semi-annual cash dividend aggregate amount of $.33 per share. One half of the Trust I securities were redeemed on June 8, 2011 and the remaining one half of the Trust I securities were redeemed on July 1, 2011. 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 68 INTERNATIONAL BANCSHARES CORPORATION AND SUBSIDIARIES Notes to Consolidated Financial Statements (Continued) (10) Junior Subordinated Deferrable Interest Debentures (Continued) Default (as defined in the Indentures) has occurred and is continuing, to defer payment of interest on the Debentures for up to twenty consecutive quarterly periods on Trusts VI, VII, VIII, IX, X, XI and XII. 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. At December 31, 2011 and 2010, the total $190,726,000 and $201,117,000, respectively, of the Capital Securities outstanding qualified as Tier 1 capital. The following table illustrates key information about each of the Debentures and their interest rates at December 31, 2011: Junior Subordinated Deferrable Interest Debentures (in thousands) $ 25,774 10,310 25,774 41,238 34,021 32,990 20,619 $190,726 Repricing Frequency Quarterly Quarterly Quarterly Quarterly Fixed Fixed Fixed Trust VI . . . . . Trust VII . . . . . Trust VIII . . . . Trust IX . . . . . Trust X . . . . . . Trust XI . . . . . Trust XII . . . . . Interest Rate Interest Rate Index(1) Maturity Date Optional Redemption Date 3.91% 3.68 3.45 1.99 6.66 6.82 6.85 LIBOR + 3.45 November 2032 May 2012 April 2012 LIBOR + 3.25 April 2033 April 2012 LIBOR + 3.05 October 2033 April 2012 LIBOR + 1.62 October 2036 May 2012 February 2037 Fixed July 2012 July 2037 Fixed September 2012 September 2037 Fixed (1) Trust X, XI and XII accrue interest at a fixed rate for the first five years, then floating at LIBOR + 1.65%, 1.62% and 1.45% thereafter, respectively. 69 INTERNATIONAL BANCSHARES CORPORATION AND SUBSIDIARIES Notes to Consolidated Financial Statements (Continued) (11) 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, 2011, 2010, and 2009 is set forth in the following table: Net Income (Numerator) Shares (Denominator) Per Share Amount (Dollars in Thousands, Except Per Share Amounts) December 31, 2011: Basic EPS Net income available to common shareholders . . . . . . . . . . . . $113,869 67,506,554 $1.69 Potential dilutive common shares . . . . . . . . . . . . . . . . . . . . . . — 62,914 Diluted EPS . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $113,869 67,569,468 $1.69 December 31, 2010: Basic EPS Net income available to common shareholders . . . . . . . . . . . . $116,897 67,921,353 $1.72 Potential dilutive common shares . . . . . . . . . . . . . . . . . . . . . . — 83,088 Diluted EPS . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $116,897 68,004,441 $1.72 December 31, 2009: Basic EPS Net income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $129,758 68,373,732 $1.90 Potential dilutive common shares . . . . . . . . . . . . . . . . . . . . . . — 20,892 Diluted EPS . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $129,758 68,394,624 $1.90 (12) 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 $3,900,000, $4,095,000 and $4,366,000 were charged to income for the years ended December 31, 2011, 2010, and 2009, respectively. (13) 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. 70 INTERNATIONAL BANCSHARES CORPORATION AND SUBSIDIARIES Notes to Consolidated Financial Statements (Continued) (13) International Operations (Continued) A summary of assets attributable to international operations at December 31, 2011 and 2010 are as follows: Loans: 2011 2010 (Dollars in Thousands) Commercial . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Others . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $185,287 44,718 $195,208 50,417 Less allowance for probable loan losses . . . . . . . . . . . . . . . . 230,005 (1,359) 245,625 (437) Net loans . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $228,646 $245,188 Accrued interest receivable . . . . . . . . . . . . . . . . . . . . . . . . . $ 1,064 $ 1,331 At December 31, 2011, the Company had $132,567,000 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 $9,870,000, $11,423,000 and $13,681,000 for the years ended December 31, 2011, 2010 and 2009, respectively. (14) 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: 2011 2010 2009 (Dollars in Thousands) Current U.S. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . State . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Foreign . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $61,279 5,083 15 $70,338 4,129 22 $77,653 3,340 30 Total current taxes . . . . . . . . . . . . . . . . . . . . . . . 66,377 74,489 81,023 Deferred U.S. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . State . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (2,296) (3) (3,394) (138) (8,513) 5,478 Total deferred taxes . . . . . . . . . . . . . . . . . . . . . . (2,299) (3,532) (3,035) Total income taxes . . . . . . . . . . . . . . . . . . . . . . . $64,078 $70,957 $77,988 71 INTERNATIONAL BANCSHARES CORPORATION AND SUBSIDIARIES Notes to Consolidated Financial Statements (Continued) (14) Income Taxes (Continued) Total income tax expense differs from the amount computed by applying the U.S. Federal income tax rate of 35% for 2011, 2010 and 2009 to income before income taxes. The reasons for the differences for the years ended December 31 are as follows: 2011 2010 2009 Computed expected tax expense . . . . . . . . . . . . . . . . . Change in taxes resulting from: (Dollars in Thousands) $70,355 $66,941 $77,293 Tax-exempt interest income . . . . . . . . . . . . . . . . . . . State tax, net of federal income taxes and tax credit . Tax refunds . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Litigation expense . . . . . . . . . . . . . . . . . . . . . . . . . Other investment income . . . . . . . . . . . . . . . . . . . . Other . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (3,682) 3,302 (2,813) 2,594 — (2,143) 5,375 — (3,172) (3,083) 761 600 (1,937) 5,722 — — (3,526) 436 Actual tax expense . . . . . . . . . . . . . . . . . . . . . . . $64,078 $70,957 $77,988 The tax effects of temporary differences that give rise to significant portions of the deferred tax assets and deferred tax liabilities at December 31, 2011 and 2010 are reflected below: 2011 2010 (Dollars in Thousands) Deferred tax assets: Loans receivable, principally due to the allowance for probable loan losses . . . . . . . . . . . . . . . . . . . . . . . . . . . . Other real estate owned . . . . . . . . . . . . . . . . . . . . . . . . . . . Impairment charges on available-for-sale securities . . . . . . . . Accrued expenses . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Other . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 34,035 3,774 3,288 514 5,189 $ 34,086 323 2,946 304 6,065 Total deferred tax assets . . . . . . . . . . . . . . . . . . . . . . . . . . . 46,800 43,724 Deferred tax liabilities: Bank premises and equipment, principally due to differences on depreciation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Net unrealized gains on available for sale investment (23,313) (24,272) securities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Identified intangible assets and goodwill . . . . . . . . . . . . . . . Other . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (47,252) (18,430) (9,439) (15,833) (18,383) (7,750) Total deferred tax liabilities . . . . . . . . . . . . . . . . . . . . . . . . . (98,434) (66,238) Net deferred tax liability . . . . . . . . . . . . . . . . . . . . . . . . . $(51,634) $(22,514) The net deferred tax liability of $51,634,000 at December 31, 2011 and $22,514,000 at December 31, 2010 is included in other liabilities in the consolidated statements of condition. 72 INTERNATIONAL BANCSHARES CORPORATION AND SUBSIDIARIES Notes to Consolidated Financial Statements (Continued) (15) Stock Options On April 1, 2005, the Board of Directors adopted the 2005 International Bancshares Corporation Stock Option Plan (the ‘‘2005 Plan’’). Effective May 19, 2008, the 2005 Plan was amended to increase the number of shares available for stock option grants under the 2005 Plan by 300,000 shares. 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 non-qualified 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, 2011, 14,161 shares were available for future grants under the 2005 Plan. The fair value of each option award granted under the plan is estimated on the date of grant using a Black-Scholes-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 historical exercise behavior. 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. No options were granted for the year ended December 31, 2010. Expected Life (Years) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Dividend yield . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Interest rate . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Volatility . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 6.13 6.13 2.58% 2.99% 1.39% 2.12% 49.21% 41.81% 2011 2009 A summary of option activity under the stock option plans for the twelve months ended December 31, 2011 is as follows: Options outstanding at December 31, 2010 . . . . . . . . . . Plus: Options granted . . . . . . . . . . . . . . . . . . . . . . . . . . Less: Weighted average remaining contractual term (years) Aggregate intrinsic value ($) Number of options 764,982 228,750 Weighted average exercise price $20.65 14.75 Options exercised . . . . . . . . . . . . . . . . . . . . . . . . . . . Options expired . . . . . . . . . . . . . . . . . . . . . . . . . . . . Options forfeited . . . . . . . . . . . . . . . . . . . . . . . . . . . 7,185 81,218 60,608 17.86 19.93 21.80 Options outstanding at December 31, 2011 . . . . . . . . . . 844,721 $19.08 4.54 $2,445,000 Options fully vested and exercisable at December 31, 2011 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 374,352 $24.87 2.33 $ 244,000 73 INTERNATIONAL BANCSHARES CORPORATION AND SUBSIDIARIES Notes to Consolidated Financial Statements (Continued) (15) Stock Options (Continued) Stock-based compensation expense included in the consolidated statements of income for the twelve months ended December 31, 2011, 2010 and 2009 was approximately $387,000, $534,000 and $655,000, respectively. As of December 31, 2011, there was approximately $1,313,000 of total unrecognized stock- based compensation cost related to non-vested options granted under the Company plans that will be recognized over a weighted average period of 1.95 years. A summary of the status of the Company’s non-vested options as of December 31, 2011, and changes during the twelve months ended December 31, 2011, is presented below: Non-vested Options Non-vested options at December 31, 2010 . . . . . . . . . . . . Granted . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Vested . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Forfeited . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Options 377,544 228,750 (113,582) (22,343) Non-vested options at December 31, 2011 . . . . . . . . . . . . 470,369 Weighted average grant-date fair value ($) $4.48 5.51 5.82 4.06 $4.68 Other information pertaining to option activity during the twelve month period ending December 31, 2011, 2010 and 2009 is as follows: Twelve Months Ended December 31, 2011 2010 2009 Weighted average grant date fair value of stock options granted . . . . . . . . . . . . . . . . . . . . . . . . . Total fair value of stock options vested . . . . . . . . . Total intrinsic value of stock options exercised . . . . $ 5.51 $661,000 $ 27,000 — $ $ $551,000 2,000 $ 3.31 $522,000 $581,000 (16) Long Term Restricted Stock Units As a participant in the Troubled Asset Relief Program Capital Purchase Program (the ‘‘CPP’’), the Company must comply with the Interim Final Rule on TARP Standards for Compensation and Corporate Governance issued in June 2009 by the Treasury, which implements the provisions of Section 111 of the Emergency Economic Stabilization Act of 2008, as amended by the American Recovery and Reinvestment Act of 2009. Pursuant to these provisions, the Company is subject to certain compensation restrictions, which include a prohibition on the payment or accrual of any bonuses (including equity-based incentive compensation) to certain officers and employees except for awards of CPP-compliant long-term restricted stock and stock units. On December 18, 2009, the Company’s board of directors (the ‘‘Board’’) adopted the 2009 International Bancshares Corporation Long-Term Restricted Stock Unit Plan (the ‘‘Plan’’) to give the Company additional flexibility in the compensation of its officers, employees, consultants and advisors in compliance with all applicable laws and restrictions. The Plan authorizes the Company to issue Restricted Stock Units (‘‘RSUs’’) to officers, employees, consultants and advisors of the Company and its subsidiaries. The Plan provides that RSUs shall be issued 74 INTERNATIONAL BANCSHARES CORPORATION AND SUBSIDIARIES Notes to Consolidated Financial Statements (Continued) (16) Long Term Restricted Stock Units (Continued) by a committee of the Board appointed by the Board from time to time consisting of at least two (2) members of the Board, each of whom is both a non-employee director and an outside director. On December 18, 2009, the Board adopted resolutions creating the Long-Term Restricted Stock Unit Plan Committee to administer the Plan. RSUs issued under the Plan are not equity and are payable only in cash. The Plan provides for both the issuance of CPP-compliant long-term RSUs as well as RSUs that are not CPP-compliant. Dennis E. Nixon, the Company’s President, Chairman of the Board and a director of the Company, received an award of CPP-compliant RSUs, granted as of December 16, 2011, in the amount of $400,000 for his performance in 2011. Mr. Nixon was also awarded CPP-compliant RSU’s granted as of December 15, 2010 and December 18, 2009 of $400,000 and $250,000 for his performance in 2010 and 2009, respectively. In order to meet the requirements of a CPP-compliant RSU, Mr. Nixon’s RSUs do not exceed one-third of his total annual compensation. (17) Commitments, Contingent Liabilities and Other Matters The Company leases portions of its banking premises and equipment under operating leases. Total rental expense for the years ended December 31, 2011, 2010 and 2009 were $12,200,000, $12,800,000 and $12,600,000, respectively. Future minimum lease payments due under non-cancellable operating leases at December 31, 2011 were as follows: Fiscal year ending: 2012 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2013 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2014 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2015 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2016 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Thereafter . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Total (in thousands) $ 6,670 5,135 3,962 2,800 2,164 2,741 Total . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $23,472 It is expected that certain leases will be renewed, as these leases expire. Aggregate future minimum rentals to be received under non-cancellable sub-leases greater than one year at December 31, 2011 were $47,100,000. Cash of approximately $73,325,000 and $67,745,000 at December 31, 2011 and 2010, respectively, was maintained to satisfy regulatory reserve requirements. 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. 75 INTERNATIONAL BANCSHARES CORPORATION AND SUBSIDIARIES Notes to Consolidated Financial Statements (Continued) (17) Commitments, Contingent Liabilities and Other Matters (Continued) The Company is involved in a dispute related to certain tax matters that were inherited by the Company in its 2004 acquisition of Local Financial Corporation (‘‘LFIN’’). The dispute involves claims by the former controlling shareholders of LFIN related to approximately $14 million of tax refunds received by the Company based on deductions taken in 2003 by LFIN in connection with losses on loans acquired from a failed thrift and a dispute LFIN had with the FDIC regarding the tax benefits related to the failed thrift acquisition which originated in 1988. On March 5, 2010, judgment was entered on a jury verdict rendered against the Company in the U.S. District Court for the Western District of Oklahoma (the ‘‘Court’’). Other than the tax refunds that are in dispute, the Company does not have any other disputes regarding tax refunds received by the Company in connection with the LFIN acquisition. An amended judgment was entered in the case on November 19, 2010, in the amount of approximately $24.25 million and was final and appealable. During December 2010, the Company deposited $24.4 million with the Court in lieu of a supersedeas bond and the Company appealed the judgment. On January 5, 2012, the Court affirmed the judgment rendered on November 19, 2010. The Company has filed a petition for rehearing. In October 2010, the Company was named as a defendant in two purported class-action lawsuits, including one filed in the United States District Court for the Southern District of Texas and one filed in the United States District Court for the Southern District of Florida where similar lawsuits against a number of other banks are currently pending in a multi-district proceeding known as ‘‘In re Checking Account Overdraft Litigation.’’ The Texas lawsuit was dismissed without prejudice on January 12, 2011, when the parties stipulated to arbitrate the matter. The Florida lawsuit was dismissed without prejudice on September 30, 2011, when the parties settled the matter. The amount expensed by the Company in connection with the settlement of the lawsuit was not significant. The settlement amount of the Florida lawsuit resolved all pending cases against the Company connected with overdraft fees or posting order, and no other substantively similar litigation against the Company or any of its subsidiary banks is known to exist. On September 22, 2011, the Company announced the approval of a restructuring plan that resulted in the closing of fifty five (55) in store branches by December 31, 2011. The branch closures were a result of reduced levels of revenue resulting from regulatory changes related to interchange fee income. The branches were closed in order to align IBC’s expenses with the reduced levels of revenue, protecting the Company’s financial strength while preserving IBC’s free products program. This restructuring plan resulted in combined charges to the Company of $5.36 million, before tax, which were recognized in the fourth quarter. The charges are included in ‘‘Depreciation of bank premises and equipment’’ and ‘‘Other’’ in the consolidated statement of income in the Company’s consolidated financial statements. (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 collectability or present other unfavorable features. The aggregate amounts receivable from such related parties amounted to approximately $51,469,000 and $53,052,000 at December 31, 2011 and 2010, respectively. 76 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 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, 2011, 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 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $1,042,237,000 60,895,000 112,343,000 20,224,000 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, 2011, the maximum potential amount of future payments is $112,343,000. At December 31, 2011, the fair value of these guarantees is not significant. Unsecured letters of credit totaled $27,991,000 and $29,160,000 at December 31, 2011 and 2010, respectively. 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. 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. 77 INTERNATIONAL BANCSHARES CORPORATION AND SUBSIDIARIES Notes to Consolidated Financial Statements (Continued) (20) Capital Requirements On December 23, 2008, as part of the Troubled Asset Relief Program Capital Purchase Program (the ‘‘TARP Capital Purchase Program’’) of the United States Department of the Treasury (‘‘Treasury’’), the Company entered into a Letter Agreement incorporating an attached Securities Purchase Agreement- Standard Terms (collectively, the ‘‘Securities Purchase Agreement’’) with the Treasury. The closing of the transactions contemplated in the Securities Purchase Agreement occurred on December 23, 2008. Under the Securities Purchase Agreement, the Company agreed to sell 216,000 shares of the Company’s fixed-rate cumulative perpetual preferred stock, Series A, par value $.01 per share (the ‘‘Senior Preferred Stock’’), having a liquidation preference of $1,000 per share, for a total price of $216,000,000. The Senior Preferred Stock will pay dividends at the rate of 5% per year for the first five years and 9% per year thereafter. The Senior Preferred Stock has no maturity date and ranks senior to the Company’s common stock with respect to the payment of dividends and distributions and amounts payable upon liquidation, dissolution and winding up of the Company. The Senior Preferred Stock generally is non-voting except for class voting rights on matters that would adversely affect the rights of the holders of the Senior Preferred Stock. The Senior Preferred Stock qualifies for inclusion in Tier 1 capital for regulatory capital purposes and the issuance of the Senior Preferred Stock increased the capital ratios of the Company. In conjunction with the purchase of the Senior Preferred Stock, the Treasury received a warrant (the ‘‘Warrant’’) to purchase 1,326,238 shares of the Company’s common stock (the ‘‘Warrant Shares’’) at $24.43 per share, which would represent an aggregate common stock investment in the Company on exercise of the warrant in full equal to 15% of the Senior Preferred Stock investment. The term of the Warrant is ten years. The per share exercise price and the number of shares issuable upon exercise of the Warrant is subject to adjustment pursuant to customary anti-dilutive provisions in certain events, such as stock splits, certain distributions of securities or other assets to holders of the Company’s common stock, and upon certain issuances of the Company’s common stock at or below specified prices relative to the initial per share exercise price of the Warrant. The Warrant is immediately exercisable. Both the Senior Preferred Stock and Warrant are accounted for as components of Tier 1 capital. 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, 2011, the subsidiary banks could pay dividends of up to $585,000,000 to the Corporation 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. 78 INTERNATIONAL BANCSHARES CORPORATION AND SUBSIDIARIES Notes to Consolidated Financial Statements (Continued) (20) Capital Requirements (Continued) Additionally, as a result of the Company’s participation in the TARP Capital Purchase Program, the Company was restricted in the payment of dividends and was not allowed, without Treasury Department’s consent, to declare or pay any dividend on the Company Common Stock other than a regular semi-annual dividend of not more than $.33 per share, as adjusted for any stock dividend or stock split. Also, all accrued and unpaid dividends on the Senior Preferred Stock would have to be fully paid before the Company paid any dividends on its Common Stock. On April 7, 2009, the Company gained consent from the Treasury Department (the ‘‘Treasury Consent’’) to use the regular semi-annual cash dividend funds of not more than $.33 per share, as adjusted for any stock dividend or stock split, to pay quarterly dividends and to repurchase common stock. The restriction ceased to exist on December 23, 2011. A company that participates in the TARP Capital Purchase Program must adopt certain standards for executive compensation under the Emergency Economic Stabilization Act of 2008 (EESA) and the American Recovery and Reinvestment Act of 2009 (the ‘‘ARRA’’) which was signed into law on February 17, 2009. While the U.S. Treasury must promulgate regulations to implement the executive compensation restrictions and standards set forth in the ARRA, the new law significantly expands the executive compensation restrictions previously imposed by the EESA. Such restrictions apply to any entity that has received or will receive funds under the TARP Capital Purchase Program, and shall generally continue to apply for as long as any obligation arising from securities issued under TARP, including preferred stock issued under the Capital Purchase Program, remain outstanding. These ARRA restrictions shall not apply to any TARP Capital Purchase Program recipient during such time when the federal government (i) only holds any warrants to purchase common stock of such recipient or (ii) holds no preferred stock or warrants to purchase common stock of such recipient. As a result of the Company’s participation in the TARP Capital Purchase Program, the restrictions and standards set forth in the ARRA shall be applicable to the Company, subject to regulations promulgated by the U.S. Treasury. Pursuant to the provisions of the ARRA, the Company may be permitted to repay the $216 million it received under the TARP Capital Purchase Program, without regard to certain repayment restrictions in the Securities Purchase Agreement, which restricted the Company’s ability to redeem the Senior Preferred Stock during the first three years following the date of investment. The redemption of the Senior Preferred Stock is subject to the consent of the Federal Reserve Bank of Dallas, which is the Company’s primary Federal banking regulator. To date, the Company has not redeemed any of the Senior Preferred Stock. 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, 2011, that the Company and each of the bank subsidiaries met all capital adequacy requirements to which they are subject. As of December 31, 2011, 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. 79 INTERNATIONAL BANCSHARES CORPORATION AND SUBSIDIARIES Notes to Consolidated Financial Statements (Continued) (20) Capital Requirements (Continued) The Company’s and the bank subsidiaries’ actual capital amounts and ratios for 2011 are presented in the following table: Actual For Capital Adequacy Purposes To Be Well Capitalized Under Prompt Corrective Action Provisions Amount Ratio Amount Ratio Amount Ratio (greater than (greater than (greater than (greater than or equal to) or equal to) or equal to) or equal to) As of December 31, 2011: Total Capital (to Risk Weighted Assets): (Dollars in Thousands) Consolidated . . . . . . . . . . . . . . . . . . . . . . $1,485,833 23.99% $495,483 417,943 International Bank of Commerce, Laredo . . . . 38,423 International Bank of Commerce, Brownsville . 12,750 International Bank of Commerce, Zapata . . . . 13,976 Commerce Bank . . . . . . . . . . . . . . . . . . . . 1,026,163 19.64 123,780 25.77 58,295 36.58 65,697 37.60 Tier 1 Capital (to Risk Weighted Assets): Consolidated . . . . . . . . . . . . . . . . . . . . . . $1,407,989 22.73% $247,742 208,972 International Bank of Commerce, Laredo . . . . 19,212 International Bank of Commerce, Brownsville . 6,375 International Bank of Commerce, Zapata . . . . 6,988 Commerce Bank . . . . . . . . . . . . . . . . . . . . 964,128 18.45 117,707 24.51 56,336 35.35 63,462 36.33 Tier 1 Capital (to Average Assets): Consolidated . . . . . . . . . . . . . . . . . . . . . . $1,407,989 12.74% $441,975 362,263 International Bank of Commerce, Laredo . . . . 34,835 International Bank of Commerce, Brownsville . 18,463 International Bank of Commerce, Zapata . . . . 21,262 Commerce Bank . . . . . . . . . . . . . . . . . . . . 964,128 10.65 117,707 13.52 56,336 12.21 63,462 11.94 8.00% 8.00 8.00 8.00 8.00 4.00% 4.00 4.00 4.00 4.00 4.00% 4.00 4.00 4.00 4.00 N/A $522,429 48,029 15,937 17,470 N/A $313,458 28,817 9,562 10,482 N/A $452,829 43,544 23,079 26,578 N/A 10.00% 10.00 10.00 10.00 N/A 6.00% 6.00 6.00 6.00 N/A 5.00% 5.00 5.00 5.00 80 INTERNATIONAL BANCSHARES CORPORATION AND SUBSIDIARIES Notes to Consolidated Financial Statements (Continued) (20) Capital Requirements (Continued) The Company’s and the bank subsidiaries’ actual capital amounts and ratios for 2010 are also presented in the following table: Actual For Capital Adequacy Purposes To Be Well Capitalized Under Prompt Corrective Action Provisions Amount Ratio Amount Ratio Amount Ratio (greater than (greater than (greater than (greater than or equal to) or equal to) or equal to) or equal to) As of December 31, 2010: Total Capital (to Risk Weighted Assets): (Dollars in Thousands) Consolidated . . . . . . . . . . . . . . . . . . . . . . $1,413,299 20.72% $545,668 467,249 International Bank of Commerce, Laredo . . . . 35,283 International Bank of Commerce, Brownsville . 13,971 International Bank of Commerce, Zapata . . . . 15,692 Commerce Bank . . . . . . . . . . . . . . . . . . . . 957,234 16.39 112,888 25.60 54,072 30.96 62,129 31.67 Tier 1 Capital (to Risk Weighted Assets): Consolidated . . . . . . . . . . . . . . . . . . . . . . $1,327,889 19.47% $272,834 233,624 International Bank of Commerce, Laredo . . . . 17,641 International Bank of Commerce, Brownsville . 6,985 International Bank of Commerce, Zapata . . . . 7,846 Commerce Bank . . . . . . . . . . . . . . . . . . . . 889,247 15.23 107,340 24.34 51,869 29.70 59,752 30.46 Tier 1 Capital (to Average Assets): Consolidated . . . . . . . . . . . . . . . . . . . . . . $1,327,889 11.58% $458,500 382,886 International Bank of Commerce, Laredo . . . . 33,586 International Bank of Commerce, Brownsville . 19,035 International Bank of Commerce, Zapata . . . . 21,095 Commerce Bank . . . . . . . . . . . . . . . . . . . . 889,247 9.29 107,340 12.78 51,869 10.90 59,752 11.33 8.00% 8.00 8.00 8.00 8.00 4.00% 4.00 4.00 4.00 4.00 4.00% 4.00 4.00 4.00 4.00 N/A $584,061 44,103 17,463 19,615 N/A $350,437 26,462 10,478 11,769 N/A $478,608 41,983 23,793 26,369 N/A 10.00% 10.00 10.00 10.00 N/A 6.00% 6.00 6.00 6.00 N/A 5.00% 5.00 5.00 5.00 (21) Fair Value Accounting Standards Codification (‘‘ASC’’) Topic 820, ‘‘Fair Value Measurements and Disclosures’’ (‘‘ASC 820’’) defines fair value, establishes a framework for measuring fair value in generally accepted accounting principles, and expands disclosures about fair value measurements. ASC 820 applies to all financial instruments that are being measured and reported on a fair value basis. ASC 820 defines fair value as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date; it also establishes a fair value hierarchy that prioritizes the inputs used in valuation methodologies into the following three levels: (cid:129) Level 1 Inputs—Unadjusted quoted prices in active markets for identical assets or liabilities. (cid:129) Level 2 Inputs—Observable inputs other than Level 1 prices, such as quoted prices for similar assets or liabilities; quoted prices in markets that are not active; or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the assets or liabilities. 81 INTERNATIONAL BANCSHARES CORPORATION AND SUBSIDIARIES Notes to Consolidated Financial Statements (Continued) (21) Fair Value (Continued) (cid:129) Level 3 Inputs—Unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the assets or liabilities. Level 3 assets and liabilities include financial instruments whose value is determined using pricing models, discounted cash flow methodologies, or other valuation techniques, as well as instruments for which the determination of fair value requires significant management judgment or estimation. A description of the valuation methodologies used for instruments measured at fair value, as well as the general classification of such instruments pursuant to the valuation hierarchy is set forth below. The following table represents assets and liabilities reported on the consolidated statements of condition at their fair value as of December 31, 2011 by level within the fair value measurement hierarchy. Fair Value Measurements at Reporting Date Using (in thousands) Assets/Liabilities Measured at Fair Value December 31, 2011 Quoted Prices in Active Markets for Identical Assets (Level 1) Significant Other Observable Inputs (Level 2) Significant Unobservable Inputs (Level 3) Measured on a recurring basis: Assets: Residential mortgage-backed securities Available-for-sale . . . . . . . . . . . . . . . . . . . . . $4,969,263 $ — $4,929,658 $39,605 States and political subdivisions Available-for-sale . . . . . . . . . . . . . . . . . . . . . 224,761 — 224,761 Other Available-for-sale . . . . . . . . . . . . . . . . . . . . . 19,891 19,891 — — — 82 INTERNATIONAL BANCSHARES CORPORATION AND SUBSIDIARIES Notes to Consolidated Financial Statements (Continued) (21) Fair Value (Continued) The following table represents assets and liabilities reported on the consolidated balance sheets at their fair value as of December 31, 2010 by level within the fair value measurement hierarchy. Fair Value Measurements at Reporting Date Using (in thousands) Assets/Liabilities Measured at Fair Value December 31, 2010 Quoted Prices in Active Markets for Identical Assets (Level 1) Significant Other Observable Inputs (Level 2) Significant Unobservable Inputs (Level 3) Measured on a recurring basis: Assets: U.S. Treasury securities Available-for-sale . . . . . . . . . . . . . . . . . . . . . $ 1,327 $ — $ 1,327 $ — Residential mortgage-backed securities Available-for-sale . . . . . . . . . . . . . . . . . . . . . 4,924,468 States and political subdivisions Available-for-sale . . . . . . . . . . . . . . . . . . . . . 145,997 — — Other 4,878,440 46,028 145,997 — — Available-for-sale . . . . . . . . . . . . . . . . . . . . . 14,665 14,665 — Investment securities available-for-sale are classified within level 2 and level 3 of the valuation hierarchy, with the exception of certain equity investments that are classified within level 1. For investments classified as level 2 in the fair value hierarchy, the Company obtains fair value measurements for investment securities from an independent pricing service. The fair value measurements consider observable data that may include dealer quotes, market spreads, cash flows, the U.S. Treasury yield curve, live trading levels, trade execution data, market consensus prepayment speeds, credit information and the bond’s terms and conditions, among other things. Investment securities classified as level 3 are non-agency mortgage-backed securities. The non-agency mortgage-backed securities held by the Company are traded in in-active markets and markets that have experienced significant decreases in volume and level of activity, as exhibited by few recent transactions, a significant decline or absence of new issuances, price quotations that are not based on comparable securities transactions and wide bid-ask spreads, among other factors. As a result of the inability to use quoted market prices to determine fair value for these securities, the Company determined that fair value, as determined by level 3 inputs in the fair value hierarchy, is more appropriate for financial reporting and more consistent with the expected performance of the investments. For the investments classified within level 3 of the fair value hierarchy, the Company used a discounted cash flow model to determine fair value. Inputs in the model included both historical performance and expected future performance based on information currently available. Assumptions used in the discounted cash flow model for the years ended December 31, 2011 and 2010, included estimates on future principal prepayment rates, default and loss severity rates. The Company estimates that future principal prepayment rates will range from 4 - 5% and used a 13% discount rate. Default rates used in the model were 10 - 11% for the first year and 7% thereafter, and loss severity rates started at 60% for the first year and are decreased by 10% for the following three years, and remains at 20% thereafter. 83 INTERNATIONAL BANCSHARES CORPORATION AND SUBSIDIARIES Notes to Consolidated Financial Statements (Continued) (21) Fair Value (Continued) The following table presents a reconciliation of activity for such mortgage-backed securities on a net basis (Dollars in thousands): Balance at December 31, 2010 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Principal paydowns . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Total unrealized gains (losses) included in: $46,028 (5,420) Other comprehensive income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Net income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (26) (977) Balance at December 31, 2011 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $39,605 Certain assets and liabilities are measured at fair value on a nonrecurring basis. They are not measured at fair value on an ongoing basis but are subject to fair value adjustments in certain circumstances (for example, when there is evidence of impairment). The following table represents assets measured at fair value on a non-recurring basis as of and for the period ended December 31, 2011 by level within the fair value measurement hierarchy: Fair Value Measurements at Reporting Date Using (in thousands) Assets/Liabilities Measured at Fair Value Year ended December 31, 2011 Quoted Prices in Active Markets for Identical Assets (Level 1) Significant Other Observable Inputs (Level 2) Significant Unobservable Inputs (Level 3) Provision During Period Measured on a non-recurring basis: Assets: Impaired loans . . . . . . . . . . . . . . . . . . Other real estate owned . . . . . . . . . . . . $81,723 34,631 $— — $— — $81,723 34,631 $15,457 9,509 The following table represents assets measured at fair value on a non-recurring basis as of and for the year ended December 31, 2010 by level within the fair value measurement hierarchy: Fair Value Measurements at Reporting Date Using (in thousands) Assets/Liabilities Measured at Fair Value Year ended December 31, 2010 Quoted Prices in Active Markets for Identical Assets (Level 1) Significant Other Observable Inputs (Level 2) Significant Unobservable Inputs (Level 3) Provision During Period Measured on a non-recurring basis: Assets: Impaired loans . . . . . . . . . . . . . . . . . . Other real estate owned . . . . . . . . . . . . $24,034 4,304 $— — $— — $24,034 4,304 $(114) 719 84 INTERNATIONAL BANCSHARES CORPORATION AND SUBSIDIARIES Notes to Consolidated Financial Statements (Continued) (21) Fair Value (Continued) The Company’s assets measured at fair value on a non-recurring basis are limited to impaired loans and other real estate owned. Impaired loans are classified within level 3 of the valuation hierarchy. The fair value of impaired loans is derived in accordance with FASB ASC Topic 310, ‘‘Receivables’’. The fair value of impaired loans is based on the fair value of the collateral, as determined through an external appraisal process, discounted based on internal criteria. Impaired loans are primarily comprised of collateral- dependent commercial loans. Impaired loans are remeasured and reported at fair value through a specific valuation allowance allocation of the allowance for probable loan losses based upon the fair value of the underlying collateral. Other real estate owned is comprised of real estate acquired by foreclosure and deeds in lieu of foreclosure. Other real estate owned 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) within level 3 of the fair value hierarchy. 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 probable loan losses, if necessary. The fair value is reviewed periodically and subsequent write downs are made accordingly. Other real estate owned is included in other assets on the consolidated financial statements. For the years ended December 31, 2011 and December 31, 2010, the Company recorded $1,100,000 and $22,790,000 in charges to the allowance for probable loan losses in connection with other real estate owned. For the years ended December 31, 2011 and December 31, 2010, the Company recorded $9,509,000 and $719,000 in write downs in fair value in connection with other real estate owned. The fair value estimates, methods, and assumptions for the Company’s financial instruments at December 31, 2011 and December 31, 2010 are outlined below. Cash and Due From Banks For these short-term instruments, the carrying amount is a reasonable estimate of fair value. Investment securities held-to-maturity The carrying amounts of investments held-to-maturity approximate fair value. 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 from an independent pricing service. The fair value measurements consider observable data that may include dealer quotes, market spreads, cash flows, the U.S. Treasury yield curve, live trading levels, trade execution data, market consensus prepayment speeds, credit information and the bond’s terms and conditions, among other things. See disclosures of fair value of investment securities in Note 2. 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. 85 INTERNATIONAL BANCSHARES CORPORATION AND SUBSIDIARIES Notes to Consolidated Financial Statements (Continued) (21) Fair Value (Continued) 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, 2011, and December 31, 2010, the carrying amount of fixed rate performing loans was $1,273,989,000 and $1,337,827,000, respectively, and the estimated fair value was $1,200,837,000 and $1,226,413,000, respectively. Accrued Interest The carrying amounts of accrued interest approximate 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, 2011 and December 31, 2010. 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, 2011 and December 31, 2010, the carrying amount of time deposits was $3,311,381,000 and $3,437,640,000, respectively, and the estimated fair value was $3,323,680,000 and $3,449,980,000, respectively. Securities Sold Under Repurchase Agreements Securities sold under repurchase agreements include both short and long-term maturities. Due to the contractual terms of the short-term instruments, the carrying amounts approximated fair value at December 31, 2011 and December 31, 2010. The fair value of the long-term instruments is based on established market spreads. At December 31, 2011 and December 31, 2010, the carrying amount of long-term repurchase agreements was $1,000,000,000 and the estimated fair value was $1,161,849,000 and $1,123,774,000, respectively. Junior Subordinated Deferrable Interest Debentures The Company currently has fixed and floating rate junior subordinated deferrable interest debentures outstanding. Due to the contractual terms of the floating rate junior subordinated deferrable interest debentures, the carrying amounts approximated fair value at December 31, 2011 and December 31, 2010. The fair value of the fixed rate junior subordinated deferrable interest debentures is based on established market spreads to the debentures. At December 31, 2011 and December 31, 2010, the carrying amount of fixed rate junior subordinated deferrable interest debentures was $87,630,000 and $139,259,000, respectively, and the estimated fair value was $43,403,000 and $74,103,000, respectively. Other Borrowed Funds The company currently has short and long-term borrowings issued from the Federal Home Loan Bank (‘‘FHLB’’). Due to the contractual terms of the short-term borrowings, the carrying amounts approximated fair value at December 31, 2011 and December 31, 2010. The fair value of the long-term borrowings is based on established market spreads for similar types of borrowings. At December 31, 2011 and 86 INTERNATIONAL BANCSHARES CORPORATION AND SUBSIDIARIES Notes to Consolidated Financial Statements (Continued) (21) Fair Value (Continued) December 31, 2010, the carrying amount of the long-term FHLB borrowings was $6,661,000 and $6,780,000, respectively, and the estimated fair value was $6,998,000 and $6,780,000, respectively. 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. 87 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, 2011 and 2010 (Dollars in Thousands) ASSETS 2011 2010 Cash . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Other investments . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Notes receivable . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Investment in subsidiaries . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Other assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 13,668 70,318 495 1,712,336 1,567 $ 24,414 65,485 250 1,577,038 3,874 Total assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $1,798,384 $1,671,061 LIABILITIES AND SHAREHOLDERS’ EQUITY Liabilities: Junior subordinated deferrable interest debentures . . . . . . . . . . . . . . . . . . Due to IBC Trading . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Other liabilities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 190,726 21 7,472 $ 201,117 21 10,706 Total liabilities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 198,219 211,844 Shareholders’ equity: Preferred shares . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Common shares . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Surplus . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Retained earnings . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Accumulated other comprehensive income . . . . . . . . . . . . . . . . . . . . . . . . 210,548 95,720 162,767 1,302,964 84,959 208,068 95,711 162,276 1,214,743 28,777 1,856,958 1,709,575 Less cost of shares in treasury . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (256,793) (250,358) Total shareholders’ equity . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1,600,165 1,459,217 Total liabilities and shareholders’ equity . . . . . . . . . . . . . . . . . . . . . . . . . $1,798,384 $1,671,061 88 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, 2011, 2010 and 2009 (Dollars in Thousands) 2011 2010 2009 Income: Dividends from subsidiaries . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Interest income on notes receivable . . . . . . . . . . . . . . . . . . . . . . . Interest income on other investments . . . . . . . . . . . . . . . . . . . . . . Other interest income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Other . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 54,800 19 7,517 69 41 $ 51,720 5 10,090 546 (742) $ 45,122 6 8,191 914 7,225 Total income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 62,446 61,619 61,458 Expenses: Interest expense (Debentures) . . . . . . . . . . . . . . . . . . . . . . . . . . . Other . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Total expenses . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Income before federal income taxes and equity in undistributed 11,073 6,543 17,616 12,201 3,408 15,609 12,535 1,751 14,286 net income of subsidiaries . . . . . . . . . . . . . . . . . . . . . . . . . . . 44,830 46,010 47,172 Income tax (benefit) provision . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (3,513) (2,090) 743 Income before equity in undistributed net income of subsidiaries . 48,343 48,100 46,429 Equity in undistributed net income of subsidiaries . . . . . . . . . . . . . . . 78,806 81,923 96,313 Net income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 127,149 130,023 142,742 Preferred stock dividends and discount accretion . . . . . . . . . . . . . . . . 13,280 13,126 12,984 Net income available to common shareholders . . . . . . . . . . . . . . $113,869 $116,897 $129,758 89 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, 2011, 2010 and 2009 (Dollars in Thousands) Operating activities: Net income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Adjustments to reconcile net income to net cash provided by operating activities: Accretion of junior subordinated interest deferrable debentures . Investment securities transactions, net . . . . . . . . . . . . . . . . . . . Accretion of investment securities discounts . . . . . . . . . . . . . . . Stock compensation expense . . . . . . . . . . . . . . . . . . . . . . . . . . (Decrease) increase in other liabilities . . . . . . . . . . . . . . . . . . . Equity in undistributed net income of subsidiaries . . . . . . . . . . . 2011 2010 2009 $127,149 $130,023 $ 142,742 9 2 — 387 (3,234) (78,806) 35 1,135 (232) 534 4,976 (81,923) 35 (6,586) (325) 655 (309) (96,414) Net cash provided by operating activities . . . . . . . . . . . . . . . . . 45,507 54,548 39,798 Investing activities: Contributions to subsidiaries . . . . . . . . . . . . . . . . . . . . . . . . . . . . Principal collected on mortgage-backed securities . . . . . . . . . . . . . Net (increase) decrease in notes receivable . . . . . . . . . . . . . . . . . Increase in other assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Net cash used in investing activities . . . . . . . . . . . . . . . . . . . . . . . — 1,355 (245) (4,193) (3,083) — (138,103) 2,791 250 (9,215) 3,324 (150) (8,311) (5,137) (144,277) Financing activities: Repayment of trust preferred securities . . . . . . . . . . . . . . . . . . . . Proceeds from stock transactions . . . . . . . . . . . . . . . . . . . . . . . . . Payments of cash dividends—common . . . . . . . . . . . . . . . . . . . . . Payments of cash dividends—preferred . . . . . . . . . . . . . . . . . . . . Purchase of treasury stock . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (10,400) 113 (25,648) (10,800) (6,435) — 484 (24,444) (10,800) (6,949) — 2,705 (23,262) (9,660) (9,346) Net cash used in financing activities . . . . . . . . . . . . . . . . . . . . . . . (53,170) (41,709) (39,563) (Decrease) increase in cash . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Cash at beginning of year . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (10,746) 24,414 7,702 16,712 (144,042) 160,754 Cash at end of year . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 13,668 $ 24,414 $ 16,712 90 INTERNATIONAL BANCSHARES CORPORATION AND SUBSIDIARIES Condensed Quarterly Income Statements (Dollars in Thousands, Except Per Share Amounts) (Unaudited) Fourth Quarter Third Quarter Second Quarter First Quarter 2011 Interest income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Interest expense . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $99,519 21,481 $103,623 23,079 $107,844 24,433 $107,138 25,305 Net interest income . . . . . . . . . . . . . . . . . . . . . . . . . . . . Provision (credit) for probable loan losses . . . . . . . . . . . Non-interest income . . . . . . . . . . . . . . . . . . . . . . . . . . . Non-interest expense . . . . . . . . . . . . . . . . . . . . . . . . . . . Income before income taxes . . . . . . . . . . . . . . . . . . . . . 78,038 9,485 54,052 77,077 45,528 80,544 5,670 51,211 80,290 45,795 83,411 (1,917) 47,864 83,942 49,250 81,833 4,080 48,366 75,465 50,654 Income taxes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 15,155 15,164 16,626 17,133 Net income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $30,373 $ 30,631 $ 32,624 $ 33,521 Preferred Stock Dividends . . . . . . . . . . . . . . . . . . . . . . . 3,336 3,324 3,315 3,305 Net income available to common shareholders . . . . . . . . $27,037 $ 27,307 $ 29,309 $ 30,216 Per common share: Basic Net income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ .40 $ .41 $ .43 $ .45 Diluted Net income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ .40 $ .40 $ .43 $ .45 91 INTERNATIONAL BANCSHARES CORPORATION AND SUBSIDIARIES Condensed Quarterly Income Statements (Dollars in Thousands, Except Per Share Amounts) (Unaudited) Fourth Quarter Third Quarter Second Quarter First Quarter 2010 Interest income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Interest expense . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $111,612 26,564 $114,255 27,902 $113,080 29,643 $119,822 29,927 Net interest income . . . . . . . . . . . . . . . . . . . . . . . . . . . Provision for probable loan losses . . . . . . . . . . . . . . . . . Non-interest income . . . . . . . . . . . . . . . . . . . . . . . . . . Non-interest expense . . . . . . . . . . . . . . . . . . . . . . . . . . Income before income taxes . . . . . . . . . . . . . . . . . . . . . 85,048 7,317 50,898 75,305 53,324 86,353 6,837 46,889 79,379 47,026 83,437 1,429 49,400 79,464 51,944 89,895 7,229 71,597 105,577 48,686 Income taxes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 22,904 13,477 17,936 16,640 Net income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 30,420 $ 33,549 $ 34,008 $ 32,046 Preferred Stock Dividends . . . . . . . . . . . . . . . . . . . . . . 3,295 3,286 3,277 3,268 Net income available to common shareholders . . . . . . . $ 27,125 $ 30,263 $ 30,731 $ 28,778 Per common share: Basic Net income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ .40 $ .45 $ .45 $ .42 Diluted Net income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ .40 $ .45 $ .45 $ .42 92 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, 2011, 2010, and 2009: 2011 2010 2009 Average Balance Average Interest Rate/Cost Average Balance Average Interest Rate/Cost Average Balance Average Interest Rate/Cost (Dollars in Thousands) Assets Interest earning assets: Loan, net of unearned discounts: Domestic . . . . . . . . . . . . . . $ 5,022,584 $282,644 9,870 Foreign . . . . . . . . . . . . . . . 239,017 5.63% $ 5,294,744 $302,779 11,423 247,486 4.13 5.72% $ 5,474,162 $322,143 13,626 274,627 4.62 5.88% 4.96 Investment securities: Taxable . . . . . . . . . . . . . . . Tax-exempt . . . . . . . . . . . . . Other . . . . . . . . . . . . . . . . . . 4,731,408 190,933 120,777 113,650 10,091 1,869 Total interest-earning assets . 10,304,719 418,124 2.40 5.29 1.55 4.06 4,095,542 144,199 99,671 135,106 7,240 2,221 9,881,642 458,769 3.30 5.02 2.23 4.64 4,281,148 104,140 69,813 185,931 5,070 607 10,203,890 527,377 4.34 4.87 .87 5.17 Non-interest earning assets: Cash and due from banks . . . . . Bank premises and equipment, net . . . . . . . . . . . . . . . . . . Other assets . . . . . . . . . . . . . . Less allowance for probable loan . . . . . . . . . . . . . . . . losses 319,466 456,840 751,654 (83,919) Total . . . . . . . . . . . . . . . $11,748,760 Liabilities and Shareholders’ Equity Interest bearing liabilities: Savings and interest bearing 285,894 475,460 715,278 (90,900) $11,267,374 285,811 479,281 738,568 (82,194) $11,625,356 demand deposits . . . . . . . . . $ 2,625,958 $ 7,783 .30% $ 2,389,699 $ 9,383 .39% $ 2,135,147 $ 10,832 .51% Time deposits: Domestic . . . . . . . . . . . . . . Foreign . . . . . . . . . . . . . . . 1,730,016 1,646,619 Securities sold under repurchase agreements . . . . . . . . . . . . . . . . . . . . . . . Other borrowings Junior subordinated interest 1,415,775 740,281 deferrable debentures . . . . . . 195,540 Total interest bearing liabilities 8,354,189 17,767 13,789 42,263 1,623 11,073 94,298 1.03 .84 2.99 .22 5.66 1.13 1,804,106 1,673,426 1,479,764 656,459 26,255 20,712 44,216 1,269 201,099 12,201 8,204,553 114,036 1.46 1.24 2.99 .19 6.07 1.39 1,718,744 1,607,431 1,462,017 1,662,489 33,691 28,564 44,723 9,451 201,064 12,535 8,786,892 139,796 1.96 1.78 3.06 .57 6.23 1.59 Non-interest bearing liabilities: Demand Deposits . . . . . . . . . . Other liabilities . . . . . . . . . . . . Shareholders’ equity . . . . . . . . . . 1,817,781 117,295 1,459,495 Total . . . . . . . . . . . . . . . . . $11,748,760 1,639,119 44,431 1,379,271 $11,267,374 1,480,994 70,060 1,287,410 $11,625,356 Net interest income . . . $323,826 $344,733 $387,581 Net yield on interest earning assets . . . . . . . 3.14% 3.49% 3.80% 93 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 IMELDA NAVARRO Treasurer WILLIAM J. CUELLAR Auditor MARISA V. SANTOS Secretary HILDA V. TORRES Assistant Secretary 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. DOUG HOWLAND Investments IMELDA NAVARRO Senior Executive Vice President International Bank of Commerce SIOMA NEIMAN International Entrepreneur PEGGY NEWMAN Investments LARRY NORTON President Norton Stores, Inc. LEONARDO SALINAS Investments ANTONIO R. SANCHEZ, JR. Chairman of the Board Sanchez Oil & Gas Corporation Investments 94